*As of 10/20/23
Despite everything happening in the world, the financial markets are really just fixated on interest rates. Every day the discussion is about what’s happening with the yield on the 10-year Treasury or the 30-year? Why do rates seem to be increasing each day? Where is the peak?
Of course, no one can be sure of the answers, hence the daily debate. But the data this week added fuel to the fire that the peak might be higher than we thought just a week or two ago. For example, the retail sales report for September was solid. It handily beat expectations for the month, and little seems to be slowing the consumer down.
It also looks like the manufacturing sector is rebounding from what has been something of a sector specific recession. Data for September showed an expansion in activity after a contraction in August. And this was despite the disruption in the auto industry.
Looking at the economy as a whole, the Citigroup economic surprise index highlights the better-than-expected data. This indicator measures which data releases either beat or fall short of expectations. A positive number, as you would expect, means more reports are beating expectations than missing. We are sitting at pretty high levels relative to history (excluding the COVID period).
Another way to illustrate what is going on is the chart below. The blue line shows the evolution of economist’s 3rd quarter GDP growth projections. Back in June it was at 0%. It now sits at roughly +3.5%. This is an enormous increase in a short period of time!!
And the Atlanta Fed estimate is even higher. I don’t think we’ve seen such a large swing in expectations for a single quarter outside of say the COVID period or right after 9/11.
We won’t get into the reasons why growth is coming in hotter than expected (we’ve covered in prior letters), but needless to say, part of the reason bond yields are higher is due to changing growth expectations.
Yields on the 10-year kissed 5% this week, but backed off on Friday, as you can see below.
It is quite possible that the bond market is starting to fully price in the more robust growth scenario (as well as the prospect of wave after wave of new Treasury supply).
From an economic perspective we now wait to see what the fallout of higher rates proves to be. After all, mortgage rates hit 8% on Wednesday.
This means home sales are likely to soften even further (this week’s data was the weakest in twelve years). And what happens in housing tends to feed quickly into the growth data as it’s the most cyclical sector (and historically the most rate sensitive).
Even the Fed is going to take a wait-and-see approach. Chairman Powell talked this week about rising long-term rates doing the Fed’s job for them. He was pretty clear that the Fed is unlikely to hike the Fed Funds rate again this year. But time will tell if the economy and inflation slow due to the lagged effect or rising rates, or whether this post-COVID world is something totally new.
(Other) Charts We Found Interesting
- Another dynamic impacting long-term rates is the outlook for rate cuts next year. In early June rate cuts totaling about 160bps were priced in. Today that has fallen to just 54bps.
- If you look at inflation without housing costs, it’s already back to the Fed’s target. This supports the idea of a Fed pause through year-end.
- New demographic data for China paints a more challenging picture. The working age population in 2100 may end up being about a third lower than thought only three years ago (might need a new model?).
- This chart shows home sales by year going back to 2000. We are on track for the fewest number of homes sold over this period despite the population of the U.S. increasing from roughly 280 million to 333 million. Can’t afford to buy. Can’t afford to sell.
- The U.S. is now producing more crude oil than at any other point in its history.
- This is a story more about duration than credit quality, but is still pretty interesting. Over the last three years, UK’s longest maturity bonds (matures 2061) have lost more than Argentinia’s longest maturity bonds (matures 2038). The definition of ‘safe haven’ is certainly being redefined around the world.
- On October 14, 2023, the moon passed in front of the sun, producing an annular solar eclipse. NASA’s EPIC (Earth Polychromatic Imaging Camera) imager aboard the orbiting DSCVR (Deep Space Climate Observatory) caught this view of the event, as the Moon’s shadow crossed North America.
Have a good day!
Chief Investment Officer
Gemmer Asset Management LLC
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