Thinking about 2015.
I know that it is a little early to be thinking about 2015, but I am…generally, because most analysts…myself included…missed the boat on our 2014 rate forecasts.
Last December, the tendency was to believe that economic growth in the Unite States was going to pick up…maybe even reaching a level of 3.0 percent or more for the year. Inflationary expectations, as built into the bond market were in the 2.2 percent to 2.5 percent range. The yield on the 10-year US Treasury Inflation Protected securities (TIPS) was around 0.75 percent. Given that the yield on the TIPS was a little lower than might be expected because there was still some “risk averse” money that had come to the “safe haven”, the United States.
And, the economies in the rest of the world seemed to doing OK…growing…with relatively low inflation.
Thus, I assumed that the longer-term growth rate of the United States would be somewhere in the 2.5 percent or above range and with inflationary expectations at 2.2 percent I came out with a feeling that without the “risk averse money the 10-year bond yield should be somewhere around 4.7 percent. I calculated that the “risk averse” money took about 75 basis points off the yield, so that by the end of 2014 the 10-year bond should be around 4.00 percent.
At the end of 2013, the yield on the 10-year Treasury note was at 3.00 percent, so, I felt comfortable that in an economy where the growth rate was rising to 3.0 percent or more, that it was not unreasonable to assume that this yield would continue to rise hitting the 4.00 percent level toward the end of the year.
Well, these things didn’t happen.
The growth rate of the United States economy came nowhere near 3.0 percent. If one looks at the rate of growth of the economy since the start of the economic recovery in 2009, the economy has only achieved a 2.2 percent compound rate of growth through the second quarter of 2014. The rate of growth in the economy in the third quarter of this year was on 2.3 percent, year-over-year. This is nowhere near a rate of growth of 3.0 percent or more.
Furthermore, inflationary expectations plummeted this year. Whereas the inflationary expectations built into the bond rates at the end of last year suggested that inflation over the next ten years could be as high as 2.5 percent, the bond market sees much less inflation ahead of us in the United States. Recently, the inflationary expectations built into bonds yields are a little above 1.9 percent. Historically, this is quite a large drop in inflationary expectations and shows the significant change in investor psychology over the year.
Finally, the economies in the rest of the world did not do so good!
Just this week the European Commission, which is the administrative unit of the European Union, put out forecasts for the eurozone and member nations. The results were pretty dim.
For the eurozone as a whole, the European Commission sees the economy increasing by only 1.3 percent this year. And, next year the expectation is for 1.1 percent growth. Nobody saw this slowdown coming last year at this time.
As far as inflation is concerned, the expectation for the eurozone is a rate of inflation of 0.5 percent this year and in 2015 a 0.8 percent rate of inflation.
Some analysts believe that these inflation numbers are high and that there is even the possibility that 2015 will see a period of deflation. The concern is that Europe is going to experience a period of secular stagnation similar to the one experienced in Japan.
One can even argue that investors have built deflationary expectations yields on European bonds. For example, German bunds, the least risky bonds in the European market have been yielding less than 1.00 percent. For example, the 10-year bund has recently been yielding 0.75 percent to 0.85 percent.
Even assuming some “risk averse” money going into these German securities, one cannot come up with an explanation for such low longer-term bond yields without writing down inflationary expectations for Europe around the zero level or just above. And, remember, this is the expected inflation over the next ten years.
The fear of another recession in Europe is causing public cries for the European Central Bank to engage in its own round of quantitative easing, similar to what the Federal Reserve did. In addition to try and stimulate banks to start lending, the hope is that this policy will also reduce the value of the Euro in foreign exchange markets and help encourage eurozone exports. The value of the Euro has dropped from about $1.39 earlier this year to below $1.25 currently.
The problem is that a lower value for the Euro hurts United States exports…and this may hurt United States economic growth going forward.
As I mentioned above, no one last year saw all these things coming and so, could not imagine that the yield on the 10-year US Treasury note would drop from over 3.00 percent to the 2.30 percent to 2.35 percent range where it now stands.
So, what does this all mean for 2015?
Well, I am in the crowd now that contends that economic growth in the United States will not be above the 2.0 percent to 2.5 percent range in the near future. If what is going on in Europe…and in the rest of the world because economic growth is slowing in China, Brazil, Argentina and elsewhere…has a significant impact on the United States, then growth will be at the lower end of the range.
Inflation may actually stay down below 2.0 percent…again depending up how much global influences impact the United States…and investors expectations of inflation over the next ten years may still stay in the 1.9 percent range.
Finally, uncertainty is going to be a big factor in the world next year and beyond. Uncertainty will continue to cause “risk averse” investors to seek “safe havens” to put their money. The United States and Germany are going to continue to benefit from this fear. Consequently, this will tend to keep longer-term yields lower than they would be otherwise.
With such an environment, how can one predict that longer-term interest rates will go up much over the next year?
And, I have one more thought to add to this picture. The United States is in its sixth year of economic recovery. If the United States continues to grow through the last two years of the Obama presidency, the economic recovery will turn into the second longest one in post-World War II history.
Some analysts are wondering whether or not the economy can really continue to grow…even at its current tepid pace…after this long of a time period. History certainly doesn’t support the possibility.
But, this would mean that expectations about economic growth and expectations about inflation in the United States might have to be lowered. And, this would take longer-term interest even lower. Bear with me…I’m just thinking……..
About John Mason John has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.