September 11, 2013 | By Scott Minerd, Global CIO
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.
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.
Source: Bloomberg, Haver Analytics, Guggenheim Investments. Data as of 9/11/2013.
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