If you don’t believe me, believe Jamie Dimon.
“I think rates should be 4% today,” the JPMorgan Chase CEO said this week, referring to the yield on the benchmark 10-year Treasury note. And if that wasn’t strong enough, he added, “you better be prepared to deal with rates 5% or higher — it's a higher probability than most people think.”
The question shouldn’t be, “Is he right?” Instead, it should be: “Why aren’t rates that high already?”
The 10-year yield ended last week at 2.95%, about unchanged from the previous week, although it did cross over into 3.0% territory for about a day before falling back. It started this week at 2.93% -- after Dimon made his comments.
Just about every Federal Reserve comment and economic and supply-and-demand figure screams that the yield on the 10-year should be at least 100 basis points higher than it is today. Yet the yield remains stubbornly at or below 3%.
About the only thing holding it back is investor concern about the effects of the supposed trade war we are in with our main trading partners, primarily China. But as I noted in a recent column, all indications so far are that the U.S. is winning that war, if the comparative stock market and currency performance are any indications.
So far this year, the S&P 500 is up 6.5%, while the Shanghai composite index is down more than 17%. The dollar gained 3.0% against the Chinese renminbi in July and is up nearly 5% so far this year. The fact is, China has a lot more to lose in a trade war than the U.S. does, and the numbers show that.
Looking at economic indicators, the U.S. economy is clearly outperforming the rest of the developed world, which argues strongly for higher bond yields.
As we know, the second quarter GDP grew at a 4.1% annual rate, nearly double the first quarter’s 2.2% pace and the strongest growth rate in almost three years. A drop in inventories took a full percentage point out of the headline GDP increase, so the anticipated rebuild in inventories should fuel third-quarter growth. The Atlanta Fed’s GDPNow forecasting tool is calling for 4.4% growth in Q3.
Last week’s July jobs report, while maybe a bit disappointing in the headline jobs number, more than made up for it in revisions and other areas. While nonfarm payrolls rose by 157,000, well below the consensus forecast of 190,000, upward revisions for May and June totaled 59,000. And if May and June are any guides, we could probably expect an upward revision in the July number next month. The economy added an average 215,000 jobs a month through July, well ahead of last year’s pace of 184,000 a month.
On the inflation front, price increases are heating up, well above the Federal Reserve’s 2% target. President Trump’s desire for low-interest rates notwithstanding, the Fed is going to have to get more aggressive about raising rates if inflation isn’t going to spiral out of control.
Then there’s the federal budget deficit, which is expected to top $1 trillion in each of the next two years. Last week the Treasury said it would need to borrow $329 billion over the next fiscal quarter ending in September and another $440 billion in the quarter after that – unless it needs to raise its expectations yet again. Those numbers are nearly two-thirds higher than what the government borrowed during the same six-month period in 2017.
While the Fed, as expected, didn’t raise rates at last week’s meeting, it will be hard to imagine it won’t at its next meeting at the end of September. It’s also largely promised one more besides that one by the end of the year. That would raise the fed funds rate up to a range of 2.25% to 2.5% from the current 1.75%. Not enough, in my opinion, but there’s always next year.
Interest rates at the short-end of the Treasury curve are moving up more steeply than at the long end, so we can probably expect the long end to catch up eventually. The yield on the three-month bill is up 63 basis points since the start of the year while the two-year note is up 76 bps. The long end has been slower to come along – the yield on the 10-year is up only 54 bps this year, while the 30-year bond is only 34 bps higher at just 3.09%.
With a booming economy, rising inflation and giant budget deficits as far as the eye can see, it just defies financial logic and common sense that long-term rates can stay this low that much longer. They will eventually, sooner more likely than later.
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George Yacik
INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
