Either bond markets have taken leave of their collective senses, or they too are smelling the re-emergence of animal spirits among investors in equity markets,
A month ago markets were warily waiting for the next disaster to hit after the Bear Stearns rescue: but $US100 billion worth of capital raisings by banks and other financial stocks in the US and Europe, the Fed’s $US360 billion 28 day money Term Auction Facility funding liquidity in the US markets, and the Bank of England $US100 billion facility to support the UK banking sector, and its becoming a case of ‘gloom, what gloom?’
Wall Street shares are within 4% of becoming positive for the first time this year and inflation fears are back in vogue among the usual bunch of hawks who were all for ‘the end of life as we know’ it a few weeks ago.
Not even confirmation that US consumer confidence sank to its lowest level in 26 years altered sentiment in bond markets.
The final reading from the University of Michigan Consumer Confidence survey revealed that high food and fuel prices, coupled with shrinking incomes and falling home values, have driven consumers to save their money rather than spend it.
The survey’s Index of Consumer Sentiment, a closely watched indicator of the economy’s current health, fell to 62.6 in April, a drop of 6.9 points from the previous month and the lowest level since 1982.
The Index of Consumer Expectations, which economists use to help determine the economy’s future direction, fell to 53.3 in April, a drop of 6.8 points from the previous month.
According to the survey, only 30% of consumers plan to spend their upcoming tax rebate, while the rest said they would use it to pay off debt or put it into savings. The first cheques from that rebate go out Monday night. Around $US162 billion will be paid out to 130 million people, give or take a few. That could be enough to get the Fed to pause at its meeting this week.
It remains to be seen what happens to confidence and rates when the Fed kicks the supports away of lower interest rates and the Term Auction facility and the twice a month exchange of T-Notes for other lesser securities, which it has to start doing soon.
But the bond market reckons things are rapidly getting back to normal. While equities and commodities have mostly enjoyed April, bond investors have found it hard going as it has gone on.
The Financial Times remarked on Friday that April has been the cruelest month for government bond markets in years, with prices falling and interest rates rising sharply in the US, Europe and Japan.
Investors who jumped into the safety of government securities, especially at the short end of three to six months, have been badly burned this month on the optimism that the worst is over.
Helping change attitudes about bonds and fixed interest has been the surge in oil and food prices, which have in turn triggered the worries about inflation. (You only have to look at what is happening here in Australia, to get a taste of that.)
The FT says a global index of government bonds from 33 countries compiled by Lehman Brothers has fallen 3% this month, its first decline since December and the worst performance since a fall of 4.3% four years ago, while Lehman’s US Treasury index has fallen 2.1%, its worst performance in four years. In contrast the Standard & Poor’s 500 has risen 5.7% so far this month.
The change in expectations has been noticeable for about a week as confidence levels in equity markets and especially in financial stocks on the flood of refinancing, led more and more analysts to conclude that at best the US Fed will cut rates 0.25%, or even leave them unchanged at its meeting this week.
The two-year US Treasury note yield reached a high of 2.50% on Friday, up from 1.6% at the start of the month. It closed at 2.41%, above the current 2.25% Federal Funds for the first time since the middle of 2006.
In Japan bonds suffered their biggest one-day drop in five years on Thursday and Friday, sparking a sell-off in other bond markets around the world.
The yield on 10-year Japanese government bonds surged 0.125% to 1.6%. Futures trading was halted for 15 minutes at one point to allow the market to calm down and yields on five-year notes jumped even higher, rising 0.19% to 1.24%.
Hedge funds had started selling earlier in the week, creating bearish sentiment in the world’s largest bond market. They were rumoured to be selling bond futures and buying equity futures.
The Bank of Japan produces its latest economic outlook this week and there’s a suspicion that despite more signs of a slowing economy, Japanese interest rates could be nudged higher because of rising producer and consumer inflation.
The headline core CPI rate, which includes fast-rising energy prices, rose 1.2% in the year to March, the highest in 10 years and a better reflection of how consumers perceive price changes.
And the drivers? Of the 1.2% rise in the headline CPI, 0.73 percentage point was due to energy and 0.41 percentage point from food.
So while poor and developing countries struggle with supplies and the price of grain and other foods, richer economies are finding a ‘price shock’ from higher oil and food prices that transcends the statisticians fiddling with the numbers to try and find core prices. In Australian food and energy were influential in boosting core inflation to 4.1% on the RBA’s preferred measure, compared to the headline CPI of 4.2% in the year to March.
That’s why bond markets have re-awakened. Eventually equity investors will awaken to the dangers of inflation. Is that the next part of this odd financial crisis t
