What are the bond markets telling us about the US economy?
The Great Pandemic Recovery (2020-2021), a stimulus-driven recovery that brought the US economy back to life after a sharp downturn, will likely go down in history as one of the most dramatic macroeconomic events ever. registered, QNB said. in its last report.
After U.S. nominal GDP collapsed more than 33% annualized in the second quarter of 2020, it rebounded strongly, posting nominal annualized growth rates of 38%, 6% and 11% over the next three quarters. until the first quarter of this year.
In the process, US markets have seen extraordinary rallies, with stock indices showing strong performances and cyclical commodities reducing previous losses or even reaching new highs, QNB said.
Above all, the macro-sensitive bond markets confirmed the positive context. In fact, from August 2020 to March 2021, bond yields indicated continued favorable winds for the U.S. economy. The benchmark spread between 10-year and 2-year Treasury bills widened, leading to a healthy steepening of the yield curve.
This was a positive sign for economic expansion, as lower yields at the short end of the curve implied monetary stimulus and higher yields at the long end of the curve implied growth expectations. or higher inflation. In addition, the price ratio between high yield corporate bonds and US Treasury bonds has increased, suggesting a high risk appetite on the part of bond investors or a “risky” environment for months, according to the company. QNB.
After March 2021, however, bond markets began to act differently, with the yield curve flattening and risk appetite diminishing. This process accelerated after the last Fed Open Market Committee (FOMC) meeting in June. Then, policymakers signaled both their willingness to start discussing a reduction in quantitative stimulus measures and projections of two key rate hikes in 2023, after a zero hike expected in March 2021.
“In our opinion, the bond markets are sending two messages to the US economy. First, bonds predict that US growth has likely already peaked in the second quarter of 2021, after several quarters of hyper-strong activity. In other words, bond markets point to a significant slowdown in the US economic recovery, with nominal growth rates expected to return to a more normal level of around 4% per year.
“This idea of bond markets appears to be supported by a plethora of other data, including weakening money supply, personal income and growth in retail sales. This is also consistent with a more risk averse stance on the part of bond investors in recent months, ”QNB said.
“Second, the bond market views current inflationary pressures as simply temporary, possibly due to commodity supply constraints linked to the pandemic. A flattening of the yield curve (rising short rates and falling long rates) suggests that inflation is only a short-term concern.
“In fact, implied inflation expectations for 10-year bonds (breakeven inflation) fell significantly by 25 basis points last month to a contained level of 2.3%, well below the level. current consumer price inflation of 5% for May 2021. Therefore, bond markets believe that inflation will moderate in the future.
QNB added, “Overall, the bond markets are sending a strong contrarian message to investors and economists, challenging the dominant narrative of continued strong growth and un-anchored inflationary pressures in the United States. . It also indicates that the Fed should be careful not to withdraw the stimulus too soon. ”