Spark Global Limited reports:
The recent surge of COVID-19 infections in the United States caused by the Delta mutant strain continues, as well as the weakening of durable goods orders, manufacturing PMI and other indicators in the United States, intensifying market fears about the us economic downturn.
Despite the improvement in the U.S. labor market in June and expectations that the Federal Reserve may taper in September, U.S. Treasury yields have continued to fall in a divergence with persistently high inflation.
However, we believe that the future US Treasury yield, especially the long-end US Treasury yield, will continue to decline limited space, and will not hit new lows due to the slowdown of the US economic recovery momentum, mainly because the US inflation is high, the long-end US Treasury yield has rarely been lower than the US CPI year-on-year growth rate.
Why the recent decline in Treasury yields?
(1) Economic indicators suggest a weaker outlook for the US economy, and the direction of long-end Treasury yields depends on the fundamentals of economic growth. In the manufacturing sector, US durable goods orders for June were significantly weaker than expected, coming in at 0.8%, compared with 2.2% expected and 2.3% last. In addition, in terms of inventories, the manufacturing sector has largely completed restocking, with the auto sector in particular recording its highest year-on-year growth rate in several years. Data showed us manufacturing inventories rose to 6.5 per cent year-on-year in May, the highest since February 2018. On the housing front, weak demand amid high inflation has pushed new home sales down 6.6% month-on-month, the lowest level since April 2020, in a sign that the red-hot housing market may be cooling, despite new home prices hitting record highs.
(2) The spread of the Delta strain could derail the U.S. economic recovery. On July 30, according to Johns Hopkins University, there were nearly 200,000 new cases nationwide, the highest number since the winter peak in January. The seven-day rolling average of new confirmed cases exceeded 100,000, the highest level since February 7.
Some US states and cities with high transmission rates, such as San Francisco, reimposed mask orders on Monday. Some high-traffic locations, such as Wal-mart, have also reinstated masks. Even fully vaccinated people need to wear masks.
(3) Both investment and consumption in the United States are at risk of decelerating as a result of high inflation and raw material shortages. From the perspective of consumption, in the second quarter of 2021, the us personal consumption support annualized rate reached 11.8%, which maintained a good growth rate from 11.4% in the first quarter. However, it is facing the constraints of high inflation and the expiration of fiscal subsidies, which may slow down in the third quarter.
With the expiration of U.S. fiscal subsidies, the growth rate of U.S. personal disposable income continues to decline to -8.7% in the second quarter of 2021. Historically, personal disposable income growth has outpaced personal consumption spending growth by one quarter. The year-over-year growth rate of personal disposable income in the first quarter has already turned a corner.
In terms of investment, we don’t think the US will have a strong capital expansion cycle. Historically, the prerequisite for accelerating capital spending in the US is sufficient corporate capital (faster M1 growth), triggered by insufficient capacity, high profits and increased leverage by households.
Us manufacturers, wholesalers and retailers have continued to experience negative inventory growth during the pandemic, resulting in a shortage of supply, but not capacity.
Recalling that between the outbreak of the epidemic last year and the second quarter of 2021, the US fiscal subsidies and extremely low interest rate environment led to a housing boom and a sharp rebound in personal consumption expenditure. The concentrated release of private and public sector demand led to a sharp rise in the US manufacturing capacity utilization rate from its low point to a 1-1/2 year high of 75.38% in June, But the 85% capacity utilisation rate seen in the 1990s is still too far off to spend manufacturing capital on a sustained expansion.
According to the IMS survey, output has climbed but is still struggling to meet substantial demand, mainly due to persistent shortages of key basic materials, labor and components, rising commodity prices and delivery difficulties, rather than capacity shortages.
Economic data also confirm that manufacturing capital spending expansion is not significant. In the second quarter of 2021, private investment in the United States fell at an annualized rate of -3.5%, the second consecutive quarter-on-quarter decline, from -2.3% in the first quarter.
Facility investment, which is closely related to the start of manufacturing capital, fell for the third consecutive quarter at an annualized rate of 13%. The strength and length of the recovery in facility investment from the previous quarter was much lower than during the recovery from the 2009-10 financial crisis.
High inflation is hard to reverse and the downside for Treasury yields is limited
Returning to the historical experience of the Fed’s cutting QE after three rounds of QE after the 2008 financial crisis, we find that each time the Fed ends QE, the MOMENTUM of the US economic recovery will slow down significantly for a period of time in the future, and the US bond yield will fluctuate and fall again, and continue until the economic short cycle bottoms out after a new round of monetary stimulus. Why does this happen?
The main reason is that the federal Reserve implemented QE in the past, and the residential leverage ratio is not high, so the rebound of commodity prices after the implementation of QE cannot stimulate the expansion of residential consumption, and it is difficult to bring about the rise of inflation.
This round may not be the case, the reason is that in 2020 after the outbreak of the fed unlimited QE had supply issues with commodity prices rebound, manufacturing industry is faced with the problem of raw materials nervous, especially the United States itself and U.S. residents add leverage by fiscal subsidies, prosperity of real estate cycle, to drive the rent and other prices, This bout of US inflation will be longer and stronger than expected.
The chart shows the year-on-year growth rate of THE US CPI and the 10-year Treasury yield
Historically, the us 10-year Treasury yield has rarely been lower than the year-on-year growth rate of CPI, except during the stagnation period of the 1970s. Therefore, both in terms of the pricing mechanism of interest rates and the characteristics of money chasing interest, the next 10-year Treasury yield is highly likely to be closer to the CPI growth rate.
We expect the core CPI year-on-year growth rate to remain above 3% in the third quarter through the end of the year, so the 10-year yield will rebound to around 3% in the future.
Add in the fact that Treasury TGA accounts will resume issuance as the debt ceiling issue is resolved and the supply of 10-year notes will increase, and yields will likely rise. Investors can use the 10-year US Treasury Bond futures (ZN) contract that promotes CME to hedge the risk of rising interest rates or capture trading opportunities.
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Reprint indicated source：Spark Global Limited information