Is the Bond Market Confusing You? Check Your IPhone.

(Bloomberg Opinion) -- The Federal Reserve has raised interest rates twice since March, and the odds are good that it will boost them twice more by the end of the year. And yet yields on longer-term Treasuries have barely budged, with rates on 10-year securities holding under the psychologically important 3 percent level for six weeks now. What gives? Thank the iPhone.
Bond bulls often cite advances in technology as a reason inflation remains muted this far into the current economic expansion. Low rates of inflation preserve the value of fixed interest payments over time. That connection was on full display Thursday after the U.S. government reported that its consumer price index for August, excluding food and energy, rose just 2.2 percent from a year earlier, below estimates for a 2.2 percent advance. Breakeven rates on Treasuries — a measure of what traders expect the rate of inflation to be over the life of the securities — tumbled. For five-year securities, the rate dropped as much as 3.72 basis points after the CPI report, the most since May. “We think it is ironic that the inflation report comes on the day after the new iPhone release, as we have argued many times in the past the number of functions that the iPhone — or other smartphones — replace in and of itself (damped) inflation (by) replacing goods demand — camera, radio, alarm clock, music collection, travel agent, etc. — that are now substituted for with smartphone functionality,” Rick Rieder, BlackRock Inc.'s chief investment officer of global fixed income, said in a research note.

What was notable about the CPI report was that medical costs declined, with that portion of the index tracking health care dropping 0.2 percent for a second month. How does that connect to Apple Inc. and its iconic iPhone? Along with unveiling the latest models on Wednesday, the company also said its new Apple Watch would have new health sensors and apps such as an electrocardiogram, or ECG, monitor. The ECG capability helps the device sense atrial fibrillation, an irregular heart rate that can increase the risk of stroke, heart failure and other heart-related complications.

CENTRAL BANK INDEPENDENCE LIVES
Some sense of sanity was detected in Turkey on Thursday when the central bank asserted a surprising amount of independence by raising interest rates against the wishes of President Recep Tayyip Erdogan, who has been advocating for a cut. The country's Monetary Policy Committee raised the one-week repo rate by a massive 6.25 percentage points to 24 percent, almost double expectations in a Bloomberg survey, an effort to shore up demand for the rapidly depreciating lira and stem a flight of capital. The lira, which had depreciated 40 percent this year through Wednesday, jumped as much as 5.17 percent against the dollar. The move came just hours after Erdogan triggered pandemonium by repeating demands for lower borrowing costs after issuing a decree curtailing the use of foreign currencies in domestic transactions, according to Bloomberg News's Benjamin Harvey and Ercan Ersoy. The independence of monetary policy has been in doubt since Erdogan pledged in his election campaign this year to exert more control over the central bank. “This massive rate hike is going to stabilize the Turkish lira,” said Bernd Berg, a strategist at Woodman Asset Management AG in Zug, Switzerland. “With a central bank that has gained in credibility by showing its independence, Turkish assets are poised to recover in the short term.”

ECHOES OF 1982 IN EMERGING MARKETS
The decision by Turkey's central bank gave a boost to emerging-market financial assets worldwide. The MSCI Emerging Markets Index of equities jumped as much as 1.66 percent, while a sister index tracking their currencies rose as much as 0.64 percent for its biggest gain since January. So, is this the beginning of the end of this year's sell-off in emerging-market assets? Bloomberg Intelligence fixed-income strategist Damian Sassower noted in a report Thursday that capital flight from emerging-market countries is on the rise, inviting comparisons with the 1982 Latin American debt crisis, when outflows resulted in an L-shaped recession, or Lost Decade, for the region's economies. Weakening currencies are leading to depleted reserves, which limit the extent to which countries can maintain stability during a financial shock, Sassower wrote in the report. Of 53 emerging markets with available data, 42 percent are below the International Monetary Fund reserve-adequacy thresholds. Risk is highest in South Africa and Turkey, with reserves 36 percent and 26 percent below par. The market value of EM dollar-denominated bonds whose countries miss the IMF reserve threshold is $625.7 billion, or 33 percent of the Bloomberg Barclays EM U.S. Dollar Aggregate.

TECH JITTERS ON THE RISE
It's no secret that a handful of tech-related stocks such as Facebook Inc., Amazon.com Inc., Apple Inc., Netflix Inc. and Google-parent Alphabet Inc. have accounted for the bulk of the gains in the S&P 500 Index this year. The Nasdaq 100 Index that tracks these and similar equities has surged 18.1 percent compared with 8.6 percent for the S&P 500. But this month it's the tech stocks that have underperformed the broader market, and investors are becoming nervous that best days may be behind the group. That's seen in the elevated demand for options that provide protection against a sell-off in tech companies. Specifically, contracts that pay off if the Nasdaq 100 falls are in greater demand than similar hedges against losses in both the S&P 500 and the Russell 2000 Index, according to Bloomberg News's Sid Verma and Dani Burger. The three-month metric, known as skew, is one point above the five-year average, placing appetite for hedges in the 76th percentile, data compiled by Bloomberg show. Verma and Burger report that the Nasdaq 100 is on track to post its most volatile year since 2006 compared with the S&P 500, judging by the average daily level of the Cboe VIX Index relative to a similar measure on the tech index. On average in 2018, the VXN Index sits 3.8 percentage points higher than the VIX, up from 3 percentage points last year.

CRUDE CRUSHED 
The biggest two-day rally in oil prices since June ended abruptly on Thursday, with futures dropping as much as 2.98 percent as global supply concerns receded. Iranian crude exports are shrinking, and the International Energy Agency said it was uncertain whether Saudi Arabia and other larger producers could or would fill any shortfalls, according to Bloomberg News's Jessica Summers. Iranian crude exports have fallen significantly before U.S. sanctions even take effect, the IEA said in a monthly report. The Middle Eastern nation will face further pressure in coming months, and the economic crisis in Venezuela is pushing output there to the lowest in decades. “Things are tightening up,” said the Paris-based IEA, which advises most large economies on energy policy. “If Venezuelan and Iranian exports do continue to fall, markets could tighten and oil prices could rise” unless there are offsetting production increases elsewhere, it said. Also, OPEC highlighted a range of risks brewing in the global economy that could hurt oil demand as producers prepared for a meeting later this month in Algiers. “Markets are still fairly well supplied,” said Ashley Petersen, lead oil analyst at Stratas Advisors in New York.

TEA LEAVES
Are U.S. consumers putting their money where their mouths are? We may find out Friday, when the Commerce Department releases its monthly report on retail sales. While measures of consumer confidence have soared to near record levels, actual consumer spending has been just fair. There are reasons for that. For example, consumers may still be extremely cautious when it comes to money matters a decade after the worst financial crisis since the Great Depression. The report coming Friday is forecast to show that so-called retail control-group sales — which are used to calculate gross domestic product and exclude food services, auto dealers, building-materials stores and gasoline stations — rose 0.4 percent in August, compared with a gain of 0.5 percent in July and in line with the average over the prior 12 months. Bloomberg Economics notes that lot of recent strength in retail sales has been driven by robust restaurant spending growth, which makes up more than 10 percent of all retail sales. That's hardly a sign of animal spirits.

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To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company's news coverage of credit markets during the global financial crisis.

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