Bond Yields Showing No Economic Spoils for Republicans
Former Republican House Speaker Newt Gingrich says Barack Obama’s policies are “artificially extending the recession.” Congressman John Boehner, the party’s leader in the House, says “stimulus policies aren’t working.” Republican Senator Jim Bunning calls Federal Reserve Chairman Ben S. Bernanke’s tenure “a failure.”
The U.S. bond market disagrees. The economy has never contracted with the difference between short- and long-term Treasury yields as wide as it is now. That gap, at 2.11 percentage points for 2- and 10-year notes, signals a 15.5 percent chance of a recession in the next year, according to the Federal Reserve Bank of Cleveland.
“Reports of the death of the recovery are greatly exaggerated,” said Andrew Busch, a public policy strategist at Bank of Montreal’s BMO Capital Markets in Chicago and former adviser to Republican presidential candidate John McCain and Treasury Secretary Timothy F. Geithner.
As politicians step up their rhetoric ahead of the November midterm elections, bond traders are watching the so-called yield curve for clues to the direction of the economy because before each of the last seven economic contractions, long-term yields fell below short-term debt. While that gap has narrowed since reaching a record 2.91 percentage points in February, it’s still almost double the average since 1990.
No Double Dip
Though economists are paring their forecasts, they still predict growth in gross domestic product of 3 percent this year and 2.8 percent in 2011, according to the median of 66 estimates in a Bloomberg News survey. Goldman Sachs Group Inc. economists say most of the sectors that drag down an economy, including housing, employment and capital spending, have “already suffered big hits.”
“As signs of slower U.S. growth have multiplied, market participants have become worried about the possibility of a double-dip recession,” the firm’s economists wrote in an Aug. 12 report. “The probability is unusually high -- between 25 percent and 30 percent -- but we do not see double dip as the base case.”
The yield on the two-year notes due in July 2012 fell to a record low of 0.4547 percent last week. The yield on the benchmark 10-year note, a 2.625 percent security maturing in August 2020, declined to as low as 2.53 percent, the least since March 2009. The yield on two-year notes was down less than one basis point to 0.49 percent today and the yield on 10-year debt was little changed at 2.61 percent.
The $8.18 trillion market for Treasuries, which help determine the cost of funds for everything from mortgages to corporate bonds, has returned 8.05 percent this year, including reinvested interest, Bank of America Merrill Lynch index data show. They lost 3.7 percent in 2009.
Republicans, who lost control of the House of Representatives and Senate in 2006, are pointing to rising demand for bonds, falling yields and faltering stocks as a sure sign the economy is poised to contract. The Standard & Poor’s 500 Index is down 3.9 percent this year.
It is time for Obama to “face up to the fact that his stimulus policies aren’t working,” Boehner of Ohio said Aug. 7, a day after the government reported the unemployment rate held at 9.5 percent in July.
The White House hasn’t made much progress in selling the stimulus spending to voters. Asked how their opinion of the programs had changed in recent months, respondents to a Bloomberg National Poll were divided almost evenly among those who say they had become more supportive, those who are less supportive and those who haven’t changed their view.
A steep yield curve traditionally indicates economic growth as investors demand more compensation for the risk of faster inflation. A flatter yield curve signals contraction and little threat of inflation.
Though yields are hovering near record lows, the curve as measured by projections of the three-month Treasury bill rate to 10-year note yield suggest the economy will strengthen by about 1.14 percent over the next year, according to a July report from the Federal Reserve Bank of Cleveland.
“The growth trajectory in the economy is sluggish, but positive, with no contraction on the horizon” said Wan-Chong Kung, a money manager who helps invest $89 billion at FAF Advisors in Minneapolis. “We’ve gotten through a really tough downturn in the economy. It could have been much worse if we didn’t have the type of policy that was put in place on the fiscal and monetary front.”
Recessions Since 1850
There have been 33 official recessions since 1850, and only three times has the economy fallen back into negative growth within a year, according to data at the National Bureau of Economic Research.
The difference between 2- and 10-year yields is up from negative 0.19 percentage point in December 2006, just before the economy began to shrink.
An inverted yield curve has twice failed to predict a recession -- in late 1966 and late 1998. The bears say bonds may be sending another “false positive.” With the Fed’s target rate for overnight loans between banks at a record low of zero to 0.25 percent, it may be impossible for long-term yields to fall below short-term debt.
“As long as the Fed continues with ultra-easy policy, the yield curve’s relative importance as an economic signal is diminished,” said Christopher Sullivan, who oversees $1.6 billion as chief investment officer at United Nations Federal Credit Union in New York.
A gradual recovery may not be enough to bolster Democrats in the November elections, BMO’s Busch said. “The number one thing on voters’ minds are still jobs, and we haven’t seen any significant progress on the employment front.”
Signs of Improvement
Since the stimulus legislation was approved in February 2009, the U.S. unemployment rate has climbed to 9.5 percent in July from 8.2 percent. The administration projects the jobless rate will average 9.7 percent for the year. Spending by consumers has slowed, with the savings rate rising to 6.4 percent 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, mines and utilities climbed 1 percent, twice the median forecast in a Bloomberg News survey, figures from the Fed showed last week.
Companies in the U.S. added workers in July for a seventh straight month as private payrolls that exclude government agencies rose by 71,000 after a June gain of 31,000, Labor Department figures showed. Corporate spending on equipment and software jumped at a 22 percent annual rate last quarter, the biggest increase since 1997, signaling confidence among company executives.
“There seems to be a doom and gloom out there,” Doug Oberhelman, chief executive officer of Peoria, Illinois-based Caterpillar Inc., the world’s largest maker of construction equipment, told analysts in a meeting at the New York Stock Exchange on Aug. 19. “We just don’t see it that way for lots of reasons. The facts aren’t bad in our business.”
The more than 75 percent of the companies in the S&P 500 that reported second-quarter profits exceeded the average analyst 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 growth never exceeded 20 percent.
“The main difference between 2008 and now is that corporations are making money,” said Andrew Brenner, managing director at Guggenheim Capital Markets LLC, a New-York based brokerage for institutional investors.
As earnings rise, companies are cutting their interest expense. The 10 lowest-yielding U.S. corporate bond deals ever were 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, the lowest coupon on record for that maturity.
The bond market is saying that it may be years before the Fed raises rates to foster the recovery, said Carl Lantz, head of interest-rate strategy in New York at Credit Suisse Group AG, one of 18 primary dealers of U.S. government securities that trade with the central bank.
Slow, persistent growth will help stave off the fear that the U.S. is starting to look like Japan in the 1990s, when the Bank of Japan struggled to revive its economy amid a combination of deflation and recessions, he said.
“The economy is improving and the yield curve will stay steep as the market is pricing in a return to more normal rates further out the curve,” said Lantz. “It will feel like Japan for awhile, but ultimately we are not Japan. We are seeing subpar growth, and a muddling along that is not particularly satisfying, but we are on the path to an eventual return to normal growth.”
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