Better To Bet On Rational Bond Market Rather Than Tentative Stock Market - Economic Highlights

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A lot of central bank headlines today, with interest rate decisions by the European Central Bank and the Bank of England and another day of congressional testimony by Fed Chairwoman Janet Yellen. The ongoing sell-off in the momentum stocks will likely continue with softer looking reports from Tesla Motors ( TSLA ) and Priceline ( PCLN ) adding to what we saw from Whole Foods ( WFM ) the other day.

The European Central Bank's (ECB) interest rate decision this morning didn't surprise anyone, though the markets do expect the central bank to start its own version of a QE program in the not-too-distant future. The persistent disinflationary trend in the region, which seems to be getting support from the common currency's strength, lies at the root of these QE hopes.

Many are hoping the ECB will start the program at its June meeting, and will be looking for clues in Mario Draghi's press conference today. Thus far, the bank has been mostly talk and not much action, which isn't that different from the currency union's political leadership.

The policy outlook for the Euro-zone runs counter to what is expected in the U.S. where the Fed is on track to get out of the QE program by the end of the year. In her Congressional testimony on Wednesday, Yellen showed plenty of confidence in the U.S. economic outlook for the current and coming quarters. This view is broadly in-line with the stock market consensus, which is looking for U.S. economic growth to 'graduate' to an above-trend pace in excess of +3% this year and beyond.

The Fed's policy is to move away from relying solely on direct bond purchases as a means to influence long-term interest rates and use instead forward guidance to anchor market expectations. This seems to be working just fine, as long-term yields have come down despite continued QE Taper and growing signs of a rebound in the economy following Q1's flat finish.

All of this seems plausible enough. But the counter argument is that the recent downtrend in treasury yields has nothing to do with effectiveness of the Fed's policy or even a safe-haven trade resulting from the Ukraine situation - it is actually a reflection of the bond market's skepticism about the Fed and stock market's economic outlook. In other words, the bond market simply doesn't see the U.S. economic growth picture improving so materially from its recent path and is betting those optimistic growth estimates will come down going forward.

Hard to tell which view is 'on the money' at this stage. The debate will likely go on for some time, but if I had to take sides, I will go with the typically more rational and unsentimental bond market. The current tentativeness in the stock market is a reflection of this debate.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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