There are only two trading sessions left in 2014, although there is little trading happening in the bond market. Although traders are taking the time to enjoy the holiday season, economists and the financial punditry are busy talking their forecasts (firms’ books). During the past two days we have heard diatribes regarding why the bond market “has it wrong,” why inflation/wage growth has to pick up next year, why QE “will save Europe” and why 2015 will be the year housing rebounds (in spite of this morning’s Case Shiller data which indicates that real estate price increases continue to slow). Let’s break this down, piece by piece.
Too many homes were built between 2003 and 2007. Many homes were built for people who could not afford them. Therefore, the supply of homes is high relative to demand (at least compared with recent history). Lending standards are tighter than they have been during the decade which preceding the financial crisis. Maybe they are a bit too tight, but they are closer to the prudent normal than many pundits would like to believe (or admit). Economists have dreams of economic sugar plums (when housing finally contributes to GDP. Bond Squad believes that this IS the recovered housing market (at least until something else happens).
To see a list of high yielding CDs go here.
The Euro QE story is becoming tiresome to Bond Squad. We have highlighted Europe’s structural problems many times (ad nauseum). Instead of explaining it again, we have included a link to an excellent Wall Street Journal editorial authored by Jesus Fernandez-Villaverde and Lee Ohanian which discusses Europe’s self-inflicted structural wounds.
It appears than many “experts” do not understand the global economy. The prevailing view in wage growth and inflation lies within the borders of the United States. They see job growth leading to wage growth and lower oil prices conducive to both job growth and wage growth. This might have been true in the past, but the relationship might be different this time around. Here is why:
- Lower oil prices mean less domestic production and/or more efficient production to be profitable at lower prices. This holds down oil prices.
- More efficient oil production means slower oil-related job growth and wage growth (even wage or job cuts).
- Oil employment extends far beyond the oil fields themselves. Although actual oil job creation is measured in the hundreds of thousands, the shale boom has created multiple millions of jobs around the country in multiple sectors (particularly in services and logistics).
- Lower oil prices mean that energy to power labor-saving machinery is cheaper. Automation competes with U.S. labor.
- Lower oil prices mean that it is now cheaper than in the recent past to ship foreign-made goods across oceans. The stronger dollar means that foreign labor has become cheaper.
- U.S. workers compete with foreign workers in both manufacturing and in areas of the service sector. There was already a plethora of foreign workers seeking employment and a middle-class lifestyle. Many of these EM citizens relied on energy and commodity exporting for their livelihoods. With commodities prices low, foreign economies could seek to expand outside of energy and commodities sectors to provide employment for their citizens.
All of this could (should) moderate wage growth and keep inflation pressures light. Bond Squad believes that the U.S. economy should continue to expand in the 3.00% to 3.50% area, but will receive little help from housing and inflation should remain below 2.0% by all measures. This is what we believe and what the bond market is pricing in. We have listened to arguments to the contrary, but these arguments seem more rooted in hope than in reality.
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