Are Bond Markets Also Signaling A Boom?

Posted: Feb 19, 2018 11:40 AM
Are Bond Markets Also Signaling A Boom?

There's an old saying: "In a multitude of counselors there is safety." That's why I like to look at what markets are telling me about what they think is going to happen in the economy. Virtually every person on planet earth is a participant in markets. Yes, there is a small percentage of the human race living in socially-isolated tribes. There are a couple of countries like North Korea and (up until recently) Burma which lived apart from the rest of the economy. But by and large everybody else is selling into the global pool of goods and services and borrowing from the global supply of capital. Every decision of all of these people to spend vs. save is embedded in the fluctuations in interest rates, for example.

In my last article on the topic of markets as economic forecasters, I focused on the stock market. But the stock market is not nearly as large as the bond market. There's more money by far in bonds. So what are bond markets signaling about US growth?

In a word - a shift towards optimism.

First, let's get clear on what we are measuring: The chart below uses a metric which compares the relative preference for treasury bonds over high yield US corporate bonds (sometimes called 'junk bonds'). The scale is set so that up indicates a preference for the safer bonds, and down indicates a preference for the riskier bonds. So up is fear and down is greed.

The chart shows how this fear metric coincides with various points in the economic history of the US in the past few decades. As you can see, the booming '90s are anticipated and accompanied by low risk spreads. The recession of 2000 and the resultant aftershock of the Enron bear market also are reflected. The Great Recession and the Not So Great Recovery show up as well.

Here's a video in which I narrate that historical progression and then explain how this approach can help you to get useful insight into future economic growth.

As of the end of last year, this market was implying a much more optimistic scenario for the US economy, then in recent years and in the last year. If we rearrange the data into a scatter chart and use it to draw a line, we see that it is implying a growth rate of about 3%, up from a surprisingly accurate anticipated 2% growth rate last year.

What has mainly been going on is a surge in high-yield bonds, especially since the election of Trump, and then again as tax reform was moving towards passage at the end of last year.