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Don't Fear the Yield, Economic Fundamentals Are Robust and Growing

Don't Fear the Yield, Economic Fundamentals Are Robust and Growing
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Tuesday, 24 April 2018 01:26 PM Current | Bio | Archive

The U.S. 10-year Treasury yield rose to 3 percent on Tuesday for the first time in more than four years as investors reduce their U.S. bond holdings on worries about rising inflation and growing government debt supply.

The two-year yield in the meantime rose to 2.50 percent for the first time since September 2008 amid bets the Federal Reserve would raise short-term rates further due to an improving U.S. economy, Reuters reported.

Investors could do well keeping in mind that the U.S. 10-year Treasury note yield rate is the global financial benchmark market rate that is used for example as a benchmark for U.S mortgage rates, but that besides that, sets the rate path of the corporate bonds as well as the emerging bond markets’ rates.

The 10-year yield it is also a good indicator for where the federal-funds rates may convert to.

This month, the yield has risen on signs that U.S. inflation is headed slowly higher while the Federal Reserve has clearly indicated the fed-fund rates could be raised another three times in 2018.

In my recent blog Investors Must Watch Bond Market for Signs of Economic Strain: “Investors could do well watching the bond market as the idea of tax cuts and more spending in an economy that has full employment and a large budget deficit is an interesting challenge to the conventional economic thinking. Watch out when the 10-year yield will rise through 3 percent. The 10-year yielded yesterday 2.84 percent.”

It could be helpful to recall that at present the yield of the 10-year U.S. Treasury note is still well below its average yield since 1988 that is a little bit above 5 percent.

Besides that, financial markets will take into account where the core U.S. inflation rate is headed for. For example, were the core U.S. inflation rate were to print 2.5 percent, which is about 0.5 percent higher than where we are at present then the “neutral rate” would be rapidly adjusted upwards, which would also be performed for other macro variables.

This brings us to the crucial question and not withstanding that question has been side-stepped for a much too long time, is the United States a “positive rate economy” or not?

For example, former Fed Chair Janet Yellen has asserted that the U.S. economy will be a 1 percent real rate economy in the medium term, and the day that is the case then a 3 percent neutral rate will come immediately in play.

Moreover, there are also an important technical issue at play as the unwinding of the quantitative easing (QE) policy of the Federal Reserve that is firmly underway.

In the third and fourth quarter this year we will probably move to a point where for the first time in five to seven years central banks will no longer be net buyers of government bonds as the QE is reversed, driven by the (gradual) unwinding of the Fed’s balance sheet whereby the Fed has effectively started to de-print money an that should continue in the coming five years at least.

U.S. fundamentals remain very robust. Consumer confidence is literally going off the charts, the last labor report showed that jobs growth was 200,000 more than replacement while survey evidence points to that wage inflation is heading towards 3.5 percent.

In my opinion, higher 10-year U.S. Treasury yields are completely on the cards.

The latest chatter on the news wires is that the oil price has inflation consequences.

I’d like to add to that only if higher oil prices lead to higher wages, leading to higher inflation risks should, then the central bank will react to oil price market moves.

Oil price increases are a “relative price change” and not inflation of itself. Inflation is a general increase in prices, not one price rising.

Besides all that, one price falling has been that of aluminum as a result of changing political signals from the United States with regards to Russian sanctions. This is an instance where politics does have some short-term market relevance because politics is interfering directly in the market.

Today’s special Congressional election in Arizona is an instance of politics that does not have an immediate economic consequence. However, a strong showing by the democrats today, especially if the turnout is relatively high, may influence expectations about what November’s midterm elections may produce. To that extend, the election may create some market noise in areas that might be considered politically sensitive if there is a change in control of Congress.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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HansParisis
U.S. fundamentals remain very robust. Consumer confidence is literally going off the charts, the last labor report showed that jobs growth was 200,000 more than replacement while survey evidence points to that wage inflation is heading towards 3.5 percent.
yield, bond, rate, treasury, economy
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2018-26-24
Tuesday, 24 April 2018 01:26 PM
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