What the bond market is telling us

[EconProf]

Allow this often-wrong forecaster to venture an opinion of where inflation, interest rates, and investment real estate are headed.
Last Fall, I and most every other economist predicted interest rates, then around three percent for ten-year bonds, were clearly headed up. I refinanced two properties and convinced my brother to refi his house. Since then rates have fallen, recently hitting 2.4%. My brother is not too happy with me. Also unhappy are the mulltitudes of “experts” and investors who placed bets on rising interest rates and mortgage rates.
What happened? I believe that markets are abandoning the idea that inflation is coming and are willing to accept the low rate of returns offered by bonds, as well as other assets. Historically, inflation only occurs during prosperity (demand-pull inflation), or when costs of production rise rapidly (cost-push inflation). Now, neither is happening, nor is likely to happen. The so-called economic recovery still limps along at under 2% per year, while The usual rate during recoveries since WW2 is about 4%. Five years of 4% growth instead of 2% would mean a GDP about 11% higher and 15 million more people at work.
Investors tend to buy an asset when their expected rate of return (cash flow plus any appreciation) exceeds the cost of borrowing. They are now rapidly changing their expectations of what the future holds.
Notice what investments have done particularly well recently:
Stocks, especially dividend-paying stocks. Stocks were up 30% last year.
Bonds
Farm land
Investment real estate, as reflected by falling cap rates
In short, anything that has assured cash flow, even low cash flow, that one borrows for in order to buy, has done well.
Accordingly, the broader real estate market will be propped up by these trends. Investors will accept a low cash flow when they buy houses to rent out, apartments, commercial real estate, etc. These lower cap rates mean higher asset values now and well into the future.
I have made colossal forecasting and investment mistakes in the past. Fortunately the right calls have outweighed the wrong ones and I am ahead overall. But in facing recent trends, it is now time to change forecasts.
The much-maligned Lord Keynes was once criticized in a debate for changing his mind. He said, paraphrased, “When I get new information, I change my mind. What, Sir, do you do?”
OK Piggs, I’ve stuck my neck out. What is your forecast for interest rates, investment real estate, and inflation?

[livinincali]

The bond market is currently telling you the economy is headed for recession or extremely weak growth. The stock market is telling you things are going to get better. One of them is wrong and history says it’s probably the stock market that is wrong.

Personally I think interest rates are going to remain low for some time but I don’t know that we get back to sub 3.5 on a 30 year fixed mortgage. I suppose we could get the ugly situation where everything sells off when the next bubble pops rather than having a good hiding spot. I.e. the great deleveraging that hasn’t happened yet. If it does than none of the assets priced with leverage are going to be good and the only safe spot will be cash. Interest rates will rise while deflation is present. The fed will do everything it can to prevent that from happening but I’m not sure it has the power to do so.

[joec]

I’ve said before that I don’t think interest rates are going up anytime soon…still…

I’d say we won’t see noticeably rate increases for 10 more years+ or longer…

Noticeably as in anything over 5% on the 30 year fixed rate…

One thing you left out that is all over the press now is European country rates for a lot of economies are BELOW the US rate. France is at 1.75% I just saw and a lot of others are at ~2% or so. So France is in better shape than the US with 50% youth unemployment? Uhh, yeah, US can fall further even and there is huge fears in Europe of deflation. They are thinking of having a negative rate in EU soon.

In the end, I think we are headed to be like Japan and rates are going to be low for a long time.

Deflation will be very scary if it comes here. Especially since I got shit loads of debt.

[moneymaker]

Companies have laid off, paid dividends to prop up stock price, and yet are still struggling with earnings. I think we are entering the shape up/down phase where the strong survive and the weak go bankrupt. Mergers coming along with people willing to accept less pay and cutting their budgets more. The rich get richer and the poor get poorer while the government does nothing to balance things out. Labor was 25% of the bill for me to get solar, I think 10-20% would be healthier for our economy.

