For most of the third quarter, we believe that we have focused almost exclusively on increasing yields on developed country bonds and the US dollar. After what we feel forever, we believe that the market evidence of a change is much stronger towards the last quarter of the year and that the fundamental case is still generally favorable to this thesis. We maintain that if we are right about the bond and currency markets, this is of great importance to stock investors, corporate bonds and emerging market bonds.
Now we can not be fanatical about the White House’s view that real growth will accelerate to 3% or more. In fact, we continue to believe that the economic recovery initiated in 2009 by the United States becomes very mature. However, we doubt that the next recession to begin in the coming quarters, despite the noise in the data due to massive storms that hit this fall, we can easily see the remaining growth in the range of 2%.
With stable real economic growth and the White House desperate to take some form of tax reform, the US bond market. UU. It begins to wake up to the possibility that yields have been too low for too long. Chart 1 below shows the performance of 10-year US generic bonds. The increase of 32 basis points in yield from the nearest point in early September is the biggest positive movement of the year and threatens to break a downward trend line as shown in the table. The image of yields on 5-year bonds is similar, although this yield is now the highest in more than six months.
The main question for us is whether the recent change of 32 basis points from the upward movements from April to May and June to July by 25 basis points and 26 basis points is subtle change in the nature of the market. If so, should we look for greater returns over time? If this is not the case, the recent increase in yields is likely to stabilize here.
1) continued abandonment of ultra-easy monetary policies in the United States and, to a lesser extent, elsewhere; 2) expansive fiscal policies in most developed countries; and (3) an expected increase in inflation. And in Europe over the next two quarters, which will only encourage central bankers to be wary of hawks’ expectations.
As for the Federal Reserve, we were told they were willing to review the sweet data that were probably affected by recent storms. They begin to worry that with an unemployment rate close to 4%, the labor market is quite small and wage growth accelerates. They are also pleased that inflation returns to its 2% target, and they modestly recognize that asset prices are high. Given all this, we suspect that they will continue to raise rates and reduce the balance as they have already indicated.
It is arguable that, in what was clearly a storm hit by the US employment report released last week, earnings data were the most significant. Figure 2 below shows three different measures of wage growth for the United States, all of which have increased in recent months. In this context, if Washington reforms taxes effectively and inflation begins to rise again, how can the Fed not follow its policy of normalization? which in our opinion means an increase in rates in December and two more in the first half of next year and a reduction in the balance (assuming the stock market behaves).
As for the currency markets, traders and investors appear to be very comfortable with the recent past of benign yields / yields and a Fed perceived as accommodative. After a nearly 10% drop in the dollar, the market had become aggressively short to the dollar at a level historically seen before a significant low level in the dollar. In fact, the US dollar index has increased weekly in the last four weeks, and stock market data show that speculators have barely changed their bearish positions. Will this change if the dollar rally starts to grow? As an example of what we are hearing, we will see the Australian dollar.