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The Economy is Roaring but Bond Yields Are Lower


Chief Strategist at Interactive Brokers

We saw some rip-roaring economic results this morning.  Rather than belaboring the specifics, I will leave it for you to read the following table:

US Economic Releases, April 15th, 2021

Source: Bloomberg

The 8:30 releases were quite impressive.  We received stronger than expected results from almost all categories of Retail Sales along with better than expected readings of Empire Manufacturing and the Philadelphia Fed.  Weekly Jobless Claims fell far more than expected, which indicates a stronger labor economy.  We can see that economists were already anticipating stronger retail sales – giving the majority of Americans $1400 will do that – but it’s clear that they failed to anticipate how quickly and how robustly the public would spend that money.  The same goes for weekly claims.  They were expected to improve (decline), but not as quickly as anticipated.  Equity futures rallied almost instantaneously, as signs of a stronger economy would be expected to bolster an already buoyant stock market.

Here’s the surprising part: bonds rallied too, quite sharply in fact.  Bond traders are supposed to take a more dour view of economic recovery.  Bond prices reflect expectations for the future path of interest rates and inflation, both of which tend to rise when economic conditions improve.  That is why many traders were surprised to see the following:

1 Day Chart of 10-Year Treasury Notes

Source: Bloomberg

We see the briefest of sell offs at 8:30.  It lasted less than a minute.  Bond traders immediately began buying 10 years in spite of the economic strength.  That is certainly counterintuitive.  It implies that traders were looking at something beyond the releases.  What might that be?

One theory could be that the strong releases could inspire the Fed to taper their monetary accommodation more quickly than expected.  If that were the case, however, we would expect to see rising rates at the short end of the yield curve.  That was not the case.  We currently see 2-year rates lower by 0.006% to 0.155%.  That indicates that the market has virtually no expectations for rate increases in the coming 2 years.  So, I took that hypothesis off the table.

I actually think that today’s bond rally is more the result of technical factors than anything else.  Notice the potential topping pattern in the following chart:

10 Year Yields, 1 Year Chart

Source: Bloomberg

When we consider the fairly relentless move in 10-year rates that has occurred over the past nine months, taking yields from about 0.50% to about 1.75%, it is not surprising that bond traders would engage in a behavior that has well-served their stock trading brethren – buying the dip.  It hasn’t worked well for bond traders during that period, but it seems to be working today.  Why now?

Let’s take a look at bond yields over the longer term.  The following chart shows 10-year yields over the past three years:

10 Year Yields, 3 Year Chart

Source: Bloomberg

When we look at the chart, we see natural resistance in the 1.50-2.00% range.  Bonds were mired in that trading range from the summer of 2019 until the covid crisis of 2020.  It is quite normal to see an uptrend get mired in a level that showed a long period of congestion.  Today’s bond rally may be a case of a stretched trade running into resistance.  Bond prices have been falling (yields rising) for months.  It is entirely possible – if not likely – that bonds became oversold at a level where natural buyers would arise.  If traders were shorting an oversold market, and that market failed to sell off even when economic releases would imply that it should, it would explain the ferocity of today’s rally in bonds.

Could it be that simple?  Sure, and since I tend to believe in Occam’s Razor, I will assert that it is a reasonable explanation of today’s activity.  Equity traders should be pleased with that idea as well.  If we see strong economic results and bonds provide a tailwind, that could bode well for further enthusiasm in the short-term.  To be fair, some of the recent moves in both stocks and bonds could be the result of some unusual seasonal factors – taxes and IRA contributions are not due today (as usual). It is entirely possible that the normal April balance of inflows and outflows has been disrupted, allowing stocks to rise on light volume and bonds to rise in spite of stronger economic data.  But for now, we’ll let the simple solution explain the day.

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