Okay, make sense of this: the US economy in a strengthening recovery, the Fed is in hold-me-back mode, jobs-jobs-jobs everywhere… and long-term interest rates have dropped as they would in a depression. Right.
Begin by stripping away three sources of confusion:
First the confetti cloud from Wall Street āanalysts.ā Assume that any commentary from a Street house, or an investment fund is a sales pitch. Maybe useful, maybe not, but frequently designed to induce fear which can only be quenched by handing your money to the firm. These pitches include attractive but indefensible criticism of the Fed, or advocate alternate universes (the gold brigade, Jim Grant marching naked in front), or government-haters.
Second, hold at a distance all commentary relying on a traditional business cycle, like all the ones after WW II. A lot of good people are caught in this one — shoot, our only guide is history and recognition of prior patterns. But, in the last 20 years weāve been moving farther away from prior pattern, less and less retracing. The cyclical allure is powerful: if more and more people are going to work, sooner or later wages will grow, and then too fast, and then weāll have an inflation problem — unless the Fed pre-empts by raising the cost of money.
Third, certainly including this author, nobody knows with any precision what happens next, not in a situation without modern precedent. However, some wisdom is available from studying the specific departures today from prior cycles.
No 1. Housing is MIA- flat
Traditional measures of affordability are off-chart high-side. Mortgages never got above 4.50% and are now under 4.00% again. Foreclosures new and old are way down. Absolutely inescapable: something(s) is missing from purchasing power. Credit is too tight, but more important….
No 2. Jobs
The shocker in Fridaytās job data was not another 252,000 jobs in December, or unemployment down to 5.6%, but the drop in hourly wages which canceled the gain in November, the net year-over-year a pathetic 1.7% gain, minimized by….
No. 3 Health care deductibles
The cost of health insurance including deductibles is killing the average household. It is not the fault of ObamaCare except by omission (cost reduction was/is every bit as important as more coverage), but the annual premium for a family (employer/family combined) reached $16,000 in 2013, and new subsidies fall off for family incomes above $75,000 per year.Ā There is a lot of good stuff going on in the US, but those three are the cement Frankensteins in the parking lot.
No. 4 Overseas issues and the Fed
Then there is the drag from overseas. The Fedās most recent meeting minutes contain more musing about foreign weakness than any Iāve ever read.Ā The German 10-year is now 0.49%, and Japanās 0.28%. Many claim that European yields are pushed down by anticipation of Ā European Central Bank (ECB) quantitative easing (QE), but rates here moved up at the onset of each round of Fed QE, hopeful that QE would work. Alternate explanations for Europe and Japan: too late for QE, debt is growing faster than economies, default in the air. Europe has a good chance to recover if it repairs euro-errors, Japan maybe not. US bond yields are pulled down by these two, yet….
No. 5 Wild cards
Europe is not in deflation. falling oil has pulled its overall CPI to negative .2%, but its core is still positive .6%. Japan is closer to zero, but the real problem in both places is American Disease: incomes compressed by global wage competition.Ā Wild cards are scattered all over the place. The collapse of oil should help, but there may be too many zero-sum effects. Everyone in that market assumes that prices will rebound to the $70/bbl level.
China is slowing, trying to re-balance its economy, but even they canāt know the pace or effects inside or out.Ā Nobody believes the Fed. Short-term Treasurys have priced-in one .25% hike this year, a Wright brothers liftoff. If considering a refi in this murk, take any deal that recaptures costs in 18 months or less, and donāt wait for lower.
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US 10-year T-note since December first.
The 2-year T-note is Fed-predictive, chart back two years, its yield not rising until mid-2014, and since up only about .25%. The Fedās rate is the overnight cost of money, which has maximum impact on short-term securities. If a 2-year trader misses sustained hikes coming from the Fed, his or her Bimmer will soon have a Dominoās sign on top. Note recent extreme volatility.
US 10-year T-note over same 2-year span as 2-year T-note chart. Note wildly opposite directions. It is more than possible that the Fed lifts off, takes out some pre-emptive insurance, and events overseas continue to hold down long-term rates — or even push them lower:
Euro in the last year. A devalued euro (which will go lower) will help the exports of Club Med. However, only exports outside the euro zone. Inside the zone Germany persists in running a 3% of GDP trade surplus with the other euro-zone nations, a catastrophic weight right out of the worst stupidity of gold standards. Unthinkable thus far: that Germany might change its behavior. As other unthinkables draw nigh, no telling what Germany might put on the table.
The whole long-term purpose of the Fed is to hold inflation as low and steady as possible. Liftoff is going to face strong political resistance, properly demanding to know, āWhereās the fire, Janet?ā Given negligible growth in wages, no matter how many jobs there are or how low unemployment goes, thereās nothing to make a fire with. The Fed steadfastly says that core inflation will rise back to 2%, but it is falling now, and not easy to figure how a tightening Fed will help it to rise.
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