Bob’s Journal for 9/12

Last update on: Jun 15 2020

Over the last seven days, I’ve seen several reports and developments that you should know about.

August was a great month for long-term treasury bond investors. In fact, it ranks among the best ever, as I reported a couple of weeks ago.

Things changed quickly last Thursday, Sept. 5. Interest rates increased sharply, and the iShares 20+ Year Treasury Bond ETF (TLT) gapped down at the market’s open. TLT was down as much as 2.4% from the previous day’s close and ended the day with a significant loss.

Investors had to know that August’s rally couldn’t continue indefinitely and that some investors would want to take some of their August profits. But the reversal was sudden and sharp.

The first catalyst for the reversal was the news that China and the U.S. would resume face-to-face talks over trade issues. This was followed by good economic data from the U.S. service sector. Also, some corporations decided to take advantage of low interest rates by bringing new bond issues to the market. The new supply exceeded demand and caused rates to rise.

Plus, U.S. central bank leaders dampened the expectations that investors had for substantial monetary easing in the next few weeks.

The decline in bonds resumed on Monday. The yield on the 10-year treasury now has increased from 1.469% at the close on Sept. 4 to 1.73% at the close on Sept. 11.

I don’t expect sustained interest rate increases from here. The significant decline in interest rates in August went too far, largely as a result of technical and computer trading mechanisms. But we’re not likely to see a burst of economic growth that would drive rates steadily higher.

Meanwhile, a report from researchers at the Federal Reserve Bank of San Francisco has thrown cold water on the idea that ever-lower interest rates will help the economy. The researchers studied the effects of negative interest rates, using the 2016 announcement by the Bank of Japan that it would initiate negative rates to stimulate the economy. The research found that negative interest rates had the opposite of their intended effects.

Negative rates are supposed to stimulate borrowing and economic activity by leading to higher inflation and fears of even higher inflation. Instead, the researchers found that expectations for inflation declined as soon as the negative interest rate plan was announced.

Another study concluded that negative interest rates in Europe hurt the profitability of banks and reduced lending.

A third study concluded that negative interest rates in Europe have increased inflation and economic growth by tiny amounts.

Yet, investors want lower interest rates and central bankers have repeatedly stated that economies would be worse off without them. The European Central Bank announced a new stimulus package today which moved interest rates even further downward.

It looks like the decline in mortgage rates isn’t going to help the housing market much. After August’s decline, mortgage rates were at their lowest levels in three years. Yet, the monthly survey by Fannie Mae found that consumer sentiment had improved by only a little. Most of the improvement was the result of consumers believing rates would fall even further.

In the survey, fewer consumers than in the previous month said that this was a good time to buy or sell a home. There also was a decline in the number of people who were not worried about losing their jobs in the next year.

Another sign that housing isn’t going to rev up a lot is that a year ago, 42% of the offers for homes were part of a bidding war. In August, only 10% of offers were in a bidding war, according to the real estate brokerage company Redfin.

Interest rates declined over the summer, primarily because of concerns that the economy was heading towards a recession. Indeed, recession fears reduce the number of people who are interested in taking on a new mortgage payment, even when mortgage rates decline.

The Data

The economy is showing the first signs of inflation in a decade. The Consumer Price Index (CPI), excluding food and energy, increased 0.3% for the third consecutive month. That’s the strongest streak of inflation since the financial crisis. In the past 12 months, the CPI, less food and energy, is up 2.4%.

Food and energy prices generally declined during August, so the headline CPI was up only 0.1% for the month and 1.7% over 12 months.

Wholesale prices told a similar story. The Producer Price Index, less food and energy, rose 0.3% for August and is up 2.3% over 12 months. Including food and energy, the index increased only 0.1% in August and 1.8% over 12 months.

While small business owners remain fairly optimistic, their optimism has declined, according to the National Federation of Independent Businesses (NFIB) Small Business Optimism Index. The index declined to 103.1 from 104.7. Most of the current conditions components of the index were strong, but fewer owners expected business conditions and sales to improve.

Reduced interest rates and a strong jobs market did make consumers willing to take on more debt in July. Consumer credit increased by the largest monthly amount since November 2017. Borrowing increased by $23 billion, compared to a $14 billion increase in June.

Credit card borrowing increased by $10 billion in July, compared to a $186 million decline in June. This should indicate strong retail sales for the next few months.

I normally don’t report the New York Federal Reserve’s monthly survey of consumers, but I’m making an exception this month. The survey found that consumers had the lowest expectations for inflation over the next three years than they have had since the survey began in 2013. The expected inflation rate has dropped sharply throughout 2019. Consumers expect 2.5% annualized inflation over three years and 2.4% over the next year.

Last week’s Employment Situation reports delivered mixed news about the economy. The economy created 130,000 new jobs in August, which is a reasonably strong number. But the number was lower than expectations. Plus, last month’s number was revised down to 159,000 from 164,000. The number of new manufacturing jobs was especially weak at 3,000.

In addition, employers are being forced to raise wages. Average hourly earnings increased 0.4% in August, up from 0.3% in July. Over 12 months, earnings increased 3.2%.

The JOLTS (Job Openings and Labor Turnover Survey) report found the labor market was steady from June to July.

The number of job openings didn’t change much over the month, and the number of hires increased by 237,000 to six million. The number of workers quitting and being separated from jobs hardly changed.

After all the factors were netted, the report found that over 12 months, there was a net employment gain of 2.6 million. The number of job openings, however, peaked in late 2018.

New unemployment claims dropped an unexpected 15,000 to bring the total for the week to 204,000. That’s the lowest level since the historic low that was recorded last April.

The Markets

The S&P 500 increased 2.11% for the week that ended with Wednesday’s close. The Dow Jones Industrial Average rose 2.94%. The Russell 2000 shot up 6.20%. The All-Country World Index (excluding U.S. stocks) added 2.18%. Emerging market equities gained 2.68%.

Long-term treasuries fell 4.74% for the week. Investment-grade bonds lost 2.01%. Treasury Inflation-Protected Securities (TIPS) gave up 1.55%. High-yield bonds rose 0.63%.

On the currency front, the U.S. dollar increased 0.30%.

Energy-based commodities rose 0.40%. Broader-based commodities declined 0.23%. Gold tumbled 3.83%.

Bob’s News & Updates

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I’m a regular contributor to the Forbes.com blog. You can view my contributor page here.

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