The Daily Prophet: Bond Market Bears Face an Inconvenient Truth

Connecting the dots in global markets.

Whatever it is, don't call it a bear market in bonds. Maybe a cub market is a more apt description. Despite the benchmark 10-year Treasury note's yield breaking above the key 2.50 percent level this week to the highest since March and renewed worries about the potential for faster inflation, there's a lot to suggest the bottom isn't falling out  from under the market.

That was clear from the Treasury's auctions of three-, 10- and 30-year bonds this week. Each was met by some of the best demand in years, with Thursday's sale of 30-year bonds attracting $2.74 in bids for every $1 offered, the highest so-called bid-cover ratio since 2014. "This depth of demand should allay some concerns about a runaway increase in yield," Aaron Kohli, a rates strategist at BMO Capital Markets, wrote in a research note. The latest monthly survey of more than 60 economists by Bloomberg released Thursday shows that the 10-year note's yield, at 2.53 percent, is expected to be little changed through the rest of the quarter, and rising to just 2.90 percent by year-end. Economists have a history of being too pessimistic on bonds. At this time last year, they expected the yield to be above 2.75 percent by now and rising to 3.25 percent by the end of 2018.

Even Bill Gross, the Janus Henderson Group fund manager who called the start of a bear market this week, is skeptical of how much damage can be done in the $14.5 trillion Treasuries market, according to Bloomberg News' Brian Chappatta. He said Wednesday that he doesn’t foresee dramatic losses. In fact, he expects the 10-year yield may only rise 15 to 25 basis points more by year-end. “The bear market that I’m talking about is a mild one,” Gross said in a Bloomberg Radio interview. “I don’t think we’re headed for investment Armageddon.”

The price of oil reached a new milestone Thursday as Brent crude topped $70 a barrel in London for the first time in three years. Any pain at the pump that might result from higher gasoline prices may be short-lived for consumers -- at least those lucky enough to own funds tracking major stock indexes. The rally in oil has done wonders for the shares of energy-related companies, which have led the rally in major stock indexes globally. The energy portion of the MSCI All Country World Index rose 9.42 percent the past month, more than double the 4.57 percent the gain in the broader gauge. Three of the top five gainers in the S&P 500 over the past month are either directly or indirectly involved in the oil business. The U.S. energy sector is expected to post earnings per share growth for the fourth quarter of more than 126 percent, according to Bloomberg Intelligence. That's 10 times the median consensus estimate for the S&P 500 as a whole. “The psychology and sentiment is really strong at the moment,” Torbjorn Kjus, chief oil analyst at DNB Bank, told Bloomberg News. “It seems to be a broad macro view that not only oil but also other commodities are going to have a good year in 2018.”

The euro was in the spotlight on Thursday, as the Bloomberg Euro Index rose as much as 0.69 percent, the most in almost two months, on news that European Central Bank policy makers are open to tweaking their policy guidance soon to align it with a strengthening economy. In the account of its December meeting, the ECB Governing Council said there was a “widely shared” view among officials that communication would need to evolve gradually based on the outlook for growth and inflation, according to Bloomberg News' Alessandro Speciale. But the language on the monetary-policy stance could be revisited early this year, leading traders to speculate that the ECB's bond purchases will end in September. That's good for the euro because it means the ECB will stop printing euros and debasing the currency to make its acquisitions. Though inflation remains weaker than the ECB would like, the broader economy is booming, with the central bank estimating the fastest expansion in 10 years in 2017. Surveys of confidence have surged and measures of activity are at multi-year highs.

Speaking of inflation, food prices globally have been in decline for the past three months and fell in December by the most in more than two years. Food got cheaper thanks to a slump in prices of sugar and dairy products from cheese to butter, the United Nations’ Food and Agriculture Organization said Thursday. Prices of meat, grains and vegetable oils fell, too. Lower prices of staples may help restrain inflation at a time when investors are betting it will pick up, spurred by a surge in commodities and the fastest world economy since 2011, according to Bloomberg News' Agnieszka de Sousa. The Bloomberg Commodity Index rose for a record 14 days in a row in the period ended Jan. 3, reaching a three-year high. Central banks often try to set aside volatile food prices when deciding on interest rates, although staples do form a bigger part of inflation baskets in developing nations such as India. Still, cheaper food will leave households with more disposable income to spend on non-essential items.

The good news is that economists expect the Republican tax cuts to give the U.S. economy a boost. The bad news is they don't see growth matching the greater than 3 percent levels of the second and third quarters, the most recent periods for which data are available. According to a new Bloomberg News survey of almost 100 economists conducted over the past week, the economy is seen expanding at an average pace of 2.5 percent over the next seven quarters, compared with an average of 2.3 percent in last month’s survey. The new tax legislation, signed into law by President Donald Trump, is seen supporting the economy along with gains in consumer spending and private investment, according to Bloomberg News' Joshua Robinson. Also, inflation could dip below the Fed’s 2 percent target by the end of the first quarter, but bounce back above target through the rest of this year and into 2019. Fed policy makers are forecast to increase interest rates two times before the end of the second quarter, according to the survey. Economists previously expected just one hike in the first half of the year.

Friday marks the official start of earnings season, as JPMorgan Chase reports fourth-quarter results at 6:45 a.m. New York time. Although U.S. companies are expected to report strong growth of 12 percent in earnings per share, it could get messy. According to the equity strategists at Bloomberg Intelligence, tax charges are likely to riddle the landscape, with results obscured by one-time tax payments for international profit. As a result, the focus will be on what company executives say about the outlook given the effects of tax reform. As the BI strategists note, while higher profit targets should reflect lower taxes, it's critical to keep an eye on revenue. A lower corporate tax rate provides near-term benefits, but the longer-term outlook will depend on revenue improvement as inflation pressures mount. Investors already know about a slew of tax write-offs due in the quarter, including JPMorgan’s "adjustment" of as much as $2 billion, a $20 billion hit at Citigroup and a $5 billion hit at Goldman Sachs.  

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