Three weeks ago, I wrote that I was sticking to my call for a U.S. recession, and that the risk of deflation outweighed that of inflation. Lakshman Achuthan of the Economic Cycle Research Institute also reiterated the recession call. I can understand the heat he's under, and the need to respond.
So, in response to many queries following the rout in U.S. Treasuries, I thought I'd address this situation again.
I didn't see the jump in U.S. Treasury yields coming. I'm still trying to figure out what happened, why, and what it means for the economy and financial markets. There is much talk in bond circles and by economists concerning this move. The considerations run the gamut: a shift by yield-hungry investors into newly issued corporate debt, a shift of European assets back to Europe following the Greek resolution, China selling, and convexity-driven selling caused by an increase in optimism concerning economic activity following the national mortgage settlement.
Of course, there are others. As I've looked into them, I've found little proof that validates any one as the prime driver of the spike in yields caused by the selling of Treasuries. (I will continue looking further and let you know what I discover.) For investors, I am most concerned about what happens next, rather than what has already happened. I wish I knew what the cause was, but we can still make assumptions to help us determine a trajectory.
Either the jump in yields and the migration away from Treasuries was a short-term technical event without fundamental basis and is not indicative of a shift in economic expectations, or it reflects a positive shift in economic expectations by bond investors. If the former is true, whatever caused the selling and yield spike should dissipate, and in a few days or so buyers will likely move back in causing yields to move toward those that prevailed Monday. If, however, this event was the beginning of a real shift in economic sentiment, the yields will not fall back next week.
Further -- and this is very important for investors in all asset classes -- if this is the beginning of a longer-term shift toward positive economic expectations, it is likely that yields will continue to rise with a near-term target for the 10-year Treasury to between 2.5% and 3%, and 3.5% to 4% for the 30-year. Those levels and the rate of change in Treasury yields will also drive mortgage rates and spreads higher over Treasuries. I addressed the negative implications of such a scenario on housing and the economy in Wednesday's column.
What happens with Treasury yields over the next few trading days will determine which way this goes. If the expectations are longer-term and the yields continue to rise, the equity and bond markets will again be in agreement on the economy and the resulting synergistic confidence would almost certainly send stocks higher.
The big question is whether the rising rates would stimulate or dampen activity in the housing market. If confidence in capital markets bolsters consumer confidence to drive home sales higher, it is probable that a new virtuous cycle of economic activity has begun. I am not optimistic about this scenario playing out, but I am watchful for it.
Contrary to a popular meme among financial pundits, most of the broad economic indicators signal that the economy is slowing, not accelerating. This phenomenon is playing out all over the world.
In the U.S., social security tax receipts collected by the U.S. Treasury from companies on behalf of their employees are declining, even as the Bureau of Labor Statistics reports that employment is increasing and unemployment decreasing. This apparent dichotomy is difficult to rationalize or explain, as is the lack of inquisitiveness by financial pundits and equity-market participants.
Freight and cargo shipments are declining rapidly worldwide. Aggregate and per capita income and consumption in the U.S. are stagnating. The consumption of gasoline is declining as the cost increases. Neither is good for consumer product sales. And there are many other metrics indicating the same.
Every post-World War II expansion in the U.S. has been led by housing. The best way to get housing activity to increase is by reducing mortgage rates. That occurs when Treasury yields decline, which makes the increase in yields this week very troubling.