The Bond Market Talks: Don’t Expect Too Much Economic Growth

The United States bond market sees very little chance for the economy to grow by much in the near future. Furthermore, the bond investors seem to see next to no impact of the Federal Reserve in terms of raising inflation rates, despite the Feds new policy approach focusing on higher […]

The United States bond market sees very little chance for the economy to grow by much in the near future.

Furthermore, the bond investors seem to see next to no impact of the Federal Reserve in terms of raising inflation rates, despite the Feds new policy approach focusing on higher rates of inflation.

Bond investors seem to be focusing more on future pictures of bankruptcies and business failures, upon rising signs of employee layoffs, like the recently announced Disney layoffs, and the drop off in commodity prices.

Although there seems to be plenty of liquidity hanging around financial markets leading to a boom in IPOs and other revived investment vehicles, like “blank check” companies, the bond markets are seeming indicating that the money is not getting to Main Street.

Consequently, little or no growth and little push on the inflation side.

Inflationary Expectations

A measure of inflationary expectations can be derived from the bond markets. Often referred to as the break-even rate, derived by subtracting the yield on the 10-year Treasury Inflation Protected securities from the nominal yield on the 10-year Treasury notes, the estimate has been a good guide of investor feelings about the direction of future inflation.

At the start of the year, 10-year inflationary expectations were about 1.80 percent. That is, the compound rate of inflation over the next ten years is expected to be 1.80 percent.

The current economic recession officially began in February. By the end of February, 10-year inflationary expectations were down around 1.50 percent.

In March, the Federal Reserve reacted to the growing financial crisis by opening up the spigots and flooding the financial markets with money. And, the Fed’s efforts were extended to the rest of the world.

During the month the seriousness of the economic disruption became real to the investment community and the 10-year inflationary expectations dropped below 1.00 percent, going as low as 0.60 percent right around the time that the Federal Reserve actions were most intense.

By the start of April, 10-year inflationary expectations were back up to around 1.00 percent.

Inflationary expectations really didn’t start to pick up again until early May and by the start of June, they had risen to about 1.20 percent.

In July and early August, inflationary expectations picked up more steam. By the middle of August, 10-year inflationary expectations had risen to about 1.60 percent.

Federal Reserve Shifts Policy

At the annual August economics conference of the Federal Reserve, Fed Chair Jerome Powell talked about the new research completed by Federal Reserve economists and suggested that the Fed would move to a more aggressive stance toward inflation.

This research was so acted upon by the Federal Open Market Committee in the hopes that a looser Fed view of inflation in the future would allow markets to become more aggressive in planning for economic growth.

Inflationary expectations jumped in the last week of August. On August 31, 10-year inflationary expectations topped 1.80 percent.

But, that was it. In the first half of September, inflationary expectations were back down around 1.70 percent and currently they are tending to be in the 1.60 percent to 1.65 percent.

The new Fed policy seems to have had only a minimal impact on inflationary expectations.

The Drop In The Yield On TIPs

During 2020, there has been a relatively steady drop in the yield on the 10-year TIPs. Often this yield on the TIPs have been tied to the expectation about the growth rate of the US economy.

In recent years the yield on the 10-year TIPs has been distorted somewhat. As I have often written over the past three or four years, movements in the TIPs yield can be connected with international flows of risk-averse monies. As US Treasury securities serve as a “safe haven” investment, we have seen large inflows of funds and large outflows of funds as risk-averse investors move money in and out of the United States depending upon world sentiment.

But, overall, the direction of the 10-year yield on TIPs can provide us with some fell for investor sentiment about expected economic growth of the US economy.

Here we see that the yield on the 10-year TIPs around January 1, 2020 was a + 0.10 percent. Around February 1, the yield was -0.30 percent; around March 1, about -0.40 percent; around April 1 about -0.30 percent; around May 1 about 0.45 percent; around June 1 about -0.50 percent; around July 1 about -0.70 percent; around August 1 about -1.00 percent; around September 1 about -1.10 percent; and currently, about 1.00 percent.

So, throughout 2020 the yield on the 10-year TIPs have fallen.

One could argue from this that investors in the bond markets believe that the growth rate of the US economy is not too strong and the expectation for future growth is weakening.

Although I don’t believe that we can take too strong a position on this from the TIPs market, I do believe that it signals that expectations of future US economic growth have fallen and show little or no sign of a pickup in the near future.

The Economic Future Of The United States

I conclude from all this that investors in the US bond market are not expecting a very robust US economy over the next few years.

Regardless of who gets elected this November 3 as the president of the United States, bond market participants seem to believe that much is going to have to be done to support and build up the US economy. And, this growth situation is going to have to be faced with federal debt load that is accelerating and will not be stemmed because of the slow growth of the economy.

This is not a very pretty picture, but it seems to be the one that bond investors are drawing.

Certainty other investors need to take a hard look at this picture.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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