What is the Bond Market Telling Us?

(click on the chart to enlarge)

The Bond Markets are the financial market with the most insight into future economic developments (global bond market size of over $100 trillion dwarfs the size of equity markets), however (like tea leaves) you just have to know how to read them!

• The first important (and telling) signal comes from the shape of the "Yield Curve".
• This was a common discussion on our Tuesday conference calls in my previous life: The Yield Curve (as you see in the above chart) is drawn by joining the relationships between interest rates (on the vertical axis) and the corresponding maturity dates (along the horizontal axis).
• A "normal" Yield Curve has a positive slope (lower left to upper right) and is an indicator of expected future economic growth and an expectation of future inflation: the investors in bonds of longer dated maturities demand a higher yield (which includes a premium for increasing inflation).
• The steeper the slope, the greater the expectation of future inflation (and hence economic growth).
• Expectations of growth and future inflation in the US Yield Curve are greater than they are in Canada because expectations of US Economic growth are stronger than they are for Canada (oil is the main factor at the moment).

• Watching how the Yield Curve moves is also important:

(click on the chart to enlarge)

• The Canadian Yield Curve over the last month has shifted to show a slight "inversion" in the shorter maturity dates.
• This is a result of the determination that in the near-term, expectations are that the Canadian Economy will grow at a slower pace and inflation is not a factor of significance. This is also brought on not only by the Bank of Canada's move to cut the bank rate by 1/4 %, but by some expectation of the possibility of another cut to .50%.
• The curve goes positive after the 3 year maturity and beyond, telling us that the economic slowdown (in Canada) will not be deep and will have a short life span.

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund.