I guess the Ben Bernanke euphoria wore off overnight, but just for bonds. The stock market took off, with both the Dow average and S&P 500 index setting record highs. (NOT adjusted for inflation, as my frequent reader Ed will certainly note.)
TIPS and the overall Treasury market took a minor beating. The 10-year nominal Treasury closed at 2.74%, up 14 basis points in a day and setting the highest yield of the year. The 10-year TIPS closed at 0.48%, up 10 basis points from Wednesday, but still off the year’s high of 0.66%. The 10-year inflation breakeven point nudged up to 2.26%, which I guess qualifies as ‘neutral’ on the expensive/inexpensive meter.
So what happened? The biggest news of the day was the report on unemployment claims, which was good news. From the Reuters report:
Data on weekly U.S. initial jobless claims and national manufacturing came in better than expected. The Institute for Supply Management index of national factory activity for July rose to its highest level since June 2011.
“The talk we’ve been hearing that the second half is going to be better than the first. We saw some follow-through on that … ,” said Brian Amidei, managing director at HighTower Advisors in Palm Desert, California.
The Federal Reserve has two data points it is watching to determine whether to continue its bond buying, which suppresses TIPS yields: 1) the U.S. inflation rate, and 2) the U.S. unemployment rate. If the unemployment rate falls below 7% and inflation rises above 2%, the Fed has a open door to shut down bond buying.
Both 1 and 2 appear likely in coming months. The stock market loves an improving economy and can deal with rising interest rates (to a point). The Treasury bond market has no fear of a bad economy, but gets very freaked out by rising interest rates.
Good news in the economy is going to cause TIPS yields to rise.
Update on this month’s 5-year TIPS reissue. The 5-year TIPS closed today at -0.45%, still well below its high for the year of -0.27%. We could see some movement toward that -0.27% ahead of the auction Thursday, Aug. 22, but right now I am guessing we won’t go higher.