The Daily Prophet: Carville Was Right About the Bond Market

Connecting the dots in global markets.

In the 1990s, the Democratic political adviser James Carville said: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” Right now, looks like bonds have the rest of the financial markets pretty intimidated, with global stocks falling the most since August.

Carville's remarks came after proposals by the Clinton administration to spur the economy in 1993 were stymied by concern about how bond investors would react to increased debt and deficits. A quarter of a century later, the Trump administration will as soon as this week start outlining its plan to boost borrowing to pay for tax reform and a rising budget deficit. And just like in the early 1990s, the bond market is responding by pushing yields up, this time to their highest since early 2014. The prospects for higher borrowing costs look like they may be spooking the equities market. “We are entering a new era in the U.S. with where the 10-year is headed,” Michael Antonelli, an institutional equity sales trader and managing director at Robert W. Baird & Co., told Bloomberg News. “Once rates start to rise precipitously, that’s a problem for the stock market.”

Two weeks ago, when the benchmark Treasury 10-year note yielded 2.55 percent, Bloomberg News' Michael Regan reported on a research report by Leuthold Group's chief investment strategist, who said the weakest returns in stocks came after the yield rose to more than one standard deviation above the downward trendline it's traced out since 1980. At the time, that one-sigma level was 2.44 percent. The yield today reached 2.70 percent.

The stock market, which was down the most since Aug. 17 in late trading based on the decline in the MSCI All Country World Index, might have another problem besides rising interest rates. The rally in equities since mid-2017 had been underpinned by signs of a strengthening global economy. But in the last few weeks, stocks continued to march higher even though the Citi Economic Surprise Index, which measures data that exceed forecasts relative to those that miss, turned lower. Nobody is ready to throw in the towel on stocks, and the weakness Monday just may have been a logical pause following the best start to a year since 1987, but there's a palpable sense of concern among global finance executives. That was evident last week at the World Economic Forum in Davos, Switzerland, as the leaders of Barclays, Citigroup and the Carlyle Group all warned of parallels between today’s soaring stock markets and the froth of the precrisis years. “You’ve got markets at record highs, and, as we know, these things don’t go in a straight line,” James Gorman, Morgan Stanley's chief executive officer, said Jan. 24 in an interview on Bloomberg Television.

Higher bonds yields in the U.S. gave a boost to the greenback on Monday, with the Bloomberg Dollar Spot Index rising the most in six weeks. But don't expect the start of a new trend of the dollar, which has been under pressure for the better part of 12 months. Bloomberg News' Lananh Nguyen reports that UniCredit, JPMorgan and Morgan Stanley all say accelerating global growth should continue to boost other nations’ currencies relative to the dollar. “We’re going to remain in this dollar bear market on a multi-quarter horizon,” Vasileios Gkionakis, head of FX strategy research at UniCredit in London, told Bloomberg News. Monday’s strength in the dollar was likely driven by investors covering profitable short positions after the latest leg lower. “Global growth remaining robust should keep USD on a bearish trend,” Morgan Stanley strategists including Hans Redeker wrote in a research note. “It looks increasingly likely that our forecast of $1.33 by end-2019 may be reached earlier than expected,” they wrote, referring to the euro-dollar rate, which is currently at about $1.2388.

The dollar's strength had an impact on the market for raw materials, as the Bloomberg Commodities Index dropped the most in three weeks. Commodities are largely traded in dollars, so gains in the greenback make it more expensive to buy commodities. Some of the biggest losers Monday were petroleum products such as Brent crude oil, as well as silver, aluminum and cotton. Hedge funds either didn’t see the rally in the greenback coming or they are think it may have more to slide. That's because hedge funds reported record wagers on continued price increases for both U.S. and global oil benchmarks, along with gasoline and diesel, according to Bloomberg News' Jessica Summers. Hedge funds raised their West Texas Intermediate net-long position -- the difference between bets on a price increase and wagers on a drop -- by 2.9 percent to 496,111 futures and options during the week ended Jan. 23, the highest in U.S. Commodity Futures Trading Commission data going back to 2006. “The long oil trade continues to be the place to be,” Rob Thummel, managing director at Tortoise Capital Advisors, which handles $16 billion in energy-related assets, told Bloomberg News.

Emerging-market investors were closing watching Russia Thursday as the nation's bonds slumped, with some yields climbing to the highest in two months before a U.S. Treasury Department report gauging the impact of possible sanctions on the nation’s debt. The review has been the biggest headwind for investments in Russia’s $120 billion debt market since it was reluctantly commissioned by President Donald Trump in August as allegations of Kremlin election meddling swirled, according to Bloomberg News' Ksenia Galouchko and Natasha Doff. While the report could serve as a basis for what M&G Ltd. called the “nuclear option” for U.S.-Russia relations, most investors attracted by Russia’s outsized real rates don’t see debt sanctions as a base case scenario. “During our trip to Moscow at the beginning of the year, nearly every single meeting contained some discussion of the potential expansion of U.S. sanctions in the nearest future,” Vladimir Osakovskiy, an analyst at Bank of America Merrill Lynch, wrote in a research note last week. But “the risk of an escalation of sanctions is currently perceived as low,” he said. UBS strategists shifted their ruble recommendation from "overweight" to "neutral," citing the sanctions report.

Before Trump gives his State of the Union speech Tuesday night Washington time, he'll get a glimpse of the latest reading on consumer sentiment from the Conference Board. This month's report is a must-watch after December's measure dropped the most since 2015. Yes, consumer confidence is still near a three-year high even with the drop, but what's worrisome is that it came even as Congress moved toward passing tax reform. A big reason why confidence declined in December is because consumers' outlook dipped the most since 2013. Maybe last month was just a pause, but government data Monday showed that the U.S. savings rate fell to the lowest since 2005. At the same time, Fed data show that consumer credit, including auto and student loans, climbed at a 4.9 percent rate in the third quarter, faster than the 1.8 percent increase in net worth.

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