In updating my files for the TIPS spread and the Yield Curve I noticed something a bit different. It does not appear all that significant in the sense of being a market mover but it does show a bit of confusion/uncertainty among bond traders in regards to the overall health of the US economy.
Maybe tomorrow’s payrolls data will help sort this out but for now I wanted to make you all aware of it.
Let’s start first with the yield curve. It has begun to steepen, ever so slowly, after looking like it has flattened about as far as it is now going to go.
Look at how the curve (“spread”) seems to have bottomed out and built a base near the 100 basis points level ( see the left hand scale). That means the spread between the yield on the 10-year Treasury and the yield on the 2-year Treasury is about 1.0%. It has ticked up a bit and steepened the last week or so.
You can see how that stability in the yield curve and the slight steepening has taken the wind out of Gold’s sails.
Here on the next chart is where I see a bit of divergence from what we are accustomed to see when comparing the yield curve and the TIPS spread.
If you look closely at the TIPS spread, you can see that it has actually moved lower the last couple of days even as the yield curve has steepened.
OF late, these two spreads ( yield curve and TIPS spread) have had a general synchronous relationship. As the yield curve has steepened ( improving growth prospects) the TIPS spread has had a tendency to rise. Remember, the TIPS is a market-based inflation expectation indicator. When the TIPS was over 2%, it was telling us that the market expected the annual rate of inflation to be slightly over 2% for the next 10 years.
Over the last month, it has gradually moved lower hitting a low of 1.84% in the last week of April. Today, it closed slightly above that at 1.86% but it did work lower on the day.
The market is telling us – at this time – that falling crude oil prices along with the general decline being seen across so many individual commodity markets such as silver, copper, gold, etc. is undercutting inflation expectations among bond traders.
However, these same bond traders have steepened the yield curve somewhat during this same time that the TIPS spread has been narrowing. Thus they see improving growth prospects but not enough to offset the decline in prices in the food and energy categories.
We’ll see if this divergence between the two spreads continues to end the week tomorrow. The big thing that I believe traders are going to be scrutinizing will be that wages data. We want to see how salaries are faring and if they are increasing at a faster clip than previously. No doubt the Fed officials are going to be looking at this same data themselves.
Supposedly we are very near to actually at full employment as far as the Fed believes. That means that they will be very sensitive to see if the labor markets have enough tightness in them that they are finally seeing upward pressure on wages/salaries or if there is still enough slack in the economy to keep the Fed on its original line of two more rate hikes this year.
So far falling crude prices are a lifeline to the Fed since that takes some of the inflation pressure off of them and removes any rush to hike rates. If energy prices were scooting higher, I think we would be hearing a completely different story from the Fed.
That being said, they will still be looking at that wages data for clues as will we all.