×

Yields are sending a disturbing message: Bond pro

It might be the market's most persistent mystery this year: If the economy is improving, and the Federal Reserve is pulling back on stimulus, then why are bond yields still so low?

For Lawrence McDonald of Newedge, the answer is simple: The first assumption, that economic growth is accelerating, is not really accurate.

Crude oil and gold have both sunk this year, and in July the S&P GSCI commodities index erased nearly all of its gains for the year. McDonald pointed out on Tuesday's "Futures Now" that you wouldn't normally see such bad commodity performance if the economy was really picking up.

Read MoreAfter awful July, commodities could mount a comeback

Within the stock market, he notes that the retail sector is "massively underperforming" the S&P 500, which also seems to send a sour message about the economy.

But to this bond expert, the most troubling sign is that the 10-year yield has fallen relative to the 2-year yield. Known as a "flattening of the yield curve," this kind of relative performance tends to occur when bond investors don't think economic growth (and thus inflation) in the longer-term will outpace economic growth in the shorter-term.

In combination with his thesis that "the data is showing us something concerning in terms of the economy," McDonald determines that "all of those things together add up" to portray a dour portrait of economic growth.


Treasury bonds traders
Getty Images

Of course, other bond experts say the flattening of the curve simply indicates that people are wagering that the Fed will raise short-term rates. This is another textbook reason why people will bet on higher short-term bond yields relative to long-term bond yields.

"Short and intermediates are starting to price in the Fed ultimately going as we get closer and closer, and the long end is seeing some very good duration buying," Cantor Fitzgerald interest rate strategist Justin Lederer commented last week.

Yield curve flattest in five years ahead of Fed

Still, with the 10-year yield at about 2.5 percent versus a 2-year yield around 0.5 percent, the spread is indeed notably slim. In fact, the yield curve is about as flat as its been in five years. And McDonald thinks that longer-term yields can continue to drop through the rest of the year.

"I've been on the show four times this year—when we were at 3 percent, when were were at 2.80, when we were at 2.60—I still think we're going to get down to 2.20, 2.25, 2.30 in terms of the 10-year yield," he said.

—By CNBC's Alex Rosenberg

Watch "Futures Now" Tuesdays & Thursdays 1 p.m. ET exclusively on FuturesNow.CNBC.com!

Videos

Host Bio & Watch Now

Trader Bios