All-time highs for the S&P 500 and another banner year for equities have kept investors' attention focused squarely on stocks. But what are bonds telling us about the state of the U.S. economy?
There's a long-held belief on Wall Street that if you want to understand what the smart money is doing, look at the bond market. That's not to say the most successful investors favor bonds over stocks, but rather that trends among bond investors have historically been more reliable indicators of future economic developments.
It's generally accepted that stock prices and equity benchmarks are more susceptible to emotional decisions and therefore prone to larger irrational swings.
The more than $40 trillion in the U.S. bond market, on the other hand, tends to be considerably more boring. Lower returns and less excitement can result in more logical decisionmaking.
Plus, the largest pools of capital on the planet — government pension programs, sovereign wealth funds, institutional endowments — tend to have major allocations to bonds and some exceptionally smart people pulling the strings.
Here are a few clues about what may lie ahead for the economy based on a longer look at the bond market:
The yield curve
A quick refresher: Parts of the yield curve began to invert in 2018, when longer-term bonds paid lower yields than shorter-term bonds. Earlier this year, the yield on the 2-year U.S. Treasury note rose above the yield on the 10-year Treasury. Widely considered to be the most significant, the 2-year vs. 10-year inversion triggered a cavalcade of recession calls.
At this point, however, you can safely assume that Uncle Joe won't be conversing about inverted yield curves around the Thanksgiving table. The Federal Reserve has driven down short-term interest rates with three cuts in three months since late July. Ten-year yields, meanwhile, have risen from 1.43% in early September to nearly 2% this month. Previously inverted, then flat, the yield curve has begun to steepen.
Once the loudest siren warning investors of a looming U.S. recession, the yield curve now appears a lot more, well, normal. From a market perspective, it's risk on, alarm off.