With Friends Like These it’s No Wonder Bonds Continue to Rally

August 15, 2019
By Bryce Coward, CFA in Economy, Markets, Portfolio Management

How in the heck can the 30 year Treasury bond yield be trading at just 1.97%, an all-time low, when just 10 months ago it was up at 3.46% and “breaking out” to the upside? We were supposed to have a bond-pocalypse, after all, with yields never again coming close to the levels that prevailed back in 2016.  In reflecting on the answer, we are reminded of a quote from the cult classic film, The Big Lebowski:

Dude: With friends like these, huh, Gary?

Gary: That’s right, Dude.

Just replace the word, “friends” with “economic data” and the explanation for the rally in bonds makes sense. Contrary to what appears to consensus opinion, the economic data is in fact weak and set to get weaker. Take, for example, today’s releases of retail sales, industrial production and unemployment claims. All of them are lagging indicators and closely follow the ISM PMI data, which itself is coincident.

Based on the ISM, the “strong” retail sales number is actually behaving as expected and set to get weaker through year end. Furthermore, if we strip out “Prime Day”, the actual retail sales in July would have grown about half as much.

Industrial production, which was not affected by a one-off event, fell .2% MoM missing expectations for a gain of .1%. This behavior is completely in line with what we’d expect given ISM’s more leading measure of manufacturing production, and more downside should be expected.

Finally, there are the jobless claims. Here we focus specifically on continuing claims. The trend of lower continuing claims clearly ended in the 4th quarter of 2018, which makes sense since peak economic growth for the cycle occurred in the 2nd quarter of 2018. Continuing claims are now morphing into an uptrend and this lagging series is set to worsen for at least the next four months, according to the leading relationship the ISM PMI shares with this employment series.

Are bond investors crazy, or just not getting any help from their friends?

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