[EconProf]

[quote=joec]I’ve said before that I don’t think interest rates are going up anytime soon…still…

I’d say we won’t see noticeably rate increases for 10 more years+ or longer…

Noticeably as in anything over 5% on the 30 year fixed rate…

One thing you left out that is all over the press now is European country rates for a lot of economies are BELOW the US rate. France is at 1.75% I just saw and a lot of others are at ~2% or so. So France is in better shape than the US with 50% youth unemployment? Uhh, yeah, US can fall further even and there is huge fears in Europe of deflation. They are thinking of having a negative rate in EU soon.

In the end, I think we are headed to be like Japan and rates are going to be low for a long time.

Deflation will be very scary if it comes here. Especially since I got shit loads of debt.[/quote]
Bond interest rates are actually prices (the price for borrowing money), and are set by supply and demand. Low or falling interest rates imply low future expectations of inflation. A weak future economy means low interest rates. That is why european interest rates, even lower than ours, reflects their slower-than-US economic growth rate. And Japan, which hasn’t seen growth in over two decades, has near-zero interest rates. Both Japan and europe are now terrified of the possibility of deflation.
It all boils down to growth. For five years economists, and politicians, have said real growth would return, and thus inflation, and thus higher interest rates. We are now giving up on that scenario.

[XBoxBoy]

[quote=EconProf]For five years economists, and politicians, have said real growth would return, and thus inflation, and thus higher interest rates. We are now giving up on that scenario.[/quote]

What about the fed? Do you see signs that they are giving up on this too? From what I’m hearing the fed is still very much on track with their belief that growth will pick up, QE will be stopped and after a while interest rates will be raised. Are you saying you think the fed is also giving up on this scenario? If so, can you cite some evidence to confirm this?

[FlyerInHi]

What about deficit spending and money printing. Will they not cause hyperinflation as some have predicted?

[Jazzman]

[quote=XBoxBoy][quote=EconProf]For five years economists, and politicians, have said real growth would return, and thus inflation, and thus higher interest rates. We are now giving up on that scenario.[/quote]

What about the fed? Do you see signs that they are giving up on this too? From what I’m hearing the fed is still very much on track with their belief that growth will pick up, QE will be stopped and after a while interest rates will be raised. Are you saying you think the fed is also giving up on this scenario? If so, can you cite some evidence to confirm this?[/quote]
The real question is are drugs and prostitution being added to growth figures?

[SK in CV]

[quote=moneymaker]Companies have laid off, paid dividends to prop up stock price, and yet are still struggling with earnings. [/quote]

For the most part, well run companies don’t have a lot of excess employees. So layoffs aren’t to increase profits, they’re done in anticipation of lower demand. (some companies over-do it, in order to increase profits, and often end up paying the price as Walmart has over the last couple years.)

But more importantly, enterprise companies aren’t struggling so much with earnings. Growth hasn’t been booming, but S&P 500 reported earnings are up almost 6-fold from 2008, up almost 100% since 2009, and are up 23% since 2010. It hasn’t been smooth sailing every quarter, but reported earnings for the 4 months this year has shown an increase over Dec ’13 of over 2.5%. On an annual basis, it would be more than an 8% increase in profits.

There are areas that are still struggling, but overall, corporate profits don’t paint a picture of a struggling economy.

[EconProf]

[quote=XBoxBoy][quote=EconProf]For five years economists, and politicians, have said real growth would return, and thus inflation, and thus higher interest rates. We are now giving up on that scenario.[/quote]

What about the fed? Do you see signs that they are giving up on this too? From what I’m hearing the fed is still very much on track with their belief that growth will pick up, QE will be stopped and after a while interest rates will be raised. Are you saying you think the fed is also giving up on this scenario? If so, can you cite some evidence to confirm this?[/quote]
The Fed has been consistently wrong in their too-optimistic forecasts. They remain perplexed that true economic growth has not yet taken hold.
But they are not relenting much on their monetary stimulus (QE1, QE2, QE3), and have recently promised low interest rates for a long time.

