Bond market sees trouble where others see green shoots

From the looks of the bond market, you might think the economy was heading south—and fast.

March's retail sales rose 0.9 percent, the first increase after three months of declines but shy of the 1.1 percent expected. It showed consumers were spending again, and the economy is not tipping toward recession. Yet, Treasury yields, which move inversely to pricing, fell along the curve, and the 10-year yield dipped to 1.85 percent from an earlier 1.93 percent.

"Traders are saying: 'Show me, prove it,'" said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi. "I guess 0.9 percent in the scheme of things, given how severe the decline was in December, January and February, isn't enough to offset the loss of sales."

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The drop in retail sales has been in large part blamed on winter weather, still an issue in March. But consumers did buy vehicles in March, with a more than 17 million annualized selling rate showing up in the sales data. Without autos, retail sales were up just 0.4 percent.

"The market was positioning and hoping for a good number. This looks like probably a disappointing number, plus some forced short covering. That's what I'm seeing this morning," said Tyler Tucci, RBS short-term markets and interest rates derivatives strategist.

The first quarter has been flush with disappointments, the biggest of which was perhaps the March employment report. Just 126,000 nonfarm payrolls were created, about 120,000 less than expected. That number helped set the tone for a market that is highly skeptical that the Fed will be able to raise interest rates as quickly as it has indicated it might.

"There's fear of secular stagflation, deficient demand and these conditions lead to deflation," said Rupkey. "It's hard to get the bond market not thinking that way. It's still early. This was March. It was the tail end of the first quarter. If I had to guess, the data is going to soar here in the later part of the second quarter, but that's two to three months away."

GDP in the first quarter is expected to grow just more than 1 percent, before springing back in the second quarter and second half.

"I think this is positioning, as opposed to the market really viewing this as a 5-, 6-basis-point rally event," said Tucci. "I think this is a kind of a bit of an end of Q1 foot stomp as we move toward Q2. The market, in general, seems to be much more bullish on the economy for the second quarter, as far as I can tell."

Rupkey said the market could be impacted by the way it trades now, given the electronic trading and other influences. He said another negative feeding the market mood Tuesday was the fact that the IMF downgraded world growth.

"People are really focused, not on the inherent worth of the data or what it suggests for the future," said Rupkey. "It seems to be just a one-day trade, kind of game based on where did the number come in based on expectations. We always had an element of that but now it looks like it's going to be over the top."