Wednesday, October 26, 2016

Bond Investors May Be Bullish On Stocks

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*Raising rates should drop longer term yields as investors worry about a recession.
*The recent rise in rates and the yield curve could mean that confidence is actually picking up.
*It could also mean that inflation risk is rising but so far inflation numbers are subdued.
*If the economy were to work out of this almost-decade doldrums that would be a huge boost for stocks, if and when it were to occur.

If a rate hike would hurt growth, long-term bond yields should drop. They are rising as is the yield curve. That could hint to underlying confidence by bond (NYSEARCA:TLT)(NYSEARCA:AGG) players in growth. Citigroup's Surprise Index hit new recent highs in Europe. If the US economy did make it out alive it would surprise many and lift stocks.
Yield Curve Should Drop If There Is Recession Risk
The Fed appears intent again on raising rates. We can't know if they actually go through with it yet. The bond market though could be agreeing with the Fed's intent.
A rate hike means the Fed is confident enough to tighten monetary policy without risking a recession. They walk a tightrope with rates near zero because they've stated they don't have the means to drop rates much further to save another recession. If they raise rates it is a clear sign of confidence by the Fed that they think the economy is picking up and strong enough.
The bond market appears to agree.
If the bond market feared a recession yields would have dropped much like they did early this year. Instead, as the market prepares for a rate hike, yields and the yield curve are rising. Bond investors' knee-jerk reaction is to sell bonds thinking long end yields could go up further.
Longer term yields go up if growth or inflation were to pick up. So far inflation has been benign so the reaction is likely anticipating growth.
Rate Hike Expectations Drive Yields
First let's look at the Fed Funds futures.

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