After three weeks of startling (and painful) movement, financial markets have staggered to a standstill.
The question before the house: Did the market-lurching signify changes in economic trend, or correction of prior events?
Stick with correction. Here is the reconstruction.
Once upon a time — 18 months ago — U.S. long-term rates were rising fast based on Fed withdrawal from quantitative easing (QE) and another apparent U.S. economic acceleration. The U.S. 10-year Treasury reached 3 percent twice, mortgages close to 5 percent at New Year’s 2014. Then, in one of the more remarkable patterns of recent times, the 10-year entered a straight-line glide path for 16 months, culminating at 1.9 percent in the third week of April.
The lurch upward since, into the 2.20s, has disturbed a lot of people but should not. The 16-month slide was the work of the U.S. economy doing far better than Europe, hence the Fed shouting intentions to raise its rate while the European Central Bank (ECB) threatened its first bond-buying QE. By last fall, into winter the central bank divergence had spectacular effect on currency markets, the euro crashing towards 1:1 with the dollar; and as the euro crashed, it forced other central banks to undercut their currencies to maintain trade competitiveness with Europe.
The dollar rising versus the world pulled cash into the U.S., pushing up prices for bonds (their yields down) and stocks. This currency force overwhelmed any market fear of a higher overnight Fed rate.
There were several sideshows during the period, oil in the lead. I argued then and restate now: The oil decline had far less stimulative effect on the world economy than any previous decline. Prices of natural gas had crashed five years before, instead of simultaneous with oil as in previous oil declines. Same for coal. The primary Western use of oil is for gasoline, and its $3.50-per-gallon rate had already been so high (the same price per liter in the rest of the world because of taxes) that that we were already weaning ourselves. “Miles driven” in the U.S. had not risen since 2008. Optimistic-side economists are still hunting for consumer stimulus, but there was no “wascally wabbit” in sight.
The oil drop has thickened the cap on inflation, but the fundamental lid has been welded, bolted, chained and cemented in place for two decades: Wages are barely growing. Here and everywhere, same.
The last month’s reversals are just correctives to an overdone fall-winter move. In a beautiful illustration of recurrent technical trading patterns, the U.S. 10-year has now retraced exactly one-third of its 16-month drop. The euro is back to $1.14, and as the dollar has slid, bonds have been dumped and yields are up. Some make the truly foolish argument that ECB QE has worked and Europe has righted itself and euro inflation is on the way. Nah. Its economies have gotten a boost from the weak euro, which has had the reciprocal effect here, weakening the U.S.
All of this feels as though global markets have reached a temporary equilibrium. Now we need for something to happen — perhaps several things in concert to tell us if the world economy is headed upward, or will drift back into the long-term disinflationary goop.
Everything I can see says the latter. Nothing grim: Big demographic shifts not far ahead will diminish the oversupply of labor and then add to its compensation. But in the meantime the whole world is trying to rig the game in favor of its exports. Except us, of course, maybe-maybe-not able to get TPP (Trans-Pacific Partnership) off the ground — and TPP is not a table-tipper, just a balancer.
Persistent QE in Europe and Japan — and its residual here, I suppose — could produce some kind of stagflation, but it’s not likely. Every nation is trying in varying degrees of desperation to keep its people at work, to service overgrown debts both public and private. That effort could not be more deflationary, and the central bank QE cash has little effect except competitive currency devaluation.
And the Fed is on hold, its forecasts in flinders.
U.S. 10-year T-note, two years back. Captures the “taper tantrum” in summer 2014, the hysterical bottom in yields in February, and the real bottom since. I assume we will slop around in a very wide range between 2 percent and 2.3 percent until “something happens.”
The New York Fed’s debt data is survey-based, hence less reliable than the Fed’s Z-1. However, these pictures are clear:
- It’s hard to get a housing recovery going without increased mortgage supply; and
- There is no credit growth except for student loans and autos — the former punishing, the second overdone.
This survey is one of the longest-running that we have. The gain in the last six months has been reassuring, but it has stalled now, a long way short of health.
An ever-so-slight upward tilt from zero in the most important U.S. job engine. By the way: Small business is NOT captured by the Bureau of Labor Statistics Non-Farm Payroll figures each month — that’s big-business only.
China since 2000: The blue line is industrial production, the gold is fixed investment. A degree in economics is not necessary to see the profound slowdown in this investment-led economy.
Everyone is tired of Greece. The ECB is tired of it. Merkel is tired of it. I am tired of it. The Greeks are tired of it — so tired that they have pulled almost half of their deposits out of their own banks, and the ECB has replaced them. If/when Greece finally defaults, the bag-holders will be the ECB and the International Monetary Fund, self-deceiving themselves into taking the place of private parties, inside Greece and out.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
