The 'Freight Train' to Higher Yields Won't Be Derailed So Easily

07 February, 2018, 01:53 | Author: Lora Ball
  • Trader Gregory Rowe works on the floor of the New York Stock Exchange on Friday

US Treasury debt has been flashing warnings of incipient reflation for months, with benchmark 10-year yields rising 75 basis points since mid-September. The Fed is also operating with just three of its seven governor seats filled.

Friday's USA payrolls report showed wages growing at their fastest pace in more than eight years, fuelling concerns that both inflation and interest rates would rise faster than expected. The FTSE was down 1.46 percent and the Nikkei 225 finished down 2.55 percent.

In fact, up to its high a week ago it went a record 310 days without a 3% or greater pullback and every month previous year saw a positive total return (ie capital growth plus dividends) which is also unusual.

Short-term Treasury yields will nearly certainly increase if the Fed sticks to its forecast for three hikes.

Even good economic news can prompt some troubling concerns.

On Friday, the Labor Department put out its monthly report on how many jobs were created in January in the United States and how fast wages are growing. It's also the prospect of more inflation.

Treasury Secretary Steve Mnuchin sent the strongest signal yet last week in comments welcoming the dollar's decline as beneficial to U.S. exports. In reality, the USA economy is doing very well right now.

We had a look at this issue last week in Higher global inflation and higher global bond yields.

"When longer-term interest rates rise, that tends to stem inflation and economic growth and that feeds back into corporate profits", he told Bloomberg News.

More news: 3 officers shot in Colorado Springs, 1 dead

The rise in bond yields, fuelled by a surging USA economy and corporate earnings, has spooked traders anxious that the Federal Reserve will raise borrowing costs more than the three times initially expected this year. Yet long-term interest rates remain low, thanks to monetary easing in the US and elsewhere.

In the past, the risk premium applicable to NZ bonds over USA bonds (also called the bond spread or margin) has ranged between 1.00% and 2.00%.

"I see this decline as an opportunity given that corporate earnings are rising, interest rates remain low, despite having risen recently, and economic indicators are pointing up", said Daniel P. Wiener, chief executive of Adviser Investments, a Newton, Mass. -based firm.

The timing of this two-part adjustment upwards in our long-term interest rates may not occur until our short-term interest start to move back up and we widen the differential to USA short-term interest rates again (refer second chart below). Most think he'll be similar to Yellen, but no one knows for sure yet.

The bottom line is: The economy is doing well but stocks might not race up from here. Companies are healthy, and investors have rewarded them by pushing up their stock prices. And their confidence has fueled consumer spending, the primary fuel of the U.S economy. Yes, there are concerns about inflation, but they have yet to materialize.

Speaking at a fixed-income conference in January, Bob Michele, head of global fixed income, currency, and commodities at JPMorgan Asset Management, said investors could "see a significant bear market". Now things are likely to get more choppy.

The opportunity cost is nothing but the cost of next best alternative - the cost of foregoing one investment option in favour of the other; in this case, the difference between returns offered by equity and, say, bonds. That doesn't mean it's a calamity, it just means we may be returning to more normal times.

Patterson explains the relevance of America's long-standing strong dollar policy to the Fed's ability to support the economy - and the risks of its abandonment by the Trump administration. On the downside, stock prices probably won't be as insanely good.

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