In times of economic uncertainty, it used to pay to check with the bond market to see what signals it was sending. Is the economy headed into a recession? See whether yields are declining. Is inflation about to accelerate? See whether yields are rising. Bonds were the economy’s crystal ball. Now, they may be no better than a Magic 8 Ball in helping decipher the future.
Bond traders seem to be as confused as anyone at the moment. That can be seen in JPMorgan Chase & Co.’s weekly survey of bond market participants released on Wednesday. It showed the percentage of respondents expecting no change in prices and yields for US Treasury securities has surged to 74%, the most since mid-2017. Just 25% expected Treasuries to either rally or decline.
Sure, this may just be a sign that traders are stepping back and reassessing the landscape after the recent rebound in the bond market. But the market is always shifting, and the percentage of traders who describe themselves as “neutral” has rarely approached its current level, having averaged 55% over the past five years. In short, traders have no conviction.
Such an assessment is backed up by a surge in implied volatility as measured by the ICE BofA MOVE Index. It soared to 156.2 as of Tuesday. Not including the early days of the global pandemic, when the world was turned upside down, that’s the highest since the global financial crisis more than a dozen years ago. You don’t get these levels of volatility when traders are relatively confident in the outlook.
There is a lot to be confused about. The data coming out of the economy is as conflicting as ever. Talk of an impending recession has reached a fever pitch, yet data released by the Labor Department on Wednesday showed that job openings remained near record highs in May, with employers having two positions open for every job seeker. Also on Wednesday, the Institute for Supply Management’s index of services — which accounts for two-thirds of the economy — remained well in expansionary territory.
And yet the Federal Reserve Bank of Atlanta’s widely followed GDPNow Index, which aims to track the economy in real time, has dropped to minus 2.08% for the second quarter. If that proves true, it would be the second consecutive quarter of contraction, meeting the technical definition of a recession.
The outlook for inflation is just as muddy. The market for raw materials — a big driver of the recent high rates of inflation — has plummeted the last few weeks. The Bloomberg Commodity Index has tumbled 19% since June 9, with energy, agriculture and industrial metals all experiencing big drops. The tumble is a reason breakeven rates on five-year Treasuries, which are a measure of what traders expect the rate of inflation to be over the life of the securities, have declined to 2.50%, the lowest since September.
And yet my Bloomberg News colleague Rich Miller reports that a broad index of inflation expectations that Federal Reserve Chair Jerome Powell flagged as being partly behind June’s jumbo interest-rate increase is expected to show a big rise when it’s published on July 15, perhaps to a record. The index of common inflation expectations comprises more than 20 indicators that measure the attitudes of consumers, investors and professional forecasters toward future price increases, Miller reported.
Minutes of the Fed’s June policy meeting released Wednesday only added to the confusion. While policy makers agreed that interest rates may need to keep rising for longer to prevent higher inflation from becoming entrenched, even if that slowed the economy, they also noted that some business contacts told them that hiring and retention had improved and that pressure for additional wage increases appeared to be receding. In other words, who knows?
The market for Treasuries has long been considered the most important in the world and the one that drives all others. Bond traders were once deemed so powerful and all-knowing that Tom Wolfe described them as the “Masters of the Universe” in his classic 1987 novel “The Bonfire of the Vanities.” But these are not normal times. As we have witnessed time and again, the unprecedented fiscal and monetary policies of the last two years have made fools of even the best and brightest attempting to predict how markets and the economy would react. The recent uncertainty in the bond market shows that trend is far from over.
Bloomberg
