The big news of the week: The U.S. economy stalled in the first quarter, GDP rising 0.2 percent. And long-term rates, which go down on weak economic news, instead went up.
There are several keys to this conundrum. The first: The economy did not stall. The most basic forward momentum in our economy (any economy): 321 million Americans need to spend money every day to live, and “personal consumption expenditures” in the first quarter plodded along at a 1.9 percent annualized rate.
Second, there is no new evident weakness in employment, although next Friday’s payroll report could surprise.
Home sales are not rocketing, but not bad either: Pending sales in March were 11 percent higher than one year ago. Today’s release of the manufacturing ISM (Institute for Supply Management) index arrived unchanged in April at 51.5, despite weakness in the oil patch and the strong dollar hurting exports.
Gross domestic product (GDP) calculations are weird. By the way: Nobody should have been surprised by a poor number — the Atlanta Fed’s real-time GDP tracker (“GDPNOW’) has had a near-zero figure for six weeks. Pulling GDP down: Investments fell in the first quarter (Q1), everything from residential to business, some of that due to pullback in drilling.
Another big sinker: Imports rose, but exports fairly collapsed, down 7.3 percent in Q1 — we were still spending, but buying the production of others.
The one aspect of the GDP report that does indicate a stall: Businesses built a lot of inventory in Q1 that did not sell, but the production boosted GDP — it would have been negative without the inventory accumulation. Now we infer that the overstock will mean underproduction in Q2. And the Atlanta Fed tracker shows no rebound in April.
If not a stall, certainly underperformance, then why the jump in mortgage and bond yields? Mortgages are still a hair below 4 percent, but the 10-year T-note is up to 2.11 percent and looks lousy. If ever you wanted confirmation that the outside world has more and more impact on daily life in the U.S., follow this bouncing ball.
Last winter, the Fed adopted the rhetoric of inevitable rate hikes ahead. If economic growth merely remained on current track, the Fed was coming. No need for inflation even to rise toward target, we’re coming. Simultaneously, the European Central Bank (ECB) and the Bank of Japan (BOJ) entered end-stage QE (quantitative easing) money-hosing — panicked, really.
In the near term, currencies move relative to each other because of changes in local interest rates (longer term: inflation and trade balances). Money will flow to the highest return, and in the era of electronic money on 24/7 screens, moves fast. So the dollar rocketed up, and the euro and yen crashed, as did nearly all important currencies, those central banks also hosing in order to be trade-competitive with Europe and Japan.
If you’re going to move to dollars, you have to buy dollar-denominated bonds and stocks. Thus U.S. bonds went up in price, down in yield, at max panic in early February, the 10-year to 1.65 percent. The NASDAQ returned to its all-time high. QE by the ECB and BOJ pushed yen and euro bonds almost to zero, adding to buy-pressure here.
Historically, big swings in currency values take a year or years to change the flow of exports and imports. In the modern era, not just money is made of electrons; so is a lot of world trade. The weak euro has suddenly pinked European economies, Spain now the strong man of Europe, second only to Germany. However, ruddy Europe is at the zero-sum cost of a pallid U.S., our exports tanking.
Hence the spreading global assumption that the Fed will have to hold off, maybe indefinitely. So the whole machine has run in reverse for 10 days: dollar down, euro and yen up. Euro bond yields up (all is relative, German 10s from 0.06 percent to 0.37 percent), U.S. bond yields up.
Hunch: All of this QE-currency hoo-ah has not changed a thing. The world is and has been caught in oversupply of labor, materials, commodities and manufactures, soggy everywhere, German and Chinese predation making all worse. The Fed may lift off (Bill Gross: “If only to show they can still get out of bed”), but the economy and rates are not going anywhere.
The 2-year T-note is always the best forecaster of Fed action, and this one-year chart says the 2s traders have priced in maybe sorta one hike this year:
The 10-year T-note looks like a bottom. Needs something ugly to go lower. And if it’s not going lower, it’s going up. But already has, and not far. Most likely to increase volatility, guessing in a wide range 1.9 percent clear up to 2.3 percent, until the economy clarifies the Fed.
This GDP tracker has done so well that it’s worth a glance every few days:
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
