10 Year Bond Yield - Stocks Reverse On Tuesday

Before getting into the 10 Year Bond Yield, let's review the stock market. Finally, after a huge spike in June, the market appears to have hit a wall early in the trading session on Tuesday. S&P 500 closed 0.8% below its morning high. Its morning peak was about 37 points below the record high. Maybe investors finally came to their senses about the economy or maybe this is a temporary stop on the road to a new record. I’m making the former prediction.

On Tuesday, S&P 500 fell 4 basis points, Nasdaq fell 1 basis point, and Russell 2000 fell 0.29%. VIX increased from 0.31% to 15.99. CNN fear and greed index fell 1 point to 36. 2 biggest losers were the utilities and the industrials which fell 0.69% and 0.9%. Utilities are down 2.02% in the past 3 days. This sector needs the 10-year yield to fall below 2% to get to a new record high. In the past 2 weeks, the 10-year yield has stabilized. 2 best sectors were consumer staples and consumer discretionary which rose 0.41% and 0.33%.

Big Potential Catalysts Friday & Next Wednesday

In terms of economic reports, Friday will be the biggest day of the week because industrial production and retail sales are released. If both are weak, we could see a big drop and if both are strong, we could see a record high. To be clear, the estimate for 1.7% Q1 GDP growth isn’t set in stone. 

If those reports are strong, estimates can rise above 2%. It seems unlikely that GDP growth will be strong because most of the recent reports have been weak, but it’s not impossible. Remember, the April industrial production report was hurt by its timing and the April retail sales report had a sharply negative seasonality calculation because of Easter.

I can’t stress how important the Fed’s guidance is at its meeting next Wednesday. The market has been trading all month like there’s no potential issue, but if the Fed guides for no hikes this year, it will be as big of a mistake as the relatively hawkish December hike. Heading into the Fed meeting, there is now a 17.5% chance of a cut. 

Just by not cutting, the market will be disappointed slightly. The Fed funds futures market sees the most likely action this year being 2 rate cuts. Personally, I understand why the market is rising because of potential rate cuts. However, by rallying to a record high, the market is stating it would rather rate cuts, than an actual strong economy. I don’t think that’s a rational assertion which is why I’m bearish.

10 Year Bond Yield - Bond Market Predictions

The 10-year bond yield has stabilized recently. It’s at 2.13% which is 8 basis points above its recent low. I mentioned a couple of weeks ago how the decline in its yield was getting out of hand. The 2-year yield is at 1.91% which is 22 basis points below the 10-year yield and 14 basis points above its 52 week low. 

If it stays below 2%, 2 rate cuts this year are expected. A neutral Fed next Wednesday could push the 2-year yield higher and invert the curve. I’m very interested in what is considered dovish/hawkish since it’s a meeting where specific guidance is given.

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As you can see from the chart above, the 2019 predictions for the 10-year yield were way off. I’m surprised the prediction for the 10-year yield to hit 3% was that popular because by the start of the year it was clear the economy was headed for a slowdown. 

Personally, I’m more surprised by the rally in stocks than the rally in bonds. Even though yields have fallen so much this year, they still are consistent with a slowdown and rate cuts rather than a recession. A I mentioned previously, my prediction for a 10-year 2-year inversion was wrong. However, I originally made that forecast earlier than the start of the year.

Mortgage Delinquency Rates Are Low

As much as investors focus on the big decline in home price growth, it’s worth repeating that this won’t be another housing bubble burst which causes a mass increase in delinquencies. As you can see from the chart below, only 4% of mortgages are in some phase of delinquency. 

That’s the lowest rate in 13 years. This is in stark contrast to the problems renters are having as rent as a percentage of disposable income is at a record high. People who own homes tend to also own stocks, so they have been helped more by this bull market. At least the low end of income earners have recently seen higher wage growth than those in the middle or at the top.

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For the cynics of this information who say, “of course delinquency rates are low in an expansion,” keep in mind that the mortgage delinquency rate started to increase way before the last recession. Specifically, the 90+ days delinquency rate bottomed in Q2 2006 at 0.9%. By Q2 2007, it doubled to 1.8%. That’s 6 months before the recession started. 

The housing market usually leads the economy by the most out of any other indicator. That being said, I highly doubt that even if there was going to be a recession in the next 6 months that the delinquency rate would increase that much.

Housing market won’t be the center of the next recession. The proof is the housing market weakened last year when rates were higher yet the Q1 90+ days delinquency rate is at the cycle trough of 1%.

10 Year Bond Yield - Conclusion

Currently, I’m bearish on the economy and stock market. But I’m not closed off to the possibility of things going right. The most obvious factor that can help stocks is a trade deal. That won’t happen in the near term. But the G20 meetings might show progress which is all the market needed in Q1 to rally. 

Don’t sleep on the possibility of solid industrial production and retail sales reports. I see them improving from April, but because of the slowdown, I’m not expecting a huge improvement. After these reports come out, we will have a great idea where Q2 GDP growth will end up.