Bond managers are as confused as anyone these days

By Robert Burgess

In times of economic uncertainty, it used to pay to check the bond market and see what messages it was sending. Is the economy headed for recession? See if bond yields fall. Is inflation going to rise? See if the returns increase. Bonds were the crystal ball of economics. Now, they may be no better than the wheel of fortune in helping to decipher the future.

Bond portfolio managers seem to be as confused as anyone right now. This is also reflected in JPMorgan Chase’s weekly survey of bond market participants published on Wednesday. It showed the percentage of respondents who expect no change in U.S. Treasury prices and yields has risen to 74%, the most since mid-2017. Just 25% expected bonds to either rise or fall .

Of course, this may just be a sign that managers are taking a step back and reassessing the environment after the recent rally in the bond market. But the market is always changing, and the percentage of managers who describe themselves as “neutral” has rarely come close to current levels, moving to an average of 55% over the past five years. In short, administrators have no verdict.

This assessment is also supported by the jump in implied volatility, as measured by the ICE BofA MOVE index. It jumped to 156.2 as of Tuesday. Excluding the early days of the pandemic, when the world turned upside down, this is the highest level since the global financial crisis more than a dozen years ago. You don’t see these levels of volatility when managers are relatively confident about the outlook.

There is a lot that is confusing. The data from the economy is conflicting like never before. Talk of an impending recession has peaked, but data released by the Labor Department on Wednesday showed job vacancies remained near record levels in May, with employers having two vacancies for every job seeker. Also on Wednesday, the ISM (Institute for Supply Management) services index – which accounts for two-thirds of the economy – remained at a growth level.

However, the Atlanta Fed’s widely circulated GDPNow index, which focuses on tracking the economy in real time, has slipped to -2.08% for the second quarter. If that turns out to be accurate, it will be the second straight quarter of contraction in the economy, which is the technical definition of a recession.

The inflation outlook is equally bleak. The commodity market – a particularly important factor in the recent high levels of inflation – has fallen sharply in recent weeks. The Bloomberg Commodity Index has sunk 19% since June 9, with energy, agriculture and industrial metals posting strong declines. That decline is one reason five-year bond breakeven rates, a measure of managers’ expectations of the rate of inflation over the life of the security, have fallen to 2.50%, the lowest level since September.

And yet, my Bloomberg News colleague Rich Miller reports that a broad gauge of inflation expectations, which Federal Reserve Chairman Jerome Powell pointed to as part of June’s huge rate hike, is expected to show a big jump when it’s released on the 15th July, perhaps setting a record. The CPI includes more than 20 indicators that measure consumer, analyst and investor attitudes toward future price increases, Miller points out.

The minutes of the Fed’s June meeting released on Wednesday only added to the confusion. While policymakers agreed that interest rates may need to keep rising longer to prevent high inflation from entrenching, even if it slows the economy, they also noted that some business contacts told them that hiring and retaining workers have improved and that pressure for additional wage increases appears to be easing. In other words, who knows?

The bond market has long been considered the most important in the world and the one that guides all others. Bond managers were once considered so powerful and omniscient that author Tom Wolfe described them as the “Masters of the Universe” in his classic 1987 novel The Bonfire of the Vanities. But these are not normal times. As we have seen time and time again, the unprecedented fiscal and monetary policies of the past two years have made fools of even the best and brightest trying to predict how markets and the economy will react. The recent uncertainty in the bond market shows that the trend is far from over.