What the Treasury Bond Market Tells Us About the Economy

While the stock market has rallied 50% in the past six months, yields on Treasury notes, bills, and bonds have barely budged. What's up with that?

Carol Baum had a good article in Bloomberg that posted a few potential scenarios. They include:

• There is no recovery. The "growth" of the past few months was stimulated by cash-for-clunkers and by the first-time-buyer tax credit, both of which are gone or going away.
• The stock market is wildly overvalued. If it falls back to 6,500 then it would make 3.5% 10-year notes look reasonable.
• The banks are stuffing their balance sheets with Treasuries as a safe place to park their cash. That demand is keeping prices down.

So, which is it? I'd say a combination of all three with other one factor thrown in. Because inflation was actually -1% last year, the real yield on 10-year Treasuries is one percentage point higher at 4.5%. Let's also note that over time, the bond market has been a more accurate predictor of future economic conditions than the stock market, which is often ruled by passion as opposed to rationality.

So, I'd say we have an ecomomy that is not as strong as the last couple of months has made appear, a stock market that is ahead itself and that will fall back, and with banks, Wall Street, and foreign investors buying and holding Treasuries as the safest investment in an otherwise risk-fraught world.

I've learned that divergences in assets never last. Either the stock market must come down or Treasury yields must go up. I'm betting both will happen.