Tag: USA

Moody’s says not only did the wide majority of experts incorrectly predict the outcome of the US Presidential election, pundits also were far off the mark regarding how markets might react to an improbable Donald J. Trump victory. Instead of conforming to pre-election expectations of an equity market sell-off and lower interest rates, both share prices and bond yields have soared since Trump’s victory. Whether they remain higher depends on a widely anticipated acceleration by business sales vis-a-vis employment costs that may not materialize.

As inferred from recent market performance, the economic, taxation, and regulatory policies of the past eight years curbed business activity considerably and, by doing so, reined in the growth of attractive job opportunities. To the degree existing policies limited US business activity, they very much facilitated Donald Trump’s Presidential upset. Perhaps, “secular stagnation” is partly the offshoot of suboptimal government policies that helped to slash US real GDP’s average annual growth rate from the 3.3% of the 10-years-ended 2006 to the 1.3% of the 10-years-ended 2016.

Nevertheless, unprecedented demographic change that is beyond the scope of an immediate government remedy is one of the major drivers of “secular stagnation”. The aging of the US population complements the deceleration of growth quite nicely.

When the US economy grew by 3.3% annually during the 10-years-ended 2006, the number of Americans aged 65 years and older rose by 310,000 annually, on average, while the number aged 16 to 64 years — a proxy for the working-age population — expanded by a much greater 2.36-million annually. By the 10-years-ended 2016, the average annual increase in the number aged at least 65 years soared to 1.28 million as the annual addition to the working-age population sagged to the same 1.28 million.

Notwithstanding the likely implementation of more stimulatory policies, US growth during the next 10-years-ended 2026 will still be constrained by projected average annual increase of only 470,000 for the number of 16- to 64-year old Americans, which is far less than the forecasted average annual addition of 2.05 million to the ranks of those 65-years and older.

If, as expected, the US working-age population grows by 0.5% annually during the next 10-years, then a likely range of 1.0% to 1.5% for the average annual rate of labor productivity growth suggests that US real GDP will increase by between 1.5% and 2% annually through 2026, which is much slower than its 3.2% average annualized increase of the 25 years ended 2006.

Older workforce may keep 10-year Treasury yield under 3% to 5% range. In addition to the overall population, the US workforce is also getting older in a manner never seen before. Since June 2009’s end to the Great Recession, the cumulative 8.5% growth of household-survey employment was unevenly split between a 3.9% increase in the number of employees aged less than 55 years and a 28.0% surge for the employment of Americans aged at least 55 years.

If employment growth remains skewed toward older workers, part-time workers will probably constitute an above-trend share of employment, while the growth of both personal income and household spending will be slower than otherwise. The underlying growth of both income and spending slowed as the share of workers aged at least 55 years soared from October 1996’s 12.1% to October 2016’s 22.8% of total US employment.

Some now warn of an impending climb by the 10-year Treasury yield to a range of 3% to 5%. However, an older workforce weighs against a much higher benchmark Treasury yield. An older workforce and an aging population are expected to limit the upsides for inflation risk, private-sector borrowing, and household expenditures growth by enough to prevent the 10-year Treasury yield from becoming stuck in a range of 3% to 5%.

Credit Markets Review and Outlook

As illustrated by Figure 1, the 10-year Treasury yield maintains a strong correlation of -0.84 with the share of employment aged at least 55 years. Getting to a forecast midpoint of 3% for the 10-year Treasury requires that the employment of Americans aged at least 55 years drop from October 2016’s 22.8% to roughly 20% of total employment. Such a rejuvenation of US employment is highly unlikely. The impossibility of making America young again renders it all the more difficult to make America great again. (Figure 1.)

Equity rally helps to drive benchmark yields sharply higher

Thus far, earnings-sensitive markets view the Republican sweep of the House, Senate, and Presidency positively. Since November 8’s election, the market value of US common stock was recently up 1.9%. Moreover, after the VIX index’s average soared from October 2016’s 14.6 points to the 20.0 points of November’s first eight days, this equity market “fear factor” subsequently dropped to a recent 14.6. The latter has been statistically associated with a 430 bp midpoint for the high-yield bond spread, which was thinner than November 9’s band of 508 bp.

The post-election equity rally stems from improved prospects for business activity and profits. The Republican sweep boosts the odds favoring a fiscal stimulus package that includes lower tax rates on personal and corporate income, as well as stepped-up infrastructure spending. Moreover, a much reduced rate of taxation on the repatriation of corporate cash held overseas is probable.

