Fitch reported yesterday losses in the sovereign debt market would globally approach $3.8 trillion if yields rose to 2011 levels. The 10-year reached a 3.74% yield on February 8, 2011 and then plummeted to a 1.71% yield by September.
To place this potential loss into proper perspective, the Dow Jones has a capitalization of $5.4 trillion. The Russell 2000’s capitalization is $1.99 trillion.
The Federal Reserve “Central Tendency” for the 10-year treasury is a 3% by 2017. The CBO is projecting a 4.1% 10-year treasury by 2026.
Wow!
Will yields rise? Inflation is a two part phenomena; too much money chasing too few goods fearing higher prices tomorrow. In other words there is a monetary and a psychological component.
I think there is little argument about the massive liquidity central banks have injected into the financial system since 2008. The US alone has over $2.5 trillion in excess bank reserves versus the historical average of $1 billion (this is not a typo). There are negative nominal yields throughout the developed world and negative real interest rates in the US, the result of failed monetary and fiscal policy.
I can make an argument from the GDP data that there are too few goods given the largest inventory drawdown in five years and the greatest decline in fixed residential spending in seven years.
What about the psychological component…fearing higher prices tomorrow? As written many times owner’s equivalent rent (OER) is rising from greatly depressed levels but has exponentially lagged residential rent increases. OER is about 32%-33% of most inflationary indices. Is OER’s nascent recovery about to accelerate given the dearth of residential real estate for sale?
Labor is the largest cost of production. Wage inflation is nonexistent except at the ends of the spectrum…low skilled because of political pressures and skilled because of a broken education system that rewards passion rather than utility.
What happens if wage inflation, i.e. cost push, accelerates at the same time as OER which is tantamount to cost pull inflation? The last time the economy experienced such a scenario was in the mid to late 1970’s, an environment amplified by an oil supply disruption.
There is great complacency is the sovereign debt market.
The national debt is now 75% of GDP, up from 39.3% in 2008 according to the CBO. Because of plunging interest rates, the US only paid $223 billion in interest last year, lower than the $232 billion in 1995 when the national debt was a third the size it is today.
What happens if the yield on the 10-year does climb to 4%? The CBO projects annual interest payments will rise to $839 billion from $223 billion. Talk about the ultimate “exploding ARM,” the same vehicle that was a major reason for the 2008-09 implosion.
Wow! The impact upon the budget would be devastating given the 2016 proposed budget is $3.9 trillion.
There has been little discussion about the deficit and the impact of higher interest rates in the presidential campaign with both candidates focusing instead upon visceral personal attacks, utilizing spurious events in attempt to gain the greatest attention on social media.
Today the ADP private sector employment survey is released, the precursor of Friday’s BLS labor report. As widely discussed the BLS labor has indicated conflicting signals of the strength of the economy. How will today’s ADP report influence the expectations of Friday’s report?
Commenting about yesterday’s market action, equities fell the most since Brexit on growth fears. The Dow has now declined for seven consecutive days, the longest stretch in a year. The 10-year was off about 5/32 to yield 1.54%.
Last night the foreign markets were down. London was down 0.27%, Paris down 0.44% and Frankfurt down 0.05%. China was down 1.65%, Japan down 1.88% and Hang Sang down 1.76%.
The Dow should open nominally lower with concerns over the direction of economic growth and oil prices. Incidentally oil is higher this morning on last night inventory survey which indicated a greater drop then expected. The 10-year is up 5/32 to yield 1.54%.
