Chris Burba (@ChrisBurbaCMT on twitter) just posted this interesting chart showing a major divergence between how bonds and stocks are acting. Normally bonds will sell off as equities rally as we go into 'risk on' mode. However this week even as equities rallied, bonds held quite steady and on a day like today are acting very strong. Yields continue to fall. Even as equities "honeybadger" their way up. So what gives?
Usually when there is a divergence between bonds and stocks people give the edge to bonds as the "smarter market". So it's plausible this is some sort of headfake in the equity market and bonds are giving us a warning. In any normal market that is the thesis I'd focus on as would the herd. But we are in a QE market. A global QE market. We are seeing strange things like Spanish and Italian debt yields plummet of late. Why? One potential reason in my mind is the Japanese money now flooding the world. That money is desperate for yield – so a 4% Italian bond looks juicy especially with the inherent backstop of the ECB. Even a 1.6% U.S. yield looks tasty in a relative sense.
So as with almost everything nowadays we have to try to figure out if the normal market signals that worked for decades are useless now under a global QE regime. There are only so many assets in the world to buy. If too much money is chasing them they get overpriced. That can work for stocks just as for bonds – which in the latter case would be showcased by a drop in yields. I don't know the answer and none of us do as we are living in a great experiment of monetary policy.
As an aside, another fellow on twitter mentioned this morning that this is the first time in 17 years the U.S. market has not had a 5%+ correction in the first 4 months of the year. More strange and interesting things in our QE world.
*** One should note that since 2009 of course the bond market is not trading "freely" – so the price action of bonds since that time can always be called into question as their has been an almost persistent bidder in that market with the exclusion of the small breaks between QE1 and QE2 and QE2 and QEunlimited.
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