It may be a trap, but the recent slide in US Treasury yields and the market’s implied inflation forecast could be a blessing that helps unleash a stronger cycle of growth. The critical factor, of course, is the strength of the US economy. So far, so good. The macro trend for the US has improved lately, and there are few signals that suggest that the positive bias is about to deteriorate. The Labor Department’s employment report that’s due out later this morning is widely expected to provide a new round of data that supports the case for optimism. If so, the US economy appears to be headed for a sweet spot: stronger growth and low/falling interest rates and inflation.
As economic conditions go, that’s about as good as it gets. The combination flies in the face of historical experience, but for the moment it seems that the US economy could be entering a golden era. It’s all subject to change, of course, but based on the numbers in hand it’s fair to say that current conditions look bright. Consider, for instance, how the benchmark 10-year Treasury yield stacks up against the US stock market (S&P 500). Although equities have been volatile lately, the trend is still up, thanks largely to robust data in recent US economic releases. Meantime, the market’s inflation forecast (10-year Treasury yield less its inflation-indexed counterpart) is sliding. Quite a lot of lower yields and inflation expectations is due to offshore macro concerns and tumbling oil prices, but the result is still a net plus for the US… assuming that the American economy can maintain its recent growth rate.
The Federal Reserve may begin to raise interest rates later this year, but the market now seems inclined to expect that the date for the first hike will come later than recently projected. Again, this is due primarily to events outside the US. The 2-year Treasury yield, which is considered highly sensitive to rate expectations, has tumbled from its recent highs lately. Meantime, the 10-year yield continues to wind lower, trading around the 2.0% level in recent sessions—the lowest in nearly two years.
The crucial issue, of course, is economic growth. If upcoming reports bring disappointing news, lower Treasury yields and inflation forecasts will look hazardous rather than helpful. For now, however, the outlook is encouraging, based on the published numbers for the US over the last several months. Recession risk was virtually nil last month, and that’s’ not likely to change for the January profile, which will be analyzed at CapitalSpectator.com later this month.
But there are risks lurking, primarily due to the deflationary winds that seem to be picking up in Europe. The annual pace of consumer inflation for the Eurozone dipped into negative territory in December for the first time in five years. That’s a concern because growth is expected to remain weak at best.
The potential for blowback for the US can’t be dismissed, but so far the troubles in Europe haven’t dented the US trend. That could change in the months ahead, of course. Indeed, the election in Greece later this month (Jan. 25) might be a deeply destabilizing event if the Syriza party wins, which some analysts say may be a prelude to the country leaving the currency union. That may be an unlikely outcome, but no one’s ruling it out at this point, which is to say that there’s quite a lot of uncertainty hanging over Europe at the moment.
But none of this matters for the US, or at least it doesn’t matter a lot… if–if— the US can hold on to the recent improvement in the macro trend.