Fourth of July combined with Wimbledon led to a quieter day for equity investors. Not even another missile launched by North Korea had much impact on sentiment. There has been a shift in investor attention in the past few days as yields have risen. Not too many moons ago, technology was a one-way bet, oil, well there was so much of it the price appeared in free fall. A fall in bond prices has led to a fall in tech stocks and the price of oil had rallied for 8 straight days. Yields on the 2-year Treasury bond, at 1.4% are the highest they have been since 2009. Yields on the ten-year US Treasury are back to 2.35%, however that is still below where they started the year. That is a flattening of the yield curve by one-third of one percent. As we have described before a flattening yield curve indicates the bond market have concerns for the outlook for growth, a steepening the inverse. Is the 30-year-old bond bull market about to come to an end? What will that do to equities if it is? Will the Philips curve, which plots the relationship between employment and inflation, finally start to play out?
On balance, the likelihood is inflation is probably not about to take off in any meaningful way, in fact, the recent bout of inflation could well have peaked. Any rise in bond yields will probably attract buyers, particularly US Treasuries. All the traditional drivers of higher inflation, wage growth and higher commodity prices, particularly oil, is not providing much in the way of inflationary pressures. The world remains consumed with debt and this again should mean yields on bonds remain close to current levels. Could the US yield curve invert as short-term yields rise further but longer end stay flat or fall? Possibly if the data from the US continues to weaken, however, there are signs that the economic data is improving slightly. The ISM manufacturing index rose in June by 2.9 points, the most since early 2013. At 57.8 it’s at its highest level in almost 3 years. Construction spending was flat in May, but the April estimate was revised up. The latest Chicago PMI for June came in well ahead of expectations. Having been on a steady downward path for most of this year, the Citi Economic Surprise Index has ticked higher recently, if only marginally.
Janet Yellen position is that the recent downturn in economic activity is transitory, she will hope these shoots will provide some well-needed support to her view.
We have also included a link to a piece we did on Bloomberg radio this morning when quizzed about the likely path of interest rates in the coming year.