Bond traders see gloom even as stocks bloom

New Straits Times - - Business -

BOND traders walk around with dark clouds over their heads. They see doom when stock­bro­kers see op­por­tu­nity. When eq­uity in­vestors are throw­ing a party, debt in­vestors sit in the cor­ner and nurse some seltzer, wait­ing for ev­ery­one else to suf­fer a hang­over.

And so it goes now.

While stock in­vestors show no fear of another Fed­eral Re­serve (Fed) rate in­crease, bond in­vestors are start­ing to worry. Their angst is crop­ping up in the form of a flat­ter yield curve, which typ­i­cally sig­ni­fies that traders are pric­ing in slower growth in the years ahead.

In fact, one of the most im­por­tant yield curves, the gap be­tween five-year and 30-year Trea­sury rates, has nar­rowed to al­most the flat­test since 2007.

This an­tic­i­pa­tion of lower growth con­trasts pro­foundly with the dom­i­nant nar­ra­tive that’s been fu­elling riskier bond and stock val­ues — that the United States econ­omy is ac­cel­er­at­ing and poised for an era of ex­pan­sion and pros­per­ity.

The Fed has bought in. On Fri­day, chair Janet Yellen all but con­firmed that the cen­tral bank would raise in­ter­est rates this month, say­ing such a move would “likely be ap­pro­pri­ate” if em­ploy­ment and in­fla­tion con­tinue to meet pol­i­cy­mak­ers’ ex­pec­ta­tions.

Yellen’s com­ments, de­liv­ered at a lunch in Chicago, sim­ply rat­i­fied what debt mar­kets had al­ready rushed to price in ear­lier in the week. Bond in­vestors now widely ex­pect near-term bor­row­ing costs to rise in short or­der. Yields on two-year Trea­suries are at about their high­est lev­els since 2009. This comes in re­sponse to fall­ing un­em­ploy­ment lev­els and sig­nif­i­cantly im­proved con­sumer sen­ti­ment.

But while traders are pric­ing in a near-term tight­en­ing in credit con­di­tions, they seem in­creas­ingly less op­ti­mistic about the longer term.

Af­ter all, that prover­bial party is com­ing to a close and the Fed is tak­ing away the punch bowl. It’s try­ing to do it slowly, so it doesn’t de­rail the econ­omy, but at some point that re­al­ity is go­ing to sink in, and in­vestors are go­ing to ques­tion the value of as­sets that have been in­flated by years of stim­u­lus.

In other words, with­out the punch bowl, it’s hard to see how junk bonds and stocks are go­ing to con­tinue to rally with­out ad­di­tional help. While that as­sis­tance may come from Pres­i­dent Don­ald Trump’s US$1 tril­lion (RM4.45 tril­lion) in­fra­struc­ture spend­ing pro­gramme, it’s still only con­cep­tual, and that’s putting it char­i­ta­bly given the po­lit­i­cal and lo­gis­ti­cal chal­lenges.

US stock mar­kets are hav­ing none of that pes­simism. They reached new highs last week and stayed near there, even as it be­came clear that the Fed is all but cer­tain to raise rates this month.

In­vestors who are plow­ing into riskier se­cu­ri­ties ought to pay heed to the dour debt party poop­ers crowded into the cor­ner. All par­ties come to an end, and some­times the hang­over is non­nego­tiable.

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