As messages from the bond market go, yesterday’s trading session was fairly distinctive. It may even be accurate.
For much of the trading yesterday, sellers were in control, based on transactions in the benchmark 10-year Treasury Note. The yield climbed steadily as the hours passed, reaching upward to nearly 4.84% just after 1 p.m., New York time, the highest since last Wednesday. For the next hour, all was calm, and the yield level more or less held. Then at 2 p.m., the buyers rushed in and the yield on the 10-year dropped like a rock, as the chart below shows. The result: the yield tumbled back to 4.78% by the close–roughly the lowest since March and virtually unchanged from Tuesday.
What happened at 2 p.m.? The release of the minutes from the Fed’s August 8 FOMC meeting, of course. The perception-altering news of the minutes, or so traders decided, was that the central bank wasn’t quite as hawkish on interest rates as had been assumed earlier in the day. Thus, the repricing of risk, namely, the nominal yield on the 10-year Treasury, which, of course, is susceptible to future inflation (and the next story to hit the wires).
But inflation, the fixed-income set resolved, isn’t going to be much of a threat. That, at least, was the message of yesterday’s bond-market action. But the casual observer can be forgiven for confessing confusion. Indeed, yesterday’s FOMC minutes made it clear that the debate on August 8 (which marked the Fed’s first pause in hiking rates after 17 previous elevations) was hardly decisive one way or the other. As the minutes advised, “In view of the elevated readings on costs and prices, many members thought that the decision to keep policy unchanged at this meeting was a close call and noted that additional firming could well be needed.”
Nonetheless, most voting members of the FOMC voted to pause on August 8, apparently concluding that inflation is fading as a material threat. Of course, it’s also true that while there was but one dissenting vote at the last meeting, the minutes reveal that several members who voted to cease and desist were less than 100% confident in the accuracy of their decision. Again quoting the minutes: “In view of the elevated readings on costs and prices, many members thought that the decision to keep policy unchanged at this meeting was a close call and noted that additional firming could well be needed.”
Holy data confusion, Batman! Is the outlook really that muddled?
Fed Chairman Bernanke has said that the Fed’s forecast of a slowing economy will pare inflation’s upward momentum of late. And in fact, the economy has been slowing, although it remains to be seen if that will translate into a sustained fall in the core rate of inflation. A minor setback, if we can call it that, on that front comes in this morning’s latest estimate on second-quarter GDP. As it turns out, the economy grew slightly faster than previously calculated, according to the Bureau of Economic Analysis. GDP advanced at an annual rate of 2.9% during April through June, which is moderately faster than the 2.5% estimate previously disclosed. By itself, that doesn’t change much. Then again, we’ll have to wait and see what Friday’s employment report for August says before coming to any fast and furious conclusions.
Meanwhile, BEA reported that the higher GDP estimate reflects “upward revisions to exports of goods, to nonresidential structures, to private inventory investment, and to state and local government spending that were partly offset by a downward revision to residential fixed investment.”
It’s anyone’s guess how the bond market will react in the days ahead, although based on yesterday’s trading, it’s clear that the path of least resistance for interpretation seems to be one of optimism, i.e., inflation’s fading and the risk of slowdown, or perhaps even recession, is rising.
Indeed, a 10-year Treasury yield just below 4.8% as we write is one that’s materially below the current Fed funds rate of 5.25%. There are many unknowns in the world of economic forecasting, but the bond market is crystal clear about what it thinks is coming. An inverted yield curve and its implications of recession may not be fate, but as a measure of expectations it’s a precision instrument.