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The Wages Of Fear: Why Fixed Income Bears Closer Scrutiny

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The Wages Of Fear: Why Fixed Income Bears Closer Scrutiny

You won’t find many people willing to argue that the fixed income market has been especially exciting over the past decade, even with the 10-year bond yield’s recent rise above 3 percent for the first time since 2014.

You might even ask “Who cares about the bond market with cryptocurrencies, oil on a tear, and the equities market still smoldering?

Well, now might be exactly the time to pay attention to that yield, and funds that have exposure (or inverse) to bonds, like Direxion’s Daily 7-10 Year Treasury Bull (NYSE: TYD) and Bear (NYSE: TYO) 3X Shares ETFs or the Daily 20+ Year Treasury Bull (NYSE: TMF) and Bear (NYSE: TMV) 3X Shares ETFs. However, the catalyst for this attention has nothing to do with that 3 percent milestone. Instead, traders eyeing fixed income should pay attention to some broader economic indicators that stand to shift the balance of the bond market.

For instance, the most recent meeting of the Federal Open Market Committee revealed that previous fears among investors of four or even five interest rate hikes this year might have been extremely overblown. The minutes from that meeting showed the committee’s willingness to let the economy generate some heat, hoping to exceed the target 2 percent inflation that has been an extremely firm ceiling for the better part of the past decade.

The commentary in those minutes, in turn, caused demand for medium- and long-term government bonds to jump and yields to fall, as much as 3 percent in the case of the 30-year. However, this willingness to let the economy overheat assumes that the U.S. economy is in line for the type of growth it hasn’t seen since the 2000’s. That outcome is possible, but not guaranteed.

By the most common measure — GDP growth — the economy is grinding along at a steady clip, something like a comfortable holding pattern between 2-3 percent that we’ve seen consistently since 2015. By other measures, corporate revenues are, on average, as good as they’ve ever been. The 2018 Q1 earnings season saw 79 percent of companies report positive earnings surprises and 74 percent with positive sales surprises. Couple those figures with the potential effects of the tax overhaul and the injection of capital that represents, and it’s hard not to see some potential in bond market yields growing beyond that 3 percent level, as investors continue to fuel the bull market.

That’s one narrative. Another narrative is far less optimistic for fixed income and the economy at large. Consider other measures of growth and economic stability like real wage growth and individual debt. It’s no secret to those who follow the market that wage growth has been worse than anemic for the better part of 20 years. That trend has shown little sign of changing for most earners, with those in the middle and lower income percentiles earning real wages about what they were in 1979.

What is changing fairly rapidly is the levels of consumer debt obligations. One of the more dramatic perspectives on this is the precipitous rise in credit card delinquencies. However, increases in auto loan rates and mortgage rates to their highest levels in years also stand to put increased debt pressure on what most Americans can (or can’t) afford to purchase.

These factors have the potential to put a damper on the excessive growth projection and any correlated rally in fixed income vehicles. What will be key in determining the demand and, inversely, the yield on government bonds is whether the average American can afford to make those payments on that new home mortgage or auto loan. If not, don’t expect those corporate balance sheets to stem the tide of fearful fund managers buying up as many treasury notes as the government can print.

For now, traders should look to the Bureau of Labor Statistics’ monthly report for indications of where the fruits of the economic growth are going. The fate of fixed income will depend on whether a rising tide truly does buoy all ships, or just the yachts.

Posted-In: direxionBonds Specialty ETFs Federal Reserve Markets Trading Ideas ETFs Best of Benzinga

 

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