Wall Street's Best Minds

Why Economy and Rates Aren’t Down for the Count

Greg Valliere argues that an improving economy and rebooted tax reform will push up Treasury yields.

By Greg Valliere


Something odd happened on the way to a 3% yield on the Treasury 10-year bond. After surging to about 2.6% a few weeks ago, yields have plunged, and now are below 2.2%. We fully agree that you don’t fight the tape, but this move looks like a fake-out; the three major reasons why interest rates have dropped seem transitory.

1. The economy is soft? Not really. For the fourth successive year, first-quarter GDP growth will be tepid, no better than 1% -- something clearly is wrong with the seasonal adjustments. Will slow growth persist into the second quarter? Maybe, but we’d bet on GDP growth of roughly 2% for the rest of 2017 -- a slight disappointment, but there’s still no recession in sight, not with unemployment at 4.5%.

Editor’s Note: It’s important to note that Barron’s Associate Editor Randall Forsyth doesn’t share Greg Valliere’s optimism about the economy and the pace of Trump’s agenda. In his latest column, he writes that interest rates will remain low.

The bigger economic story is that this soft patch has not significantly changed attitudes at the Federal Reserve, where officials are committed to gradually raising rates and reducing the Fed’s balance sheet. With inflation close to the Fed’s target and the labor market in very good shape, we still expect two second-half rate hikes -- but the Treasury market seemingly is dismissing that likelihood.

2. Geopolitical tensions? They may subside: Kim Jong Un may be unstable but he’s not stupid; he is not prepared to endure 21,000 pound U.S. bombs. So this crisis may subside a bit. The next crisis -- French elections this Sunday -- could intensify fears over a breakup of the European Union, but even if one of the two Euro-skeptics make it to the runoff on May 7, they do not have enough support in the French parliament to pull out of the EU. In any event, we think Emmanuel Macron, a moderate, is likely to prevail in the end.

3. Trump is imploding? We don’t see it: As we suspected, last night’s Georgia House results failed to produce a 50% total for a young Democrat insurgent, who now faces a more difficult runoff in June. So -- two special House elections this spring, and two failures by the Democrats. We don’t see an anti-Trump wave developing, although Democrats clearly are angry and well-funded. (Of course, their biggest draw, Bernie Sanders, proclaimed yesterday that he isn’t a Democrat.)

As for Trump’s agenda hitting a wall, there’s no doubt that it will take longer to enact than he -- or the markets -- anticipated. But his agenda is not dead; hearings begin next week in the House on a tax reform package. As long as tax cuts still look likely -- even if it takes another year -- the markets will be patient.

BOTTOM LINE: By early summer, economic growth will be well above the lame first-quarter pace. The labor market will be tight, with wages moving higher. The threat of geopolitical crises may have subsided. President Trump, still controversial, will continue to benefit from a weak opposition. And the long slog toward tax reform will be underway.

Is this a prescription for rock-bottom interest rates? We don’t think so.

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