This is a good thing

//This is a good thing

This is a good thing

Long term bonds are moving their way through 3% for the first time since the end of 2013. Interest rates have been so low for so long, investors can be forgiven for fearing the idea of higher rates. But they shouldn’t.

The 10-year U.S. Treasury Note, a benchmark rate that influences borrowing costs for governments, corporations and consumers started the year at 2.41% and touched 2.91% last week. At the same time, earlier this month, stocks experienced their first correction in nearly 1,000 days, long overdue by historical averages. But stocks have bounced back over the past week, reflecting continued optimism over growth in the economy, corporate earnings and consumer incomes.

Rising share prices in tandem with rising bond yields reflect markets that are moving past their obsession with the “new normal”, referring to the hypothesis that economic growth worldwide and interest rates would remain depressed amid excessive leverage, weak employment and flat wages. Interest rates bottomed in the summer of 2016 and economic growth has picked up too.

Instead, investors are focusing on inflation, long thought dormant and one of two mandates whose management responsibility is held by the Federal Reserve. CPI measures reported last week that inflation is picking up. Headline inflation was 2.1%, but if you annualize the last 3 and 6 monthly changes, both are running over 4.0%. Core inflation, which excludes food and energy is not far behind. 3-month annualized core CPI is running at 2.8% and 6-month core CPI is at 2.5%. Producer Price Inflation reported the next day told much the same story; inflation isn’t dormant anymore.

Federal Reserve expectations for three increases to the overnight night rate 2018 are still in place, and they continue to reduce their balance sheet at a measured pace. The additional factor is the government itself. With the passage of $1.5 trillion in tax cuts and further talk of an infrastructure program, the stock market sees support for corporate earnings and investment in new projects, supporting the stock market rally. However, larger budget deficits threaten to drive up yields as the government boosts the amounts of bonds it sells at the same time the Federal Reserve is stepping back as a very large buyer.

Even now, yields remain low by pre-crisis standards. There is a point beyond which rates can climb that will slow the economy, but we are not there yet. Moving slowly past 3% would be a good thing.

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2018-02-28T13:23:11+00:00 February 21st, 2018|Market|0 Comments

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