The Bond Goes on a Tear in the Markets

May
11

Written by: Jon McGraw

bondGovernment bonds have gone wild!

Sure, you might expect high-yield bonds to act unpredictably from time to time. That’s why they’re high-yield bonds. They don’t receive investment-grade ratings—BBB through AAA—from leading credit rating agencies because they are not considered to be as creditworthy as investment-grade bonds and carry a high degree of risk.

U.S. Treasuries are a different story. They are backed by the full faith and credit of the U.S. government, which can raise taxes to cover its debts. Treasuries are considered by many to be one of the safest investments around. As a result, they’re usually pretty stable and stodgy.

That wasn’t the case last week, though. The U.S. Treasury chased after its cousin, the Bund, which is issued by the German government. The Bund has been on a tear recently. Experts cited by Bloomberg.com reported a shift in sentiment and fundamentals may have triggered European bond behavior that “helped wipe $436 billion off the global fixed-income market in the past week.”

The performance of German bonds reverberated around the world, according to Bloomberg.com, affecting U.S., French, Spanish, Japanese, Australian, Polish and Italian government bond performance. Bond prices fell as yields rose higher. Barron’s reported:

“Seasoned observers must have been shaking their heads. Not only do high-grade government bonds not normally gyrate more than a few basis points in a day, those swings typically don’t move across oceans like tsunamis.”

Since February, U.S. Treasury yields have risen from a low of 1.67 percent without any significant change in fundamentals, according to Barron’s. It could be that U.S. markets think the Federal Reserve rate hike will occur sooner rather than later. Last week, Chairwoman Janet Yellen voiced the opinion that stock market valuations were, generally, pretty high. That could indicate the Fed is ready to act.

Be prepared for a volatile ride until the uncertainty driving markets begins to settle.

Data as of 5/8/15 1-Week Y-T-D 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks) 0.4% 2.8% 12.8% 15.8% 12.8% 6.0%
Dow Jones Global ex-U.S. 0.2 7.9 1.3 7.9 4.9 3.7
10-year Treasury Note (Yield Only) 2.2 NA 2.6 1.8 3.5 4.3
Gold (per ounce) 0.9 -1.1 -7.9 -9.6 -0.2 10.8
Bloomberg Commodity Index 0.7 -0.2 -23.6 -8.6 -4.4 -3.7
DJ Equity All REIT Total Return Index 0.7 -0.1 12.1 11.4 12.9 8.3

Reading the Unemployment Tea Leaves

Americans have long relied on unemployment statistics to provide insights into our country’s economic health. The Richmond Federal Reserve defined full employment as “the level of employment at which virtually anyone who wants to work can find employment at the prevailing wage.” Interestingly, full employment is not zero unemployment because jobs are being created and eliminated constantly.

Many analysts have been asking what full employment is today, in part, because the Federal Reserve has said it will begin raising short-term interest rates when the economy is nearing full employment (and inflation is about 2 percent). It may turn out to be a trick question. The Economist wrote:

“Although the number of jobless Americans has fallen, the share of the working-age population in the labor force has also dropped considerably, from 66 percent before the financial crisis to less than 63 percent now. Temporary factors have affected the statistics, but much of the change has been driven by structural factors such as retirement of the baby-boomer generation and rising college enrollment. These developments may explain why, as the unemployment rate has fallen from 10 percent in 2009 to 5.4 percent today, the Fed’s target long-run unemployment rate has also declined, from 6 percent in 2013 to just 5.2 percent at present.”

On Friday, the Labor Department announced the unemployment rate was 5.4 percent. However, there is some skepticism about whether the American labor market really is close to full capacity. Experts cited by The Economist suggest a stronger jobs market might coax more people into the workplace. By their estimates, America’s true unemployment rate is about 6.6 percent.

The Economist suggested labor market slack is one reason average hourly earnings have remained sluggish. Many thought low oil prices would push consumer spending higher. They did not. It looks like bad weather and stagnant wages may be behind lethargic economic growth.

Weekly Fun—Think About It

“Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do.”

—Steve Jobs, Co-founder of Apple Inc.