Until Tuesday, the bond market was looking for rising inflation as a reflection of “better” economic conditions. Our economy is still anemic after more than six years of central bank meddling, but traders don’t trade on truth — they trade on perception.
Reports still seem solid. Inflation is ticking higher as consumer prices rose last month to 1.8% on an annualized basis. The Fed’s target is 2%. Unemployment is down to 5.4%, participation in the labor force rose to 62.8%, and even wages have risen a bit.
In fact, job openings have surpassed the level they were before the financial crisis in 2008. As Harry and Rodney have noted many times over the years, consumers drive 70% of economic activity here in the U.S. So, when the labor market finally tightens to the point that wages move higher, economic growth follows. When our economy grows, inflation follows.
But while bond traders were keeping their eyes on wage growth, inflation, and economic growth, they weren’t waiting on those things. They were already pricing that future growth in. Yet, bond yields dipped lower Tuesday.
So what changed? Greece. Or, the realization that Greece is very likely to default.
Market participants may have bet that some sort of agreement in Europe would happen. Greece has some major loans due in the next few days and no way to pay. Over the weekend the negotiations came to a standstill.
On Tuesday stocks fell sharply and money moved to the safety of U.S. Treasury bonds, causing yields to fall as well. A rate hike might still be in the cards sometime this year, but Tuesday served as a reminder that what happens in Europe and elsewhere in the world can impact our markets.
Even at home, there are concerns on what will happen whether or not the Fed hikes rates in June. If the Fed doesn’t raise short-term rates sooner rather than later and long-term yields move higher, that could spark a crisis. If they do act in June, it could cause bubbles to burst in stocks, bonds, and real estate.
Damned if you do, damned if you don’t.
I’ll leave the predictions to Harry but stock traders, bond traders and investors everywhere need to be ready to act quickly. Be ready, have a plan and beware of the dangers!