[EconProf]

[quote=FlyerInHi]What about deficit spending and money printing. Will they not cause hyperinflation as some have predicted?[/quote]
So far, no, to the surprise of all of us.

[EconProf]

[quote=SK in CV][quote=moneymaker]Companies have laid off, paid dividends to prop up stock price, and yet are still struggling with earnings. [/quote]

For the most part, well run companies don’t have a lot of excess employees. So layoffs aren’t to increase profits, they’re done in anticipation of lower demand. (some companies over-do it, in order to increase profits, and often end up paying the price as Walmart has over the last couple years.)

But more importantly, enterprise companies aren’t struggling so much with earnings. Growth hasn’t been booming, but S&P 500 reported earnings are up almost 6-fold from 2008, up almost 100% since 2009, and are up 23% since 2010. It hasn’t been smooth sailing every quarter, but reported earnings for the 4 months this year has shown an increase over Dec ’13 of over 2.5%. On an annual basis, it would be more than an 8% increase in profits.

There are areas that are still struggling, but overall, corporate profits don’t paint a picture of a struggling economy.[/quote]
You are correct, SK. Companies have boosted profits during this recession by eonomizing on labor wherever possible. That is one reason stocks have more than doubled since their low point during the recession, and why the stock market has done so well.
Companies know they can be stingy on wage hikes and hiring because of the weak recovery. They are acting rationally. If we had had 4%/year normal growth rates in the roughly five years since the bottom of this recession instead of 2%/year growth rates, workers (employed and unemployed) would now be faring much better. Economic growth is the worker’s best friend.

[SK in CV]

[quote=EconProf][quote=FlyerInHi]What about deficit spending and money printing. Will they not cause hyperinflation as some have predicted?[/quote]
So far, no, to the surprise of all of us.[/quote]

Not quite “all of us”. There have been predictions of hyperinflation for decades. Ron Paul, in pushing for a return to the gold standard, said this:

I believe such a standard to be not only desirable and feasible, but absolutely necessary if we aim to avoid the very real possibility of hyperinflation in the near future, and economic collapse.

He said that more than 34 years ago. And has repeated it often since then. So far, he’s been wrong every time.

There are many economists that were pushing for an even larger stimulus without fear of higher than target inflation. Inflation doesn’t happen until demand exceeds supply. We haven’t seen that, and it hasn’t been anywhere on the horizon for the last 7 years. While Keynes wouldn’t have been enthusiastic about recent monetary policy, he did accurately predict that it wouldn’t lead to hyperinflation, absent excess demand.

Undoubtedly there will be inflation sometime in the future. But not any time soon. And there are a whole lot of economists that have been saying that for the last 7 years.

[SD Realtor]

Literally the “can” can be kicked down the road longer then anyone ever thought.

[joec]

The problem with the profits growth story is for a lot of companies, this is due to cutting costs and mergers and acquisition and stock buy backs. If you look at a lot of large corporations, there hasn’t been any revenue growth at all during these past 5 years and it has almost all/bulk to do with stock buy backs, cost cuts, etc…(IBM comes to mind).

I don’t have the report or links, but it’s pretty easy to find I believe and reported often.

I suppose a lot of this is also a gut feeling and intuition from watching bloomberg all day every day for the past few years and just following news in general (and here, even though the demographics here tend to be middle/upper income).

I think some people will continue to do very well also and the wage/income/asset gap will worsen, but since Japan happened and we’re sorta doing the same thing, I just think it’s human nature to do the same thing as them and it’ll be a long long time before rates go up (all IMO).

Also, I think the fed is pulling back on the housing QE because they have been quoted (I believe) as saying that it wasn’t really helping the overall labor market or economy so it wasn’t working overall…so why bother? Interest rates are technically still 0% so until that moves up, nothing to see here.

A bigger boost IMO would be, say just refinance everyone who hasn’t yet for free to a lower rate with no credit check if they are already current on their mortgage. I know it’s impossible, but it’d help me (I’m selfish) and that’d free up money (self employed)…

Oh well, will revisit this area in 10 years to see where rates are still. 🙂

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