Is this the long-feared wake-up call for the bond market? Maybe, but the bond ghouls don’t give up so easy. But there’s at least reason to sit up and take notice, if only to keep things interesting and provide a change of pace for a day or two. Indeed, this week’s economic data was unmistakably positive, and in some cases far stronger than the consensus expected. The fixed-income set responded, but only modestly so far, selling the benchmark 10-year Treasury to the tune of lifting its yield to 4.52% as of yesterday’s close. That’s up about 10 basis points from the end of last week.
The rise of long-term rates may be warranted from current levels, given the robust upward revising in third-quarter GDP to 4.3% growth from 3.8% previously estimated. And as this morning’s employment report reminds, November was the 30th consecutive month of rising nonfarm payrolls. Meanwhile, the European Central Bank has joined the interest-rate-hiking bandwagon and elevated the price of money on the Continent for the first time in five years. It may not be a trend, but it certainly smells like one.
But if an epiphany is coming in the bond market, you wouldn’t know it by reading the latest missive from Pimco’s Bill Gross, who runs the world’s largest bond fund. Gross continues to talk of a slowing economy and lower yields. Writing in his latest Investment Outlook, he opined, “Now after 300 basis points and 17 months of tightening – which by the way is typical of prior bear cycles as well – it should only be logical to expect a slower economy in 2006, an end to Fed tightening, and the beginning of an easing cycle late in the year.”
It’s unclear if the bond market agrees, only because yields have tended to move sideways for some time, and that habit more or less remains intact for the moment. True, the 10-year’s yield has nudged up this week. Then again, the 10-year’s yield hasn’t changed all that much since May 2004.
The bond ghouls may be a determined crew, but the forces of optimism are fighting back. Brian Wesbury, chief investment strategist with Claymore Advisors, skewers the pessimists today in a Wall Street Journal op-ed (subscription required). “During a quarter century of analyzing and forecasting the economy, I have never seen anything like this,” he wrote. “No matter what happens, no matter what data are released, no matter which way markets move, a pall of pessimism hangs over the economy.”
But the pessimists aren’t likely to be moved. There are more than enough worries out there to keep the bond ghouls active and thoughts of crisis bubbling. Indeed, preceding Wesbury’s chastising in today’s Journal was another op-ed piece in Thursday’s Journal from Michael Darda, chief economist at MKM Partners, who warns that any of the new tax hikes being discussed in Washington might take a heavy bite out of the economy at this juncture. One reason is that things might not be as rosy as they appear. Darda notes that using gold as a deflator, instead of the government’s consumer price index, reveals an economic horse of a different color: “If we use gold (which is real) as a deflator instead of the Consumer Price Index (which is not), the median home price stood at $216,200 as of October 2005, compared with $334,000 (in 2005 gold-based dollars) in July 1970.”
Northern Trust’s Paul Kasriel is partial to such thinking, as he explained in a research note yesterday. “If we use the price of gold as the deflator rather than the Commerce Department’s deflator of chained 2000 dollars,” Kasriel wrote, “it looks as though the U.S. economy still is in a recession despite the touted supply-side tax cuts we have had since 2001. Thanks for the tip, Mr. Darda!”