The Daily Prophet: Can Anything Stop This Bond Market Rally?

Connecting the dots in global markets.

Perhaps the ultimate pain trade in recent years has been to bet against bonds. Despite never-ending warnings that fixed-income assets were a massive bubble about to burst, the market has largely rewarded those who stayed the course and punished those who have constructed massive short positions.

While bonds did have a nasty sell-off at the end of 2016, sparked by Donald Trump’s election victory and the prospects for faster inflation, they have since staged a comeback. The Bloomberg Barclays Global Aggregate Index is headed for its third straight monthly gain. Bonds rallied today after Reuters reported that European Central Bank policy makers feel their remarks about monetary policy earlier this month were misinterpreted as being too hawkish. The demand carried through to the U.S.’s auction of $28 billion of seven-year notes, which saw near-record demand from a class of bidders that includes foreign central banks.

The economists at FTN Financial, who have been very accurate at forecasting the bond market in recent years, see the rally lasting at least through next year. They forecast the yield on the benchmark 10-year Treasury, which was at 2.39 percent today, will fall to 2.25 percent at the end of 2017 and to 2.10 percent at the end of 2018. While collapsing expectations for meaningful U.S. fiscal stimulus are part of their thinking, the bigger reason is that “Fed has earned a reputation for excessive zeal in its fight against inflation,” FTN Chief Economist Chris Low wrote in a note to clients. “The result will either be persistent sub-2 percent inflation or a recession and a few years of well-below 2 percent inflation. Either way, the [yield on the 10-year] note cannot go much higher in the medium term.”

The ECB report weighed on the euro as traders pushed back their timing for when the central bank starts retreating from its extraordinarily easy money policies. The Bloomberg Euro Index, which tracks the currency against a basket of its peers, fell the most in five weeks. The only major currency that the euro didn’t fall against was the Swedish krona. Demand for the shared currency had been on the rise in recent weeks as concerns eased that French presidential candidate Marine Le Pen, who favors taking the nation out of the euro, would have a chance at winning the election. That’s one reason why Credit Suisse currency strategists said today that they were raising their forecasts for the euro against the dollar over the next three and 12 months.

Evercore ISI just conducted a survey on the outlook for stocks and found that 72 percent of respondents view the S&P 500 as overvalued. The survey also found that almost 78 percent still expect equities to rise over the coming year. The benchmark, which was little changed today, is limping into the end of the month as traders begin to doubt whether the Trump administration will be able to push through meaningful stimulus measures, namely big tax cuts, anytime soon after its health-care defeat. One worrisome sign is margin debt, which at about $530 billion has reached a new record. Bears like to point to high levels of margin debt as evidence enthusiasm for equities is overheating because the value of stock loans usually tops out at the same time as the S&P 500. The growth in margin debt over the last year, though, has been in line with the gains in the S&P 500, a departure from when margin-debt growth outpaced share gains by threefold in 2007 and almost five times in 2000, according to Bloomberg News’s Lu Wang.

The oil market may turning a corner after crude collapsed to as almost $47 a barrel in recent weeks from almost $55 in February. Prices rose again today, capping the biggest two-day gain since mid-January. West Texas Intermediate for May delivery rose $1.14, or 2.4 percent, to $49.51 a barrel after the government reported a larger-than-projected decline in U.S. gasoline inventories. Gasoline supplies dropped 3.75 million barrels last week, according to a U.S. Energy Information Administration. A 2 million-barrel decline was forecast by analysts surveyed by Bloomberg, according to Bloomberg News’s Mark Shenk. Refineries boosted the amount of crude they processed by the most in almost three years.

The U.S. housing market is on fire. Last week, the Commerce Department said purchases of new homes increased to a seven-month high in February. Today, the National Association of Realtors said contracts to buy previously owned homes jumped 5.5 percent in February, the most since July 2010. The gains ratify data showing big increases in consumer confidence. They also signal that warmer weather in February may have helped bring forward the start of the busy spring sales season. Buyers may have also felt pressured to buy amid expectations of higher interest rates down the road. At the same time, lean inventories are keeping asking prices elevated, according to Bloomberg News’s Patricia Laya. The Dow Jones U.S. Select Homebuilder Index has soared 16.4 percent this year, compared with a gain of 5.53 percent in the S&P 500 Index. 

At its current pace of gains, the Mexican peso could erase all of its losses related to Trump’s election victory in a matter of days. The peso has appreciated 8 percent this year, more than any of the other 31 major currencies tracked by Bloomberg. Part of the gains can be tied to optimism that the Border Adjustment Tax included in Republicans’ initial tax reform proposal may not make it to the final bill, at least in its current form, according to Deutsche Bank. Also helping are the three interest-rate increases by Mexico’s bank since the November election. It may act again on Friday, boosting the benchmark rate to 6.50 percent from 6.25 percent, according to the median estimate of economists surveyed by Bloomberg.

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