The Media's Message on the Bond Market is Right…Sort Of

The media has largely attributed the current US bond market rally—10-year Treasury yields have fallen 65 basis points since the end of June—to two factors: an oncoming recession and reduced inflationary pressures. They are right on one count but wrong on the other.

First, the wrong. One theory goes that the decline in long-term interest rates have inverted the yield curve, which almost always signals a recession is coming. However, in the last 20 years or so, this pattern has become less reliable. As financial institutions and capital markets have become increasingly global, money has flowed more freely across borders. Thus, analysis of a yield curve in a single country has become less meaningful. Ultimately what matters is not the yield curve itself, but the availability of capital to fuel investment. On that note, there appears to be amble liquidity available, as evidenced by strong corporate bond issuance an increases in commercial loans.

Another theory says investors flock to safer assets, like Treasury bonds, when the economy is heading south. But if investors were moving into safer assets, why are stock markets reaching new highs? Bond yields have broadly declined for the past twenty years, a period generally a good time for economic growth. The two do not necessarily go hand in hand.

And the right. Inflation is not a concern. After several months of touting inflationary fears, the media appears to have finally realized the obvious. Market based inflationary indicators, such as TIPS spreads, have shown for some time that inflation was not a cause for concern. We're glad to see this is beginning to be widely appreciated.