It Helps to Watch the Bond Market

Treasury prices are climbing higher in early trading with the benchmark 10yr up almost a half of a point to yield 3.88 percent while the 30yr bond is roughly a full point higher to lower its yield to 4.32 percent. Highlighting the pronounced degree of volatility currently embedded within the financial sector, investors should expected further consternation in the general direction of interest rates given the release of the employment data at the end of the week and the next FOMC meeting eight days away. Despite all the uncertainty, however, the broader economy remains poised to outperform the financial sector as indicated by the corresponding slopes of the Treasury yield curves.

With a difference of 60 basis points, the spread between the 2yr/30yr curve and the 3mo/10yr curve is particularly low given historical norms. Due to the abnormal amount of productivity accumulated over the course of the prior decades and mostly underutilized to this point, the economy will have relatively easier time acting with a greater degree of efficiency than that of the financial sector as investors un-extrapolate growth prospects already “priced-into” a number of investment vehicles.

As far as interest rates are concerned, nominal levels have a strong tendency to go lower overall (not, however, in a straight line dynamic) as the current environment is decidedly non-inflationary in nature. With the output gap (the difference between realized and potential rates of GDP) continuing to widen, the strength of long-term disinflationary pressures are poised to easily overcome that of any transitory inflationary dynamics that flare up in the interim. One such risk would be the reversal of the current trade environment.


According to last quarter’s GDP data, exports growth topped 18 percent for the period, extremely high for a service-dominated economy. The uncharacteristic performance of exports, subsequently, owes much of its near-term success to the general weakness in the trade-weighted dollar. The performance of the dollar reflects the health of trade at any given time which means that should trade revert to more efficient fundamentals; the dollar should begin to regain its value over a protracted timeframe. Domestic good-production, therefore, will need to be monitored closely for any signs of such a change, a major reason why today’s ISM data is so important.

According to the Institute of Supply Management (ISM), the monthly diffusion index for November came in at 50.8, mostly in line with consensus estimates. The lowest realized level since January, activity was about the same it was in October (50.9) showing signs of slowing manufacturing growth quarter-to-date. Much like the headline data, new orders grew at a similar pace they did in October (52.6 vs. 52.5), decidedly below the six month average of 55.3. Hiring, meanwhile, fell to below contractionary sub-50 levels for the first time since March. New export orders, however, was strong again last month while imports fell for the second consecutive month. Taken altogether, although overall export orders remain strong, the overall sustainability of continued strength remains very much in question given the lack of further investment within the manufacturing sector.