Updating the Bond Market & Its Implications
20+ year Treasury bond fund TLT is making a potential whipsaw shakeout move back above the 200 day moving average. This in the wake of a weak GDP report.
Depending on what happens on Friday with the October Payrolls report, we could see a tamping back down of recently risen inflation expectations. That would be a good thing for the gold mining sector, fundamentally. It would also be a good thing for the counter-cyclical view if these signs of economic weakness were to persist (as personally expected).
The 2yr yield has risen of late, right along with inflation expectations, as it would. It could be vulnerable to bad economic news (again, Payrolls on deck for Friday).
The 10yr-2yr yield curve of course shows a spread between long and short-term bonds. The curve has been steepening since mid-summer and un-inverted in September. The strength of the 2yr yield has been pressuring the curve lately. This is a sign of the market still implied to be respectful of the Federal Reserve and its capacity to fight the inflation (which it created, so it is in Wonderland).
Much of the curve steepening has come with disinflationary pressure. But most recently its lofty status was supported by inflationary pressures. The curve can steepen deflationary or inflationary.
Deflationary steepening: Nominal yields decline, but short-term yields decline more as participants flock to the safety of short-term T-bonds and cash equivalents.
Inflationary steepening: Nominal yields rise, but long-term yields rise harder as participants fear rising forward inflation, which affects long-term bonds more adversely.
Bottom Line
If GDP and Payrolls combine for a clearly negative economic view, inflation signals are likely to decline also. That may have begun with the above-noted whipsaw in long-term bonds (TLT). Our view has been that the macro is in a new age of less effective inflationary monetary policy going forward. That is because the decades-long downtrend in long-term yields has been busted.
But within that, the favored view has been for an interim drop in yields, instigating a disinflationary (Goldilocks) to potential deflation scare situation. This interim view has been tested heartily as you can see by how far down TLT declined, almost to a breakdown. If the data come in weak and TLT/long-term bonds do hold and rise anew, we’ll be back on the original plan of interim disinflation. If they break down, we’ll prepare for inflation sooner rather than later.
Today is a sign that we are still on plan. Payrolls upcoming on Friday.
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