The yield on the US 10-year Treasury Note sank from a high of 3.97% in April to touch 2.49% recently.
But just what is the bond market trying to tell us? My analysis indicates that more than 75% of the yield on the 10-year note can be explained by MZM velocity, calculated as the ratio between GDP (current terms) and MZM (money zero maturity). When the historical relationship is applied to the current yield on the 10-year note of 2.54% it indicates that the bond market is expecting MZM velocity to fall from 1.55 to 1.47. Given the most recently released numbers for MZM a fall in MZM velocity will de facto imply that the US economy has shrunk by 5.2% in current money terms in the third quarter on a quarter-ago basis (22.5% annualised). You have to ask yourself whether this is realistic or not. What it means is that the bond market is saying that the US is already in a deep recession – therefore the double dip is already here!
The market has been wrong before. It tends to overshoot the underlying economic fundamentals significantly. In the final quarter of 2008 the market anticipated a much worse underlying economy than that which has eventuated. Since the second quarter of 2009 through the first quarter of this year the market was overly bearish on bonds by forcing up yields in anticipation of a much stronger economy. Is the market now overly bullish on bonds and bearish on the economy by forcing the yield on the 10-year note to levels similar to those that prevailed in the midst of the liquidity crisis?
It seems that the bond market takes its cue from consumer confidence rather than the underlying economy. In the final quarter of 2008 the yield on the 10-year note fell in line with the Conference Board’s consumer confidence index, thereafter rose in line with consumer confidence and overshot in the first quarter of this year.
The current yield on the 10-year note implies that the Conference Board’s consumer confidence index fell to approximately 40 from 50.4 in July. This will be the worst slump in consumer confidence since the second quarter of 2008. But how feasible is that? I think a slump to that extent is a real possibility especially in the light of extremely poor home sales in the US during July. The University of Michigan Consumer Sentiment Survey is due later today and is likely to give a clue on The Conference Board’ consumer confidence survey to be released on 31 August.
Considering the above, I am of the opinion that the bond market is correctly anticipating consumer confidence but that the yield on the 10-year note has overshot the underlying economic fundamentals. Time to close those longs in the bond market!
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