"It's a slow day," lamented one equity trader midday Wednesday, accurately describing a stock market that sulked through another low-volume session. But he obviously wasn't watching Treasuries, which suffered another sharp selloff that weighed on rate-sensitive stocks.
The Treasury market's
skepticism about Tuesday's
Federal Open Market Committee
announcement was seemingly justified by Wednesday's economic data. In addition to a surprisingly strong 1.4% rise in July retail sales, the government reported that import prices rose 0.5% in July, bringing the year-over-year increase to 2.1%.
The data confirmed the bond market's worst fears: that the economy is reviving, and because the Fed has pledged to keep the fed funds rate at 1% for a "considerable period," inflation is likely to make a comeback. At the very least, the Treasury market is building in higher inflation expectations than in prior months and that it finds the Fed's warnings about an "unwelcome fall in inflation" (substantial or otherwise) to be disingenuous.
Reflecting the fixed-income market's distaste for the Fed's apparent intention of reviving inflation, the price of the benchmark 10-year Treasury fell 1 4/32 to 97 14/32, its yield rising to 4.57%, its highest level since July 18, 2002. The 30-year bond fell 1 16/32 to 98 27/32, its yield rising to 5.46%.
iShares Lehman 20+ Year Treasury Bond Fund
fell 1.9% to an all-time closing low of $81.27 on heavy volume. Volume in the TLT was 2.2 million shares, or 153% of its 30-day average, according to Baseline. The approximately one-year-old exchange-traded fund has become traders' favorite proxy for long-dated Treasuries, as reflected in its slide.
"People are coming to the conclusion we're not going to be in structural deflation," said Robert Lunder, global head of government bond trading at Bear Stearns. "The Fed seemed to be raising the alarm
about deflation back in May and pushed us too low in yields. When they came out in July and eased but turned off the alarm, that's what's brought us back here."
Currently, "the prospects for growth are also being bolstered by the weekly and monthly economic data, combined with fiscal policy," he continued. Yet FOMC members are "leaving the funds rate at 1% and weren't indicating they're going to tighten anytime soon."
It's hard to imagine a worse combination for Treasuries than rising economic growth and aggressive monetary and fiscal stimulus, plus the Fed's stated intention to stand pat on rates, especially in the aftermath of a huge rally in Treasury prices that brought yields to generational low levels. "A 4.50% 10-year yield is still one of the lowest in our lifetimes," Lunder noted. "I think we're near that equilibrium rate, but an accelerating recovery could dictate higher yields in the future."
In other words, if the economy continues to improve at its current pace (or faster) -- something equity bulls certainly expect and want to see -- Treasury yields will keep going higher. Just as the pendulum apparently swung too far toward the bullish (low-yield) side in the spring, it could swing beyond what current fundamentals suggest is a still-low inflation environment. As Lunder observed, "The bond market has to be ahead of the Fed."
The risk, of course, is that higher borrowing costs associated with rising yields will sabotage the recovery in its infancy, and that wouldn't be beneficial to shares. On a related note, the Mortgage Bankers Association reported that refinancing activity, a critical element to consumer spending in recent years, fell 20% for the week ended Aug. 8. The association's index of applications for purchases and refinancings fell by 16.3% from the prior week and was down 17.6% vs. the same week a year earlier.
In reaction to that news and the selloff in Treasuries, the S&P Homebuilding Index fell 3.2%, and the Philadelphia Stock Exchange/KBW Bank Index shed 0.7%. Meanwhile,
fell 1.9% after reporting its duration gap between its assets and liabilities widened to six months in July vs. negative one month in June, its widest swing this year.
Given that backdrop, the stock market's performance Wednesday was either an impressive show of resilience or blind ignorance of the dangers posed by higher rates, depending on one's perspective.
Several sentiment indicators support the latter, i.e., bearish, view. The CBOE Market Volatility Index, which approached 26 intraday last week, quickly retreated back toward 20 and settled at 20.62 Wednesday even after rising 2%. The put/call ratio ended at 0.79, up from 0.77 the prior day but down from over 1.0 last Thursday. Finally, Chartcraft.com said bullish sentiment rose to 52% from 51.5% in its
survey, while bearish sentiment dipped to 19% from 20.8%. The spread between bullish and bearish sentiment remains historically wide, noted
contributor Steven Smith.
Reflecting the overriding bullishness, it was a fairly uneventful session for equities, despite the carnage in Treasuries. Even a sharp selloff between 2:30 p.m. and 3:30 p.m. EDT proved fleeting, as major averages recovered noticeably in the session's final 30 minutes.
After trading as high as 9322.11 and as low as 9233.94, the
Dow Jones Industrial Average
ended down a relatively meager 0.4% to 9271.76. The
shed 0.6% to 984.03 after trading as high as 992.50 and as low as 980.85, while the
finished fractionally lower at 1686.60 vs. its best of 1695.80 and nadir of 1681.30.
The Comp's relative strength was produced largely by semiconductors, which apparently rallied in the wake of upbeat comments late Tuesday by
. The Philadelphia Stock Exchange Semiconductor Index rose 1.9%.
At 1.2 billion shares on the
and under 1.5 billion over the counter, trading volumes were again below average.
Elsewhere, gold futures rose 1.5%, and related stocks climbed in concert while the dollar fell vs. the euro and yen despite the upbeat economic data. Still, the greenback held up relatively well given the shellacking in Treasuries; same could be said of equities. Whether those trends can persist remains to be seen.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.