BND: Falling Employment Stability Temporarily Lifts Bond Market Outlook (NASDAQ:BND)

Low-risk long-term bonds are among my favorite asset groups to track, as I feel the bond market is often more telling of economic trends than stocks. Mostly, I’ve held a bearish outlook on the longer-term bond market, such as those in the popular ETF, NASDAQ:BND. I first became bearish on BND in 2020 as I expected QE efforts to cause excess inflation and a rise in the long end of the yield curve.

For most of the past year, my outlook has fluctuated from bearish to neutral, primarily due to fluctuations in inflationary signals. As of March, I’ve held a bearish view on BND, believing that inflationary factors would rebound, as signaled by services inflation. I must update my view, given that services inflation has turned sharply in the disinflationary direction since then, coinciding with increased labor market pressures that may signal a traditional recession.

The Labor Market Signals Deflation

My long-term views on BND are effectively unchanged from my previous outlook. As detailed there, it seems impossible for the US to handle its public and private debt load without allowing for a prolonged price increase. Interest accounts for a quarter of Federal Tax receipts, while public debt is around 6.4X tax receipts. The Federal deficit is also widening again despite a slight increase in tax revenues. Two-thirds of BND is in US government debt, and the fund has effective maturity of 8.4 years. It does not carry the same risks as longer-duration bond funds, but still has ample risk associated with an expected chronically elevated inflation rate over the coming years.

Still, it is very rare for low-risk bonds, particularly government bonds, to lose value during recessions. My previous view was bearish in both the short-term and long-term. BND has been unchanged since March but may have some upward pressure over the coming months as it seems short-term disinflationary pressures are mounting that may cause a risk-off shift from stocks to bonds. Again, my long-term view on BND remains bearish, per my long-lasting statements, but given services inflation has fallen so fast, I must revise my short-term outlook.

I believe service inflation is significant to watch because it is less impacted by commodity price volatility. Although core inflation removes the direct impact of food and energy, those commodities still indirectly influence the price of all goods (with a longer lag) because energy costs drive manufacturing, transportation, and most other key goods market costs.

However, services are not as impacted by global commodity prices and have much more to do with the supply and demand of the domestic labor market and key industries like housing and healthcare. For the most part, services inflation is less volatile than goods inflation, so if there is a sharp monthly decline or rise in services inflation, that gives us some indication of where the overall inflation rate may be headed.

As you can see below, we saw a sharp upward move in services inflation, followed by a recent crash:

When services inflation was at 8% annualized, it seemed inflation was chronically elevated. Indeed, the rebound in “super-core” inflation (similar to services inflation) was likely a driving reason for the Fed’s decision to delay rate cuts until 2025. See the rise in the interest rate outlook from January to now:

The one-year ahead expected interest rate change has notably increased in 2024, pushing rate cuts into 2025. However, that trend ended around two months ago, coinciding with the sharp decline in services inflation.

Interest rates are primarily driven by the inflation and employment outlook, which the Federal Reserve aims to manage. Over the past two years, we’ve typically seen very high employment and inflation, implying the need for higher rates to slow inflation at the expense of employment. However, politically speaking, I’d argue that low employment and low inflation (a standard recession) are worse than the recent paradigm.

According to Federal Reserve Chairman Jerome Powell,

There’s an argument that they (employment) may be a bit overstated, but still, they’re strong.

I argue that Jerome Powell cannot be completely honest regarding the Fed’s economic outlook. If they provided a negative outlook, they’d almost certainly cause a negative shift in business and consumer sentiment, creating a self-fulfilling prophecy. Still, I think this statement is crucial for investors to be mindful of, as he essentially admits that the government’s recent employment data is likely not entirely accurate, stemming from the growing disconnect between establishment and household employment surveys.

This is not to say that unemployment is very high today, only that the “strong jobs growth” headline is not as accurate as it may seem. I recently discussed this regarding short-term bonds, though it is relevant here. If we adjust the employment metrics to look only at singular full-time job holders compared to the total available working population, we can see an apparent decline in employment stability:

From this standpoint, we can see an evident decline in singular full-time employment, such as that proceeded and coincided with the 2000 and 2008 recessions. In my opinion, this metric is far more useful than the overall employment rate because it accounts for changes in labor participation and those working part-time or second jobs. That is not to say part-time and second jobs are not benefiting the economy, only that it is problematic when all job growth since mid-2022 is from part-time jobs, while many with full-time jobs are taking on additional work, likely due to rising living costs.

