Chart of the Week - Bond Yields vs PMI

Is the bond market making a mistake?

The July flash PMI data showed the developed markets manufacturing PMI basically holding steady at very strong levels. But yet, bond yields continue to edge lower… it begs the question: who is wrong? Is the bond market making a mistake?

As noted, the chart below shows the path of US 10-year bond yields and the developed markets PMI. I use developed markets because in the age of a globally integrated financial system we need to incorporate data from these economies as it will ultimately provide a tell on the path of QE programs - whose impact will inevitably spillover across borders.

Aside from the influence/impact of QE, the red line basically tells us the state of affairs in terms of the near-real-time pulse of growth and inflation. These are the key macro variables the impact bond market sentiment. Dislocations between the two lines can basically be attributed to excesses in sentiment.

For instance, look at the back half of 2020: the PMIs were rebounding as the world not only came back from the brink but was energized by probably the world’s largest and most coordinated stimulus efforts in recorded history. Yet bond yields took a while to turn: in my view this represented the sentiment aspect - safe haven demand… but again, also the QE aspect.

But as previously noted, the world is slowly but surely undergoing another policy pivot away from easing towards tightening as inflation starts to bite. In essence, the patient seems to be recovering, so economic life-support measures are incrementally less necessary. As such a number of countries are ceasing or winding down their QE programs: incrementally this will mean less buying demand for bonds and less “artificial“ downward pressure on yields.

Bottom Line:  bond yields appear to be too low vs the key macro variables; sentiment and QE effects are likely the key culprit; but these effects should diminish in the coming months.

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Best regards,

Callum Thomas
Founder & Head of Research at Topdown Charts

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