Long-term rates rose last week. In our perverse world, the cause was too much good news.
As always, rate-watching is a probability business, surprise the only constant. Odds have shifted from the May-June flirtation with lower rates toward a test of the highs of this year. But the good news is not good enough to pull forward a rate hike by the Fed.
Short holiday weeks usually magnify data surprises, but this one seems to have suppressed response. Today’s all-important employment report found 288,000 net-new jobs in June plus prior-months’ upward revision of another 29,000. Average hourly earnings before inflation have risen only 2% in the last year, but in the last two months at a 3% annual pace.
As all the bond market smarty-pants now understand, incomes are everything. The number of jobs, the unemployment rate — none of that matters except to a White House grasping for a life jacket. We have no idea what the US workforce really is, or how it will behave, or at what point jobs at last growing slightly in excess of population might be inflationary. The Fed is correct to wait to see the whites of the eyes of rising wages, avoiding traditional pre-emption.
Another force holding down yields on Treasurys and mortgages despite the Fed’s monthly trimming of bond-buying: borrowing is shrinking. The US of all nations has made more budget progress than any except one. Our deficit is way down, down by two-thirds in three years even though we have dodged structural reform of the out-years. New mortgage supply is too small to notice, refis mostly over and purchase volume off last year.
The one major-nation exception, with more budget progress than we: Germany has balanced its budget. Can’t call them suicidal because they think they’re doing the right thing. Reflexive? Rigid? Robotic? Whatever, exactly the wrong thing to do to the rest of Europe, contractionary, deflationary, and pulling down on interest rates everywhere.
The Fed would love to get above zero, but faces two US vulnerabilities beyond wages and jobs. The lesser one is the stock market, the DowĀ closing above 17,000. Not explosive exuberance, but certainly overconfident. My son this morning told me his college IT classmates are trading IPO shares provided by parents. Guysā¦ the news is so good that the Fed is coming to kill you, and you’re still buying? Never confuse a bull market with brilliance, and remember Gary Larson’s dog, bragging that he’s going to the vet to get tutored.
The second vulnerability: housing. In all prior expansion cycles, recession-low interest rates have ignited a housing run which has lasted well into the next tightening cycle. The beneficial push from rising prices of homes overcomes the first two-percentage-points of higher rates, and pulls the whole economy. The next recession has been precipitated by rates finally high enough to choke housing.
This housing recovery had a fair year in 2013, led by the acutely temporary Charge of the Cripple-Shooters, buying up the last too-cheap distressed inventory. Normal people released some pent-up demand. This yearā¦ no legs. NAR reported a sudden jump in pending sales late month, but the figure is not supported by any other data and NAR reports are notoriously approximate. Mortgage bankers’ national purchase-loan applications are flat.
The technical mechanism to watch when the Fed does come above zero: the spread between the Fed’s overnight cost of money (the fed funds rate) and the 10-year T-note, proxy for all long-term lending. In normal times (these not), the 10-year should rise and take mortgages along in anticipation of Fed hikes.
But this time we may get lucky. The long-term markets may well perceive pervasive weakness, and instead of ratcheting with the Fed anticipate the negative effects of Fed tightening. The signal: spread closing (“yield curve flattening”), the funds rate coming up but the 10-year not moving much. So I hope. Happy 4th! Click on the charts below to enlarge.
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Don’t expect the 10-year to hold 2.65% next week; we are overdue for a run upward.
Great chart! Although only through mid-2013, capturing the 10-year move upon the Fed’s tapering announcement. Main thing: note independent movement of Fed and 10-year. The Fed insists that 4% is the natural neutral position for fed funds, but the two times in the last 15 years it has been so high were followed quickly by recession.
I hear all the music from the housing trumpets, but I donāt see the band.
Thin new construction still a mystery. Possibly just very extended recovery.
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