Earlier today Bloomberg’s Lisa Murphy was showing the relationship between USTs and stocks pointing out that bonds were not confirming the stock rally. Is this simply a product of the Fed’s ZIRP pledge or is there some wildly differing growth and inflation interpretation by these two markets? We have a couple of theories
1> The Risk-On/Risk-Off trade inverted. The speculative community has been very short the equity market since last year and what looks to be a risk-on buying of risk premium has really been a risk-off covering of shorts. Conversely these same “Large Specs” as well as Primary Dealers have at the same time been increasing exposure to the 5YR sector of the Treasury curve, presumably in anticipation of further QE. What typically is a risk-off position has become risk-on.
2> These markets are discounting the divergence between performance in the private economy v the public economy. Since the recovery in Nominal GDP (NGDP) began in 2009 there has been a clear trend of private v public spending as a percent of overall NGDP. Private investment has been steadily increasing while public spending has been rapidly decreasing. This same trend can be seen in private v public payroll growth. It’s quite possible that the equity market is discounting the improving performance of the private sector while the bond market is discounting the massive deceleration of public spending of which the Fed is (implicitly) committed to filling via QE.
While we don’t endorse this type of central bank policy we do believe it is behind the divergence and whether right or wrong it is what it is, as they say. Thus we believe its very dangerous to simply look at one market v the other and conclude one is right and one is wrong.. they both may be right..