Bond Yields Showing No Economic Spoils for Republicans in 2010
Former Republican House Speaker Newt Gingrich says Barack Obama’s policies are “artificiallyextending the recession.” Congressman John Boehner, the party’sleader in the House, says “stimulus policies aren’t working.”Republican Senator Jim Bunning calls Federal Reserve ChairmanBen S. Bernanke’s tenure “a failure.”
The U.S. bond market disagrees. The economy has nevercontracted with the difference between short- and long-termTreasury yields as wide as it is now. That gap, at 2.11percentage points for 2- and 10-year notes, signals a 15.5percent chance of a recession in the next year, according to theFederal Reserve Bank of Cleveland.
“Reports of the death of the recovery are greatlyexaggerated,” said Andrew Busch, a public policy strategist atBank of Montreal’s BMO Capital Markets in Chicago and formeradviser to Republican presidential candidate John McCain andTreasury Secretary Timothy F. Geithner.
As politicians step up their rhetoric ahead of the Novembermidterm elections, bond traders are watching the so-called yieldcurve for clues to the direction of the economy because beforeeach of the last seven economic contractions, long-term yieldsfell below short-term debt. While that gap has narrowed sincereaching a record 2.91 percentage points in February, it’s stillalmost double the average since 1990.
Though economists are paring their forecasts, they stillpredict growth in gross domestic product of 3 percent this yearand 2.8 percent in 2011, according to the median of 66 estimatesin a Bloomberg News survey. Goldman Sachs Group Inc. economistssay most of the sectors that drag down an economy, includinghousing, employment and capital spending, have “alreadysuffered big hits.”
No Double Dip
“As signs of slower U.S. growth have multiplied, marketparticipants have become worried about the possibility of adouble-dip recession,” the firm’s economists wrote in an Aug.12 report. “The probability is unusually high - between 25percent and 30 percent - but we do not see double dip as thebase case.”
The yield on the two-year notes due in July 2012 fell to arecord low of 0.4547 percent last week. The yield on thebenchmark 10-year note, a 2.625 percent security due in August2020, declined to as low as 2.53 percent, the least since March2009. The yield on two-year notes was 0.4869 percent today andthe rate on 10-year debt stood at 2.6 percent.
The $8.18 trillion market for Treasuries, which helpdetermine the cost of funds for everything from mortgages tocorporate bonds, has returned 8.05 percent this year, includingreinvested interest, Bank of America Merrill Lynch index datashow. They lost 3.7 percent in 2009.
‘Policies Aren’t Working’
Republicans, who lost control of the House ofRepresentatives and Senate in 2006, are pointing to risingdemand for bonds, falling yields and faltering stocks as a suresign the economy is poised to contract. The Standard & Poor’s500 index is down 3.9 percent this year.
It is time for Obama to “face up to the fact that hisstimulus policies aren’t working,” Boehner of Ohio said Aug. 7,a day after the government reported the unemployment rate heldat 9.5 percent in July.
The White House hasn’t made much progress in selling thestimulus spending to voters. Asked how their opinion of theprograms had changed in recent months, respondents to aBloomberg National Poll were divided almost evenly among thosewho say they had become more supportive, those who are lesssupportive and those who haven’t changed their view.
‘We’ve Gotten Through’
A steep yield curve traditionally indicates economic growthas investors demand more compensation for the risk of fasterinflation. A flatter yield curve signals contraction and littlethreat of inflation.
Though yields are hovering near record lows, the curve asmeasured by projections of the three-month Treasury bill rate to10-year note yield suggest the economy will strengthen by about1.14 percent over the next year, according to a July report fromthe Federal Reserve Bank of Cleveland.
“The growth trajectory in the economy is sluggish, butpositive, with no contraction on the horizon” said Wan-Chong Kung, a money manager who helps invest $89 billion at FAFAdvisors in Minneapolis. “We’ve gotten through a really toughdownturn in the economy. It could have been much worse if wedidn’t have the type of policy that was put in place on thefiscal and monetary front that.”
