Monday, March 2, 2009
Here's a headline from this morning's news: "Stocks drop worldwide, Treasuries gain on concern economies are worsening." Stocks are indeed dropping, with the market cap of global equities down 57% from its high, and the S&P hitting a new multi-year low today. Rising prices for Treasuries typically reflect a market that sees less growth ahead, and in this market it makes perfect sense for Treasury prices to rise as equity prices fall.
But as this chart shows, that is not the pattern that has prevailed so far this year. Even as equities continue to hit new lows, bond yields have been ratcheting higher. Equities appear to be saying that the economy is getting worse, but Treasuries are saying that the outlook is improving.
One way to explain this divergence is to say that the prospects for economic growth have worsened (as reflected in lower equity prices and lower prices on corporate debt), but the prospects for deflation have lessened (as reflected in higher nominal yields and relatively stable real yields on TIPS).
If that is indeed the thinking behind the big moves in markets so far this year, I take that as a positive. The economy was facing three major risks at the end of last year: depression, deflation, and a big increase in future tax burdens. To the extent we can minimize or eliminate any of those risks that is good news.
P.S.: Commodity prices reinforce the message of Treasuries, since they have been holding pretty steady since the end of November, and in some cases have even risen. This suggests that economic activity is not deflating or collapsing.
Posted by Scott Grannis at 10:27 AM