eyeQ: bond markets issue clear warning sign

“Our signals are crafted through macro-valuation, trend analysis, and meticulous back-testing. This combination ensures a comprehensive evaluation of an asset's value, market conditions, and historical performance.” eyeQ

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We wrote about the bond market only last week but need to revisit it again today because of recent price action in financial markets. The 10 February article focused on gilts as a way to measure political stress in the UK and fears around the longevity of the Keir Starmer government. 

But, in recent weeks, global bond markets have arguably provided the most interesting price action.

First, we had Japan’s supermajority, which gives Sanae Takaichi freedom to aggressively pursue her chosen policy mix as prime minister. Many fear that will mean fiscal stimulus, which should mean more Japanese government bond (JGB) issuance and, hence, higher yields. Instead, 10-year JGB yields are around 20 basis points (bp) lower. 

Then, in the US, we’ve had a run of stronger economic data which, even with last week’s benign CPI print, should mean lingering inflation concerns weigh against immediate rate cuts. On paper, it wouldn’t have been surprising if that forced US Treasury yields higher. Instead, they’ve fallen around 25bp so far in February. 

There’s an old adage in markets that when something doesn’t sell-off on bad news, that’s an important tell. So, what’s happening?

The timing of this significant re-pricing in global government bonds coincided with the escalation of the artificial intelligence (AI) scare trade. 

In equities, that means various sectors take it in turns to get de-rated on fears of AI disruption. But is the bond market sniffing a broader deflationary move? That AI could lead to job losses and disinflation across the whole economy?

On eyeQ, our model suggests 10-year US Treasury yields should be grinding higher, not falling. The sharp fall in yields has been accompanied by a big drop in eyeQ macro relevance. A score of just 25% means US Treasuries are not a macro trade right now.

eyeQ’s model for 10-year gilt yields looks the same - model value remains elevated, actual 10-year yields are falling, and low macro relevance.

Source: eyeQ. Past performance is not a guide to future performance. 

So, to try and summarise, the bond market seems to be sniffing out a hard landing for the economy, possible because of AI. But eyeQ’s model - which includes economic growth and inflation - isn’t capturing the same thing.

Low macro relevance normally means something else other than macro is driving price shifts - could it be that flows are back in the driving seat? With precious metals wobbling, are investors flocking back to government bonds as the best “safe haven” hedge during times of uncertainty? For a long time, bonds have been unloved and under-owned. A positional squeeze could have serious legs. 

That could explain both the move in markets and our model’s low macro relevance scores. For now, no signal. But a clear warning sign. Equity investors need to be keeping a close eye on the bond market. If this fall in bond yields continues, that’s a clear message that risks of a growth scare are increasing. 

Useful terminology:

Model value

Where our smart machine calculates that any stock market index, single stock or exchange-traded fund (ETF) should be priced (the fair value) given the overall macroeconomic environment.

Model (macro) relevance

How confident we are in the model value. The higher the number the better! Above 65% means the macro environment is critical, so any valuation signals carry strong weight. Below 65%, we deem that something other than macro is driving the price.

Fair Value Gap (FVG)

The difference between our model value (fair value) and where the price currently is. A positive Fair Value Gap means the security is above the model value, which we refer to as “rich”. A negative FVG means that it's cheap. The bigger the FVG, the bigger the dislocation and therefore a better entry level for trades.

Long Term model

This model looks at share prices over the last 12 months, captures the company’s relationship with growth, inflation, currency shifts, central bank policy etc and calculates our key results - model value, model relevance, Fair Value Gap.