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Bonds Persist In Their Warning About US Economy

  • Written by Syndicated Publisher No Comments Comments
    August 16, 2014

    Bonds do not like economic strength, but love economic weakness.

    It makes sense. In a strong economy there is upward pressure on interest rates, and therefore on bond yields. When bond yields go up, their prices go down.

    In a weakening economy, there is downward pressure on interest rates as the Fed cuts rates to re-stimulate economic growth. When interest rates and bond yields go down, bond prices go up.

    The Fed cut interest rates to record lows, near zero, in efforts to pull the economy out of the ‘Great Recession’, and along with other dramatic efforts, it worked.

    However, the Fed has been of the opinion since December that the economy is now in a zone of sustained recovery. It is tapering back its bond-buying QE stimulus at an impressive pace, and already debating when it will begin raising interest rates to prevent the economy from overheating.

    The bond market disagreed from the get go.

    Although the consensus opinion was that bond prices would collapse as soon as the Fed began tapering back its monthly bond-purchases, bonds launched into a rally at year-end, the instant the Fed began to so do.

     

    Bonds seemed to be onto something when it was subsequently reported that GDP growth had plunged into negative territory in the first quarter.

    However, they continued to rally even after GDP growth recovered from its first quarter stumble. They continue to rally now even though the Federal Reserve assures us the first quarter was just a weather related glitch, and economic growth continues.

    Unless the bond market’s ability to anticipate trouble has gone away, the bond market is still seeing the situation quite differently than the Fed.

    It’s interesting that in a similar manner, bonds began rallying early in 2011, and we soon learned then that GDP growth had turned negative in the first quarter of 2011 (the last time it did so).

    In 2011, bonds also continued to rally after GDP recovered in the second quarter, like now apparently still worried about the economy. The bond rally then spiked up sharply in 2011 when the stock market began to plunge on its own concerns about the economy. It was not until October that the bond rally paused, when the Fed, panicked by the stock market’s 19% decline, rushed in with promises of QE3 stimulus.

     

    As in 2011, the bond market’s rally this year has continued even though the economy (GDP) recovered from its first quarter decline. By doing so, is it warning that the Fed is wrong this time too, that the economic recovery is not as sustainable as it seems and will need the Fed to bring QE stimulus back again?

    If so, will the Fed repeat its 2011 lagging response by ignoring what the bond market and economic reports may be saying, and continue to taper back QE until the stock market scares it by plunging again?

    The stock market is more overvalued than in 2011. And it has also gone for a similar unusual long time as in 2011 without even a normal 10% to 15% correction.

    Its current pullback is only around 3% and it’s already trying to bounce off that.

     

    But the continuing warning from bonds regarding the economy, and the deterioration of our technical indicators, do have our attention. So we shall see.

    In the interest of full disclosure my subscribers and I still have a position in the iShares 20-year bond etf, symbol TLT, and initial downside positions on the stock market in inverse ETFs, ProShares Short Dow, symbol DOG, and ProShares Short Russell 2000, symbol RWM. We are watching our technical indicators for confirmation of a potential stock market top before adding to those initial positions.

     

    Sy Harding is president of Asset Management Research Corp, and editor of www.StreetSmartReport.com, and the free market blog, www.streetsmartpost.com. He can also be followed on Twitter @streetsmartpost.

    Images: Flickr (licence attribution)

    About The Author – Sy Harding, Street Smart Report

    Sy Harding publishes the financial website Street Smart Report Online and a free daily Internet blog at Sy’s Free Blog. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!

    It includes our research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s.

    It provides two model portfolios as guides. One is based on ourSeasonal Timing Strategy, one on our Market-Timing Strategy.

    In depth updates are provided every Wednesday, with interim ‘hotline’ updates every time we make a trade. An 8-page traditional newsletter Street Smart Report is provided on the website every 3 weeks, in pdf format for viewing or printing out.

    There is the Street Smart School of online technical analysis ‘seminars’,commentaries to keep you ‘street smart’ about Wall Street, and much more. 

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