The European Central Bank yesterday joined the bond market in reasserting the belief that the path of least resistance for the price of money, if not lower is at least sideways. The ECB kept its key interest rate at 2% yesterday, despite predictions by some pundits that monetary easing was imminent on the Continent. Standing pat at the ECB comes in the wake of the 25-basis-point hike in fed funds to 3.25% on June 30.
The diverging trends in rates between the U.S. and Europe is striking, and reveals itself in long as well as short rates. Lending the French and German governments money for 10 years will deliver current yields on the respective sovereign bonds in the neighborhood of 3.2%. The same transaction with U.S. Treasuries nets a juicier treat in the form of a current yield just over 4% as we write.
Perhaps the edge in Treasuries is no small reason for the dollar’s rally of late, which has scored a technically bullish breakout above 90 in the U.S. Dollar Index this week.
More of the same may be in store if predictions of even higher fed funds comes to pass. “We see Fed policy raising the short rate,” writes David Kotok, chief investment officer of Cumberland Advisors, today in an email to clients. The next stop: 3.5%, when the Fed meets again on August 9, he opines. But Kotok parts company with the bond market in seeing long rates moving higher too. “We look for 4-1/2% to 5% at year-end,” he predicts. Curiously, Kotok isn’t necessarily dismissing the idea that the economy will stumble. “We may get slowing but it will be inflationary.”
Perhaps, but there was no overt sign of a slowdown in this morning’s employment report for June. The nation’s jobless rate slipped last month to 5.0% from 5.1% in May. At 5.0%, the unemployment rate is the lowest since the ill-fated month of September 2001. The decline was tempered a bit by the news that nonfarm payrolls advanced a slower-than-expected 146,000 last month. But as Nomura’s chief economist David Resler notes today in a missive to clients, the job market continues to bubble along on average when surveyed over the longer term. “Nonfarm payrolls rose 146,000 but with revisions to prior months winds up being +190,000,” he observes. That’s “amazingly close to the average of about 183,000 for the past year and a half.” As a result, “net, net, the June data show no deviation from trend employment growth as labor markets maintain their underlying momentum.”
The main challenges overhanging the U.S. economy are still no less threatening. That includes the large and growing mountain of debt accumulated by consumers, the ever-expanding U.S. trade deficit, and the fallout from what could be a correction in real estate prices. Throw in the jokers of rising oil prices, an approaching change in management at the Fed, terrorism, and an assortment of other unknowns and there’s no shortage of reasons to worry.
Yet the stock market seems inclined to climb a wall of worry. The S&P 500 has climbed 3% since the end of April. During that stretch, the yield on the benchmark 10-year Treasury Note has shown a tendency to fall to around 4.05% from 4.2% at April’s close.
The great debate about whether the economy will sink or swim remains the sun, moon and stars for the capital markets. Par for the course of late is deciding which corner of the capital markets is right and which is wrong. Today’s economic news gives believers in growth a reason to remain cheerful, but it’s not compelling enough to convince the bond market to rethink its long-held assumptions. Indeed, rewiring the thoughts of either the pessimists or optimists to any degree will take time, and or some extraordinary event. Maybe next week.