Breaking Good

Global CIO Commentary by Scott Minerd

This week, 10-year U.S. Treasury yields broke out of their recent trading range to drop below 2.5 percent, their lowest level since October of last year. I believe, for a number of reasons, that yields could trade significantly lower, perhaps dipping as low as the 2.0 to 2.25 percent range in the coming months.

Over the past few weeks I have written about the role capital flows from overseas have played in keeping U.S. interest rates low. Tensions in Ukraine and China’s devaluation of the renminbi have caused a flight to safety, which has put downward pressure on U.S. Treasury yields. The reality is, however, that these events alone do not explain the declining trajectory of interest rates.

Structurally there is very strong demand for fixed-income products that is not being satiated. This demand, which is especially robust among pension funds and insurance companies, is likely to play a leading role in driving yields lower. At the same time, U.S. corporations are holding a substantial amount of cash and not feeling any great pressure to borrow money. That dynamic has caused the new corporate debt issuance calendar to lighten up. With lots of cash waiting to be invested, there is a supply-demand imbalance which is pushing the prices of everything from investment-grade corporate bonds to U.S. Treasuries higher. Most areas of U.S. fixed income, with the notable exception of asset-backed securities, municipals and bank loans, are now overvalued. Triple-C rated credit is particularly overvalued but, overall, current spreads of both investment-grade bonds and high-yield bonds have further room to compress.

There is nothing significantly negative to say about prospects for the U.S. economy, especially given that interest rates are on a declining path. Mortgage rates are likely headed lower, making housing more affordable and thereby boosting consumption. Employment levels are trending higher and we are headed into the first summer in years where there is no talk of battles over the U.S. debt ceiling or of a potential federal government shutdown. Finally, several years of buoyant equities markets have boosted the wealth effect among U.S. consumers. After a tough first quarter, the U.S. economy is poised to post much stronger economic growth in the second quarter, possibly 4 percent or higher. U.S. GDP growth for the full year should come in at 3.0 to 3.5 percent.

Of course, with much of the U.S. fixed-income market now overvalued, we must guard against the pitfalls of overvaluation, but, as I have said before, markets that are overvalued and then become even more overvalued are called bull markets.

Improving U.S. Budget Deficit to Cut Treasury Supply

Driven by strong tax receipts and continued spending cuts, the U.S. federal government budget deficit is on a rapidly improving trend. This has important economic implications over the longer term, but the near-term effect might be felt most acutely in the Treasury market. With less need to borrow, the U.S. Treasury Department will likely decrease its issuance of securities over the coming months, adding to downward pressure on yields. Our projections forecast that Treasury issuance could fall to about $350 billion over the next two quarters, about 40 percent lower than one year ago.

U.S. FEDERAL BUDGET BALANCE AND TREASURY ISSUANCE

Source: Haver, Guggenheim Investments. Data as of 3/31/2014. Note: Data seasonally adjusted by Haver Analytics.

Economic Data Releases

Bounce Back in U.S. Retail Sales Slows

• April retail sales were below expectations, inching up just 0.1 percent. Sales excluding autos and gas fell 0.1 percent. Prior months were revised higher, accounting for some of April’s weakness.
• The NFIB small business optimism index increased to 95.2 in April, the highest level since 2007.
• Industrial production fell by 0.6 percent in April after rising the prior two months.
• The NAHB Housing Market Index inched down to 45 in May from 46 in April, the lowest in one year.

• Initial jobless claims dropped to 297,000 for the week ended May 10, the lowest since 2007.
• Job openings fell in March to 4.01 million following February’s strong gain. The quits rate was unchanged.
• The CPI accelerated from 1.5 percent to 2.0 percent in April, led by higher food prices. Prices were up 0.3 percent from a month earlier, the most since last June.

Euro Zone GDP Disappoints, Chinese Exports Recover

• Euro zone first-quarter GDP was weaker than expected at 0.2 percent, as strong German growth was offset by weak readings in France and Italy.
• Euro zone industrial production fell in March for the fourth time in six months, down 0.3 percent.
• Germany’s GDP rose 0.8 percent in the first quarter, the best growth in three years.
• Germany’s ZEW survey of current conditions reached 60.5 in May, nearly a three-year high. The expectations index, however, decreased for a fifth straight month, dropping sharply to 33.1 from 43.2.
• French first-quarter GDP disappointed with no growth as consumption spending fell.

• China’s export growth returned to positive in April, rising 0.6 percent year-over-year after declining over the previous two months.
• Chinese retail sales were below expectations in April at a year-over-year growth rate of 11.9 percent, the lowest in more than five years.
• Industrial production in China slowed in April, falling to 8.7 percent year-over-year, the lowest growth rate since 2009.
• China’s Consumer Price Index dropped to 1.8 percent year-over-year in April, the lowest since October 2012. Producer prices fell for the 26th straight month.
• First-quarter GDP in Japan surged to an annualized rate of 5.9 percent as consumer spending growth reached a 39-year high before the sales tax hike.

VIDEOS AND PODCASTS

 

2022’s Upside: The Fed Has Put the Income Back in Fixed Income

Anne Walsh, Chief Investment Officer for Fixed Income at Guggenheim Investments, joined Asset TV to discuss macroeconomic conditions, risk, and relative value in the bond market.

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2022’s Upside: The Fed Has Put the Income Back in Fixed Income

 

Macro Markets Podcast Episode 26: Mortgage-Backed Securities, Structured Credit, Market Liquidity

Karthik Narayanan, Head of Securitized for Guggenheim Investments, discusses value in the residential mortgage-backed securities market and other ABS sectors. Anne Walsh, Chief Investment Officer for Fixed Income, answers a listener question on liquidity. Jerry Cai, an economist in our Macroeconomic and Investment Research Group, brings the latest on the labor picture and an update on China.

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Macro Markets Podcast: Episode #26