Rally in stocks and bonds reveals diverging views on the economy

  • By Stephen Grocer,
  • The New York Times News Service
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Simultaneous rebounds in the stock and bond markets are sending conflicting signals about the direction of the United States economy.

The S&P 500 (.SPX) is off to its best start to a year in nearly a decade, up 11 percent so far on optimism about economic growth in the second half of 2019.

Bond investors have taken a more pessimistic view on the economy’s fate. Prices on the benchmark 10-year Treasury note have risen this year, pushing down its yield to 2.69 percent, from 3.23 percent just three months ago. Yields fall when bond prices rise.

Stock and bond prices are not supposed to rise and fall in tandem. Historically, when investors fret about the future, they pull money out of stock markets and buy relatively safe United States Treasury securities. This dual stock-bond rally has added to doubts about the current rebound in stock prices.

Investors have plenty of cause to be worried about the economy. The trade war between the United States and China has continued to drag on economies across the globe and on corporate earnings. Hopes that the two countries will strike an agreement have increased, but significant differences remain in the talks.

Behind the dual rally is the Federal Reserve’s decision last month to pause its interest rate increases. The Fed’s shift has left investors in a familiar situation: an economy that isn’t strong enough to compel the Fed to raise rates but is strong enough for corporate America to keep expanding its bottom line.

That is the dynamic that has dominated throughout the post-crisis bull market when stocks marched higher, while bond yields plumbed lows. And with the United States economy expected to grow more than 2.5 percent this year and corporate profits forecast to rise 5 percent, it’s one that could prove supportive of stocks in the coming months.

But how long this so-called Goldilocks scenario can persist will depend on the Fed’s plan for rates and the United States-China trade negotiations.

Investors have grown increasingly convinced that the Fed will not raise rates this year, and some are wagering that the central bank will even cut rates by the end of 2019. This confidence that rates will remain low has made stock returns more appealing and reduced investors’ anxiety about how higher borrowing costs for companies and consumers would crimp the economy.

But it’s far from certain that the Fed will hold steady for all of 2019. Minutes from the Fed’s January policy meeting show a divergence among officials, with “several” saying they believed it would be appropriate to raise rates again later this year “if the economy evolved as they expected.”

On the trade front, President Trump has indicated that he is prepared to extend the March 2 deadline for a deal with China, when he has threatened to raise tariffs on $200 billion worth of Chinese goods to 25 percent from 10 percent. An extension would avoid the worst outcome for the markets, but the longer the talks go on, the more the trade war will drag on the global economy and corporate earnings.

And that would raise doubts about the second-half pickup on which investors seem to be counting.

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