In addition, business operating costs are likely to be effectively reduced by the repeal of the Affordable Care Act and a broad-based easing of federal regulations. On the regulatory front, Bloomberg reports that Trump’s Financial Services Policy Implementation team will devise a strategy that aims to dismantle 2010’s Dodd-Frank Act. Expectations of both Dodd-Frank’s demise and Fed rate hikes have driven the KBW index of bank stock prices up by more than 9% since November 8.

Nevertheless, upwardly revised outlooks for business activity and corporate earnings quickly drove the 10-year Treasury yield up by 27 bp from November 8’s close to a recent 2.13%. Not since January 2016 has the 10-year Treasury yield been this high.

Recent auctions of new 10- and 30-year Treasury bonds were weak. The 2.22:1 bid-to-cover ratio for November 9’s $23 billion auction of 10-year Treasury notes was the lowest since March 2009. In addition, foreign participation was weak at both sales. Trump’s surprising victory may have temporarily scared off foreign buyers of US Treasuries.

Nevertheless, the dollar exchange rate has climbed higher since the election. The recent widening of the yield spreads between US Treasuries and the sovereign government bonds of other advanced economies may help to further firm the dollar exchange rate, where expectations of an even stronger dollar may contain Treasury yields by (i) reducing inflation expectations, (ii) boosting foreign purchases of US Treasuries, and (iii) lowering the outlook for US corporate earnings.

Credit Markets Review and Outlook

Despite a costlier dollar exchange rate, industrial metals prices have soared. On November 9, Moody’s industrial metals price index was up by 29.4% from a year earlier.

However, the still relatively modest pace of global industrial activity questions the sustainability of the latest surge by base metals prices. Perhaps, speculative buying in anticipation of a lively rejuvenation of global industrial activity now drives base metals prices higher. If the world’s consumers fail to cooperate and spending does not rise by enough to support costlier base metals, base metals price deflation will return.
Given the persistent price deflation afflicting tangible consumer goods, manufacturers will have difficulty passing on higher materials costs to final product prices. In October, the annual rates of price deflation were -2.3% for the consumer durable goods’ component of the PCE price index and -0.6% for the core consumer goods price index. The underutilization of the world’s production capabilities should continue to contain prices of internationally tradable products regardless of forthcoming stimulus and deregulation.

A fundamentally excessive climb by Treasury bond yields could sink share prices and widen spreads. Thus, credit-sensitive activity may offer insight as to how high interest rates might climb. In view of how unit home sales recently slowed amid a less than 3.5% mortgage yield, an impending climb by the mortgage yield to a range of 3.75% to 4% risks an outright year-over-year contraction by home sales.

Thus far, according to Moody’s, US financial assets have fared poorly during the fourth quarter. Fear of a fundamentally unwarranted climb by Treasury yields has weighed on the performance of earnings-sensitive securities.

The latest climb by the 10-year Treasury yield from a September 2016 average of 1.63% to a more recent 1.81% has been ascribed to expectations of a series of Fed rate hikes in response to a possibly much faster than 2% annual rate of CPI inflation. Though the current bout of inflation anxiety may be overblown, holders of earnings-sensitive securities worry about long-term borrowing costs reaching burdensome levels. In addition, higher yielding Treasury securities will drive up the returns investors demand from other assets. And, the surest way to boost an asset’s future prospective return is to lower its current price.

Since the end of September, the market value of US common stock was recently down by -4.0%. The accompanying -7.3% dive by the Russell 2000 stock price index shows that the prospective loss of liquidity to higher interest rates may weigh more heavily on small- to mid-sized companies.

For businesses incurring flat to lower sales volumes, higher borrowing costs make absolutely no sense. It should be noted that the NFIB’s survey of small businesses found that the net percent of polled firms reporting a three-month increase by sales volumes sank from the -5.5 percentage points, on average, of the year-ended June 2016 to the -7.8 points of Q3-2016. (When the net percent is negative, the number of surveyed firms incurring a decline by sales volumes tops the number reporting an increase.)

Only once during the current recovery has the sales volume statistic’s moving three-month average achieved a positive reading — the +1.1 points of the three-months-ended May 2012. For the current recovery, the sales volume index has averaged a woeful -9.4 points, which was worse than its insipid +1.0 point average of 2002-2007’s upturn.

Housing-sector share prices plunge

The fourth-quarter-to-date’s -8.0% plunge incurred by the PHLX index of housing-sector share prices reflects considerable worry over a possible ascent by benchmark yields that will stifle housing activity. Markets remember all too well how a climb by mortgage yields during the “taper tantrum” of 2013 reduced home sales.

Yes, the 10-year Treasury yield could jump up to 2% or higher, but its stay will be limited if housing buckles under the weight of higher mortgage yields. The fact that housing did not get more of a boost from a -50 bp drop by the 30-year mortgage yield from a Q3-2015 average of 3.95% to the 3.45% of Q3-2016 warns of an annual contraction by home sales if the 10-year Treasury yield remains above 2%.

