Despite a heavy schedule for Treasury auctions, real yields have fallen over the past week or so. Indeed, the ten-year yield has dropped 13 bps since March 21, with real yields down 11 bps. Higher supply should mean higher real yields, but it is easy to forget: the decline in real yields since the crisis of 2007/08 was not simply a response to QE. The big rise in IT investment has cemented a shift in the balance of power away from labour to capital, which began in the early 1980s. After the sub-prime crisis, regulators reined in banks and brought an end to the loose lending policies that had characterised business cycles over four decades or so. Deregulation had also contributed to the rise in real borrowing costs during the 1980s, which, from a longer perspective, were an anomaly.
The two trends were mutually reinforcing: slower lending growth led to lower interest rates and brought down the break-even rate for long term investment. Spending on intellectual property products rose to record levels (as a share of GDP). The productivity data have not reflected this shift in full, partly (it could be argued) due to measurement issues. However, the cost savings tend to come through more quickly in an economic downturn. That is why the FOMC will struggle to realise their interest rate forecasts (2.9% Q4 2019 and 3.4% 2020). Indeed, trying to hit these targets for the Fed funds rate will trigger a deeper stock market correction and a much bigger reversal in corporate bonds.
Summary
- Attack on Amazon should not matter
- Economy still strong, as claims tumble
- But higher rates will hurt equities
