How to read the US bond market's mixed signals

Falling US bond yields have sparked talk of a slowdown in US growth, but there are several reasons why this view is misguided.

You’d think that policymakers and economists would be happy with the latest US GDP print. It was, after all, quite a bit above expectations at 3.9 per cent, compared with 3.3 per cent in the September quarter. 

Yet once again, much of the commentary produced suggests that the result was a ‘mixed bag’. Indeed, following the release of the numbers, the US 10-year bond yield actually fell by around 8 basis points to 2.25 per cent (2.24 per cent at present). This is the lowest yield in about a month. And despite the fact that the Fed has ceased QE III and the US economy has accelerated sharply this year, bond yields have fallen by around 75 basis points since the beginning of 2014. Remarkable.

On the face of it, that would seem to justify some of the commentary suggesting that US growth momentum cannot last. It’s what the bond market points to after all (on that view) -- and it’s probably consistent with data showing US consumer confidence falling etc.

Yet I don’t think that’s quite the right way to think.

For a start, US growth momentum is incredibly strong. This latest update makes the September quarter, the fourth quarter out of 5 where GDP was above 3.5 per cent. In fact the average annualised growth rate over that period is over 4 per cent. excluding the one quarter of weather-distorted growth. They are exceptionally strong outcomes, considering the average is only around 2.5 per cent.

The big question I have for those who think momentum will slow is: just what exactly is going to drive that slowing? A dip in consumer confidence doesn’t really cut it for mine, especially when consumer confidence is a fairly volatile indicator, and one that doesn’t seem to have a good relationship to actual spending anyway.

Consumer spending is growing at a decent clip, and did so even when consumer confidence was well below average (only a touch below average now). More to the point, with jobs growth the strongest since World War II and the unemployment rate on a rapidly falling trajectory, it’s much more likely that the modest dip in confidence will correct. That is, I don’t think weak confidence can last given real economic outcomes. It’s not like they’re ambiguous. 

In the meantime, crude prices are currently at a five year low -- the lowest since the GFC and down $40 from the 2013 peak. That’s clearly a fairly sizeable stimulus to the US economy. So too is that 75 basis-point slump in the 10-year-bond yield, while we’re at it. The reality is we’ve got a very strong economy that just got a huge dose of extra stimulus. Boneheaded economists plugging those variables into their models could only possibly come up with stronger growth outcomes, certainly not weaker. I don’t know where these concerns come from.

In any event, I don’t think it’s really the case that the US bond market is predicting a US slowdown at all. It wouldn’t make sense to see all of the above factors and bond yields slip. The bigger picture issue is that the Bank of Japan and the ECB seem to be taking up from where the Fed left off by  printing or preparing to print more money (or about to).  The fact is, if you’re a European bank getting free loans from the ECB (or a Japanese bank with more free money than you know what to do with) then US bonds don’t look so bad at 2.24 per cent. The equivalent German yield is 0.66 per cent, while the Japanese 10-year offers even less at 0.2 per cent.  

It’s an interconnected world, and the only thing the latest slump in bond yields proves is that central banks are going to have to coordinate any exit from ultra-loose monetary policy for any one country’s domestic policy to be effective. With the European Central Bank and the Bank of Japan ready to do whatever it takes, there is very little chance of ultra-low rates normalising next year. Bond yields could even keep falling as the global economy accelerates sharply into 2015.

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