This note is written prior to the election results. Just a few points to make that are more structural in nature, and perhaps not particularly election dependent. First, as of the futures settlement time of 3:00 pm EST, the long end of the treasury curve is at new high yields since May. For example, the ten year treasury yield ended at 1.86%, having been as low as 1.36 post-Brexit. The 30 year bond yield is 2.62% and was as low as 2.10 post Brexit. The 2/10 treasury yield curve has gone from a low of 74 to a high (again since early June) of just over 100 bps.
The reasons for higher yields at the long end are varied, including higher wage growth, year over year comparisons in energy prices that will have a tendency to make inflation appear as if it’s revving up, increases in market based inflation measures, and, perhaps most importantly, the growing feeling that central bank policies in developed markets have run their useful course. I would also note that M2 money supply growth has accelerated from 6% earlier in the year to 7.4% annually currently. The Fed is on track to further remove accommodation by way of a rate hike in December (January 2017 Fed Funds contract settled at 9941.5, indicating greater than 75% chance of a hike in December), and the ECB has given indications of possible tapering regarding QE, though that might be some time away.
Note that a steeper curve and higher rates at the long end are not necessarily indicative of a robust economy. Indeed, there are some indications that consumers are under increasing stress, though growth should still be able to muddle along around 1.5 to 2.0%. The Fed has consistently stressed gradual rate increases, and all Eurodollar one-year calendar spreads remain below 25 bps, so at this point, the market completely accepts the idea that rate increases will be on a slow trajectory. Where the election might make a difference domestically is with regard to government spending on infrastructure which would give a shot in the arm to growth prospects.
In any event, the next administration will face myriad challenges, including high and increasing federal debt levels, entitlement programs that are taking an increasing share of limited resources, and a more hostile international environment where US influence has waned. Let’s hope our political leaders are up to the challenges.
