Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Bond traders walk around with dark clouds over their heads.

They see doom when stockbrokers see opportunity. When equity investors are throwing a party, debt investors sit in the corner and nurse some seltzer, waiting for everyone else to suffer a hangover.

And so it goes now. While stock investors show no fear of another Federal Reserve rate increase, bond investors are starting to worry. Their angst is cropping up in the form of a flatter yield curve, which typically signifies that traders are pricing in slower growth in the years ahead.

In fact, one of the most important yield curves, the gap between five-year and 30-year Treasury rates, has narrowed to almost the flattest since 2007.

This anticipation of lower growth contrasts profoundly with the dominant narrative that's been fueling riskier bond and stock values -- that the U.S. economy is accelerating and poised for an era of expansion and prosperity.

The Fed has bought in. On Friday, Chair Janet Yellen all-but confirmed that the central bank will raise interest rates this month, saying such a move would "likely be appropriate" if employment and inflation continue to meet policy makers' expectations.

Yellen's comments, delivered at a lunch in Chicago, simply ratified what debt markets had already rushed to price in earlier in the week. Bond investors now widely expect near-term borrowing costs to rise in short order. Yields on two-year Treasuries are at about their highest levels since 2009. This comes in response to falling unemployment levels and significantly improved consumer sentiment.

Big Shift
Traders have substantially boosted their expectations for a March Fed rate hike
Source: Bloomberg

But while traders are pricing in a near-term tightening in credit conditions, they seem increasingly less optimistic about the longer term.

Slowing Down
Debt traders are pricing in higher short-term yields but lower long-term rates
Source: Bloomberg

After all, that proverbial party is coming to a close and the Fed is taking away the punch bowl. It's trying to do it slowly, so it doesn't derail the economy, but at some point that reality is going to sink in, and investors are going to question the value of assets that have been inflated by years of stimulus.

In other words, without the punch bowl, it's hard to see how junk bonds and stocks are going to continue to rally without additional help. While that assistance may come from President Donald Trump's $1 trillion infrastructure spending program, it's still only conceptual, and that's putting it charitably given the political and logistical challenges.

Losing Luster
Investors are earning the least from the S&P 500 relative to 30-year bonds in years
Source: Bloomberg

U.S. stock markets are having none of that pessimism. They reached new highs this week and stayed near there, even as it became clear that the Fed is all but certain to raise rates this month. 

Investors who are plowing into riskier securities ought to pay heed to the dour debt party poopers crowded into the corner. All parties come to an end, and sometimes the hangover is non-negotiable. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net