The strange bond boom

The world economy is supposed to be picking up, but the bond market is acting as if America is diving into recession. What next? asks James Ferguson.

Something very odd appears to be happening on Wall Street this month. For each of the past six weeks, the stockmarket has risen, a sign - or so one would think - that investors think the "soft patch" of the summer is behind us and the path ahead for the American economy is a smooth one. Yet at the same time, yields on ten-year US government bonds have fallen - from around 4.8% in June to 4% this week. When the economy is "running hot", you'd expect stocks to rise and bonds to fall as investors switch into higher-growth equity markets. However, when the economy is simply "sputtering along", you would expect the prices of bonds to rise in expectation of rising interest rates, and those of shares to fall. Today, they're both rising: the markets, says Daniel Gross at https://www.slate.com/, are "about as polarised as the American electorate".

That has left many market participants very confused - from the press to the brokers. Last week, Morgan Stanley reported a 34% drop in its third-quarter earnings, largely because the bank's traders had bet that bond yields would follow interest rates upwards. That's exactly what should have happened, given the stage of the economic cycle we are supposed to be at. Ever since ten-year Treasury yields reached their nadir at about 3.1% in summer 2003, all the talk has been about a growing economy, firming inflation, and, since June, rising interest rates. So, by early summer, bonds had slumped and yields were above 4.8%. As The Economist points out, that "should have brought a warm glow of satisfaction" to those who earlier in the year had suggested that ten-year Treasuries would sport yields of 6% by the end of the year. Not any more.

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James Ferguson qualified with an MA (Hons) in economics from Edinburgh University in 1985. For the last 21 years he has had a high-powered career in institutional stock broking, specialising in equities, working for Nomura, Robert Fleming, SBC Warburg, Dresdner Kleinwort Wasserstein and Mitsubishi Securities.