Bob’s Journal for 8/10/22

Why Interest Rates Could Move Higher Soon

We’re probably at a turning point in the treasury bond market.

Over the last 18 months, interest rates on treasury bonds didn’t increase as much as many observers expected. The Federal Reserve rapidly increased the short-term interest rates it controls. Other interest rates increased, but not as rapidly as the short-term rates.

That’s one factor that kept the economy out of a recession. But there’s a good possibility treasury bond rates will be pushed higher even as the Fed slows down or pauses its interest rate increases.

The Fed and banks purchased almost all new treasury bonds issued in 2020 and 2021.

As part of its tightening policy beginning in late 2021, the Fed curtailed its purchases of new treasury bonds and stopped replacing bonds in its portfolio as they mature and are redeemed.

At the same time, banks slashed their purchases of treasury bonds. Banks haven’t had as much cash to invest since the Fed stopped flooding them with liquidity.

Banks also are less inclined to purchase treasury bonds, since rising interest rates generated significant losses on bonds the banks already owned. That situation led to the banking crisis earlier in 2023 and has put a number of banks on watch lists at credit-rating firms.

Despite the reduced bond purchases from the Fed and banks, interest rates on treasury bonds increased slowly the last 18 months. That’s largely the result of tactical moves by the U.S. Treasury. It drew down its cash balances more than usual, especially during the government funding dispute earlier this year. It is time to replenish the cash reserves.

The Treasury also issued mostly short-term treasury bills when it had to raise cash. There were few new issues of intermediate and long-term treasury bonds, so the absence of buyers wasn’t a problem.

That change has run its course. The Treasury likes to maintain a balance between short-term and longer-term debt and can’t issue more short-term debt if it wants to maintain that balance. Also, higher spending and lower tax revenue than expected mean the Treasury has to borrow more than previously expected.

Starting this week, to refund maturing bonds the Treasury plans its biggest bond issuances since last year. The announcement of the planned bond auctions a few weeks ago is likely why interest rates on treasuries started rising in late July.

The need to issue more treasury bonds is likely to persist for a while, and it’s not clear who will replace the Fed and banks as buyers.

Starting this week, we’ll see if current interest rates will attract enough buyers. If not, interest rates on treasuries will rise even as the Fed pauses monetary tightening.

The Big China Surprise

There’s a big reason why commodity prices haven’t increased and inflation has declined slowly but steadily this year.

The reason is China’s economy.

At the start of the year, expectations were that China’s economic growth would surge as its zero-COVID policies ended and the economy opened. There was a brief increase in growth. But that ended. For most of the year, the economic data from China has been weak.

This week, China announced that its exports to the rest of the world fell at the fastest pace since February 2020. China also reported that consumer prices declined, pushing it into deflation.

Those are only the latest in a series of disappointing data from China. Part of China’s problem is that over the last few years, the government has been less supportive of economic growth and more hostile to the private sector.

In addition, China has structural problems that developed over the last couple of decades. There’s a lot of debt, and there was significant overbuilding in several sectors, especially the property sector.

Despite expectations that growth would resume in the property sector after the economy opened, the sector has been very weak. This weakness is felt in many commodity markets around the globe and has kept a lid on commodity prices.

Also, much of China’s infrastructure spending historically is done by local governments. Those local governments took on too much debt during the boom years and now can’t use infrastructure spending to stimulate growth the way they did in the past.

Lower exports and reduced property activity has led to lower domestic consumption and higher unemployment in China.

In addition, China has an aging population. Productivity steadily declined over the years even as the economy and exports grew. Recent reports indicate that younger Chinese now are averse to working in factories to produce goods for export, at least at the wages being offered.

Another problem for China is the international movement to become less dependent on the country as a trading partner. Outside investment in the country declined along with its exports. China substantially increased exports to Russia, but not by enough to replace the trade it lost with the rest of the world.

Current leadership doesn’t seem inclined to engage in the type of stimulus policies frequently used in the United States and the western world. Instead, China’s leaders seem likely to focus on financial stability and will accept slower growth.

China’s leadership plans to shore up growth primarily by building its technology sector. If it works, the progress won’t occur in the short term. It could take several years for those efforts to overcome the current structural problems in the economy.

