Today is “Interest Rate Thursday,” the day which we devote to discuss all things interest rate related, both foreign and domestic. Looking around the globe, it appears that there is not much “interest” in global interest rates, in spite of aggressive and extraordinarily aggressive monetary policy accommodation. Could it be that monetary policy alone is not enough to boost economic growth? We will discuss global interest rate conditions, but first the economic data.
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Initial Jobless Claims for the week ended August 9th came in at 311,000, up from a prior revised 290,000 (up from 289,000) and higher than the Street consensus of 295,000. The four-week average of claims (a less-volatile measure of weekly claims) increased to 295,750 from 293,750 in the prior week. Continuing Claims for the week ended August 2nd came in at 2,544,000, up from a prior revised 2,519,000 (up from 2,518,000) and higher than the Street consensus of 2,507,000.
Initial Jobless Claims have printed below 300,000 for two of the last four weeks. This has led some economists and market participants to ring in a new era in the employment recovery. We were not as hasty. We believed that the drop in Jobless Claims below 300,000 was due to seasonality formulas intended to account for auto assembly line shutdowns. This pushed the Claims numbers lower because automakers kept production rolling through the summer. We have written on this every week for the past month. We have also stated that when the seasonality formulas change, Initial Claims could very well climb back above 300,000. Traditionally, auto manufacturers begin reopening assembly lines in August as new model year vehicles are delivered to dealers in the fall.
Just as we did not believe that the Initial Claims prints earlier in the summer were signs of a strengthening job market, we do not believe today’s data indicate that the jobs situation is deteriorating. Seasonal noise has caused volatility in the Jobless Claims data. That said we are concerned that the pace of job creation might be peaking. If the large number of long-term unemployed Americans cannot be enticed to leave the sidelines, demand could be satisfied by other means, such as technology and foreign hiring. Recent data indicate an increase in capital spending. It could be that, rather than increase wages to attract workers; businesses are adding or upgrading equipment. Several months-worth of data will be required to confirm any trends, but it is not a forgone conclusion that a continued economic expansion will drive job and wage growth significantly higher.
Import Prices declined on a monthly basis in July, coming in at -0.2% versus a prior +0.1% and a Street consensus of -0.3%. On an annual basis, July Import Prices came in at +0.8% versus a prior revised +1.1% (down from +1.2%) and in line with the Street consensus estimate. The biggest increase in Import Prices came from the food and beverage component, which was up 1.0%. The biggest decline came from the vehicles component, which was down 0.8%.
Neunundneunzig Basis Points
Sovereign interest rates are trending lower around the globe today after disappointing retail sales results in the U.S. and a report that Germany’s economy contracted in the second quarter. This caused the yield of the 10-year German bund to fall to 0.99%. Global 10-year sovereign yields are as follows:
What is driving long-term rates lower in the face of aggressive and, in some cases, extraordinarily-aggressive monetary policy? It all comes down to economic structure and fiscal policies. The developed economies which are performing the best tend to have the most labor flexibility and have positive population growth (which is not a panacea); the economies which are performing poorly tend to have less labor flexibility and overly-regulated economies. Now we are seeing economies which took steps to loosen labor rules, such as Germany, begin to contract. The German economy contracted in the second quarter (-0.2%). The contraction of the German economy came prior to the sanction war with Russia. The second half of 2014 is looking bleak for the Eurozone.
Weak economies would explain the ultra-low sovereign yields in Germany and Japan, but what about the fairly-low yields in the U.S., UK and Canada? Believe it or not, there is a reach for yield occurring in the global interest rate markets. When the German 10-year bund is yielding around 1.00%, a 2.40% 10-year UST looks attractive. Then there is the currency aspect. The Federal Reserve is expected to begin raising policy rates in 2015, but the ECB has not even (truly) engaged in quantitative easing. Simply put, U.S. policy is moving in the direction of a stronger currency while ECB policy is moving in the direction of a weaker currency. This also makes U.S. Treasuries attractive versus EMU sovereign debt. Why is the German 10-year bund yielding 1.01% when there is risk of a weaker euro? Because many investors (corporate, bank and individual) need to and will continue to hold euros. In times of economic or political crisis, a risk-off mentality takes hold among investors. As a result, capital flows into sovereign debt denominated in one’s home currency keeping yields low.
Can’t Get Enough of Your Debt
It appears as though sovereign debt yields are not on an upward path for the second half of 2014. Increased retail spending and wage growth could put upward pressure on long-term U.S. interest rates, but such positive conditions are far from forgone conclusions. We do not believe that Europe and Japan are close to economic recoveries. Well that is not exactly true. Japan’s and the Eurozone’s economies might be performing at or near their structural capabilities. Until fiscal policies are adjusted to reflect internal and global economic realities, growth in Japan and the Eurozone could disappoint for years, if not longer.
We have even heard rumblings that there are still an ample amount of shorts on long-dated U.S. Treasuries. If this is the case, continued downward pressure on global interest rates could cause a short-squeeze-driven rally on the long end of the curve. Our range for the 10-year UST during the second half of 2014 is 2.25% to 2.75%. If the 10-year breaks out of this range, it might be more likely to do so to the downside. Our belief is that the U.S. economy is closer to “recovered” conditions than it feels to most people.
Yesterday’s auction of $24 billion new 10-year U.S. Treasury notes indicate that there is no shortage of demand for long-dated U.S. Treasuries. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.83, versus an average of 2.69 at the past 10 sales. Indirect bidders, which include foreign central banks, purchased 47% of the notes, compared with an average of 44.5% for the past 10 auctions.
Today’s auction of $13 billion 30-year U.S. government bond was a blowout. The first new 30-year bond since May 2014 priced to yield 3.224%. The bid-to-cover ratio came in at 2.60 versus a ten-auction average of 2.40. Indirect bidder participation (which includes foreign central banks) climbed to 45.9 percent of the bonds, compared with an average of 44% for the past 10 auctions. Direct bidders purchased 24% of the new 30-year. Direct bidders include individual investors.
At the present time, we see little upward pressure on long-term rates emanating from the U.S. or global economies. It is appears as though we are entrenched in a global low-inflation/disinflationary trend. We believe that global interest rates are better indicators of present and future global economic conditions than equity market valuations. Allianz Economic Adviser, Mohamed El-Erian reminded a CNBC audience today that it is not just accommodative central bank policy which is important, but the success of that policy.
Puerto Rico Time is Running Out (Smoke on the Water)
Although this is “Interest Rate Thursday,” we will discuss a credit story. The Puerto Rico Electric Power Authority (PREPA) is seeking yet another debt payment extension from its banks. PREPA has already had two debt payment extensions. The deadline is today. Word on the Street is that hedge funds had been big buyers of troubled Puerto Rico debt at cents on the dollar. We mention this because retail investors might be tempted to do the same. Investors need to understand that these hedge funds are not necessarily expecting to receive par at maturity, only more than what they paid for the bonds. Few individual investors are suited to engage in such speculation. Readers who are considering investing in Puerto Rico debt are encouraged to contact us prior to pulling the trigger.
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
- November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
- December 2011 – November 2012 – Bond Squad, Kunkletown, PA
- April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
- June 1986 – March 1988 – E.F. Hutton, New York, NY
Director of Fixed Income
Wealth Strategies & Management LLC