Capital Markets Update

By Louis S. Barnes                         Friday, August 16th, 2013

Long Treasuries broke upward, out of the trading range of the last eight weeks. Not by much, but out, the 10-year T-note above 2.80% for the first time in more than two years, 2.86% at this moment. Mortgages are stickier, the rise negligible (investors have lost fear of another refi wave), but the march toward 5.00% is underway.
Two patterns are helpful, one 24-hours old, the other a 60-year vintage.
Before discussing those, dismiss a false lead: the 17-nation euro zone enjoyed positive GDP in the 2nd quarter, ballyhooed in US press as an “end to recession.” A positive quarter is the technical definition recession-end, but not even the Europeans believe this is anything more than a passing moment of stabilization.
Yesterday’s trading was instructive. News which should have helped long-term rates did not: Egypt’s descent into civil war, 200 points off the Dow, and zero-gain industrial production in July. News which overwhelmed all else and pushed up rates: new claims for unemployment insurance last week fell to a six-year low 320,000.
Thursdays’ market calculus is now persistent: jobs override all. If employment is strengthening, the Fed will taper QE to zero within six months. Thus stocks traded down on good economic news. I have never found a direct conveyor of QE cash to stocks, except running through the vacant minds of stock boosters. Whether real or imaginary, the mind prevails, but it does not say much for the investment-value underpinnings of stocks that good economic news is bad news.
The trading-desk shorthand for unemployment insurance applications is “claims.” Every US recession since the big war has ended in the same pattern: credit-sensitive housing and autos rebound as soon as the Fed cuts rates. The job market is the last to recover, often lagging housing by two years. Jobs are the most politically sensitive element, which typically forces the Fed to be too easy during recovery for too long — and which the Fed knows as surely as sunrise. Claims have been the best leading indicator for the Fed, but when claims plunge the Fed is already too late, forcing it into catch-up, which many fear today.
The Fed chopped rates in late 2008, but housing did not turn until 2012. Too much distress in the market, and tight credit offset cheap rates. Today, one year into housing recovery, right on schedule jobs are showing signs of life.
However, the job market today has headwinds even stronger than housing. For one, housing will continue to be thin until Congress and the White House take their feet off the mortgage hose. Even more important, since the early 1990s the US has faced unprecedented competition from labor overseas. Median household income had been stuck near $55,000/year from the mid-1990s until 2009 when it fell almost to $50,000, where it still is, and its purchasing power undercut by health-care racketeering.
Claims are down in part because there isn’t anybody left to fire. The drop in claims this time may not have cyclical counterparts: more jobs and higher incomes. The whole point of the Fed’s removing the punch bowl is to prevent overheating and inflation, but we can’t have either one without rising incomes. And they ain’t. And no economy anywhere ever overheated without a surge in credit. Not here, not hardly.
Another historical pattern: when the Fed appears to be turning, long-term rates always rise. And people like me always warn that the rise may abort the recovery, and it never has. This time is different in two ways (maybe). First, the panicked run up in long rates since May is not justified by Fed statements or implications, or by economic data — especially inflation. Too far too fast. Second, can it be that a still-impaired and mis-regulated financial system has been more dependent on QE than we or the Fed have known? Despite falling mortgage production and Treasury issuance, the Fed has been the only buyer, and rates must go much higher to find another?
Then there is the world. As US markets and the Fed conspire to jack long rates, they are rising everywhere. The US economy is better, but everywhere else is slowing or in trouble one way or another. Fainting elsewhere is our best chance for lower rates.