Why interest rates are falling
# * !? CRASH BAM @ # $ As a result, the markets (well, at least the bond market) are now seeing interest rates fall in the short and medium term. The US 10-year T-Note fell 1.47% on June 30 to close at 1.29% on Thursday, July 7 (a big move in just four market sessions). Part of the rapid drop was due to short coverage, so Friday’s slight comeback (to 1.36%) was no surprise. For context, the yield on the 10-year T-Note closed up to 1.53% on June 24. Such movements in bonds are not trivial.
This couldn’t have happened if the bond market gurus truly believed the inflation story. History has shown that bond specialists are better at the underlying economy than equity specialists. Our regular readers know our long-held view that interest rates fall when the ‘hot’ economy turns out to be only lukewarm, and that the inflation narrative fades as the ‘transitional’ view would turn out.
These declining yields point to a slower pace of GDP growth than what has been incorporated into financial markets. We have been reporting this for several weeks. And most of the new data continues to support this notion.
· Initial Unemployment Claims (CI) (unadjusted for seasonality) stood at 370K with the Labor Department report on Thursday (July 8). A reminder: this is a proxy for “new layoffs”, still at recession levels (the “normal” before the pandemic was 200K). Not a word on this report from the financial media because, from a market perspective, it was a get up of + 11K vs. 359K initially reported (revised to 366K with release of data). The consensus was 350K, so a big, big misfire and in the wrong direction. As you’ll see from reading the sequel, the consensus has missed every data release on the ‘high’ (bullish) side.
· Continuous unemployment claims (CC) kept their rate of decline, falling to 14.2 million (week of June 8) against 14.8 million the previous week. The graph at the top shows how shallow the downward slope has been, especially in 2021. The normal before the pandemic was 2 million.
As we’ve written in previous blogs, the data shows conclusive evidence that states that opted for the $ 300 / week Federal Unemployment Supplemental Payment have seen their CCs drop at a much faster rate than states. who didn’t (or couldn’t: MD and IN initially withdrew, but the courts ruled they couldn’t).
· The table shows the date of deregistration, the number of states that deregistered and the percentage change in state CCs between May 15 and June 26. Note the large differences between states that opted out and those that remain in the federal program until it expires on September 6.
The aggregate percentage changes of all opt-out states are -14.0% versus -6.4% for opt-ins. However, looking only at the 11 states (the first two rows of the table) where the opt-out has already taken place, the overall percentage change between May 15 and June 26 is -29.6% (vs. -6.4% for the opt-in).
· The JOLTS (Job Opening and Labor Turnover Survey) which was just published for May also disappointed the markets. Jobs (9.209 million) were lower than the originally published April number of 9.286 million (revised to 9.193 million with the release of the data). The consensus estimate was 9.325 million, so another failure on the side of “hot” growth. Reinforcing the easing, new hires and voluntary departures fell. Some would say the data here is still high. But we’re talking about the direction of growth, and all of the labor numbers appear to be weaker than expected.
Other economic data
- The table shows the spending data – all down since helicopter money fell in March.
- Mortgage applications fell -1.8% the week of July 2 after falling -6.9% the week before. These are now -36% lower than their peak (new shopping apps -26% and refi apps -41%). This is despite a fall in mortgage interest rates of -35 basis points (-0.35 percentage point). This could be soaring house prices! It doesn’t matter! The point is, the data is softer, which means slowing economic growth.
Inflation and the money supply
We read a lot of editorials that claim inflation is here to stay because the money supply has grown by more than 25% since the start of the pandemic, and the Fed continues to “print” $ 120 billion per month. . Commentators often quote Milton Friedman’s famous quote “Inflation is always and everywhere a monetary phenomenon”. What is missing here is that the newly created money never gets into the hands of the public. He stayed in the banking system. We have followed and commented on the inflated size of the Reverse Repo market (overnight bank “loans” to the Fed of their excess cash taking treasury bills as collateral). The money has stayed in the banking system and is never in the hands of businesses or consumers. This is equivalent to the Fed printing $ 100 bills to the tune of $ 120 billion a month, but never puts them into circulation, but keeps them locked in coffers at the Mint.
The graph shows bank lending to businesses since the start of 2018. Note the peak where the economy was shut down by government decree in early 2020. It was businesses that were using their bank lines of credit to ensure that ‘they would have enough liquidity during the shutdowns to survive. (They were concerned that the banks would withdraw lines of credit like they did during the Great Recession!). But note the continued decline in outstanding loans since the peak. We believe the downtrend will continue or even accelerate in Q3 / 21 and Q4 / 21.
Even if the Fed continues to print (which it will do, even while its downsizing, just at a slower rate), if the money stays in the banking system and is not loaned to the private sector, economic growth will not be stimulated upward; and inflation will be a non-starter. That’s not to say that money printing doesn’t have the potential to become inflationary. It does, but current conditions are not conducive to quick bank lending, especially since Dodd-Frank has changed the way banks are regulated. As a concrete example, since 1990 the Bank of Japan has provided quantities of bank reserves and liquidity to this economy, but deflation, not inflation, has been the dominant problem.
Is the pandemic over?
It does not appear. Due to the rapid spread of the Delta variant, Israel reinstated the restrictions and Japan canceled spectators at the upcoming Olympics. In addition, some under-vaccinated US states have seen their new infection numbers jump. If such trends continue around the world, US exports will suffer. There are significant probabilities of slower growth than currently forecast.
Fed Economic Growth Forecast
The Atlanta Fed and the NY Fed both cut their GDP growth forecasts for the second quarter.
For Q3 / 2021, the Atlanta Fed expects 5.0%; NY GDP growth of 3.9%. Quite the decline in previous blockbuster growth views.
When the moratoriums end
What is missing in today’s economic blogosphere is a discussion of what the economic impacts will be when the moratoria on rent and loan payments end.
- When the rent moratoriums are over, even if there are no evictions, spending will slow down as those who are behind on their rent will have to make additional payments to landlords rather than spending on Amazon (landlords generally have a lower marginal propensity to consume than their tenants);
- We haven’t seen any business survival analysis for businesses (and individuals) that have payment arrears and now need to start repaying their loans. Like tenants behind on rents, those who can make the catch-up payments will have less to spend on other businesses. Those who cannot make such payments will become problematic loans on bank balance sheets and impact loan loss data.
So, as the economy continues to recover, the patient is far from healthy.
- The bond market now seems in tune with the idea that economic growth will be slower than is generally believed and currently valued in equities;
- The latest employment data confirms a slowdown in the labor market and consensus estimates appear overly optimistic;
- Spending trends have also been much slower than consensus forecasts, with many key spending indicators showing weakening trends;
- Mortgage applications are dropping despite falling mortgage rates. The blame for soaring house prices can be blamed, but the point is that, for whatever reason, housing appears to have peaked, which means slowing economic growth;
- The Fed’s monthly money printing seems stuck in the banks (Reverse Repo at record levels). Bank loans to the private sector are declining;
- The pandemic does not seem to end on its own. New cases are increasing in some parts of the world, and even in some US states where vaccination rates are low;
- We do not know the economic consequences of ending the moratoriums on rents and loan repayments. They won’t be pretty;
- The bond market seems to have recognized these problems. Interest rate: “Lower for longer”.
(Joshua Barone contributed to this blog.)