The Real Economy Is Talking, but Treasuries Aren't Listening

Something's gotta give?

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A woman walks past a statue of Albert Gallatin, the 4th Secretary of the U.S. Treasury, while entering the Treasury building in Washington, D.C.

Photographer: Brendan Smialowski/Bloomberg

There's a massive divergence between recent economic data and U.S. Treasury yields.

Amid widespread risk aversion, the yield on 10-year debt fell below 1.60 percent this month before recovering to back over 1.75 percent on Thursday. According to Deutsche Bank AG Chief International Economist Torsten Sløk, that's still far too low.

The Atlanta Fed's GDPNow indicator provides an estimate for quarterly economic growth based on recently released economic data, which currently stands at 2.6 percent for the first quarter:

Deutsche Bank

"Using the historical relationship between the Atlanta Fed GDP Now estimate and 10y rates shows that 10y rates today should not be 1.82% but instead 2.3%," he wrote. "Put differently, markets are currently pricing a deep recession, but that is simply not what the data is showing."

Some caveats apply: The sample size depicted here is quite small, so there's no guarantee the Atlanta Fed's GDPNow will prove accurate, and the composition of growth, not merely the headline rate, is important in assessing economic health.

Additionally, while it makes intuitive sense for there to be a relationship between yields on sovereign debt, it's worth remembering what goes into a bond yield: expectations regarding short-term interest rates, market-based measures of inflation compensation, and the term premium (what investors demand for taking on more duration).

At present, market-implied expectations for the federal funds rate and inflation are quite low. Term premiums are also suppressed, due in part to strong demand for U.S. assets that are perceived as a safe haven, particularly in times of market turmoil. Those assets also provide a yield that's more attractive than most other advanced economies.  

Expected nominal GDP, therefore, would be a superior (though still imperfect) proxy for judging where yields ought to be.

Building off Sløk's chart by adding the Cleveland Fed's expected core inflation to the mix, Renaissance Macro Research Head of U.S. Economics Neil Dutta, who favors consumer cyclicals and U.S. industrial stocks, found the correlation between the two even tighter. He concluded that nominal growth either has to go down or yields have to go up:

Renaissance Macro

"I have said this to clients: If you want to hold a 10-year U.S. Treasury yielding sub-2.0 percent with wage inflation at 2.5 percent and core inflation near 2 percent, be my guest,'' said Dutta. ''I'll find something else.''

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