There have only been 16 occasions during the past half century when interest rates rose more than 20 percent over 200 days. On a percentage basis, the recent rise in rates has been the most violent on record and we are continuing to see evidence of the negative effects of this in the real economy. In particular, lower activity in the housing market and the reduction in residential construction have caused a drop in disposable income.
Aggregate income growth has slowed over the past four months, and the resulting downturn in consumption caused a poorer-than-expected back to school season for nearly all major retailers. On top of that, the September 6 employment report, which saw only 169,000 new jobs created and included significant downward revisions for the previous two months, was in all shapes and forms a disappointment. This will create further problems for generating the type of wages and household income necessary to support consumption.
The signals in the real economy suggest that yields may already be somewhat stretched, yet the current upward move in rates does not appear to be over. Primarily, this is because investors are focusing on the outlook for quantitative easing. My previously stated target of about 3.5 percent for the 10-year note still appears accurate. Equities also look stretched at current levels, and divergences are exacerbating, meaning we could be facing a pull-back. The situation in the stock market right now brings to mind the words of Baron Rothschild who said the secret to his great wealth was that he sold early.
Real 10-Year Treasury Yield vs. Consumer Confidence
Historically, the real yield for 10-year Treasuries has tracked closely with the University of Michigan Consumer Sentiment Index. However, the correlation has broken down in 4Q2011 due to the Federal Reserve's effort to lower long-term interest rates. As the Federal Reserve is set to slowly reduce the pace of its asset purchases, the gap between 10-year Treasury yield and consumer confidence has begun to converge. Today, economic conditions as measured by consumer confidence would suggest that the 10-year real yield should be around 50 basis points higher if monetary policy were to normalize.
UNIVERSITY OF MICHIGAN CONSUMER CONFIDENCE VS. REAL 10-YEAR TREASURY YIELD
Source: Bloomberg, Haver Analytics, Guggenheim Investments. Data as of 9/11/2013.
Economic Data Releases
U.S. Payrolls Disappoint as the Unemployment Rate Shrinks on Falling Labor Force
- Non-farm payrolls rose a less-than-expected 169,000 in August. The prior two months were revised down by a total of 74,000.
- The unemployment rate inched down to 7.3% due to a declining labor force.
- Average hourly earnings rose 0.2% after a flat July, and the average weekly hours ticked up to 34.5 from 34.4.
- Initial jobless claims decreased for a second consecutive week for the week ended August 31, down to 323,000.
- Job openings in July fell to the lowest level in six months.
- The ISM non-manufacturing index jumped to 58.6 in August, the highest level since December 2005.
- The NFIB index of small business optimism in the U.S. ticked down to 94.0 in August from 94.1. However, the hiring plans component grew to the highest level since January 2007.
- The MBA mortgage application index plunged 13.5% from a week earlier in the week ended September 6, the largest one week drop since October 2011 and reaching a five-year low.
- U.S. factory orders dropped 2.4% in July after rising the previous three months.
German Data Weaker, China Rebound Continues
- Industrial production in Germany decreased 1.7% in July, the worst month since April 2012.
- German exports unexpectedly fell in July, down 1.1%.
- Industrial production in France fell for a third straight month in July, forecasts had seen an increase.
- U.K. jobless claims decreased by 32,600 in August, falling for a 10th straight month.
- China's exports rose for a second straight month in August, up 7.2%. Gains were led by exports to Southeast Asia, with shipments to the U.S. and Europe also up.
- Chinese industrial production accelerated to 10.4% year-over-year growth in August, the highest amount since March 2012.
- Japanese second quarter GDP was revised up to 3.8% annualized growth from 2.6%. The substantial revision increases the likelihood that the planned sales tax increase will go ahead as planned.
- Japan's Economy Watchers Survey declined for a fifth straight month in August to 51.2.
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