As rates have risen, investors have, once again, started asking the perennial question: Is the bond bull market over and are rates normalizing? In thinking about bond yields, it is important to keep longer-term factors in mind that have nothing to do with central bank policy. Low yields have correlated with two, related longer-term trends: low nominal GDP (NGDP) and an aging population. The reason they’re related is that an aging population means slower growth in the workforce, and in turn, slower economic growth.
An aging population impacts rates through a second mechanism. As consumers age, their borrowing and investing patterns shift. Older households tend to borrow less and demonstrate a preference for income, in the process raising the demand and lowering the supply of bonds. The net result is that older populations tend to be associated with lower real, or inflation-adjused interest rates. This dynamic has been at work for decades and helps explain why low yields predated the financial crisis.
Because the population will not get younger any time soon, what would need to change to push rates back to “normal”? In terms of the real economy, the simple answer is faster nominal growth. Looking back over the past 60 years, the level of nominal growth has been the key to understanding the level of rates. During this period, a smoothed average of nominal growth explains almost 60% of the variation in long-term rates (see the chart below).
Read more »
“Property is as safe as houses, at least until the roof falls in. Our latest tally of global housing markets shows that American house prices have recovered to a new nominal high, and in Spain and Ireland, prices are again rising at a decent clip. In the English-speaking Commonwealth countries of Britain, Canada, Australia and New Zealand, prices have risen largely unabated in recent years.
Since autumn 2014 $1.3trn of capital has flowed out of China. Some of that cash has found its way into residential property in some of the world’s most desirable cities. In America, Chinese investors bought some 29,000 homes in the 12 months to March 2016 with a total value of $27bn, according to the National Association of Realtors. Much of this money is focused on a handful of cities: Seattle, San Francisco, New York and Miami. Foreign money has helped propel skyrocketing prices in other places, too. In Vancouver, home values have risen by 47% in four years; in London they have risen by 54%; and in Auckland the rise has been a whopping 75%. The influence of foreign capital flows on housing markets is being scrutinised, particularly as affordability becomes ever more stretched.
Read more »
According to the latest data on global GDP released by the World Bank this February, the U.S. still is the world’s biggest economy – by far. As shown by this Voronoi diagram, the United States (24.3%) generates almost a quarter of global GDP and is almost 10 percentage points ahead of China (14.8%), in second place, and more than 18 percentage points ahead of Japan (4.5%) on three.
Read more »
Bill Gross: “The expansion of central bank balance sheets from perhaps $2 trillion in 2003 to a now gargantuan $12 trillion at the end of 2016 is remarkable. Not only did central banks buy $10 trillion of bonds, but they lowered policy rates to near 0% and in some cases, negative yields.
Withdrawal of stimulus, as has happened with the Fed in the past few years, seemingly must be replaced by an increased flow of asset purchases (bonds and stocks) from other central banks, as shown in Chart below. A client asked me recently when the Fed or other central banks would ever be able to sell their assets back into the market. My answer was “NEVER”. A $12 trillion global central bank balance sheet is PERMANENT – and growing at over $1 trillion a year, thanks to the ECB and the BOJ.
An investor must know that it is this money that now keeps the system functioning. Without it, even 0% policy rates are like methadone – cancelling the craving but not overcoming the addiction. The relevant point of all this for today’s financial markets? A 2.45%, 10-year U.S.Treasury rests at 2.45% because the ECB and BOJ are buying $150 billion a month of their own bonds and much of that money then flows from 10 basis points JGB’s and 45 basis point Bunds into 2.45% U.S. Treasuries. Read more »
If we define the term “Earnings Recession” as two consecutive quarters during which S&P 500 earnings decline year-over-year, then the current earnings recession began in Q3 2015 and is still ongoing. We’re in the third consecutive quarter of year-over-year earnings declines.
Yes, the market is experiencing an earnings recession going on three quarters, but it’s coming from the energy and materials sectors, which are minor parts of the market on both an absolute basis and relative to history. Financial and Consumer sectors are only into their first quarter of declining y-o-y earnings and the remaining six sectors are still showing EPS growth.
More importantly, there is a history for this sort of thing that isn’t especially dour. There have been 12 earnings recessions since 1954 and 3 of them did not accompany an actual economic recession. The instance that occurred in 1985-86 for example, was caused by a sudden drop in oil prices (sound familiar?) and occurred in the midst of a period of economic expansion.
Read more »
“During a tightening cycle it is normal for short-term rates to rise more than long-term rates, resulting in a flattening of the yield curve. what is the yield curve signaling? Could it be that the growing chatter of a possible U.S. recession has some merit? Or are these fears overdone?
The Ground Rules
During uncertain times like these, we look to reliable indicators of past recessions to see what they are telling us. Although many variables such as growth in hourly earnings or high yield spreads over Treasury bonds have been shown to “predict” recessions in advance, the slope of the yield curve remains a powerful indicator of what lies ahead for the U.S. economy.
Perhaps I’m partial to this indicator because of its origin. I’ve had the privilege of having many good professors teach me throughout the years, standing on the shoulders of giants, if you will. One of these was Campbell Harvey, an investments professor of mine at the University of Chicago Booth School of Business. Professor Harvey wrote his dissertation thesis on how the slope of the yield curve predicts future economic growth.
In his dissertation, Professor Harvey measured the yield spread between 3-month and 5-year Treasuries and then compared the resulting yield curve to consumption growth. He discovered that when the yield curve inverts, such that short-term yields are greater than long-term yields, an economic recession can be predicted to occur 12 months later on average. Since Harvey first published this theory, the yield curve has inverted three more times (1989, 2000, and 2006) predicting subsequent U.S. recessions in 1990-1991, 2001, and 2007-2009. In each of these times, the Fed was in the midst of a tightening cycle.
At What Rates Could The Yield Flatten?
Using history as a guide, let’s take a look at three different methods for assessing the levels at which the yield curve has gone on to flatten or invert.
Fed Funds Rate
Historically, the Fed has stopped raising rates when the federal funds rate approximately equals U.S. nominal GDP, which is currently about 3.9% (2.4% plus inflation of 1.5%). If we assume that the sustained U.S. expansion continues at a modest pace and we move toward the Fed’s inflation target of 2%, then the Fed may complete its tightening cycle with the short-end of the curve ending up between 3% to 4%. Read more »
“There was a frenzy of speculation about Chinese currency devaluation earlier this year after a series of surrise moves that weakened the yuan (also called the renminbi) against the dollar. For all the discussion, the yuan has fallen by only about 3% in value against the dollar in 2015.
McKinsey estimated that Chinese debt has quadrupled since 2007 and its debt to GDP ratio has risen above that of the US. The question is, given the semi USD/RMB peg and China’s increasing open capital account (which come at the expense of China’s monetary independence), whether China can live with higher US interest rates and a higher US dollar. A weaker currency generally would boost China’s export potential and might help to prop up its flagging growth figures.
The yuan has actually strengthened in general over the past decade. It is still up by about 6.5% against the greenback since the middle of 2010 and up by 22.8% in the past 10 years, since the currency was unpegged from the dollar in 2005.
But before that period of pegging, you can see how massively the currency was devalued over a 15-year period, rising from less than two to the dollar in the early 1980s to over eight to the dollar by 1994“.
Read more »