Deciphering the collective mind of the bond market is one of the more challenging tasks in the 21st century, right up there with trying to cure cancer and deciding if the bull-market run in Google’s stock is the Internet bubble reincarnated.

Consider this morning’s release of May’s U.S. Import Price Index from the Labor Department. Import prices dropped a hefty 1.3% last month, the biggest monthly decline since December 2004’s 1.4% fall. The main reason for retreat in May was the slide in petroleum prices last month. Given America’s voracious appetite for imported oil, any decline in crude prices necessarily pares import prices generally, as today’s numbers remind.
It all looked like a confirmation of the bond market’s general theory of late, i.e., that pricing pressures were less than expected by the inflation hawks. For the moment, at least, the bulls of fixed income had been redeemed with economic support.
But if you thought the import-price news would spur fresh buying in the benchmark 10-year Treasury Note, you were mistaken. Big time. The 10-year’s yield jumped sharply today to around 4.04% as traders sold the associated Treasury in no uncertain terms. That’s the first time the yield has settled above 4% since May 30.
Whatever the reasons for the reversal of fortunes in the bond pits, the combination of falling import prices and higher yields in long-dated bonds gave inspiration to fixed-income traders, who bid up the U.S. Dollar Index to its highest close since September 2004. But logic may be question in forex trading too, or so one could argue after considering today’s trade balance news for April. The Bureau of Economic Analysis advised that the red ink on the U.S. trade ledger grew a bit, dipping to –$57 billion in April, down from a revised –$53.6 billion the month previous. One could reasonably ask: is that the kind of news that traders like to hear if they’re long the greenback? Today it was. Ah, but will it hold true next time?
Don’t answer that. Rather, ponder the fact that it’s a different world, and what passed for prudence and judgment in the past can be easily torn asunder. The financial world is the most wired, most technologically advanced industry in the world, but it’s no more predictable (or rational) than it was when telegraphs were the leading edge of high-tech communication tools. It may even be a bit less so, but that’s a subject for another day.
Meanwhile, in the here and now, it’s all a matter of interpretation. It always was, of course. And always will be, leading to the perennial rule of relevance: One trader’s worries are another’s reason to buy. Exercising that freedom, one strategist favors the sunny side of the trade-deficit interpretation and asserts that “we actually see a lot of positives” in the trade numbers from the dollar’s perspective. So says Robert Sinche, head of currency strategy at Bank of America in New York, who also tells Bloomberg News today: “We’re now getting signs the trade balance is stabilizing.”
Stabilizing? Not so fast so a card-carrying dollar bear. Peter Schiff, president of Euro Pacific Capital, and a veteran skeptic on the so-called American economic miracle, was unimpressed as ever with today’s trade news. In an essay posted today on the firm’s web site, Schiff dismisses the happy talk with his usual growl and bite: “The fact that the fourth-worst monthly deficit ever is considered good news is startling evidence of just how far the bar has been lowered when it comes to America’s deteriorating trade imbalance.”
Indeed, some strategists tried to meet the Sinches and Schiffs of the world halfway by suggesting that today’s dollar rally is less about an improving outlook for the buck and more about deteriorating expectations for the euro, which suffered no small amount of damage after France and the Netherlands torpedoed the European Constitution last week. And to judge by the continuing decline and fall of the euro today, that’s a reasonable observation.
But just to keep things interesting, gold decided to rally, which is somewhat surprising given the dollar’s strength today. Indeed, the precious metal jumped more than $3 an ounce, its highest close in nearly a month. Gold usually rallies when the dollar falls.
Let’s assume at least that the gold bulls didn’t take comfort from the news that the federal budget deficit is showing signs of receding a bit. May’s red ink fell considerably from a year ago thanks to a jump in tax revenues, according to Treasury data via BusinessWeek. Then again, the White House yesterday pared its forecast for economic growth a touch, predicting a rise of 3.4% in 2005, slightly below the forecast of 3.5% made last December, according to The New York Times.
Does the latter offset the former? And while we’re asking questions, can a trade deficit that grows worse in May vs. April be good for the dollar? Can gold rally along with the dollar? Are falling import prices bullish for bonds? Whatever the answers, rest assured they’ll change on Monday.