Tuesday, June 25, 2013

Putting higher interest rates in perspective

As I detailed last week, the dramatic rise in nominal and real yields since the end of April marks a big change in the market's expectations for the future of the U.S. economy. Two months ago, the market believed the economy would be so weak that the Fed would be unable to raise short-term interest rates for the next two years. Today, the market expects the economy to be doing well enough to allow the Fed to raise short-term rates to about 1% two years from now. As a result, interest rates all across the yield curve have jumped, and it's all because the market has gained confidence in the economy's ability to grow. It's hard to see how this can be interpreted as a negative for the equity market, or for the housing market, since even after the expected rate increases occur—if indeed they do—interest rates would still be relatively low from an historical perspective.

 

The chart above shows the Treasury yield curve as it stood at the end of last April, as it stands today, and as the market expects it to be in two years. 5-yr Treasury yields were 0.7% two months ago, and are now expected to climb to 2.7% over the next two years. 10-yr Treasury yields were 1.7% and are now expected to be 3.3% in two years. These are significant changes, but they are hardly life-threatening from the economy's perspective.


As the chart above shows, a 3.3% yield on 10-yr Treasuries would still qualify as an extraordinarily low yield from an historical perspective. 


As the chart above suggests, the current -0.2% real yield on 5-yr TIPS is only now approaching levels that might be consistent with the economy growing by a tepid 2% per year for the next several years—at about the same rate that it has grown over the past several years. What stands out in this chart is just how low real yields had fallen two months ago. The bond market was exceptionally bearish on the economy's prospects last April, and now it is much less pessimistic. But it is still far from being optimistic.

Today's interest rates, which embody expectations of higher interest rates to come, are not likely to pose a threat to the U.S. economy. They have presented a problem, however, for investors who thought that interest rates would remain close to zero for a very long time. 


The jump in Treasury yields has boosted mortgage rates by almost a full point, as seen in the chart above. Does this threaten the housing market? I doubt it. In the entire history of the U.S. mortgage market, rates have only been lower than they are today for the preceding year. Prior to 2012, rates have never been lower than they are today. 


Today's release of the Conference Board's measure of consumer confidence marked a new high for the current recovery. This is consistent with the action in the bond market: people are feeling a bit more comfortable now about the future prospects for the U.S. economy. 

UPDATE: According to ICI, taxable bond funds this month have experienced their biggest net outflow in over four years. Big things are indeed happening; the bearish case for the economy—which calls for very low interest rates for as far as the eye can see—has been dealt a serious blow.


5 comments:

L.A. said...

Higher rates are great news IMO at this point in the expansion. If I'm a bank I'm reluctant to lend 30 year money at 3.5% to anyone with anything except a perfect credit score. Credit expansion occurs from here. Helps business investment, housing, commercial construction.... get ready for the expansion to begin to accelerate.

Benjamin said...

There is some indication that the sudden surge in yields is related to policy actions taken (or not taken) by People's Bank of China. The Market Monetarist blog has some posts on that.

I see no macroeconomic reason for such a sudden move, although, as Scott Grannis points out, historically, interest rates and inflation remain at historic lows, and the resent spike looks like a molehill from a long-term perspective....

Are people getting more bullish?

I sure hope so...maybe QE is working...now if the FOMC hawk members, who have played the role of destructive oose cannons on deck, can just keep their mouths shut for a year or so.....

L.A. said...

On credit expansion...http://online.wsj.com/article/BT-CO-20130620-709238.html?mod=djempersonal

Gloeschi said...

No, Scott, neither the Fed nor the market believes in a bright future for the economy. It's only you.

What has changed is that the Fed has reneged on its inflation, or N-GDP, target. That has blown up a lot of trades, including gold, betting on negative real yields (due to artificially suppressed nominal yields). Hence the rise in real yields. Has nothing to do with economy. Please read Vincent Foster's comments at Minyaville.

theyenguy said...

You write, “As I detailed last week, the .... it's all because the market has gained confidence in the economy's ability to grow.” And you write “Today's interest rates, which embody expectations of higher interest rates to come, are not likely to pose a threat to the U.S. economy”.


I rspond, that its all because of Jesus Christ stimulated a quick rise of the Interest Rate on the US Ten Year Note, ^TNX, to 2.01% on May 24, 2013, and that this constituted an “extinction event”, that is a cataclysm, which literally destroyed the investment choice offered by bankers as the way of life, and terminated the paradigm of Liberalism. Jesus Christ is operating at the helm of the Economy of God, Ephesians 1:10, and has pivoting the world into the paradigm of Authoritarianism, where the diktat of nannycrats is the now way of life.


As a result, interest rates all across the yield curve have jumped, and that’s because of fears, first of credit liquidity, and second, that debtors will be unable to repay creditors, with the knock on fear that the world central banks monetary policies are unable to stimulate eorporate profit and global growth.


And you write: “Today's release of the Conference Board's measure of consumer confidence marked a new high for the current recovery. This is consistent with the action in the bond market: people are feeling a bit more comfortable now about the future prospects for the U.S. economy”


I respond that Consumer Confidence is consistent with Libersalism’s final inflationism, beginning with QE 1 and ending with QE4, causing a grand finale surge of M2 money, stated by the US Fed, with recent values of 10,594, 10590, 10579, 10557, 10541, as well as a surge in Automobile Stocks, CARZ, Retail Stocks, XRT, up until June 18, 2013 as is seen in their ongoing Yahoo Finance chart.


New Economic Action has commenced, as Jesus Christ continues pivoting the world from inflationism to destructionism. Soon the M2 Money figures will peak and turn lower. Most of the Retailers, seen in this Finviz Screener, have turned lower as wealth is dissipating, as investors realize that the monetary policies of the world central banks, specifically policies of interventionism, of Quantitative Easing, POMO, Global ZIRP and Kuroda Abenomics, have made “money good” investments bad.