Friday, July 22, 2016

Bonds Dislike Positive Surprises

Admittedly with the benefit of hindsight, the recent backup in bond yields shouldn’t be a surprise. That’s because there has been a strong positive correlation between the daily Citigroup Economic Surprise Index (CESI) and the 13-week change (in basis points) in the weekly average of the 10-year US Treasury bond yield since the start of the CESI data in 2003.

A close inspection of the two series shows that the change in the yield has sometimes led, sometimes coincided with, and sometimes lagged the surprise index. Currently, the CESI is leading, jumping from this year’s low of -55.7 on February 5 to Friday’s reading of 36.7, the highest since December 30, 2014. The bond yield has responded, rising from an all-time low of 1.37% on July 8 to 1.59% on Monday, though it was back down to 1.55% today. (See our new CESI & Bond Yields.)

The yield spread between the 12-month ahead and the nearby federal funds rate futures has widened from zero on June 27 to 18.5bps on Thursday. Interestingly, this spread doesn’t correlate well with the CESI. The spread continues to suggest that a Fed rate hike over the next 12 months is unlikely. That may help to keep a lid on the bond yield despite the recent rebound in the CESI. I lowered our forecast range for the government bond from 2.0%-2.5% to 1.5%-2.0% on April 6. That remains my forecast for the rest of the year, though I will be keeping a close eye on the CESI.

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