Financial Market Weekly

Transcription

1 Financial Market Weekly Abbreviated format this week. 11 NOVEMBER 216 CHRISTOPHER S. RUPKEY, CFA MANAGING DIRECTOR CHIEF FINANCIAL ECONOMIST ECONOMIC RESEARCH OFFICE (NEW YORK) (212) MUFG 1251 Avenue of the Americas New York, New York 12 BOND MARKET DOESN T SEEM TO LIKE PRESIDENT-ELECT TRUMP 1-YR YIELDS BREAK HIGHER ABOVE 2% The bond market doesn t seem to like Trump although maybe that s a good thing. Bond yields are too low for this point in the economic/business cycle, assuming there still is one after the s neglect of having left rates alone and untended at basically zero for nearly eight years..5% today still counts as zero. Bond yields should be above 2.2% core CPI inflation-1 bps more. Sometimes it takes an 2.4 RECENT TREND IN 1-YR GOVERNMENT NOTES (N.Y. CLOSING) unexpected news event to trigger an upward 2.3 push in yields; in this case President-Elect Trump s surprise victory makes investors think the will be moving up rates more quickly, there will be additional fiscal spending, he wants to double GDP s 2% growth, stocks are at new highs from less regulation and tax cuts for business perhaps. It doesn t matter if these things don t happen; the bond market runs on the idea for a while yr Treasury yields closed at 1.86% Tuesday night ahead of the election results. Yields fell to 1.7% at midnight as it became apparent Trump was going to win. Bond yields fell initially as they normally do when stocks fall. Dow July % GDP Aug 26 Yellen Jackson Hole Sep 6 ISM nonmfg 51.4 vs Sep 21 No hike Oct 14 Yellen run hot Oct 27 Global yields spike Nov 9 Trump wins Jul Aug Sep Oct Nov Dec 1-yr yields shatter 2.% ceiling November % 1-yr 3-yr Friday Nov Last Friday before election week Monday Nov Dow +371pts, FBI Clinton s OK Tuesday Nov Election Day, 3-yr auction Wednesday Nov Surprise Trump victory, 1-yr auction Thursday Nov Day of reflection for elites, 3-yr auction Friday Nov Bond market closed, Dow +39 points

2 industrials futures closed at 18,25 Tuesday and had fallen a terrifying 867 points by midnight on the unexpected Trump news. Good thing most Americans were asleep. Yields closed the week on Thursday 2.15% which was 37 bps higher than employment day Friday November 4, with the cash Treasury market closed on Veterans Day Friday. eral Budget Deficits fiscal years ending September $bln OMB (FY17 Budget) 458 1,412 1, QE Purchases of Govts Treasuries Held in Custody fgn central banks Foreign private purchases Govts (TIC) Commercial Bank holdings Treasuries Leaving aside how a Trump presidency might change the, a lot of the story of 2%-plus bond yields this week has been the expectation of greater fiscal spending. Spending on infrastructure. It would certainly have to be pretty big to move the needle on interest rates, and the recent history is not very supportive of this argument for higher yields. Obama had some trillion dollar budget deficits, and yields did not move higher, partly because the was pulling yields in the opposite direction with QE and once-in-a-lifetime guidance to the markets that is unlikely to work again. Foreigners were buying a lot of our debt, China of course the biggest player with their trade surplus that is now on the decline. The February 29 $787 billion fiscal stimulus package of Obama s was roughly one-third infrastructure projects and it was hard back then to find so-called shovel-ready projects that could pump money into the economy immediately. Some construction projects were questionable in terms of the good they would due for the public as a whole. The infrastructure effect on eral government spending and the overall economy will take some time and is unlikely to be the savior for growth: Trump has said he wants to double the economy s 2% growth (his vision was shared by every single candidate during the Republican and Democratic primaries.) Can we afford more deficit spending? It is unclear whether the budget deficit is going to rise from fiscal year September 216 s $587 billion. It certainly looks like it will with tax cuts for business and individuals being talked about as well as more spending on infrastructure. As an economist it seems odd to us for the government to talk about more stimulus when the economy is at 4.9% unemployment full employment. It is unclear why stimulus is necessary. Moreover, there is not that much room 11 % U.S Government Debt Q2 216 $trln to pump up deficit spending with the GDP as a % of nominal GDP eral Debt Private Held baby boom retiring and requiring more Percent % 9 eral Debt 15. so-called entitlements like social Private Held security and healthcare. eral debt 8 8 outstanding is 15% of the $18 trillion 7 7 eral Debt GDP economy when you count the future nonmarketable debt that social 6 6 security will cash in to pay retirement 5 5 Q4 27 benefits. The baby boom is call it 5 recession 4 starts 4 Privately Held QE2 to 7 years old today and twenty-five eral Debt years from now in the year they will be 75 to 95 years old and Total eral debt is approaching 1%, but it 2 Debt to GDP fell with includes nonmarketable securities held by U.S. surplus and faster Government Accounts which are largely somewhere a little before or after that economic growth in accounting entries that are not financed in the 2 the late 9s before 1 markets through public auctions, and it also time there will be a whole lot of the 21 recession includes (QE) holdings. 1 spending going on that will be unavoidable and society will have to pay. Don t like eral government spending? Relax. Just think how rich America will be once the baby boom generation is gone

