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  1. Economy and Politics
  2. Economy

Oil Prices Say the Economy Is Improving. The Bond Market Begs to Differ

By:
Paul J. Lim
3 min read
Oil pumping units, also known as "nodding donkeys" or pumping jacks, stand on an oilfield operated by Tatneft OAO near Almetyevsk, Russia, on July 31, 2015. - Andrey Rudakov—Bloomberg/Getty Images
Oil pumping units, also known as "nodding donkeys" or pumping jacks, stand on an oilfield operated by Tatneft OAO near Almetyevsk, Russia, on July 31, 2015. Andrey Rudakov—Bloomberg/Getty Images

Since the end of January, crude oil prices have rebounded more than 30% to $36 a barrel.

To Wall Street, that could mean only one thing. "The surge in crude prices indicated a reduced risk that global growth was deteriorating," said Jay Leopold, head of U.S. investment risk at Columbia Threadneedle Investments in Boston.

In other words, investors felt comfortable wading back into economically sensitive—and speculative—parts of the stock market since they thought oil was signaling an improving global economy.

Sure enough, since early February, the S&P 500 index of U.S. equities has soared nearly 12% while investor confidence has bounced back.

Yet stock investors are ignoring one big thing.

Since the start of February—when oil price began shouting that the global economy was back on track—the bond market has been screaming just the opposite.

In fact, the yield on 10-year Treasury bonds has sunk from around 2% down to below 1.7%. Bond interest rates move in the opposite direction of fixed income prices. So the fact that yields have sunk so much so quickly means investors have been racing to buy humdrum government bonds, which tend to thrive in slow-growing or stagnant economies.

Yet the drop in U.S. bond yields is only the tip of the iceberg.

"Overseas, many government bond yields have fallen to record lows," notes Ed Yardeni, president and chief investment strategist at Yardeni Research. In Europe, for instance, the yield on 10-year German bonds has sunk to a mere 0.09%. Less than a year ago, 10-year German bonds were paying investors close to 1%. Meanwhile, in Japan, yields on 10-year government bonds have actually gone negative, paying a negative rate (or charging) 0.07%.

READ NEXT: Why Stocks Could Rise 20%

So what's the takeaway?

For starters, you shouldn't overlook the ability of the bond market to forecast the economy. While stocks are supposed to foreshadow the economy several months out, the same is true for bond yields.

Longer-term, says Leopold, "investors should maintain a disciplined philosophy and process, resisting the urge to rely on simple narratives which naturally form to explain complex market movements." Like the narrative that says that because oil prices are rising, the global economy must be improving.

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