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Interest Rates and the Bond Market

Author: Bob Lang (info)
Website: http://trade-mentor.com
Posted: November 13th, 2006 at 1:37 am EST
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We’ve seen some serious gyrations in the bond market the last couple of weeks.  A cascade of buying into bonds ensued after when some slow growth news hit the wires.  In fact, the ten year bond yield peaked in this latest cycle on Oct 23 just under 4.85%.  From that point, yields cascaded lower, reaching nine month lows just above 4.5%.  Not a big move you say?  For a rate this low and to be this late in the growth cycle, it was pretty substantial.  Yields have pretty much been falling in a straight line since late June.  Looking to shorter term paper, the five year bond currently yields 4.56%, barely lower than the ten year.  Compared to even shorter term rates, the curve is completely inverted.  The Fed Funds yields 5.25%, a whopping 70bps more than five year rates!  History tells us an inverted yield curve presumes a recession is on the horizon.  But another school of thought says differently:  Back in 2005 Alan Greenspan said this:

 “inversion signals economic trouble, pointing out that the shape of the curve is less predictive than it once was.”   A brief, shallow inversion won’t signal any marked slowdown in the economy. Over the past several decades, the yield curve has had to invert by two percentage points or more before a recession materialized.

What does this mean exactly?  Perhaps the current situation is not pointing to a recessionary period.  It’s been said the bond market is so paranoid that it has predicted 12 of the last 7 recessions.  Certainly the situation is not as healthy as a normal yield curve (upward sloping, left to right).  We’ll have to see how the current bond market environment is resolved, but clearly the Fed is not as irrelevant as some would like to believe.  If the next move is not a rate hike, then surely a rate CUT is in the cards.  Fed Funds futures point to this exact action in the coming year.  In years past, an easing Fed has been GOOD for the equity markets.  Famed investor Marty Zweig once coined the term ‘Don’t fight the Fed’.  Words to trade by. 

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