#*!? CRASH BAM @#$ Suddenly, markets (well, at least the bond market) now see falling interest rates in the short and intermediate term. The 10-Year U.S. T-Note fell from 1.47% on June 30 to close at 1.29% on Thursday July 7 (a big move in just four market sessions). Some of the rapid fall was due to short covering, so the slight give back on Friday (to 1.36%) wasn’t a surprise. For context, the 10-Year T-Note yield closed as high as 1.53% on June 24. Such moves in bonds are not run of the mill.
This could not have happened if the bond market gurus truly believed in the inflation narrative. History has shown that the bond folks are better at the underlying economics than are the equity people. Our regular readers know our long-held view that interest rates would be falling as the “hot” economy proved to be only lukewarm, and that the inflation narrative would fade away as the “transitory” view proves out.
Those falling yields foreshadow a slower pace of GDP growth than what has been priced into financial markets. We’ve been pointing this out for several weeks. And most of the fresh data continue to support this notion.
Initial Unemployment Claims (ICs) (Not Seasonally Adjusted) came in at 370K with Thursday’s Department of Labor report (July 8). A reminder: this is a proxy for “new layoffs,” still at recessionary levels (pre-pandemic “normal” was 200K). Not a word about this report from the financial media as, from a market perspective, this was an unexpected rise of +11K from an originally reported 359K (revised up to 366K with the data release). The consensus view was 350K, so a big, big miss and in the wrong direction. As you will see when you read on, the consensus missed every data release on the “high” (optimistic) side.
Continuing Unemployment Claims (CCs) retained their snail’s pace descent, falling to 14.2 million (week of June 8) from 14.8 million the prior week. The chart at the top shows just how shallow the downslope has been, especially in 2021. The pre-pandemic normal was 2 million.
· As we have written in prior blogs, the data show conclusive evidence that those states opting-out of the federal $300/week unemployment supplemental payment have seen their CCs fall at a significantly faster pace than those states that haven’t opted-out (or couldn’t: MD and IN originally opted-out, but courts have ruled they could not).
· The table shows the date of opt-out, the number of states opting-out, and the percentage change in the state CCs between May 15 and June 26. Note the large differences between the opt-out states and those remaining in the federal program through its expiration on September 6.
The aggregated percentage changes of all the opt-out states is -14.0% versus -6.4% for the opt-ins. However, looking just at the 11 states (first two lines of the table) where opt-out has already occurred, the aggregate percentage change between May 15 and June 26 is a whopping -29.6% (vs. -6.4% for opt-in).
· The JOLTS (Job Opening and Labor Turnover Survey) just published for May also disappointed markets. Job openings (9.209 million) were lower than the originally published April number of 9.286 million (revised to 9.193 million with the data release). The consensus estimate was 9.325 million, so another miss on the “hot” growth side. Reinforcing the softening, both new hires and voluntary quits fell. Some will say the data here are still high. But we are talking about the direction of growth, and all the labor numbers seem to be softer than expected.
Other Economic Data
- The table shows spending data – all softening since the March helicopter money drop.
Mortgage Loan applications were down -1.8% the week of July 2 after falling -6.9% the prior week. These are now lower by -36% from their peak (new purchase apps -26%, and refi apps -41%). This, despite a fall in mortgage interest rates of -35 basis points (-0.35 percentage points). It could be the skyrocketing prices of houses! No matter! The point here is that the data is softening and that means slowing economic growth.
Inflation and the Money Supply
We read a lot of op-eds that claim that inflation is here to stay because the money supply has grown over 25% since the pandemic began, and the Fed continues to “print” $120 billion/month. The commentators often cite Milton Friedman’s famous “Inflation is always and everywhere a monetary phenomenon” quotation. What is missing here is that the newly created money never gets into the public’s hands. It has stayed in the banking system. We have followed and commented on the bloated size of the Reverse Repo market (bank overnight “loans” to the Fed of their excess cash taking Treasury Notes as collateral). The money has stayed in the banking system and never gets into the hands of businesses or consumers. This is equivalent to the Fed printing paper $100 bills to the tune of $120 billion/month, but never putting those into circulation, instead keeping them locked up in vaults at the Mint.