Your Credit Score Can Still Matter in Retirement

Most people enter retirement with little or no debt and no plans to buy another house, take out a mortgage, or add other debt. They think credit scores don’t matter much anymore. That can be a mistake.

Credit scores can affect premiums on all types of insurance policies and even whether you are approved for insurance. A credit score also can affect whether you’re approved to enter an assisted living or other long-term care residence.

Of course, if you continue to have debt in retirement, even credit card debt, or want to refinance debt, the credit score matters.

For the typical retiree, the credit score declines in retirement, even if you continue to pay all bills on time.

A frequent practice of retirees is to pay down debt and cancel credit cards. Those actions can decrease your credit score, which many people find ironic.

In addition, the credit score calculation favors a mix of different types of debt, so paying off a mortgage and auto loans can hurt your score. Closing accounts, even inactive accounts, also reduces your score.

Once you stop working, a missed or late payment can have more of an effect on the credit score than during the working years.

It is important to keep some credit accounts active. Some people take pride in not using credit cards or having other debt. But if you don’t have any credit activity for six months, some credit-rating firms stop giving you a score. Others will reduce your score.

The bottom line is that while retirement doesn’t automatically cause credit scores to deteriorate, natural actions taken during retirement can cause scores to drop.

One good way to keep a healthy credit score is to charge purchases regularly to one or more credit cards and pay the balances off each month. That shows you have an active credit history and that you are paying bills on time.

The Data

The Small Business Optimism Index from the National Federation of Independent Business (NFIB) increased a little in July to 91.9 from 91 in June. That’s the third consecutive monthly increase and the highest level since November 2022.

The percentage of business owners expecting business conditions to improve over the next six months improved to a net negative 30%. That’s a 10-point improvement from June and the best level since August 2021. But it still indicates less than half of business owners expect business conditions to improve.

The ISM Services Index declined to 52.7 in July from 53.9 in June. The June level was a four-month high.

The PMI Services Index also declined, falling to 52.3 in July from 54.4 in June.

The PMI Composite Index for the economy fell to 52 in July from 53.2 in June.

Consumer credit increased at an annualized rate of 4.3% in June. But revolving credit (mostly credit cards) declined 0.4% while nonrevolving credit (mostly vehicle and student loans) increased 6.0%.

If we have several months of low growth or declines in the use of revolving credit, that indicates consumers are reducing their spending.

Factory orders increased 2.3% in June, the highest level since January 2021. They increased only 0.4% in May.

But after excluding the volatile transportation sector, orders increased 0.2% in June, which follows a decline of 0.4% in May.

Nonfarm productivity increased 3.7% in the second quarter after declining 1.2% in the first quarter. The second quarter jump in productivity was the highest in almost three years.

Output increased in the second quarter, while hours worked decreased for the first time since the second quarter of 2020.

Hourly compensation increased 5.5%.

The result of all those changes was a 1.6% increase in unit labor costs, down from a 3.3% increase in the first quarter.

There were 187,000 new jobs created in July, according to last week’s Employment Situation reports. Over 12 months, the number of new jobs created each month has averaged 312,000.

The strong payroll reports for May and June were revised lower to reflect a total of 49,000 fewer jobs than initially reported.

Average hourly earnings increased 0.4% in July, the same as in June. Over 12 months, average hourly earnings increased 4.4% as of July, matching the rate as of the end of June.

New unemployment claims increased by 6,000 to 227,000 in the latest week. The previous week was a five-month low.

Continuing claims, which lag a week behind new claims, increased to 1.700 million from 1.679 million.

The Markets

The S&P 500 lost 1.69% for the week ended with Tuesday’s close. The Dow Jones Industrial Average fell 0.89%. The Russell 2000 declined 2.39%. The All-Country World Index (excluding U.S. stocks) decreased 2.22%. Emerging market equities retreated 3.45%.

Long-term treasuries lost 1.48% for the week. Investment-grade bonds declined 0.33%. Treasury Inflation-Protected Securities (TIPS) rose 0.23%. High-yield bonds gained 0.24%.

In the currency arena, the U.S. dollar rose 0.32%.

Energy-based commodities fell 0.32%. Broader-based commodities lost 0.92%. Gold declined 1.03%.

Bob’s News & Updates

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