The S&P 500 Index has rallied mightily off of its March 23 low, climbing almost 40% through the close of the market yesterday, as market participants look ahead to the economy continuing to gradually reopen. While there are signs that bond market participants’ overall assessment of the economy is slowly edging toward a similar outlook, it’s hard to call them true believers yet.
“Bond markets do tend to be more cautious than stock markets,” said LPL Equity Strategist Jeff Buchbinder. “As a result, historically we often get earlier warning signs from bond markets when things are about to go sour, but equity markets may have an edge in signaling the potential for an economic turnaround.”
As shown in the LPL Chart of the Day, while the 10-year Treasury yield has advanced in recent months, the move off the bottom remains muted, and the 10-year yield remains lower than where it was when the S&P 500 bottomed March 23. It makes for an especially strong contrast with the start of prior periods of Federal Reserve (Fed) bond-buying, or “quantitative easing,” when 10-year yields started to rise more robustly as markets began to anticipate stronger economic growth, although it could still be early.
Nevertheless, there are some positive signs in current bond markets. While Treasury yields haven’t moved much, they are moving in the right direction. Investment-grade and high-yield credit spreads continue to contract, a sign of economic confidence. We are seeing some steepening in parts of the yield curve (the difference between longer-term and shorter-term Treasury yields), usually also a positive economic signal. Perhaps most important, Fed policy has helped resolve some of the bond market dislocations we saw when market stress was at its highest.
There are several forces in play keeping bond yields restrained independent of growth expectations. Inflation remains low, and there’s likely to be minimal inflationary pressure as the economy recovers. US Treasury yields remain attractive compared with other developed economies. Finally, the Fed and other central banks are buying bonds, creating added demand.
Assuming no major setbacks in reopening the economy, we expect Treasury yields to become more responsive to the economic environment over time and drift higher, but looking into 2021, we think the likelihood of a significant, sustained move higher remains low.
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