Kamis, 08 Agustus 2013

Claims keep declining

First-time claims for unemployment came in as expected, but the more important news is that they continue to trend lower.

This chart shows the long-term trend of claims (using their 4-week moving average) and the 52-week moving average of that. Clearly, the trend remains down. There is no sign at all of any deterioration in the labor market as of last week. There is thus no reason to think that the economy can't continue to grow by at least 2%.

As the above chart of 10-yr Treasury yields shows, rates have moved sharply higher in the last few months, and are significantly higher than they were at last summer's low. This, despite valiant efforts by the Fed to purchase Treasuries and MBS. It's worth repeating that this is not really a paradox, since it merely goes to show that the Fed has very little power to artificially depress interest rates. Fed purchases may seem large, but they are very small in relation to the outstanding stock of bonds, all of which are priced off Treasuries. The market sets bond yields. The market has taken interest rates higher because the market has more confidence in the economy's ability to grow. Thus, QE makes less sense, and the tapering of QE seems reasonable. The bond market is even looking ahead to the day when the Fed not only stops buying bonds but begins to raise the interest rate it pays on reserves.

According to Fed funds and Eurodollar futures contracts, the market doesn't expect the Fed to raise rates meaningfully for the next two years (June Fed funds futures currently reflect a tightening of only 25 bps, to 0.5%). According to the market's current thinking, therefore, the tapering of QE may take many months, and the beginnings of a modest tightening could be two years in the making. This is hardly a scary picture. Indeed, if the economy continues with present trends it's difficult for me to see the Fed waiting as much as two years before beginning to adjust rates higher.

The market is getting used to the idea that interest rates are going to move higher, and it's all due to the market's new-found realization that the economy is on more sustainable growth path, even though that growth is very slow compared to what it could be. The more evidence—such as declining claims—we see that the economy is avoiding a recession, the more reason there is for interest rates to move higher. That's not a threat to growth, it's a validation of growth, however modest.

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