Short Term Treasury Yields Are Now At The Highest Level Since September 2008

By: Kent Engelke | Capitol Securities

A theme of these remarks is to expect the unexpected. At the beginning of 2017, all were expecting the dollar to continue to rally. Instead. the greenback has fallen about 10%, a decline that is occurring in the face of higher than expected interest rates, which in theory should have supported the dollar. As noted several times, two months ago consensus had expected only two increases. Now there is the specter of four.

A simplistic explanation for this weakness is economic growth is strong in the rest of the world. Back in 2014 when the world economy was weaker than that of the US, even the suggestion that the Fed would begin to raise rates triggered a big rise in the dollar.

Yesterday, the Treasury Department held its six-month bill auction. The yield was the highest since September 2008. The two year — or the instrument most sensitive to monetary policy — also rose to the highest level since 2008.

The declining dollar will have big effects on the economy. The recent spending deal, together with tax cuts already passed will provide a boost to domestic demand and import growth in the near term. Ultimately, the depreciation of the dollar suggests that export grow will accelerate, thus suggesting the big drag on economic growth from net trade in the fourth quarter of last year will not be sustained in 2018.

It is generally accepted the declining dollar will add about 0.5% to the CPI, a combination of higher import prices and greater growth.


Speaking of higher interest rates, the S & P 500 earnings yield relative to the 10-year Treasury yields is now at an 8-year low. Traditionally, if the 10-year yields more than the earnings yield, equities will experience volatility. Will the volatility be heightened?

It is now the consensus view that technology via algorithmic trading is dictating market direction. The vast majority of trading decisions are not made upon any macroeconomic or geopolitical analysis, but rather momentum and moving average lines. In my view, the markets are totally void of rational thought. The environment will change, reverting back to rationality, but the catalyst is perhaps the one not yet discussed, occurring when least expected.

Speaking of possible over reaction, yesterday Wal-Mart fell over 10% and the most since 1988 as its earnings fell short of expectations, the result of lower than expected growth in its e-commerce division.

Today the Minutes from the January Fed meeting will be posted. How will such be interpreted?

Last night the foreign markets were mixed. London was up 0.04%, Paris was down 0.32% and Frankfurt was down 0.69%. China was closed for a holiday, Japan was up 0.21% and Hang Sang was up 1.81%.

The Dow should open flat ahead of the Fed Minutes. The 10-year is unchanged at a 2.89% yield.

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