Kristian Rouz –The yield of 10-year US Treasuries surpassed a two-year high on Monday as a massive rally in global oil prices spurred inflation expectations higher, resulting in higher investment appeal for the more volatile real economy assets, including those in manufacturing and non-financial services.
These recent developments are stemming from the investor outlook on the Trump teams’ economic agenda, coupled with the pickup in commodities, all pointing at the industrial renaissance across the advanced economies.
Investor selloff of fixed-income assets continued on Monday, led by the US debt, as the Fed hike expectations, higher oil prices, and President-elect Donald Trump’s commitment to provide fiscal stimulus to the economy have spurred the interest non-financial sector assets. Albeit a higher profitability of such assets has been effectively offset by significant market volatility in the past year and a half, investment capital in coming back to manufacturing and retail, energy and utilities, and several other segments of the non-financial sectors.
“It (the decline in US bond value) does seem to be oil-driven, but clearly the bearish sentiment around fixed income prevails,” Mitul Patel of Henderson Global Investors said.
Indeed, should the Trump administration increase budget spending, the new fiscal policy will require accelerated borrowing in the form of higher volume Treasury note issuance. The US bonds, having started their decline in value after Trump’s election last month, are poised to dip further, and the rising benchmark 10-year yield is pushing natural interest rates higher.
The Fed’s borrowing costs, however, are far below the 10-year yield, standing at 0.25-0.5pc compared to the latter above 2.5pc. The Fed will likely employ a faster pace of interest rate hikes next year, whilst there is little doubt that on December 14 the rates will go up 0.5-0.75pc. Meanwhile, Fed fund futures dynamics suggest a 65pc chance of additional hikes before June 2017.
"Their path is going to move up faster and a little sooner," Steve Rick of CUNA Mutual Group said.
According to data from the Commodity Futures Trading Commission, investor sentiment of US debt notes has been increasingly bearish last week, hitting rock bottom recently, which suggests that the continued selloff would put additional upward pressure on natural interest rates.
There is, however, a significant downside to this Trump- and oil-motivated US economic resurgence. With the supply of Treasury bonds projected to increase by the yearend, a massive issuance of new Treasuries in 2017 will be required to finance Trump’s fiscal stimulus. This might might result in a critical decline in the value of the US debt. Subsequently, foreign holders of US debt might dump their stockpiles of Treasuries, pushing benchmark yields and natural US interest rates even higher.
Whether the US Fed will be able to keep up its pace of interest rate hikes amid such potential developments, is unclear. A major risk could be US inflation spiralling out of control, similar to that in 1979-1981, and high Fed funds rates could hurt American borrowers and propel delinquency rates to the sky. A very high level of US household indebtedness is a challenge to Trump’s economic planning – something he’s well aware of.
"It's like the baseball players — they go out and have a good season and they think it is going to happen again," Trump said in September. "That's what we're doing. We're living like we're going to have no interest because rates are so low."
