The bond market is telling Federal Reserve Chair Janet Yellen that future growth and inflation isn't going to match her calculations.
The question may be whether she hears the message, according to Joseph Calhoun, founder of Alhambra Investment Partners.
In a
commentary on the company website, Calhoun noted that the yield on the 10-year Treasury note has slumped about 0.70 percent since the beginning of 2014 even though the Fed keeps signaling higher rates are coming.
“Now most people, seeing a market not reacting as they expect, might consider the possibility that something was wrong with their strategy. But not the Fed. If markets aren’t reacting the way they think they should, it must be a problem with the markets, not their policies,” Calhoun wrote.
“Let me clear this up for the Fed. There is no conundrum. The bond market is providing solid information about future growth and inflation just as it usually does and Ms. Yellen would be wise to heed the warning that it is sounding loud and clear. It is saying that future growth and/or inflation are not going to measure up to her or the market’s expectations.”
Calhoun conceded that markets are not always right, and that bond traders could simply be acting irrationally in keeping yields down so low while the threat of higher rates looms.
In fact, the bond market is predicting 10 year forward annual real GDP growth of just 0.5 percent and inflation during that time of just 1.85 percent – which might be unlikely.
But Calhoun suggested the bond market may be concluding that the Fed’s hands are tied.
“From my perspective, the reaction of the bond market to potentially higher interest rates from the Fed is pretty clear; given its debt load, the global economy can’t handle higher rates from the Fed.”
He noted commodities are also very weak, which also suggest very weak economic growth ahead.
“Sentiment toward commodities, particularly gold, is the polar opposite of stocks, about as bearish as I can remember. And, of course, everyone is bullish and long the dollar.”
What does the current economic environment mean for investors?
“Well, I’ve been pondering that for weeks and if one assumes the extremes in sentiment will be reversed – as they always are – then a couple of scenarios emerge. Either U.S. growth expectations will fall or the rest of the world growth expectations will rise but the gap between the two seems likely to converge.”
Reuters reported mixed signals from U.S. economic data may be confusing the Fed.
A tool the Fed uses called the Taylor Rule as one of its inputs for setting interest rates has apparently gone awry recently.
While the Fed has signaled its intent to raise rates in coming months, the Taylor Rule has suggested something otherwise, according to a research paper from the San Francisco Fed.
“Using the gap between the economy's potential rate of growth and its actual growth, the Taylor rule currently suggests a policy rate that's about a half of a percentage point below zero, the paper shows,” Reuters reported.
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