10 Year Yield - Stocks Stay High Despite High Yields

The Russell 2000 finally increased after a terrible run; it was up 0.92%. The overall stock market was up slightly as the S&P 500 was up just 7 basis points.

The real action today was in the treasury market. An important point about the stock market is it didn’t sell off. The S&P 500 is less than 1% away from its record and it increased with bond yields.

This destroyed the headlines which claimed stocks were falling because of nervousness about yields when the S&P 500 was down earlier in the trading session. Stocks and Treasury yields are much higher than when investors initially feared the 10-year yield hitting 3%.

This was a faulty concern because higher yields mean quicker economic growth.

10 Year Yield - Massive Selloff In The Long Bond Because Of ADP & ISM Data

There is the possibility of the 10-year bond yield surpassing its cycle high of 3.11%. The employment report a pivotal one for the yield. I figured wage growth would play a role in whether it hit new highs.

However, the yield spiked on Wednesday due to either the strong ISM non-manufacturing survey. Or the strong ADP report which implies wage growth will increase in the September BLS report.

The ISM report was a 5 standard deviation beat. As you can see in the chart below, it wasn’t consistent with the regional surveys model.

The 10-year bond yield increased 11 basis points from 3.06% to 3.17%. This is the highest level this cycle and the biggest increase since November 2016.

It’s amazing that the 10-year yield had a move comparable to the period after the presidential election. The election was much bigger news than the ISM report.

There are a few possibilities which explain this movement.

10 Year Yield - The algorithms took this ISM report at face value. 

If employment actually is the strongest since at least 1997 and the services economy is the strongest since 1998, the 10-year yield should increase sharply. My point is the soft data hasn’t been matching the hard data.

Even though the ISM report stated the PMI corresponds with 4.6% GDP growth, the chart below shows it implies quarter over quarter annualized growth of above 6%. I don’t think Q3 GDP growth will be 4.6%, let alone above 6%.

As you can see, the light blue line, which represents the ISM composite index, has been much higher than GDP growth for the past couple of years.

Another possibility is there was technical resistance at 3.11%. Once that was broken because of good reports, it kept going because there was no resistance.

If the 10-year yield is still increasing in the anticipation that the September jobs report will show high wage growth, a disappointment in hourly wage growth will cause a massive collapse in yields.

The final reason the 10-year yield may have increased is because WTI oil hit a 4 year high. On Wednesday, WTI increased by 1.6% to $76.41. Higher inflation means higher yields. Saudi Arabia’s reluctance to increase production and the sanctions on Iran are pushing up oil.

Oil initially fell on Wednesday because Saudi Arabia’s energy minister said the country increased production to 10.7 million barrels per day in October and will increase that in November. Highest production ever was 10.72 million barrels per day in November 2016.

10 Year Yield - More Fed Rate Hikes?

The 2-year treasury bond yield also increased on Wednesday as it went up 6 basis points to 2.87% which is a cycle high. This means the curve steepened sharply as the difference between the 10-year yield and the 2-year yield is 30 basis points.

All the bears who discussed a 2019 recession because the curve was close to inverting look very wrong now. Since the 2-year yield increased, the chances of rate hikes increased.

Chance of at least one more hike this year increased to 81.8%. The Fed is being allowed to raise rates more than 2017 without an inversion because bond investors are bullish on U.S. growth and inflation.

10 Year Yield - Quotes From The ISM Non-Manufacturing Report

Since the ISM non-manufacturing report catalyzed this recent spike in yields, let’s review some of the quotes from it to get color on how great it was.

A retail trade company said, “Our general state of business is strong, but there is a lot of uncertainty [about] the pending tariffs. This may cause a shift [in] production sites.”

This firm is clearly enjoying near-record consumer confidence. In the latest Redbook survey, year over year same-store sales growth was 5.7% which was down from the previous week’s growth of 5.8%.

A wholesale trade company stated, “Import tariffs on steel, plywood, and [other] lumber are inflating prices, which are difficult to pass along to the end user due to competitive pressures.

Labor and trucking shortages are affecting the industry. Low finished goods inventory is inflating home prices and causing buyers to delay purchases.”

There is a trucking shortage because the demand for workers is high, but supply is limited. No matter how much employers pay, many people can’t work a job that will take them away from their families.

Rising house prices are making it tough to buy a home in some areas even though nominal wage growth has been strong. Finally, it’s interesting to see some of the inflation caused by tariffs isn’t being passed on to the consumer.

A finance and insurance company stated, “Economy continues to exhibit strength. New construction, both residential and commercial, abound. Harvest [is] about over. Overall, results appear promising. Every day is a bit better than the last”.

Lending growth to consumers and businesses is strong. C&I lending was up 5.6% year over year in August. That’s huge growth compared to the bottom last November where growth was only 0.61%.

Economic momentum may have slowed according to some reports, but this one implies the economy is overcoming the obstacles such as tariffs.