Bond Market Confusion

Global stock markets are soft across the board as we swing into the first trading day of February. At first glance, this appears to be responsive to the constant drumbeat of terrible economic news, as economies and trade shrink in unison.

The action in the bond markets appears to be somewhat healthier. For several weeks, the theme underneath the surface noise in corporate debt markets has been gradual stabilization. Things are far from normal, but they’re inching along in the right direction. Spreads between corporate debt and government debt have been compressing, and the tone shows that risk tolerance is making a comeback in some sectors.

Here, and in the slightly-improving tenor of the short-term capital markets, you can see the positive impact of the Treasury and the Fed’s heroic stabilization efforts, including the much-maligned TARP.

The government debt market is where the real action is. The yield curve has been neurotically steepening and flattening as participants weigh the broadly offsetting influences on prices for governments: the steadily worsening economic news tends to support prices, and the gargantuan amounts of new issuance push the other way.

I think the friction and noise being generated as markets absorb new supply is the surface phenomenon, and the continuing strong demand for risk-free debt is the deep structure.