Thursday, August 27, 2015

Bond market update

By my model, last Thursday, the mean expected date of the first rate hike was around the end of November, suggesting about a 30/70 split of a rate hike in September vs. December.  The mean date has moved forward to the beginning of March - a full quarter move.  Uncertainty has increased, so there is still some expectation of a September hike, but this also means there is some expectation of a hike later than March.  The slope of the curve hasn't changed much, but the long end has actually moved up a bit.  So, on the Eurodollar curve, from the close last Thursday to today, 2016 rates are a little lower, 2017-2018 rates are about the same, and rates at the long end of the curve are up about 14bp.  This suggests to me that the bond market sees hope for a more dovish future trend coming from the expected capitulation by the Fed to delay the rate hike.

This shift puts us back at about 6 months away from the next hike, continuing the pattern of the future rate hike date shifting ahead in time whenever there is not a QE program in place.  There may be enough momentum to eventually break that pattern now, especially if we can see any renewed expansion in real estate investment.  But, it would be nice for the Fed to just pull the rate hike off the table for a while.  What does everyone think is going to happen?  Five percent NGDP growth?  Two percent inflation?

If the Fed announced tomorrow that there would be no rate hikes until at least June 2016, the slope of the yield curve and long term bond rates would rise immediately.  Wouldn't that be normalization?  That looks a lot more normal to me than what people are calling normalization.

The slope of the yield curve after the first hike is around 20bp per quarter until it flattens out around 3%.  Normal yields in every recovery since the early 1960s have risen by at least 50bp per quarter, up to more than 5%.  And in the recoveries before that, when rates were lower and rose more slowly, NGDP growth was topping out at 10%.  There is a lot of leeway between here and normal, let alone between here and reckless.

There is a great way to know if the Fed is being reckless, too.  If it ever becomes too accommodative, equity values will fall relative to corporate operating profits, like they did in the 1970s.  Anti-market bias leads to this massive case of attribution error, where we each individually know just what a "bubble" looks like and how to avoid it, but "those people", otherwise known as "the market", or "us", will be led down the primrose path.


  1. It is amazing for people to simultaneously decry bubbles and short selling. "I just know that prices are too high, but I want it to be illegal for people who are smart like me to make any money with that knowledge." What?

    1. Ha! Yeah.

      Our culture has become very Pharisaical - it's not whether you are honest or dishonest, skilled or not; it's whether you are clean or unclean. Financial gains are unclean, long or short. I don't know...maybe it's always been this way. But it seems like it has gotten worse. We're living in Mencken's world.