Today the Federal Reserve held a two-day meeting and released a statement. They didn’t change their rates but the marketplace changed the rates dramatically downward. The ten year Treasury bond yield dropped from 2.61% to 2.525%, a drop of 8.5 basis points, several times a typical day’s movement. The technical traders who follow chart patterns have felt the rate might never go below 2.62% and would instead go above 3% and stay above that, thus the decline significantly below 2.62% is a shocking technical indicator matter, implying the “Invisible Hand” of the market “knows” that a recession will soon come. The futures market estimates a 50% probability of an eventual Fed easing of the Fed’s official rate. The drop
The annual federal deficit budget is 5% of GDP, or 7% if count some one-time excluded items. The percentage has been growing. The government has relied upon foreign investors and central banks to buy U.S. Treasury’s. The Treasury Bills have been used as the world’s money, thus absorbing the funding needs of the U.S. If foreigners decide to stop this then the dollar would drop in value and the Federal Reserve would have to monetize the deficit, creating inflation. As long as the other major economies have so many significant contingent financial problems (the negative interest rates in the EU and Japan, the huge debts in China and Japan) then the world economy will continue operating the same way.
The dollar crashed last night against the Yen in a Flash Crash, dropping 3% (a very significant figure), before settling in to a 1% decline to 107.5 Yen to a dollar. This demonstrates a potential risk that the Yen could appreciate roughly 10% or even 20% to reach fair value. Its price is held down by Japan so that they can encourage exports through devaluation. If global investors get burned by a US stock crash they may decide to withdraw funds from the US, thus making the dollar go down and the Yen to go up. This would force Japan to have even deeper negative interest rates, thus pulling down global interest rates. If Japan devalues that can cause
Regarding the concern that interest rates will rise to dangerously high levels, I doubt this will occur. The fear that Quantitative Tightening, where the Fed sells its holdings of bonds to undo QE, will make rates go up a lot is incorrect. When QE was implemented from 2009-2014 it didn’t create inflation and probably only lowered interest rates by 0.5%. The reason yields went down was because of global fears of falling into a debt/deflation trap and because other Developed countries (the EU, Japan, Scandinavia, Switzerland) had negative rates. I don’t see things getting better in Europe; probably the economic problems have not been truly solved in Japan. Thus since the fundamental reason for low yields in the U.S.
Yesterday’s dramatic bond market crash may make some people worry about rising rates, but I disagree. First, this year has seen an unusual degree of tax cut stimulus with huge federal deficits. This stimulus acted to make economic statistics including employment, hotter than normal, which resulted in rising interest rates. However, the typical scenario of a big stimulus package is a 5.5% GDP growth, not the 3.2% for the first half of 2018. The fact that the economy is growing 2% slower than it should (based on tax cuts) implies the stimulus may soon fade away and thus reduce the risk of inflation. During the two days before the monthly BLS Payroll Employment report bond yields tend to go
The yield curve spread between 2 year Treasury bond and ten year is 21.5 basis points, it was about 25 a week ago, and is consistently dropping to new lows not seen since last economic top of 2007. Economists say that a declining spread eventually moves the yield curve to inversion which is a symptom of recession, and partly a cause of it. Global rates have already inverted as have some domestic esoteric short term bond swap contracts for 2 and 4 year maturities. The old paradigm that the ten year Treasury yield is the same as nominal GDP hasn’t worked since 2008 crash because a new world exists where major regions such as the EU and Japan
Many articles have been written by other people forecasting that the dollar will decline, but I disagree. The huge and growing federal deficit is a concern, but it can be handled and reduced by switching to a European system of government controlled health care. Much of the deficit can be attributed to health care costs. A popular myth is that Americans don’t pay as much in tax as people in other Developed countries. But some articles written about this topic seem to only focus on federal income tax and not on payroll tax, state income tax, etc. Also, most countries, except the U.S., don’t tax their individual citizens on offshore earnings held in corporations located offshore. Many wealthy
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
The dollar has declined from 103 points in December, 2016 to 89 points. This implies that interest rates need to rise to encourage an inflow of foreign capital, even though our rates are the highest in the Developed world, except for Australia. The global markets may be concerned that the U.S. deficit is growing and so they want to avoid the U.S. The dollar index has fluctuated between 70 to 130 since the gold window was closed in 1971. If one excludes the one-time effects of ending the gold standard in 1971, the extreme high interest rates of 15% in 1981, and the extreme tech stock bubble of 2000 then typically the dollar’s value fluctuates gradually in a trading
The Yen is now about 100 to the dollar. Yesterday the central bank of Japan announced new policies and the market’s reaction was to make the Yen go up. Usually when a central bank is trying to stimulate the economy that creates cheap and easy money conditions. These actions should cause foreigners to flee because they would then fear devaluation and inflation. This should have made the Yen go down. It rose from a May, 2015 price of 125 to the dollar despite Japan’s central bank trying massive Quantitative Easing and negative rates to devalue the currency. Many other nations worried the attempted devaluation would be in violation of agreements to avoid big devaluations. Thus it is quite a surprise