3 Anyway, the graph here shows there is not all that much room for additional government spending with the huge baby boom retirement costs looming on the horizon. Trump may have spending plans, but the Republicans in congress may not agree. In terms of the two main valuation methods for bond yields, inflation and policy, the bond market has been pricing its yields too low relative to where inflation is headed core consumer inflation. Maybe there is a glut of world savings with yields low or negative in Europe and Japan. Maybe massive corporate bond issuance is being swapped to pay zero short-term rates which drives down the future Libor curve for rates and so bringing down 1-yr Treasury yields. Anyway the Trump effect in raising 1-yr yields to 2.15% this week is welcome for those tired of getting a negative real return. These old ideas about why rates were low are, well, looking old. Bond yields were too low relative to inflation. Hopefully, the market s valuation of yields is going to change for good or at least until we get another 38K weak jobs report. 1-yr yields have averaged 1.74% through September this year which is less than 2.2% core CPI inflation. 1-yr Real Treasury Core Yield Yield CPI bps to September Average annual data Real 1-yr Treasury Yields % 1-yr yields minus core CPI inflation September 216-YTD yr 2.2% core CPI equals -46 bps The effect on bond yields? The interest rate cycle is kind of broken with the keeping rates down at zero for so long, left there we guess to support the recovery as they say. The 2.15% Treasury 1-yr yield now is 165 bps higher than the.5% rate. It could go a little higher based on history. But we would need to see more what deficit spending Trump was going to unleash at some point to keep the higher yield trend going and to see if there is any change in policy. Yellen s fouryear term ends in February 218 if all goes as scheduled, and we would expect two more governors will be appointed by the Republicans that might change the policy debate a little. The has become somewhat more 3 4 bps % to 6% Shaded areas represent recessions-everything else are the good times 1-yr yield minus rate (bps) 4.75% to 6.5% 1% to 5.25% Oct yr 1.76% Daily effecitve rate.4% Spread 136 bps Sometimes the market gets too far out in front of the... not lately, not this cycle

4 political with the Obama appointee governors voting as a block. To conclude, we will keep the rates forecast where it is for now and wait for fast market conditions to slow. Probably should not have cut it from 2.2 to 2. percent at the end of this year after the did not move in September. Did not know Trump was going to get himself elected and that Republicans would hold on to the House and the Senate: a clean sweep. One half of the electorate is happy and one half is 3-Sep Q4 Q1 Q2 Q3 Q4 Q Yr Bond Yr Note Yr Note Yr Note month Libor eral Fund Rate s/1s spread certainly not, given the demonstrations nationwide, but the result is irreversible, so we need to look ahead. At least for interest rates. Interest rates are looking up for now, but the still needs to get back in the game. The consensus is for just two rate hikes in 217, and a rate of 1.25% this time (almost) next year may not be putting enough backbone in our 2.7% 1-yr yield forecast at the end of 217. We need more from the to get yields up to 3% by early 218. P.S. Since this was written and before it could be sent out 1-yr yields rose as high at 2.3% at 6am Eastern Time on Monday, November 14 in chaotic market conditions. Too many funding themselves at the trough of zero percent for too long perhaps. We will see how high yields stick after breaking important resistance at 2.%. It s a long time to wait for the rate hike on December 14 and things can happen. 4

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