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Today's December private sector jobs report beat expectations (223K vs. 140K) and that supposedly triggered a sharp, negative response from the bond market. Interest rates are now priced to only one more cut in the Federal funds rate for the rest of this year. As a result, in the past few months short-term interest rates have jumped by almost one percentage point, 10-yr Treasury yields have jumped by more than one percentage point, and 30-yr mortgage rates have risen to almost 7%.
But the perceived health of the jobs market wasn't the only thing that rattled the bond market today. Another contributing factor was the Fed's fear (shared by the market) that Trump's threatened tariffs would boost inflation, as revealed in the minutes of the last FOMC meeting. From mid-August, when Trump's probability of winning the election bottomed, 5-yr average inflation expectations have jumped from 1.87% to 2.54%. In any event, it remains the case that inflation is not caused by a stronger jobs market or stronger economic growth: growth has soundly beat expectations in recent years even as inflation has declined significantly.
Whatever the cause, higher rates and higher inflation expectations effectively put the kibosh on hopes for lower mortgage rates, and thus will likely worsen the prolonged period of historically weak home sales, housing starts, and new mortgage applications which began over two years ago. Sadly, it will add insult to the injury of many thousands of displaced Los Angeles area residents seeking to rebuild or replace homes lost to multiple fires.
As I see it, the rationale for today's sharply higher rates and slumping stock market has weak underpinnings: the mistaken belief that tariffs will boost inflation and thus require tighter-than-expected Fed monetary policy.
Chart #5 compares the level of real yields on 5-yr TIPS to an index of the dollar's strength vis a vis other major currencies. Rising real yields are an excellent measure of how tight monetary policy is. Not surprisingly, tight money and high real yields have significantly boosted the dollar's appeal. A strong dollar positively impacts our purchasing power while also keeping imported goods prices low; indeed, a strong dollar is an excellent defense against inflation, especially when accompanied by tight monetary policy.
Chart #1
Chart #1 shows the monthly change in private sector payrolls over the past 3 years. Note how volatile this statistic is on a month-to-month basis; that anyone—especially the Fed—would use just one month's number as a basis for important long-term policy decisions strains credulity. But that's what happens every now then, with today being a prime example.
Chart #2
Chart #2 uses a more realistic approach to interpreting the state of the jobs market, by focusing on percentage changes in jobs over 6- and 12-month periods. By either measure there has been a dramatic slowdown in jobs growth in recent years. At best, jobs currently might be growing at a 1.3% annual rate, which is marginally lower than the 1.4% annualized rate that has prevailed over the past 30 years (a period that includes three recessions). Current jobs growth is moderate at best.
Chart #3
Chart #10 shows the level of 10-yr Treasury yields, which is the benchmark for all long-term interest rates (including fixed-rate mortgages). Simply put, interest rates have exploded higher in recent years. Only abundant liquidity has kept this from tanking the markets and the economy. (For a longer explanation, see this post from last November.)
Chart #4
Chart #4 compares the level of fixed rate mortgages to an index of new mortgage applications (as opposed to mortgage refinancings). The plunge in new applications reflects a similar plunge in new home sales and housing starts. In effect, sharply higher rates have crushed the housing market.
Chart #5
Chart #6
As I mentioned in my last post, a strong dollar puts downward pressure on commodity prices. Indeed, industrial commodity prices have declined in both real and nominal terms over the past two years, as shown in Chart #6, thanks to a strong dollar.
Monetary policy is tight and has become tighter of late, as the market and the Fed worry about the presumably inflationary impact of Trump's tariffs that have yet to be imposed. It makes much more sense to believe that Trump's promises to significantly lower tax and regulatory burdens will deliver stronger growth with low inflation.
2 comments:
The rise in long term rates is puzzling - Could it be less about tariff fears and more about QT and China divesting of US debt?
In my experience, I have come to believe that interest rates on Treasuries are primarily determined not by supply and demand (i.e., deficits, or the trading of those who invest in Treasury debt) but by macroeconomic variables such as inflation and the expected stance of monetary policy. After all, Treasury yields form the backbone of all yields everywhere. A rise in long-term Treasury yields thus affects the pricing of nearly all asset classes. Whether China buys or sells even as much as trillions of dollars of Treasuries is not as important as the rate of inflation and expected inflation, which in turn affect the pricing of all assets (e.g., bonds, stocks, currencies, goods).
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