Bonds move in mysterious ways

Contrary to custom, bond and stock prices are hitting records at the same time in America.

"It isn't supposed to happen that way," says Anna Louise-Jackson on Stocks and bonds are typically "risk-on/risk-off complements", moving in opposite directions. Under normal circumstances, good economic news causes stocks to rise and bond prices to fall, as fixed-income investors begin to factor in higher inflation and interest rates.

Similarly, bad times spur demand for the relative safety of bonds, along with expectations of lower rates. Yet in the US, bond and stock prices are hitting records at the same time an unprecedented situation. The S&P 500 hit a new high early this week while the yield on the US ten-year Treasury bond reached a new low under 1.4% (yields move inversely to prices). So what's going on?

Equity investors have reacted to the latest indications that the economy strengthened after a dip in the first quarter. Payrolls grew by a spectacular 287,000 in June, showing that the labour market remains robust.

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The unemployment rate ticked up to 4.9%, but only because workers returned to the labour force. Meanwhile, with around $12trn of government debt trading on negative yields, US bonds look relatively appealing for risk-averse international investors. The dollar's recent strength has also helped.

What's more, futures prices suggest investors think the Federal Reserve will keep interest rates on hold for another 18 months, which has bolstered bonds' appeal. But they could be in for a nasty surprise. Annual wage growth has reached a 12-month high of 2.6%, and surveys point to an acceleration to 3% over the next few months, according to Capital Economics.

Central banks are notoriously bad at nipping inflation in the bud, so the danger is that the Fed will fall behind the curve and have to put rates up faster than anticipated. That would be very bad news for the overpriced bond market. Expect this bond-stock lockstep to end with falling bond prices.

Abenomics stays on track

Altering the document's pacifist clause is "a lifelong obsession" of his, notes The Economist, but on the plus side there have also been hints that a long overdue liberalisation of the country's rigid labour market is on the cards. Whether he delivers that or not, the outlook for equities remains solid. The Bank of Japan is likely to loosen monetary policy even further to weaken the yen, and liquidity tends to find its way into asset markets.

Still hooked on Opec oil

When oil prices plunged in 2014, Opec producers kept pumping in order to defend their market share, rather than cut back to prop up prices. US production is falling, while other relatively high-cost producers, such as Canada and Brazil, have also reined in output. As prices have fallen, oil companies worldwide have embarked on the biggest cost-saving measures in 30 years, crimping non-Opec supply.

Meanwhile, despite shale, the US is still "an importer and will be for some time", Fatih Birol, executive director of the International Energy Agency, told the Financial Times. It ships in around 4.7 million barrels per day, down from 12.5 million in 2005. In short, says an FT editorial, "the world is still vulnerable to an oil supply shock".

Andrew Van Sickle

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.