Yield Curve
Is the economy strengthening?
By blackhedd Posted in Economy — Comments (14) / Email this page » / Leave a comment »
I've been rejected for membership in Interest Rates Anonymous (yield-curve division). They must have made me for a recidivist. Anyway, things have been quite interesting for the last several months in the Land of Rates. You may have noticed the action if you have a home mortgage.
In short, the yield-curve is riding about 50 basis points higher than at the bond-market highs of late February/early March, and the mild inversion it has shown for much of a year is now gone.
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Do you have an adjustable-rate mortgage on your home? Or are you shopping for a new home? If so, you've probably noticed that home-mortgage rates have been marching upward for perhaps two months now.
(I'm very curious to know if there is any regional variability to this phenomenon. Please tell me in the comments section if home-mortgage rates are up, down, or sideways in your part of the country, and by how much!)
As you know, home-mortgage rates correlate closely with the 10-year maturity of risk-free Treasury securities- about the middle of the yield curve (which is plotted on a logarithmic scale). That's because the "duration" of a portfolio of mortgage-backed securities is such that it can be hedged with positions in 10-year govvies.
Last March 13, the 10-year had its highest close of the year, yielding 4.50%. At that time, you remember, world financial markets had seen a massive flight-to-quality in the wake of the large drop in the Shanghai Stock Exchange on February 27 and the subsequent spillover to other markets.
Since then, bond prices have dropped sharply across the yield curve, and yesterday the 10-year closed to yield 4.97%.
That's why your mortgage rates have been going up.
The bond market is an awfully big place, with a lot of different dynamics going on at once. I'm not going to have the hubris to tell you why fixed-income prices have been so weak, although I suspect technical factors to some extent. (Global markets did a lot of housecleaning in March and April.)
What are the implications for the economy, if the trend continues?
Well, your mortgage will keep getting more expensive, and this is known to be a key factor in the strength of the real-estate market. I would look for this market to remain weak. I would also look for the mainstream-media (who live for mendacious scare stories) to keep talking about "bubbles, meltdowns, subprime-mortgage disasters, and free-falling home values." Don't be taken in.
Falling prices for fixed-income securities always put downward pressure on stock prices. In RedState's contributors' predictions post at the beginning of this year, I said you could expect the year to end with the Dow Jones Industrials Average at 13,500. (It was then in the mid-12,000 range.) I believe stocks have seen their peak for the year.
Much more to the point, as Wall Street sees it, is the response of the Federal Reserve to the interest-rate environment. The Fed targets the level of short rates through a variety of policy tools. The stock markets have been hoping fondly all year for some sign that the Fed would see their way clear to cutting short-term rates, but that gets harder to do as the rest of the fixed-income market falls in price. This is a fairly strong psychological negative for the stock market.
What about the real world? Higher rates may be telling a story of commodity-price inflation. They may also be telling of economic strength in the United States. That also squares up with the fact that, for all the weirdness in China's financial "markets" (if you'll pardon the expression), they're not encountering any serious dislocations.
Demand in the US puts a floor under much of Asia's economy. (The economic story in Euro-land, which also is a market for Asian production, is looking very strong, very healthy too.)
And demand for money, which causes rates to rise, could be telling us good things about the economy.
(As always, the usual disclaimer: I'm presenting analysis and interpretation. NOTHING I have said here should be construed as investment advice.)
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Yield Curve 14 Comments (0 topical, 14 editorial, 0 hidden) Post a comment »
I'm skeptical that the Fed will be able to painlessly hold in the inflationary pressures that are building. I'm expecting slow growth (but not a recession) in the last quarter of this year and the first two quarters of next year.
Interesting, especially since bond ADT volume was rising each year until dropping '05 to 06' (mostly due to T-bill and FAS). My only question is will that spell trouble for MBS next.
Overall, I am not really worried on the fixed income side of the house, especially when looking globally.
"Dulce et decorum est pro patria mori"
Contributor to The Minority Report
since July 2006
...until I checked myself. Then I had to pop my eyeballs back into their sockets. Bloomberg story (with rate quotes) here. If the 10-year ends up at 5.75, as the story hints, an awful lot of things change. Not surprisingly, the US dollar is up sharply today, too.
I officially take credit for today's bond-market slaughter! (Truth be told, if I'd known it would be today, I'd have been trading rather than writing about it.)
People who know me get tired of hearing me say there's too much money in the world, which has been true for at least ten years. We might be seeing the beginning of the end of the cycle. And if so, let's hope it coincides with the development of some new risk that is of a higher quality than has been the norm.
Let's also be thankful that the geniuses in Congress have no clue about any of this stuff. That limits their ability to make trouble.
Blackhedd, another contributing factor was Bill Gross's (PIMCO) bearish interview on CNBC. Still, interesting analysis.
Pimco has a huge fixed-income portfolio, one of the biggest I know about. Anything that makes bonds easier to buy is good for Bill Gross.
Seriously, I wasn't aware of the close correlation between the 10yr UST and the 30 year mortgage rate until I read your explanation of the duration match.
A good deal of real estate speculation has been driven by low mortgage rates on both the fixed and floating sides of the street. So the higher 10 year will intensify the weaknesses in the real estate market.
You are officially granted credit for the slaughter in the bond market!
here (subscription required)... that talks about how the cost of labor has been increasing rapidly even in places like China and India.
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Underlying most arguments against the free market is a lack of belief in freedom itself. - Milton Friedman
In India, I know from experience that there is a shortage of qualified technologists who can work on projects for American companies. They're graduating about 400,000 engineers a year, but very few of them have the language and business skills needed to be valuable. So prices for Indian techs are on the way up.
Places like Romania, Bulgaria, Brazil and (the latest one I've heard about) Honduras are becoming the new hot countries for programmers and techs.
(Why can't Americans do it? Too expensive by at least 5x. Patriotism matters, but not at economically insane prices like that.)
In China, I'm less sure what's going on, but that won't stop me from laying my pet theory on you: strong internal inflation, caused by their dollar-reserve surplus in combination with the currency peg.
Everyone assumes (and the Chinese may even believe it to some extent) that an artificially undervalued renminbi makes Chinese exports cheaper and more attractive in export markets in the US. As you can see, markets are bigger than governments. Vastly bigger, in fact. And they have a nasty habit of biting your backside if you try to manipulate them.
I still believe that the next Fed Rate move will be higher rather than lower. And yet I think that the stock market will trade higher as well (as long as market interest rates don't spike).
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The CIA has better politicians than it has spies - Fred Thompson
correcting speculation in real estate. In New York people told me of speculators flipping condos in a building that hadn't been built yet. (!)
Speculation has driven the hot markets in single family homes across the country, and most are cooling rapidly now.