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THE UNRELENTING DEFLATIONARY TIDE continues but is it fully discounted by the Treasury market?
Lumber futures fell the daily limit Tuesday, which followed a week of steady declines in energy, metals and other industrial prices. As Wednesday's Wall Street Journal reports, steel prices are falling anew. Meanwhile, the Baltic Dry Index, the leading measure of the cost of shipping dry bulk goods such as steel, has been in a four-week tailspin, totaling some 45%. According to Lombard Street Research, the Baltic index "points to the recovery's shaky foundations."
These real-time indicators of industrial activity underline the slew of recent data, such as June's much-weaker-than-expected employment report and declines in both the manufacturing and service-sector Purchasing Managers Indexes. And the plunge in lumber prices corroborates the renewed slide in housing activity in the starts and sales data since the federal government's tax credits expired at the end of April.
Markets are supposed to look ahead, not behind at trends that by now have become obvious even to Federal Reserve district bank presidents. Even so, even some prominent Wall Street economists don't quite get it, such as one who published a report entitled, "He's not dead, he's just sleeping."
That's an allusion to the classic Monty Python sketch, "Dead Parrot," in which a customer attempts to return the dead bird he just bought. The sleazy pet shop owner insists the parrot isn't really dead but just napping. Or being a Norwegian Blue Parrot that he's "pining for the fjords." It's all quite absurd, denying what is obvious, but no more so than the forecasts at the end of the first quarter that Treasury yields, then peaking at 4% for benchmark 10-year notes, had nowhere to go but up.
The bond market got the joke, however. And, as a result, bonds' returns are outdistancing those of stocks by the widest margin since 2001, at the depths of the last recession, according to Bloomberg News.
Global equities, as measured by the MSCI World Index of 24 developed countries' stock markets, suffered a negative 9.5% total return during the first half while world fixed-income, as measured by the Bank of America Merrill Lynch Global Broad Market Index returned 4.2%, a gap of more than 13 percentage points. That's the biggest margin since global bonds beat stocks by more than 11 percentage points in the second half of 2001.
Yet, the momentum of the flight to quality spurred by the debt problems in Europe and deflationary trends globallyâ??plus policy makers' impulse to counter these problems by imposing austerityâ??has waned in the currency and securities markets.
The headlong plunge in long-term Treasury yields has stalled, with the 10-year note just under 3% and the 30-year bond slightly below 4% since early last week. At the short end of the yield curve, the two-year note has done the same, dipping under 0.60% and since bobbing up a bit over it.
Concurrently, Woody Dorsey's Market Semiotics' polling of market opinion shows bond bullishness exceeding positivism towards stocks by a hefty margin. In past instance, that psychological align has portended stock rally, although he says he not so sure this time.
The dollar, another beneficiary of the flight to quality and therefore, a flight from Europe, also has stalled. As Michael Kahn writes in his Getting Technical column, the euro's reboundâ??which he first spied a month agoâ??is showing it has some legs. The Australian dollar, which is highly sensitive to the strength of the global economy and especially China's. plunged in tandem with U.S. bond yields, from 93 cents in early April to nearly 80 cents by early June, before stabilizing around 85 cents.)
Taken together, it seems the sharp drop of more than a full percentage point in long Treasury yields has discounted the deflationary trends in the bond market. As the old floor-trader's expression goes, the market doesn't discount the same thing twice.
Email: online.editors@barrons.com
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