A recent Bloomberg story caught my eye by posing a very good question: “What do America’s banks know about the state of the U.S. economy that has them hoarding ultra-safe bonds?”
It seems that some of America’s biggest financial institutions have been big buyers of U.S. Treasury securities. In fact, banks have been consistent bond buyers for 16 months straight and now hold more than $2 trillion worth of Treasury and federal agency dept, the most since 1973!
In part, this is due to tighter financial regulations that require banks to hold more capital and bolster their balance sheets with higher-quality assets, like Treasury bonds.
|America’s biggest financial institutions loading up on Treasuries.|
But it’s also a sign of slack in our economy, including lack of demand from borrowers, that banks prefer to invest deposits at record-low yields rather than lending out the money.
To be sure, record low interest rates have led to increased corporate borrowing. Commercial and industrial loans have risen 13 percent to $1.8 trillion. In turn, businesses have increased hiring with the economy adding about 250,000 jobs a month over the past year.
But consumer loan growth is just 5 percent, as many Americans continue to pay down debt. And this underscores the mixed-signals our economy has been throwing off recently.
In fact, while the economic data out of Europe has turned more positive, U.S. economic reports are moving in the exact opposite direction; with more negative than positive surprises in the data. That’s why the Citigroup Economic Surprise Index (below) is one indicator to monitor closely.
It’s a handy gauge that tells me if recent economic reports have been beating forecasts (positive surprises) or falling short (negative). The line rises when economic data beats forecasts, but the index falls when data misses projections.
For example, Tuesday’s Consumer Confidence Index showed a drop in sentiment to 96.4 this month, which fell short of the consensus estimate of 99.5. A negative surprise, which helped push the index down further.
In fact, this indicator now rests at the lowest level in two and one-half years, which means far more negative than positive surprises in U.S. economic reports so far this year.
So why should this be important to you?
It’s because, in the past, there has been a very high correlation between downturns in this index warning of trouble ahead for the stock market. The vertical lines on the chart point to prior peaks in the index, which line up well with past corrections in the S&P 500 Index.
The good news is that the S&P 500 has already had a volatile, sideways correction since December, at one point down about 5 percent. More recently, the S&P and other stock indexes have been able to shake off the negative economic news and move to new highs.
That’s why I’ll be watching this index closely. More nasty surprises in the economic data could mean more volatility ahead for stocks, but a decisive upturn in the economic surprise index should bring more new highs for stocks. Stay tuned!