Asset Allocation Weekly: The Citigroup Economic Surprise Index and bond yields

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Confluence Investment Management offers various asset allocation products which are managed using top down or macro analysis. We publish thoughts on asset allocation on a weekly basis in this report, updating the report every Friday, with an accompanying podcast.

As market strategists, we are always on the lookout for reliable indicators of future financial market performance, wherever we can find them. Some indicators are highly correlated by themselves, with performance criteria such as stock prices, dividend yields or bond yields. Other indicators are indices made up of several data points, and they can also indicate future performance of financial markets. In this class, we would include the Citigroup Economic Surprise Index (CESI), which assesses whether a set of core economic data series has been below expectation, expectation, or above expectation. A review of the recent CESI trend shows that it pointed to lower bond yields over the summer, despite growing investor concerns over rising inflation and interest rate hikes from the Reserve federal. Looking ahead, CESI now suggests bond yields could be relatively stable in the short term.

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The chart below shows that CESI can be volatile, but that’s not necessarily because of the ups and downs in real economic activity. On the contrary, the index captures how economic indicators present themselves in relation to the expectations of investment analysts. This therefore reflects the changing optimism or pessimism of analysts and the fact that they have been caught in the wrong direction of their expectations. Calculated over a sliding three-month window, the index weights its constituent indicators according to the strength with which positive or negative surprises have affected financial markets in the recent past. When the index is less than zero, it means that the constituent indicators have been below expected levels, overall, and vice versa. At the end of October, the index stood at -16.1, suggesting that the indicators have recently been disappointing.

Positive surprises or disappointments can affect investors’ willingness to buy assets, and statistical analysis confirms the relationship. In the graph below, we have modeled the three-month evolution of the 10-year Treasury yield (in basis points) as a function of the CESI level. Over time, a lot of things affect Treasury yields, and CESI certainly doesn’t explain the majority of how yields evolve. Yields often move more or less than our model might suggest. Nevertheless, the analysis offers positive confirmation that there is a relationship between the two variables. We believe this relationship can be a tool for understanding where bond yields could be heading.

Since the middle of last year, for example, CESI has been weakening as the initial, surprisingly strong economic recovery from the coronavirus pandemic has started to moderate. The model therefore predicted that the rise in Treasury yields should start to slow and then turn negative (the green line). However, investors were slow to focus on the moderate recovery. Bond yields have been pulled higher by greater optimism about growth and growing concerns about inflation and the Fed’s rate hikes. Yields accelerated sharply in the spring to reach a level well above what the model would have suggested (the red line). In other words, the rate hike has accelerated far beyond what would have been expected given the reduced level of positive surprises in the economic data. This condition foreshadowed that the bond selloff and the associated surge in yields might be about to end or be reversed, which is one of the reasons we have become more willing to hold bonds longer. maturity in our asset allocation strategies during the spring.

What is CESI signaling currently? As the chart shows, recent fluctuations in returns have been very much in line with what our model would suggest. If the positive and negative surprise data now remain closer to their historical balance and the CESI stabilizes, bond prices could remain close to their current levels. Additionally, yields could remain within a relatively narrow range for now, despite some investors’ concerns about rising inflation and tightening monetary policy.


Past performance is no guarantee of future results. The information provided in this report is for educational and illustrative purposes only and should not be construed as individualized investment advice or a recommendation. The investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial situation. The opinions expressed are current as of the date indicated and are subject to change.

This report was prepared by Confluence Investment Management LLC and reflects the current opinion of the authors. It is based on sources and data believed to be accurate and reliable. The opinions and forward-looking statements expressed are subject to change. This is not a solicitation or offer to buy or sell securities.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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