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By HaleStewart January 14, 2018 7:45 am
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US Bond Market Week in Review: Bond Market Potpourri

            Rather than have a longer, common theme to this week’s column, I have several smaller stories.  Hence, “Bond Market, Potpourri.”

The Big Sell-off in the 10-Year

            Several news stories attributed diverse causes to the sell-off.  The FT noted that low bond market volatility should concern investors, while another FT story reported that, based on technical readings, several prominent bond market commentators proclaimed the “bond bear market” had started.  There were also reports about declining Chinese and Japanese purchases lowering global demand for treasuries.  Whatever the reason, rates are clearly heading higher.

But even so, yields are hardly restrictive.  The 10-year yield closed the week at 2.54 hardly a restrictive level.  And with the natural and actual rate of inflation still low, it’s difficult to see a massive spike in yields.


The Market is Very Liquid Right Now

CCC yields (top chart) are nearing 10%, some of the lowest levels in a year, while the AAA/treasury and Baa/treasury spreads (second and third from topo) are at 5- year lows.  Financial stress (as measured by St. Louis and Kansas City Financial Stress Indexes) are very low.  In other words, the corporate market is very liquid right now. 


The Amazon Effect May Be Real


Several Fed governors have argued that technological factors are keeping prices low.  A new paper supports that view:

Using data collected through Adobe Analytics, which tracks online prices and quantities, University of Chicago economist Austan Goolsbee and Stanford’s Pete Klenow find that online inflation averaged about 100 basis points lower than inflation in the CPI for the same categories between 2014 and 2017. What’s more, there was a huge variety of products sold online – goods were introduced and removed rapidly – and factoring that in implies shaving off another 90 to 150 basis points from online inflation versus the matched CPI indices. This research is in its early stages, but it could be  a big deal, because it quantifies that internet commerce could be weighing on goods prices and making them harder to measure.


Phillip’s Curve Comes Under Renewed Attack


The Fed continues to assume that low unemployment will eventually lead to higher wages and, finally, inflation.  This is the fundamental relationship contained in the Phillip’s Curve, which remains a central tenant of Federal Reserve modeling.  Recent research has shown the curve is flattening.  Now additional economists are arguing against the curve’s efficacy as a policy tool:

At the Jan. 5-7 annual meeting of the American Economic Association in Philadelphia, economists questioned the usefulness of a cornerstone concept in mainstream economics that links changes in inflation to fluctuations in joblessness.

“The Phillips Curve is a terrible idea,’’ said Robert Hall, a professor at Stanford University in California who also heads the recession-dating committee of the National Bureau of Economic Research.

Skepticism about the Phillips Curve is significant because the Fed and other major central banks are counting on declines in unemployment to foster faster wage increases and lift inflation that they deem to be too low. Indeed, it’s the major rationale behind the U.S. central bank’s plan to keep raising interest rates. If the curve is broken, it’s unclear what lodestar monetary policy makers would adopt to help guide inflation back up to target.



Fed President Williams

Finally, Fed President Williams argued that the Fed should keep rates lower longer in order to spur inflation.  This would provide a natural modest boost to the economy:

The U.S. Federal Reserve could better fight a recession by committing to keep interest rates lower for longer to keep average inflation on a steady upward path over the years, San Francisco Fed President John Williams said on Monday.

“It basically promises extra stimulus,” said Williams, whose comments come as U.S. central bankers have appeared increasingly open to debating changes in how they target economic stability.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 





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