As the election looms, here are some economic issues to watch.
It wasn’t a huge surprise when the FOMC cut the Fed funds target by 50 basis points to 4.75-5.0 percent in late September. Whether that decision was wise is a different matter (for what little it is worth, I thought that a more cautious 25bp was the way to go: Premature declarations of victory over inflation can be expensive). Nor was it a huge surprise when the yield on the ten-year bond went up in the aftermath of the FOMC’s cut. That’s a normal enough response. Easier money now could mean higher inflation further down the road, and there can also be turbulence as traders adjust their holdings.
But it’s much more of a surprise that, after that first knee-jerk move, ten-year rates have carried on rising, moving up from 3.8 percent at the beginning of the month to 4.2 percent as at the time of writing, a level above their 200-day moving average.
So, what’s going on? As usual in the markets, there are competing explanations. Writing in the Financial Times on October 21, Robert Armstrong pointed to a clutch of data releases (including September’s jobs and retail numbers) suggesting that the economy is in stronger shape than had been thought. Some even suggest that rather than a soft landing, the economy may be headed for a “no landing.” Moreover, as Armstrong points out, it does seem that the decline in inflation seems stalled in the 2.5-3.0 percent range. Increasing speculation that Donald Trump might win in November may also be playing a part. He’s regarded as more likely to pursue an expansionary policy than Kamala Harris, and the possibility that he will usher in higher tariffs remains an unwelcome wild card.
And as always, there are technical factors to consider. Looking at the trading of inflation-protected bonds, it seems that only about a third of the jump in yields on the ten-years can be tied to inflation fears. Armstrong quotes Arif Husain, head of fixed income at T Rowe Price. He expects yields at the long end to return to above 5 percent. As Armstrong explains, “US government deficits are flooding markets with Treasuries at the same time as quantitative tightening removes a big buyer from the market.”
Ah yes, the deficit.
Speaking of which, how’s gold doing? When I wrote about gold in a Capital Letter in April, it was trading at around $2,400/oz. It’s now priced at $2,700. Over the past year, it has risen by some 40 percent. Part of that may reflect geopolitical worries and fiscal concerns, and there has also been steady buying by central banks. Perhaps the latter is just a fairly standard operation to diversify a little away from the dollar, but Pimco’s Mohamed El-Erian thinks that something more significant may be going on: Growing interest “in exploring possible alternatives to the dollar-based payments system that has been at the core of the international architecture for some 80 years.” That, in part may be a response to America’s aggressive recourse to financial sanctions, particularly in the wake of the full-scale Russian invasion of Ukraine, something that has chipped away at the notion of the dollar as the ultimate safe haven. I looked at this issue in early 2022 here and here.
There are a good many reasons why the U.S. should want the dollar to keep that safe-haven status. One of them is that it underpins the international demand for treasuries that keeps interest rates lower than they would otherwise be. Given the size of the debt and the deficit that matters. A lot.