A Stitch in Haste

I don’t usually comment on day-to-day market action, mainly because the obligations of my job preclude it. But today saw some interesting market movements.

Every first Friday of the month the Bureau of Labor Statistics releases the non-farm payrolls report, which essentially estimates the number of new jobs created in the economy.

This month’s number was a relatively paltry 78,000 jobs, well below the Wall Street consensus of 175,000 jobs.

Now, when the actual number falls below consensus, this is the typical pair of results:

–The stock market falls because the number suggests that the economy is weaker than previously thought.

–The bond market rises because, if the economy is weaker than previously thought, then it is less likely that inflation will accelerate (inflation is bad for bonds).

Those two effects should also reinforce each other, since stocks and bonds are essentially substitutes (i.e., weakness in one market should accompany strength in the other).

Today the stock market behaved the way it was supposed to, falling noticeably after some very strong recent gains.

The bond market also behaved properly — at first. But after the long Treasury bond began the day with very strong gains, it sold off, ending the day down 0.72%.

Interesting.

The extraordinary rally in the long bond in light of eight consecutive increases by the Federal Reserve of short-term rates (i.e., the quite pronounced flattening of the yield curve) has caused many market observers — myself included — some intense befuddlement.

Could today have been the high-water mark? If a security goes up when it shouldn’t (i.e., is “overbought”) and then goes down when it shouldn’t, that’s as good a time as any to call a top. So I’m calling it: Expect a significant correction in long treasuries (i.e., a significant steepening of the yield curve) in the weeks and months ahead.

Two tests will come next week. First, the Treasury auctions $24 billion in new securities. Any weakness in the bidding could reverberate across the yield curve. Second, Federal Reserve Chairman Alan Greenspan testifies before Congress on the state of the economy. Expect interest rates and the (potential) housing bubble to be discussed at length.

Perhaps “Treasury bubble” is too drastic a term, but I remain convinced that long-term interest rates are going up soon, fast and far.

And if they do, then the housing market is in very serious trouble indeed.

(The alternative is that the yield curve inverts — a rare and bizarre phenomenon that is not something to look forward to either, as this Slate piece explain.)

Similar Posts:

• Connecting Some Econo-Dots
• Foreclosing the Bubble Debate
• Is There a “Patriotic Duty” to Accept Lower Savings Bond Returns?
• Quo Vadis, Yield Curve?
• Is the Housing Market Comparable to the Stock Market?

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