Banquo’s Grain and U.S. Interest Rates

The U.S. economy is strong enough to suggest higher interest rates ahead, but a number of factors suggest U.S. Treasury yields could move lower.

October 02, 2014    |    By Scott Minerd

Global CIO Commentary by Scott Minerd

Early in Shakespeare’s "Macbeth," Lord Banquo asks the prophetic three witches, "If you can look into the seeds of time, and say which grain will grow, and which will not, speak then to me." Banquo’s turn of phrase reminds us that if a farmer planted the wrong grain he could yield a poor harvest, or worse, he might even starve.

I thought about this recently when asked about the outlook for U.S. interest rates. Investors, like farmers, have a sense of the seasons that guides which grains, or investments, are more likely to yield favorable results. While I have no special divining powers, I can draw on our macroeconomic research team that employs the not-so-mystical forces of data and analysis.

Based on macroeconomic research, we estimate “normalized” real interest rates could justifiably be 100 basis points higher than they are today. The U.S. economy is certainly doing well enough to suggest higher interest rates ahead. With quantitative easing ending in the United States this month and the U.S. Federal Reserve preparing investors for a higher federal funds rate in 2015, the stage is set for U.S. interest rates to move higher. But that may not be the grain that grows: The reality is that, despite a strengthening U.S. economy, the greater risk is that interest rates head lower, not higher, in the near future.

Looking at the world today, there are a number of forces that could keep rates low. The first is the impact higher rates would have on the U.S. economy. Remember what happened following the “taper tantrum” last year? Before rates were able to reach historical norms, the average rate on a 30-year mortgage spiked almost a full percentage point in two months—the sharpest rise since the late 1990s—resulting in an abrupt housing slowdown, which slowed the U.S. economy materially. The impact of higher interest rates on the housing market and the broader U.S. economy is something the Fed is extremely mindful of, especially after the first quarter winter soft-patch where the U.S. economy contracted by 2.1 percent.

Next, U.S. Treasury yields are materially higher than those in any other developed market. The spread between 10-year U.S. Treasuries and comparable German bunds reached 157 basis points in September, its widest level since 1999. After inverting in late 2011, the Treasury/bund spread has steadily risen for the past three years as U.S. yields have moved higher while German rates have dropped. The spread between 10-year Treasuries and 10-year Japanese government bonds is now 189 basis points. With developments in the Middle East resembling something from the Bible’s New Testament Book of Revelation and turbulence continuing elsewhere from Ukraine to Hong Kong, the relative price value of U.S. government bonds versus other safe haven investments should continue to be a factor keeping U.S. interest rates low.

Elsewhere in financial markets, the U.S. stock market is vulnerable to higher volatility over the short term. I told my investment team in a meeting on Sept. 23 that, were I a trader, I would tell them to go short stocks, but I am not a trader, I am an investor, and the long-term trends of this bull market still look solid. To paraphrase Shakespeare’s witches, while in the near term something wicked may come this way to markets, the evil portends of this wicked season of volatility may sow new seeds of yet one more rally for U.S. stocks and bonds.

Increased Foreign Buying Pushes U.S. Interest Rates Down

Foreign investors will likely look to the United States for higher yields on government bonds as foreign central banks increase monetary accommodation in their own economies. Historically, rising foreign purchases of U.S. Treasuries have pushed U.S. yields lower. So far in 2014, foreign buying has accelerated—a trend likely to continue, putting downward pressure on U.S. Treasury yields.



Source: Haver, Guggenheim Investments. Data as of 9/30/2014.

Economic Data Releases

U.S. Consumer Confidence Cools as Home Prices Slow

  • The ISM manufacturing index slowed more than forecast in September, falling to 56.6 from a multi-year high of 59.0. The production sub-index climbed to a new high, while orders declined.
  • Durable goods orders dropped 18.2 percent in August following July’s 22.5 percent surge, in line with expectations. The less volatile core capital goods components beat expectations, rising 0.6 percent.
  • Personal income rose 0.3 percent in August, with compensation rising by a five-month high of 0.4 percent. Personal consumption beat expectations in August, rising 0.5 percent after a flat July.
  • Pending home sales fell 1 percent in August, a bigger drop than expected. Sales were down in three out of four regions.
  • Construction spending decreased 0.8 percent in August, mostly due to lower non-residential building.
  • The S&P/Case-Shiller 20 City Home Price Index fell more than expected in July, with the year-over-year reading slowing to 6.75 percent from 8.07 in June, the lowest since November 2012.
  • University of Michigan consumer confidence was unchanged in the final September reading, remaining at a 14-month high of 84.6.
  • The Conference Board’s Consumer Confidence Index dropped to 86 in September from 93.4 in August. The expectations index led the drop.
  • Initial jobless claims fell by 8,000 for the week ending Sept. 27, decreasing to 287,000.
  • The Core Personal Consumer Expenditures deflator, the Fed’s preferred measure of inflation, was flat at 1.5 percent year over year in August.

Euro Zone Periphery Recovers While Core Stagnates

  • The euro zone Consumer Price Index (CPI) remained at a four-year low of 0.3 percent year over year in September. The core CPI was lower than expected at 0.7 percent.
  • Euro zone economic confidence declined to 99.9 in September, the lowest level this year.
  • German GfK consumer confidence fell for a second consecutive month in the October reading to 8.3 from 8.6, its lowest level since February.
  • Germany’s CPI remained at 0.8 percent year over year in September, the third straight month at that level.
  • German retail sales surprised to the upside in August, rebounding 2.5 percent after a 1.1 percent drop.
  • Germany’s manufacturing Purchasing Managers Index (PMI) was revised into contraction territory in the final September reading to 49.9, the first reading below 50 in 15 months.
  • The U.K. manufacturing PMI fell to 51.6 in September, a 17-month low.
  • China’s manufacturing PMI remained flat in September at 51.1.
  • Japan’s CPI continued to tick down in August, reaching 3.3 percent, but the data is distorted by Japan’s sales tax hike.
  • Japan’s Tankan survey of large manufacturers was better than expected in the third quarter, ticking up to 13 from 12. However, the non-manufacturing index was weaker than expected and outlook indices declined for both.


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