For Bonds It's Déjà vu All Over Again

 | Jan 14, 2017 | 12:00 PM EST
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One of the issues I've been pounding hard on over the past year is that there is no pent-up consumer demand, and there can't be because all income is now collateralized to meet current debt-servicing requirements.

As simple as this observation is I keep repeating it because I keep receiving communications from subscribers that essentially start with "Yeah, but..." and then go on to point out some way that demand may be caused to actualize.

The arguments usually concern confidence increases by consumers and businesses, the belief in imminent fiscal stimulus that will drive consumption and investment, the rise in equity values since the U.S. elections that has increased wealth and the stated belief by FOMC members collectively, as evidenced in their last statement, that domestic economic activity is accelerating and that warranted a rate hike in December.

These are all worthy issues to discuss, but none of them is indicative of imminent demand increases, and more importantly none of them falsifies the observation that consumers are capacity constrained.

The evidence of this constrainment is more clear in the housing sector. A rebound and subsequent increase in economic activity has traditionally been evidenced first in the housing sector. Thus, the aphorism: "As goes housing, so goes the economy."

I've discussed the reasons for that in multiple columns over the past several years, so I won't go into that logic here again. In short, though, if you want to determine if a consumption led rebound has begun, first look at the housing sector. If it's not happening there, it's not happening.

And, it's not happening, as I last addressed just 10 days ago in the column, There's No Pent-Up Housing Demand.

This past Thursday, Hovnanian Enterprises (HOV) , fell by about 10% after it was downgraded by JPM Securities to Market Underperform with a new price target of $1.60. That is still another 35% below that day's close and about where it was before the U.S. elections.

What's most interesting to note about that, though, is that JPM's primary justification for the downgrade was simply that the post-U.S. election pop in the stock was "overdone" in comparison to the broader equity markets.

In other words, it's a trading decision, not a reflection of the fundamental potential issues I've written about.

The fact that their near-term target price is close to where the stock was trading before the U.S. elections, however, implies that JP Morgan Chase (JPM) is probably not of the opinion that the fiscal stimulus measures being considered by Trump will have an immediate impact on economic potential or activity.

This is a view that was shared by St. Louis Fed Bank President James Bullard yesterday in a CNBC interview in which he stated that an economic impact by Trump's fiscal plans is a potential for 2018/19 but not for 2017.

Bullard is not a voting member of the FOMC this year and his comments are in contrast to those expressed so far by the 2017 FOMC members, although they won't meet for the first time until the end of January.

Bullard's assessment, though, is being reflected by bond market participants.

The 10-year and two-year U.S. Treasury yields have declined by about 25 and 10 basis points, respectively, from cyclical peaks they reached as the FOMC was last meeting.

The cyclical increases and decreases in these yields is matched by what occurred during the runup and subsequent decreases that were evidenced during the taper tantrum of 2013 and the Fed rate hike in December 2015. In both cases, after the tapering actually began in 2013 and the Fed actually raised rates in 2015, the long-end yields reversed and declined substantially afterwards.

The decline in the first half of 2016 resulted in a new record low yield for the 10-year this past July.

As the markets begin to exhibit an understanding that there is no imminent fiscal stimulus driven economic activity and that the private sector is capacity constrained in delivering that increase, no matter how confident consumers and business are about the future, I think it's probable that long-end bond yields will again follow the paths of 2013/14 and 2015/16 and move substantially below current levels.

I also continue to believe that ultimately they will have to fall below the record levels of this past summer, and drag mortgage rates down with them before there can even be the potential for a secular resurgence in housing activity.

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