Most economists expect rising inflation. Blackrock said core CPI might go to 2.4% and then drop to 2.2%. David Rosenberg warned that in a previous cycle core CPI had gone from 1% to 3%. If core CPI goes to 2.3% and the “natural” real rate is zero then the overnight Fed funds should be 2.3%. Currently 90 day Libor is 2.18% and the two year Treasury is 2.28% (2.5% state income tax-adjusted). Thus some short term rates set by the market have already discounted rising inflation that will make rates go up. When the Fed raises rates that will make long term bonds’ yield go down slightly when investors see the Fed is trying to fight inflation. It won’t take
Today the monthly BLS employment report was released showing 313,000 new jobs, a much higher increase than the typical 170,000. Nominal hourly wages up 3.2% annualized (using 3 mo. average); YoY up 2.6%. David Rosenberg says wage gains are real; and says the report is a “perfect report”; importantly that manufacturers added 100,000 jobs instead of the low wage service jobs. Economist Mike Bazdarich has an excellent commentary, using his methods, showing only modest, gradual increase in employment and wages occurred when excluding two volatile occupations. ECRI says unemployment rate actually increasing in recent months if one looks down to the third decimal place. Remarkable: “All of the growth in jobs since 2000 has been among those 55
Economics firm BCA said short German government Euro denominated bunds, and go long, unhedged for foreign currency changes, the 30 year US Treasury bond because of the interest rate differential. I think investors hold a prejudiced view that Europeans like to pay higher taxes and thus have a more sound currency due to smaller deficits. I disagree with that claim, I think the EU has plenty of loopholes and is not a haven for those who like to collect high taxes and use the tax revenue to pay down debt; instead they have many aspects of deficit spending. The EU financial system is inherently unstable, using a new type of system never tried before where they have national central
Reasons inflation may increase: Full employment economy of 4.1% unemployment Economy is strongest since the bottom in 2009 Tax cuts will stimulate the economy leading to excessive growth and inflation Reasons inflation won’t increase: The dominant economic paradigm is that giant companies export good jobs in Developed countries to EM countries to cut costs and cut taxes. Corporations will seek to lower their taxes by moving more activities offshore where they can pay 12.5% instead of 21%. Continued hallowing out of mid-skill good jobs results in workers taking a demotion, pay cut, and shifting to unreliable gig economy work instead of a real job. This demotion results in workers qualifying for smaller loans and thus cuts their ability to
Trying to estimate what are a fair level of interest rates, I feel today’s rate are fair. A 2016 article by the Fed says real neutral rate is close to zero and use PCE inflation rate so that implies 1.5% nominal short term rate is OK, we are at 1.42% Fed Funds now, so no problem with rates. See August, 2017 Bloomberg article. The neutral real rate declined to negative 0.22 percent, from 0.12 percent in the first quarter of 2017. Recently is has increased to negative 0.1%. James Bullard of @stlouisfed (President of the St. Louis Fed) concludes desire for safe assets is the largest driver of the drop in real natural rate of interest. Today he
Some inflation measures are rising and there appears to be an intermediate term trend of gently rising inflation and a growing economy. This could threaten bonds. However, I believe this is merely a brief intermediate or short term cyclical trend and that the fundamental dominant paradigm of a secular trend of bond-friendly disinflation will continue. At the end of a nine year economic cycle the final year often has a sudden upward burst of inflation, pay raises, less unemployment, more GDP growth, etc. However, this phenomenon may be the last hurrah before the once in a decade recession. It is like stocks’ charts where a stock, nearing its top, goes through a “blow off phase” where the price
Economists may focus on the short term overnight Fed Funds rate, now roughly 1.4% but the free market short term rate is the 90 day T-Bill yield, now at 1.64%. An even more objective, less manipulated rate is the two year Treasury Note, now at 2.26%. Adjusted for the fact it is free of state tax means its taxable equivalent yield is 2.48% for residents of CA, NY, etc. Assuming PCE inflation is 1.5% and that Owner’s Equivalent Rent component of inflation needs to be adjusted downwards shaving off at least 15% of this then the PCE should be 0.22% lower or about 1.28%. The difference between 2.48% and 1.28% is a short term risk free real yield of
If stocks are overpriced 2 times fair value because of irrational emotions of the crowd, then what about bonds? No one seems to be emotionally in favor buying bonds yielding about 2% or even 3%, so it seems that market is dominated by logical minded professionals seeking to use bonds as a haven to protect from a contingent risk of a crash of risk-on assets. It is possible the decision to increase one’s fear of rising inflation could cause, on the margin, some bond investors to make an emotional leap out of bonds. If stock investors overpaid for stock by 2x because emotions perhaps some bond investors will misdiagnose the threat of inflation and push down bonds prices to a
The uninhibited boost of the deficit by Trump and members of both parties in Congress on Feb. 9th may trigger fears of Banana Republic-style out of control deficits. The preponderance of evidence is that growing debt loads are not yet morphing into an inflationary Banana Republic. Some people are frustrated that Tea party Republicans were eager to oppose scary huge deficits during the crisis era in 2008 when TARP and the AIG bailout were needed to prevent a depression and now these same politicians appear to have abandoned their anti-deficit principles. However, it is a mistake to assume that, because of this change, to leap to the conclusion that Republicans have morphed into a party of Zimbabwe-style fiscal policy.
The federal budget signed on 2-9-18 will have annual $1Tril deficit in a 2 year average of FY 2018 & 2019. Of this $150B per year is from a tax cut passed 12-22-17 and $150B extra per year approved Feb. 9th, and $700B per year from previous administrations. So under Trump the annual deficit increased $300B a year or 1.5% of the $20T outstanding federal debt balance, or about same rate as PCE inflation, which implies on an inflation-adjusted “real” basis Trump didn’t increase the annual deficit, using a long term averaging of his tax cut program. (However, the initial years are front loaded with the biggest benefits). Of course, it would be better if no increase in debt occurred.