Housing’s muted response to a less than 3.5% 30-year mortgage yield suggests only a limited upside for the 10-year Treasury yield. After surging by +16.1% year-over-year during the year-ended June 2016, dollar outlays on single family home construction dipped by -0.8% year-over-year during Q3-2016.

In addition, the year-over-year percent increase for unit sales of new and existing homes slowed from the 4.9% of 2016’s first half to the 1.6% of the third quarter. Looking ahead, a slowdown by the annual rise for the index of pending home sales from first-half 2016’s 1.7% to the third quarter’s 1.2% signals a slowing by home sales that risks deteriorating into an outright contraction if mortgage yields jump higher.

Inflation worries overlook deep pockets of deflation

Forecasts of a 10-year Treasury yield noticeably above 2% are derived from expectations of faster price inflation. Nevertheless, exaggerated fears of faster price inflation have surfaced at various times during the current recovery. Remember those earlier off-the-wall predictions of Weimar-like hyperinflation for the US economy? Forecasts of persistently rapid price inflation have proven to be so very wrong largely because US consumers have lacked the cash needed to fund runaway price inflation. In addition, the aging of both the US population and the US workforce add to the difficulty of sustaining accelerations by consumer prices.

Price inflation now lacks breadth. If the Fed decides to fight headline inflation, the plight of those having exposure to tangible consumer goods is likely to worsen. Third-quarter 2016’s PCE price index rose by 1.0% annually, which was well under the Fed’s 2% target for PCE price index inflation. Moreover, the third-quarter’s yearly pace for the Fed’s preferred index of consumer prices contained major pockets of consumer-goods price deflation.

For example, Q3-2016’s price index for durable consumer goods was down by -2.3% from a year earlier, while the price index for consumer nondurable goods fell by -1.3% annually. By contrast, the consumer services’ component of the PCE price index rose by 2.3% annually. Thus, consumer service price inflation explains Q3-2016’s 1.7% annual increase by the core PCE price index, which excludes food and energy prices.
Many fret over an increase by the annual rate of core CPI inflation from September 2015’S 1.9% to September 2016’s 2.2%. However, that quickening was largely the consequence of an increase by core consumer service price inflation from 2.7% to 3.2% that differed radically from an accompanying deepening of core consumer goods price deflation from -0.5% to -0.6%.

The rise by the annual rate of core consumer service price inflation was driven by increases in (i) medical-care service price inflation from September 2015’s 2.4% to September 2016’s 4.8% and (ii) shelter cost price inflation from 3.2% to 3.4%. Excluding shelter costs, the annual rate of core CPI inflation rose from September 2015’s 1.0% to a still very low 1.3% for September 2016.

Shelter cost inflation may peak soon

Recent data favor a slowing of shelter cost inflation from September’s 3.4% annual pace. The National Multifamily Housing Council (NMHC) compiles an index describing the tightness of apartment market conditions for the US. The rate of change for apartment rents tends to respond with a lag of 12 to 15 months following a major swing by the index of apartment market tightness.

After most recently peaking at the 89.7 of Q1-2011, the apartment market tightness index has subsequently plunged to the 28.0 of Q3-2016. The latter was the index’s lowest reading since the 20.0 of Q2-2009, or the final quarter of the Great Recession. (Figure 1.)

Each previous drop by the apartment market conditions index to a reading of less than 30 was followed by a significantly slower rate of growth for rents and, in turn, the shelter cost component of the core CPI. For example, in response to Q2-2009’s ultra-low apartment conditions index, the average annual rate of rent inflation sank from the 3.1% of 2009’s first half to the 0.2% of April 2010 through December 2010. Thus, rent inflation is likely to slow noticeably from Q3-2016’s 3.7%.

Other forthcoming sources of consumer price disinflation include autos (owing to a glut of used vehicles and sweetened sales incentives) and restaurant meals (stemming from an excess supply of eateries).

In summary, if Treasury yields extend their latest climb absent indications of much improved profitability, the recent sell-off of high-yield bonds may continue. After bottoming at October 25’s 6.10% — the lowest reading since May 2015 — the composite speculative-grade bond yield rapidly ascended to November 2’s 6.63%. In response, the accompanying high-yield bond spread widened from 478 bp to 531 bp. The latter is very close to the spread’s predicted value of 529 bp mostly because of the return of an above-trend VIX index. To the degree Treasury yields rise faster than what is warranted by business activity, higher yields practically assure lower prices for equities and lower-grade corporates.