Markets ≠ The Economy: Yields vs Data
Great economic data coming out of the US last week has the market in a tizzy. Unfortunately it’s the confused-not-great kind of tizzy, not the giddy-everything-is-rosy kind.
Retail sales in the US grew at a mindblowing 27.7% YoY, while jobless claims came in at 576,000; the first time it printed below 700,000 in about a year. Given that the last few months have seen USTs at the forefront of assets “pricing in” the great reflation, the majority of traders were looking to see yields explode even higher.
Instead, yields… fell. Needless to say, everyone rushed to defend their chosen narrative. Some rolled out the classic line, “the market has fully priced it in”. Others claimed that it was a bear market rally, and that US yields would rise again (that is, UST prices drop as selling restarts).
However, from a broader standpoint, 10 year yields have been falling for over a decade. From this multi year perspective, the whole move higher in 10 year yields from their Covid 2020 lows to the ~1.8% levels seen in April ‘21 is the correction; and the buying after last week’s data a return to trend. (Assuming the buying continues)
The common thread linking both of these lines of thinking is that they assume markets move together with the economy, that asset prices must faithfully reflect an underlying economic reality. Because they cling on to the idea in their heads that markets “should” behave in a certain way, they are unable to see market developments from other standpoints.
USTs, for one, are not just mere puppets whose strings are pulled by market perceptions of inflation and economic growth. They are a crucial part of the global financial system through their use as collateral in the repo market. Moreover, central bank action has made them ever scarcer.
Perhaps from the repo standpoint of people needing to own USTs, good data just isn’t as pertinent as the fact that 10 year USTs are trading at their cheapest levels for a year? More importantly (and ominously), in failing to see things from outside their “market should do what I think it does” perspective, they fail to ask: “Why are people looking to acquire more safe collateral even when presented with blockbuster data?”
Ultimately, the economy doesn’t care if traders and market participants are confused. At the point in time where the data was collected and relevant, US consumers/workers had a ray of optimism in a very bleak last twelve months.
But will it last? Only time will tell how much of retail sales growth was due to stimulus check spending and further reopening. The true challenge is making this positive spike sustainable. This means getting the labor force participation rate back up to pre-Covid highs at the very least (pre ‘08 levels should be the true objective, although this seems like a bridge too far). Doing so will provide the impetus for the kind of economic recovery lacking since the 2008 financial crisis – an all inclusive one.
In the meantime, let the economy be giddy for a while, as the markets run through another episode of “good data is bad and bad data is good”.
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