The chart shows bank lending to businesses since the beginning of 2018. Note the spike where the economy was closed by government fiat in early 2020. That was businesses drawing on their bank lines of credit to ensure they would have sufficient cash during the lockdowns to survive. (They feared the banks would pull the lines of credit like they did in the Great Recession!). But note the continued fall in outstanding loans since the spike. We believe the downtrend will continue, even accelerate, in Q3/21 and Q4/21.
Even if the Fed continues printing (which they will, even during their taper, just at a slower rate), if the money stays in the banking system and isn’t loaned to the private sector, economic growth won’t be spurred upward; and inflation will be a non-starter. That doesn’t mean the money printing doesn’t have the potential to become inflationary. It does, but today’s conditions aren’t conducive to rapid bank lending, especially since Dodd-Frank changed the way banks are regulated. As a real-world example, since 1990, the Bank of Japan has been providing gobs of bank reserves and liquidity to that economy, yet deflation, not inflation, has been the dominant issue.
Has the Pandemic Ended?
It doesn’t appear so. Due to the rapid spread of the Delta variant, Israel has reinstated restrictions, and Japan has cancelled spectators at the upcoming Olympic Games. In addition, some under-vaccinated U.S. states have seen their new infection numbers jump. If such trends continue in the world, U.S. exports will suffer. There are significant probabilities of slower growth than in the current forecasts.
Fed Economic Growth Forecasts
Both the Atlanta Fed and NY Fed have reduced their GDP growth forecasts for Q2.
For Q3/2021, Atlanta Fed is forecasting 5.0%; NY 3.9% GDP growth. Quite the come down from earlier blockbuster growth views.
When Moratoriums End
What is missing in the current economic blogosphere is discussion of what the economic impacts will be when rent and loan payment moratoriums end.
- When rent moratoriums are ended, even if there aren’t evictions, spending will slow as those behind in their rent will have to make additional payments to landlords rather than spending on Amazon (Landlords generally have a lower Marginal Propensity to Consume than do their tenants);
- We haven’t seen any analysis of business survival for those businesses (and individuals) that have payment moratoriums and must now begin to make loan payments. Like the tenants behind on rents, those that can make the catch-up payments will have less to spend on other business ventures. Those that can’t make such payments will become problem loans on bank balance sheets and will impact loan loss data.
So, while the economy continues to heal, the patient is far from healthy.
- The bond market now appears to be in sync with the idea that economic growth will be slower than generally thought and currently priced into equities;
- The latest employment data confirm a slowing labor market, and the consensus estimates appear to be overly optimistic;
- Spending trends, too, have been much slower than consensus forecasts, with many key spending indicators showing weakening trends;
- Mortgage applications are falling even in the face of lower mortgage rates. One can blame it on skyrocketing home prices, but the point is that no matter the reason, housing appears to have peaked, and that means slowing economic growth;
- The Fed’s monthly money printing appears to be locked into the banks (Reverse Repo at record levels). Bank lending to the private sector is falling;
- The pandemic doesn’t appear to be ending of its own accord. New cases are rising in some parts of the world, and even in some U.S. states where vaccination rates are low;
- We don’t know the economic consequences when rent and loan payment moratoriums end. They won’t be pretty;
- The bond market appears to have recognized these issues. Interest rates: “Lower for Longer.”
(Joshua Barone contributed to this blog.)
Robert Barone, Ph.D. is a Georgetown educated economist. He is the co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (NYSE Symbol: FFIU). Robert is also a financial advisor at Four Star Wealth Advisors. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, a Director and Chairman of the Federal Home Loan Bank of San Francisco, and. similarly, a Director and Chairman of the CSAA Insurance Company (the AAA brand). Robert currently is a Director of the AAA Auto Club of Northern California, Nevada, and Utah, and a Director of Allied Mineral Products (Columbus, OH), America’s leading refractory company