Lacy Hunt and Van Hoisington write,
Presently the inflation picture is most favorable to bond yields. The year-over-year change in the core personal consumption expenditures deflator, an indicator to which the Fed pays close attention, stands at a record low for the entire five plus decades of the series
True.
Over the past year, the Treasury bond yield rose as the nominal growth in GDP slowed. The difference between the Treasury bond yield and the nominal GDP growth rate (Chart 4) is important in two respects. First, when the bond yield rises more rapidly than the GDP growth rate, monetary conditions are a restraint on economic growth. This condition occurred prior to all the recessions since the 1950s, as indicated in the chart. This condition also signaled the growth recessions in 1962 and 1966-67. Second, the nominal GDP growth rate represents the yield on the total economy
True.
But then I downloaded from the Fred database the 10-year Treasury rate and the level of nominal GDP. I took the three-year average of nominal GDP growth rate, and I subtracted it from the 10-year rate, to get a rough measure of the differential between the 10-year rate and the growth rate of nominal GDP. From 1963 to present, this differential averages -.18. A super-simplistic model is that the nominal interest rate should revert to this average differential. So, if nominal GDP growth is 6.25 percent and the average differential applies, the nominal interest rate should be 6.07 percent.
For the latest three years, ending in Q1 of this year, nominal GDP growth has averaged 3.85 percent. Using the super-simplistic model of the nominal rate, it should now be 3.67 percent. In fact, it is now 2.52 percent.
Hunt and Hoisington are betting that the nominal interest rate is going to fall, but when I look at the same GDP data they do, I think it ought to be higher than it is now.
Perhaps a series of discontinuities has occurred in the factors which supported those correlations.
I used to be a stocks guy, but no more after the past 10 years. A lot of stress, crazy ups and downs, and only the brokers get rich. Heck, even IPOs aren’t a safe bet anymore.
I’d go for bonds now. Not AAA bonds, but those of second-tier creditors like France or Austria. They won’t go bankrupt and you get a bit more than on a bank account. But the main benefit is that I won’t spend the money on useless things while it’s tied up.
Arnold:
A couple of problems with your (and the Hunt/Hoisington) model setup … alluded to (I think) by R. Richard Schweitzer, above:
1.) Between 1963 and now, U.S. GDP (nominal or real) slipped from about 70% of global GDP to its current approximate 20% contribution to global GDP. The share of U.S. GDP contribution to global GDP is declining, and will continue to decline. And will continue to decline as long as there are some 3 Billion or more other (outside the U.S. jurisdiction) people on this planet who have both the will and the means to improve their standard of living.
2.) U.S. Treasury debt is, and always has been, a globally accessed and traded debt-investment asset. Just now, something around $5 Trillion in U.S. Treasury debt is held by foreign entities – approximately $1 Trillion each by Japan and China alone.
3.) The U.S. dollar has become the global preferred reserve currency AND the preferred global trade currency, with the Euro as a second-place runner-up. To my knowledge, this is the first and only time in human history that a fiat currency (or currencies) have achieved that status.
Given these three observations, I would suggest using global GDP data, rather than U.S. (alone) GDP data to improve your model – with some very significant adjustment for the declining contribution of U.S. economy to that global GDP data. And inasmuch as inflation is the most significant influencing factor on the merits of a debt instrument investment, you might also want to factor that in as well – global inflation expectations, not local (U.S.) inflation, that is.
The price (conversely, interest return rate) of any U.S. dollar denominated debt instrument is going to be set by global bidders, based on their perceptions of global and local risks, and global and local inflation expectations, relative to the expected risk adjusted returns of other global asset classes.