INSIGHTS

On October 03, 2018

AAM Viewpoints – Will Interest Rates Rise? Economic Fundamentals Will Rule.

Whether it be trade wars, tariffs, North Korea or the latest “breaking news story” – of which there are numerous ones every day and of course the tweets – I believe the basic economic fundamentals will win out over the latest predominantly negative headline news with the majority being negative. Most of the negative news is sensationalized, meant to draw the reader or viewer to pay attention or to click on a story. Tariffs and trade wars are the latest. Jamie Dimon, Chairman and CEO of JPMorgan Chase, put it into perspective best, “It’s not a trade war, it’s a skirmish.” Negative news tends to lower U.S. Treasury interest rates as investors seek a safe haven and a flight to quality occurs. Positive economic data tends to encourage interest rates to rise.

Economic Indicators

Initial Jobless Claims track the number of people who have filed for unemployment benefits for the first time; this can be viewed as an indicator of how well the economy is doing. If this number is low that means there are plenty of jobs and if the number is high it is a reflection of the lack of jobs available, thus a weaker economy. The monthly initial jobless claims during the last quarter has been the lowest it has been since the early 1970s which was followed by years of inflation.

The Consumer Price Index (CPI) is a measure of the prices paid for consumer goods. Many believe that the growth rates of the CPI indicate inflation rates. The CPI is strong around 2.8% and that in itself is impressive. If you are a reversion-to-the-mean-type person you will find it interesting that the 20-year historical average spread between the CPI number and the 10-year Treasury bond yield is around 140bps (basis points). Currently the spread between the CPI number and the 10-year Treasury bond is about 25bps. Even if the spread between the two reverted to only 50% of the historical spread that would have the 10-year Treasury at a 3.50 yield instead of the 3.05 yield it currently sits; 100% of the historical spread has the 10-year Treasury bond at a 4.20 yield.

Another piece of data that would indicate that the economy is still strong with potential inflationary results is the JOLTS (Job Openings and Labor Turnover Survey) data. JOLTS is a survey done by the U.S. Bureau of Labor Statistics to help measure job vacancies. The JOLTS Job Openings is the highest it has been in 15+ years. It might follow that in order to entice workers to fill job opening, salaries may need to increase.

A new indicator for us is the Capacity Utilization (CapU) analysis. Breaching the 80% level is an indication of a healthy economy. It’s been a decade since we breached the 80% level and it appears we are getting there again.

Speaking of CapU and CPI, we typically see elevated inflation at moments of rising CapU. The blue boxes denote a mixed movement while yellow arrows denote similar moves in inflation with higher CapU.

One argument that has been tabled for interest rates staying low is the enormous amount of debt worldwide that has a negative yield. How can rates rise when there is so much pressure from lower yielding and negative yielding bonds? That trend is changing also. The amount of negative yielding debt has dropped almost in half since 2016. During the same period the 10-year German Bund went from a negative yield to a positive 0.50 currently.

Let’s not get into the increasing budget deficit and the issuance of Treasury bonds to fund this debt.

There are two sides to every story and two sides to every market; as always check with your financial advisor before investing.

CRN: 2018-1002-6924 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.