Labor participation has declined since last September and never recovered after 2020, 2008, or 2000. The above chart clearly shows how, since ~2000, there has been a consistent recession-led decline in singular full-time employment. This metric also indicates recessions, having declined before 2000 and 2008. Since this data became available, there have been no periods where full-time singular employment has dropped as much as it has since 2022 without resulting in an unemployment-driven recession.

We could argue the rise of the gig economy and social or economic changes since 2020 may be causing a decline in full-time employment that is not indicative of a recession. However, as other data confirms labor and consumer strains, I find that unlikely. Notably, sustained low personal savings combined with falling real retail sales and rising credit card delinquencies. See below:

Following the QE bonanza in 2020, higher inflation led to decreased personal savings. Initially, lower savings were not matched by lower retail spending, as many people resorted to consumer credit. Today, we’re seeing consumer credit growth decline and delinquencies rise while real retail sales are slipping, implying that a growing number of people have maxed out their borrowing capacity and now need to cut spending.

Low savings and high debt suggest this should continue and potentially accelerate. Lower retail spending points to reduced employment, which could quickly result in a deflationary spiral, considering most adults do not have enough savings to account for even a month of their usual spending. Should they lose their incomes, their defaults should soar exceptionally quickly. Indeed, this is already happening, even with a tepid decline in employment stability.

Job openings are also falling very fast, with a markedly accelerated decline in May. Overall, openings are still high compared to historical levels. However, I believe that is because it is far more common today for companies to always have job openings posted, even if their intent on hiring is low. Inflation may also play a role in this, as people may find higher wages by changing jobs as employers are not used to keeping up with a high inflation rate, resulting in a sustained turnover increase.

Finally, there is also a notable decline in working hours. US working hours are still well above levels seen in most Western countries but have sharply declined since 2020. Undoubtedly, the shift toward part-time from full-time is associated with this change. However, it is again a signal of declining labor market stability. See below:

Will BND Always Rise in a Recession?

In my view, it is relatively clear that the US is headed into a typical employment-driven recession. Following the rise in labor costs and interest rates, people are not maintaining spending and borrowing levels, causing a negative shift in employment that could easily cause a negative feedback loop. This may be the Federal Reserve’s aim. However, I’d argue their direct influence over the economy is widely overestimated, as higher interest rates have had little impact on stock market performance, and consumer borrowing is likely slowing due to capacity, not borrowing costs. In my view, in the modern liquidity-driven economy, QE and QT have a far more significant economic impact than short-term interest rates (outside of a few rate-sensitive sectors).

Still, it is likely the Federal Reserve’s interest rate outlook will fall in an employment-driven recession. I continue to expect oil and food prices to rise, regardless of the economy, largely due to geopolitical trade issues. However, the shock of higher unemployment may still temporarily push inflation toward or below zero. Historically, this would be a bullish factor for BND, as interest rate outlooks usually fall with the economy.

Even if medium-term rates decline, BND may not rise if spreads on high-grade corporate bonds decline. This spread has been low in recent months, potentially stemming from underestimating corporate credit risk. The third BND in such bonds should lose some value in a recession unless there is a substantial decline in Treasury rates. See this metric below:

That said, I still expect BND to gain some value over the coming six months, associated with the disinflationary, or potentially deflationary recessionary transition. As with the Fed, my view is “data-driven,” so my outlook on BND is mainly dependent on the employment and services inflation changes. Since March, I believe BND’s outlook has improved because of the more accelerated recessionary signals.

Now, I will not be buying BND today because my long-term view remains very bearish. Indeed, should a recession arrive, I expect the Federal Reserve will quickly shift back toward significant rate cuts and QE, as it has a political need to stimulate the economy, even if that creates inflationary pressures. They may not take such extreme measures, learning a lesson from the post-2020 debacle, but I doubt it. Indeed, given overall debt levels and poor bank solvency, I do not see how the Fed avoids shifting back toward excess liquidity creation.

Thus, outside of geopolitical or other black-swan events, I expect inflation to decline markedly and then rise even higher as a recession prompts a return to excessively dovish policies. Of course, that view is speculative, and my shifting outlook on BND primarily pertains to short-term economic shifts. Those with a speculative mindset may find some defined-risk potential in out-of-the-money call options on BND or perhaps higher-duration bond funds like (EDV), (TLT), or (ZROZ). I may consider taking a bullish stake through such means, as I expect a temporary sharp increase may occur by year-end. Still, I reiterate that I do not expect the US will return to sustained near-zero interest rates (for two or more years) within the foreseeable future. Thus, my BND outlook is neutral, with a short-term bullish outlook and a long-term bearish one.