The Real Reason For The Bond Market Sell-Off
Since last Tuesday, when Alan Greenspan gave his semi-annual testimony to
Congress about the economy, the US treasury market has experienced a massive
sell-off and yields have gone up as a result (remember prices and yields are
inversely related). For reference, the yield on the closely watched 10 year note
(
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PowerRating) has increased from 3.73% to 4.15%, as illustrated in the chart below.
The puzzling thing about this whole event, however, was that there was nothing
specific in the Chairman’s remarks that warranted such a move in bonds–in my
view anyway–as most of his remarks reflected what was in the statement released
by the FOMC when it cut rates by 25 basis points last month. Admittedly, he
didn’t give bond bulls the words they wanted to hear, but the market wasn’t
really expecting much after last month’s Fed meeting anyway, and the market was
already pricing this in. So why the dramatic sell-off then? The answer to this
question is actually in what Mr. Greenspan and his associates at the Fed did and
not what was said. Let me explain.
Each time the Chairman of the Federal Reserve gives his semi-annual Humphrey
Hawkins testimony about the state of the US economy to Congress, an accompanying
report containing the Fed’s GDP forecasts is also released. Needless to say, it
was these projections that caught the market by surprise, as the Fed managed to
beat most of Wall Street’s forecasts for next year’s GDP growth. To be specific,Â
the Fed is predicting that GDP growth for 2004 will measure between 3.75% and
4.75%–whereas the most recent Bloomberg survey of economists (taken at the
beginning of this month) indicates that the average expected growth rate for the
US economy by investment house economists is 3.7%. The Fed’s outlook for the
future was far rosier than their most recent remarks would suggest, and as
a result, bond market investors have been making the appropriate adjustments to
their portfolios. However, at this point, the current pace of the sell-off
in Treasuries needs to slow down–which I expect–before rates begin to choke
off this nascent economic recovery.
Edward Allen