Here is part two of NWIC’s Economic Breakfast featuring Dr. Bill Conerly.
For those who missed Dr. Bill Conerly’s presentation on the local and national economy, or those who want to see it again, please click on the video to hear excerpts from part one of his enlightening talk.
As a general rule, it can be risky trying to predict the direction of interest rates. However, as investment professionals we are constantly considering different scenarios for where rates (the 10-yr Treasury in particular) may head and the economic and political factors behind those potential movements. Below we lay out some thoughts on the direction of rates, and our approach to dealing with such scenarios.
Rates on the short end of the curve remain largely tied to Fed policy and the long bond (30-yr) may be the better indicator of long-term economic sentiment. However, I’ve found that the bonds we most often buy, whether on the short end of the curve, or slightly longer, tend to respond most actively to the 10-yr Treasury rate. As was mentioned most recently in the quarterly outlook, the 10-yr Treasury has bounced around since the end of January in a tight 20 basis point range (a basis point is one-hundredth of one percentage point, or 0.01%). That range has been between 2.60%-2.80% with small breaches on either end. Going into 2014, many investors and economists alike predicted that rates would build on last year’s sell-off (a sell-off in the bond market causes rates to rise) and climb from the 3% level where the 10-yr started the year to higher and higher rates. The idea was that we were far enough along in the economic recovery, that higher inflation was close enough on the horizon, and that Fed policy would tighten enough to support upward rate momentum. Alas, this has not been the case. A frigid winter and tension in Ukraine, among other factors, have kept a lid on interest rates, and have helped bonds to a positive return in the first part of the year.
Most recently, investors have looked to the jobs report for any signs of economic strength most likely to impact rates. In the latest report employers added a net 288,000 jobs and the unemployment rate fell by almost half a percent. What these sanguine numbers didn’t immediately indicate was that approximately 800,000 discouraged Americans stopped looking for work, dropping the labor force participation rate to 62.8%. It would seem that the lower unemployment rate was a reflection of workers leaving, not job gains.
Our current thoughts on interest rates pertain to upcoming jobs reports and other economic news releases, such as the consumer price index (CPI) and producer price index (PPI). Stated most simply, much of the lackluster economic performance year to date has been blamed on the weather. If positive indicators prevail in the next few months, the consensus on the weather’s economic impact will be validated, and interest rates should resume their upward journey. If, on the other hand, mixed to poor labor market news, and the like, continues into the second quarter, investors and economists might reassign the blame from weather to broader economic weakness. Should this happen, look for the yield on the 10-yr Treasury to head back down towards 2%.
Because we don’t base the bulk of our bond purchases on perceived interest rate movements, we will continue to find relative and absolute bargains in the bond market. Individual issues, companies, and odd-lot bond tranches will retain value and offer deals when the proper homework is done. However, we will wait patiently to see if the market can offer investors a break in the form of higher bond yields.
There are still a few seats remaining for our annual Economic Breakfast with Dr. Bill Conerly. RSVP today so you don’t miss out on Dr. Conerly’s views on the local and national economies. Please note that this event will be held at 5300 Meadows Rd and not at our offices. See link for map: