Market Insider

The bond market appears to be signaling the worst is over for the economy

Key Points
  • Bond strategists say the bond market is signaling that investors believe the worst period for the economy was April.  
  • ADP's private payroll report showed job losses about 6 million fewer than expected, and that helped stoke a rally in stocks and a sell off in bonds.
  • Bond yields, which move opposite price, broke out of a range and are now poised to go higher, but not that much higher given the weak economy and expected 20% unemployment. 
A woman in a face mask carries away fresh seafood after shopping at Captain White Seafood in Washington, DC, on May 29, 2020, as the District's phase 1 reopening plan begins.
Jim Watson | AFP via Getty Images

The bond market has caught a tiny bit of the stock market's optimism, and it's selling off on the idea that the economy may have hit rock bottom in April.

Bond yields, which move opposite price, have been edging up, and on Wednesday they made a significant move higher off their relatively low base. The benchmark 10-year Treasury yield, which influences mortgages and other loans, rose to 0.77% from just under 0.70%. The 10-year was at 0.757, its highest level since April 13.

"We thought the bond market was left for dead, but it showed some life today," said Chris Rupkey, chief financial economist at MUFG Union Bank. "It seemed to be set up by the ADP report, but the bond market has always had a good strong reaction to the ADP jobs report even if other markets don't watch it as much."

ADP's private sector payrolls showed 2.76 million jobs were lost in May, while economists had expected to see more like 9 million lost jobs. The report is not an accurate guide to the government's monthly employment  report but it is watched for clues.

VIDEO2:1602:16
ADP: Private payrolls decline another 2.76 million in May

The May employment report is due Friday and is expected to show about 8.33 million jobs were lost and unemployment rose to 19.5%, according to Dow Jones. Some economists could revise their estimates after the ADP report, and Goldman Sachs economists said they will release their forecast after the weekly jobless claims report Thursday.

As yields move higher, the yield curve has also been steepening. That means the spread between the shortest duration securities and the longer duration notes and bonds is widening. It is the opposite of the so-called flattening yield curve which signals a worsening economy and recession.

The bond market has been mired at very low yields, in part because the Fed has set its target rate at zero, and also because of fears the economy will have a hard time getting out of the deepest and most rapid recession in history. The Fed is also actively buying Treasurys and other securities, which has been keeping rates low.

The 10-year yield's move higher took it out of a range that it's been at since April 16, when it rose above 0.74% Wednesday.

"I think it's acknowledging the worst of the economic hit might be in the rear view mirror," said Jon Hill, senior fixed income strategist at BMO. "That doesn't mean the Fed's raising rates. It doesn't mean we have a big bout of inflation. It doesn't mean quantitative easing is ending."

Stocks also were sharply higher Wednesday, with the S&P 500 up 1.4% at 3,122. Since bottoming on March 23, the S&P has rallied more than 41%. The 10-year yield, however, was at 0.79% on March 23, and it has gone lower as the stock market moved higher, reflecting a negative view.

Michael Schumacher, director strategy at Wells Fargo, said there's been a disconnect between the two markets, and today's action was the type of correlation they normally should have with stocks and rates rising, as bonds sell off.

"Stocks have gone crazy and bonds have not done much," he said, adding he expects yields to rise with the 10-year reaching 1% or higher by year end.

"You feel like the really bad data doesn't extend into May that much or linger into June. It's terrible but at least it's visibly getting less bad," he said. "There's still  20% unemployment and the payrolls [are expected to decline by] 8 million. These numbers are so bad they're numbing ... It doesn't matter as much as long as you think the forward path is better."

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Analyst sees 'good opportunity' in Asian high yields

Rupkey said the markets were much more suspicious of less bad data after the Great Recession, and the worry of high unemployment tempered market behavior. "I'm mystified that the market this time is saying the worst is over," he said. "I think the magnitude of how wrong things went for the economy is so great that a bottom in the economy doesn't mean as much as it used to simply because we're so far down, it will take years to climb back."

Rupkey said the best solution for the economy could be a vaccine or signs the coronavirus is no longer a threat.

Stocks have rallied on the prospect of new vaccines, but the bond market has mostly ignored that news. "It's going to be grim, at least for a year. ... If we can get past the wearing of masks, the caution. If we could get past the public wanting to save more money in the bank in case something goes wrong. There's going to be a lot of caution and people are going to be saving more and more and spending less," said Rupkey. 

U.S. yields have also been rising as German bund yields have moved up, on the prospect that the European Union will agree to a fiscal stimulus package, and ahead of the European Central Bank meeting Thursday. The German 10-year was at minus 0.35%, and it often moves in tandem with the U.S. 10-year. 

Hill said he's been watching the spread between the 5-year note and the 30-year bond, and it made a strong technical move to 118.2 basis points Wednesday. That level was from March 19, but if it continues to move the next level to watch is 121, a level that goes back to 2017. In afternoon trading, the 5-year was yielding 0.37% and the 30-year was at 1.55%.

The spread on the 2-year versus the 10-year yield was also the steepest since March 19.

"When you a fundamental steepener, plus a technical breach, you can get larger price action than you would normally," said Hill. He said it was also important that the 10-year broke its range.