Politics and the 10-Year Treasury
Yield on 10-year Treasuries have declined, but geopolitics seem to be the primary driver, as global investors seek safe havens amid some worrisome developments. Weaker first quarter GDP may be reinforcing this decline in interest rates. But the “weakness” in the data is likely to be resolved more quickly than the turmoil overseas, enabling rates to float higher again. Should concerns over North Korea be resolved, whether by negotiation or conflict, interest rates would be likely to come under even more upward pressure.
Tensions over North Korea are pushing investors to seek safe haven assets, like U.S. government bonds, pushing down domestic interest rates and providing solid support for the dollar. The favored strategy of the U.S. is enlisting the assistance of the Chinese to deter the North Koreans from further development of nuclear and missile technology, thereby avoiding a military confrontation. It seems very likely that President Trump told Premier Xi that without China’s aid in resolving the situation peacefully, the U.S. might be forced to resort to a military solution. China seems to be getting more involved. By cutting off coal supplies, more economic pressure is being brought to bear on North Korea. Even so, it remains unclear whether the situation will be resolved peacefully. It is known that the Chinese requested a meeting with North Korea’s leadership and this request was denied. So, the uncertainty level remains very high, which makes Treasuries an attractive place to park capital. In the very short run, weaker data and tension over North Korea will keep domestic bond yields depressed. Moreover, until the face off over North Korea’s behavior is resolved, interest rates could be pushed lower still, since tension levels could easily be ratcheted higher at almost any time.
On the economics side in the very short run, the latest economic data reinforce the downdraft in yields, as first quarter GDP is widely expected to be quite low. Some of this is clearly due to bad seasonal factors and unusual winter weather. But it is also widely expected that growth will pick up in the near future. Odds of a recession remain quite low and any improvement of growth in the spring would cause rates to rebound, at least to some degree. With layoffs extremely low, as is evident from unemployment claims, and hiring demand quite firm, as is clear from the job openings report, there is little reason to expect economic growth to falter. There is also strength evident in the housing market. So, the decline in interest rates must be largely attributable to the high level of international tension. Should it be resolved, market attention will quickly revert to the economy, which would allow interest rates to rebound. But healthier data in the second quarter may also provide some counterweight against the effects of these political tensions.
Companies are now reporting first quarter profits and those results should further relieve any concerns over the economy. In fact, profit estimates are quite solid for the entire calendar year. Nonetheless, equities may not benefit much while we are all watching the global political situation. Until that’s resolved, it will remain the focal point of our attention.
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