Robert Burgess

Markets Have No Use for Economists These Days

Investors in the US awakened Thursday to a slew of reports from economists upgrading their second-quarter growth forecasts. The new estimates from the likes of JPMorgan Chase & Co. and Amherst Pierpont Securities LLC ranged from 2.75 percent to 4.2 percent. And yet the S&P 500 Index fell and Treasuries rallied. The message? All bets are off in a trade war.

Any optimism investors might have had about the economic outlook was quickly dashed when the Trump administration announced it was imposing tariffs on steel and aluminum imported from the European Union, Canada and Mexico. Bloomberg News called the move the most aggressive trade action yet by the US against its chief allies. Those allies promptly said they would take immediate steps to retaliate. At this point, nobody knows where this will end or what the impact will be on the economy. As such, investors face a pretty big dilemma. They can either stick with higher-risk assets such as equities and hope a full-out trade war is averted, or go into supposed safe assets such as bonds and hope the recent acceleration in inflation proves fleeting despite the red-hot jobs market.

Sticking with stocks isn't a bad idea, relatively speaking. Bank of America on Thursday became the latest big firm to recommend that investors pummeled by turbulence from emerging markets to Europe raise holdings in US stocks, according to Bloomberg News's Lu Wang. Citing heightened political risk in Italy and economic slowdowns from Japan to Europe, strategists including James Barty advised clients to sell shares in the Nikkei 225 Stock Average and buy those in the S&P 500.

The US bond market had an interesting reaction to the tariff news Thursday. On the one hand, longer-term Treasury yields dropped and the difference between two- and 10-year yields shrank to less than 41 basis points for the first time since 2007. Both are classic signs that bond traders expect economic growth to slow. But breakeven rates on five-year Treasuries, or what traders expect the rate of inflation to be over the life of the securities, rose. Put all the moves together and you get what economists call "stagflation," a pernicious development that last struck the US economy in the bad old days of the 1970s. Of course, one day's move doesn't guarantee anything happening in the future, but investors have been quietly debating the issue of stagflation for a few months, given how flat the yield curve has been (an inverted yield curve is notable because it's a reliable precursor to recessions) and forecasts for a recession hitting as soon as late next year.

For whatever reason, May has become a horrible month for the commodities market. The Bloomberg Commodity Index has fallen in May in each of the past eight years. But this May, that losing streak came to an end, with the gauge rising 1.25 percent. Of course, the jump in such energy prices as crude oil and gasoline had a lot to do with that, but the gains were broad-based and included both precious and industrial metals as well as agricultural products. That suggests investors either expect a global trade war to lift prices for raw materials or that they have a lot of confidence in the resiliency of the global economy – or maybe a bit of both.

Bloomberg View