Inverted Yield Curve
There have been 33 official recessions since 1850, and onlythree times has the economy fallen back into negative growthwithin a year, according to data at the National Bureau ofEconomic Research.
The difference between 2- and 10-year yields is up fromnegative 0.19 percentage point in December 2006, just before theeconomy began to shrink.
An inverted yield curve has twice failed to predict arecession -- in late 1966 and late 1998. The bears say bonds maybe sending another “false positive.” With the Fed’s targetrate for overnight loans between banks at a record low of zeroto 0.25 percent, it may be impossible for long-term yields tofall below short-term debt.
“As long as the Fed continues with ultra easy policy theyield curve’s relative importance as an economic signal isdiminished,” said Christopher Sullivan, who oversees $1.6billion as chief investment officer at United Nations FederalCredit Union in New York.
A gradual recovery may not be enough to bolster Democratsin the November elections, BMO’s Busch said. “The number onething on voters’ minds are still jobs, and we haven’t seen anysignificant progress on the employment front.”
Signs of Improvement
Since the stimulus legislation was approved in February2009, the U.S. unemployment rate has climbed to 9.5 percent inJuly from 8.2 percent. The administration projects the joblessrate will average 9.7 percent for the year. Spending byconsumers has slowed, with the savings rate rising to 6.4percent in June, from 1.7 percent in August 2007.
There are signs of improvement, as production in the U.S.rose more than forecast in July. Production at factories, minesand utilities climbed 1 percent, twice the median forecast in aBloomberg News survey, figures from the Fed showed last week.
Companies in the U.S. added workers in July for a seventhstraight month as private payrolls that exclude governmentagencies rose by 71,000 after a June gain of 31,000, LaborDepartment figures showed. Corporate spending on equipment andsoftware jumped at a 22 percent annual rate last quarter, thebiggest increase since 1997, signaling confidence among companyexecutives.
‘The Facts’
“There seems to be a doom and gloom out there,” Doug Oberhelman, chief executive officer of Peoria, Illinois-basedCaterpillar Inc., the world’s largest maker of constructionequipment, told analysts in a meeting at the New York StockExchange on Aug. 19. “We just don’t see it that way for lots ofreasons. The facts aren’t bad in our business.”
The more than 75 percent of the companies in the S&P 500that reported second-quarter profits exceeded the averageanalyst estimate since July 12, data compiled by Bloomberg show.Earnings will rise 36 percent this year, the most since 1988,forecasts show. Following the 2001 recession, income growthnever exceeded 20 percent.
“The main difference between 2008 and now is thatcorporations are making money,” said Andrew Brenner, managingdirector at Guggenheim Capital Markets LLC, a New-York basedbrokerage for institutional investors.
Not Japan
As earnings rise, companies are cutting their interestexpense. The 10 lowest-yielding U.S. corporate bond deals everwere sold in the past 14 months, according to Deutsche Bank AG.Armonk, New York-based International Business Machines Corp.issued $1.5 billion of 1 percent three-year notes on Aug. 2, thelowest coupon on record for that maturity.
The bond market is saying that it may be years before theFed raises rates to foster the recovery, said Carl Lantz, headof interest-rate strategy in New York at Credit Suisse Group AG,one of 18 primary dealers of U.S. government securities thattrade with the central bank.
Slow, persistent growth will help stave off the fear thatthe U.S. is starting to look like Japan in the 1990s, when theBank of Japan struggled to revive its economy amid a combinationof deflation and recessions, he said.
“The economy is improving and the yield curve will staysteep as the market is pricing in a return to more normal ratesfurther out the curve,” said Lantz. “It will feel like Japanfor awhile, but ultimately we are not Japan. We are seeingsubpar growth, and a muddling along that is not particularlysatisfying, but we are on the path to an eventual return tonormal growth.”
