U.S. bond markets are riding their biggest moves since the 2016 Presidential election Thursday, pulling yields higher and widening the gap between short and long term interest rates in a move that should erase one of the most closely watched signals of economic recession.
With the ISM non-manufacturing index hitting the highest level in 21 years last month, a reading of private sector job creation pointing to another month of 200,000 -plus gains in non-farm payrolls for September and some of the biggest U.S. employers signalling wage increases -- just as consumers prices are set to bump higher thanks to the twin impact of trade tariffs and rising oil prices -- bond and currency markets are re-pricing their bets on Federal Reserve interest rates as the U.S economy continues to pull away from the rest of the world.
"So with US yields rising on a tide of good news, should we be happy or worried? Well, that depends where you live," said ING's chief Asia-Pacific economist Rob Carnell. "Here in Asia, the US story is a double-edged sword."
"Normally, one side of that sword would be the implied gains in Asian exports to the US and the rest of the G-7 based on soaring domestic demand there. But that edge has been thoroughly blunted by US trade policies," he noted. "The other side, higher global interest rates, and a stronger (US dollar) are certainly not helpful."
Benchmark 10-year Treasury yields extended gains Thursday, following yesterday's 12 basis point increase -- the biggest single-day move since the 2016 Presidential elections -- taking them past 3.23% for the first time since 2011. The moves took the gap between 2-year and 10-year notes to around 35.6 basis points, well ahead of the 11-year low of 26 basis points recorded only two weeks ago.
Long-bond yields were also on the rise, jumping to 3.378% in what is known as a "bear steepening" of the yield curve, where long-term rates rise faster than shorter-term ones, before pulling back to 3.348%.
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Last month, the U.S. Commerce Department said average hourly earnings grew at a 2.9% annual clip, the fastest in nine years, as the economy added 201,000 new jobs.
The so-called yield curve, a term for the difference between interest rates of different maturities in the bond market, had "flattened" throughout the spring and summer months and 2-year bond yields rose in anticipation of interest rate hikes from the Federal Reserve and 10-year yields remained sluggish amid questions over mid-term growth prospects.
"With the economy running hot and headwinds - such as trade wars - not yet weighing, the Fed is clearly very comfortable maintaining the pace of tightening and is willing to go further in order to keep it in check," noted Oanda market analyst Craig Erlam.
The flattening had investors fretting over an an inversion of the yield curve, a condition where 2-year yields rise above 10-year yields and which has signaled nearly every U.S. recession for the past 60 years.
However, the potential curve inversion has always sat in contrast to the surging pace of economic growth, with second quarter GDP rising at a 4.2% clip and the Atlanta Fed's GDPNow forecasting tool suggesting a 4.1% pace for the three months ending in September.
Several Fed signals, including the removal of the word "accommodative" in last month's interest rate decision, has some investors betting that the Fed is now "catching up" to market projections for inflation, even as some Fed Governors suggest that short-term volatility won't change their focus on a "gradual" rate path.
Cleveland Fed President Loretta Mester, in fact, told a conference in St. Louis Wednesday that "the fact that interest rates moved on one day is not a concerning thing. Markets are volatile ... it is still appropriate for us to be moving interest rates up gradually."
There remains some investor concern, as well, that the pace of corporate earnings growth will ease into next year as the impact from the stimulus brought by Republican-led tax cuts -- and that of the escalating trade war between the U.S. and China -- fades.
What's interesting note at present, however, is that bond investors are finally adjusting their assumptions for faster inflation, even if they think that growth will slow over the near-term.
So, while in some ways the yield curve isn't suggesting immediate recession concerns, the so-called bear steeping that we're witnessing instead -- where long-term rate increases outpace shorter ones -- is yet another signal that the current equity bull market will sternly tested in 2019.