IN THIS ISSUE:
1. US Gains 288,000 Jobs in June – Unemployment 6.1%
2. 32 States Have Not Regained All Lost Jobs
3. Long-Term Interest Rates Are Down This Year – Why?
4. The Problem: A Shortage of Long-Dated Bonds
5. Hope You Had a Happy 4th of July Weekend!
Today I will attempt to explain why longer-term interest rates have fallen significantly this year when almost everyone expected rates to rise. This discussion focuses on the fact that there is a shortage of Treasury securities in the marketplace today, especially in maturities of 10 years or longer. The shortage is due to a combination of factors that I will discuss below.
The bottom line is that when Treasuries are in short supply and demand is strong as it has been this year, buyers bid up the prices of these securities. When bond prices go up, yields fall. This is why the Fed would like investors to sell their bonds to help solve the shortage.
It is doubtful that this trend of lower interest rates will continue if the economy continues to gain momentum. This should be an interesting letter for those of you who own bonds and pay attention to interest rates.
Before I get to that discussion, let’s take a look at last Thursday’s surprising employment report for June. The economy created significantly more jobs than expected (288,000) last month, and the unemployment rate fell to 6.1%. I will break down the internals of the report just below.
While the national economy has finally recovered the apprx. nine million jobs it lost during the Great Recession, 32 states have not. We will look at the states that have still not recovered, as well as some that are booming. Let’s get started.
US Gains 288,000 Jobs in June – Unemployment 6.1%
The economy added 288,000 jobs in June, and the unemployment rate fell from 6.3% to a nearly six-year low of 6.1% as more people entered the labor force and found work, the government reported last Thursday. The strong jobs report suggests the economy is gaining momentum. The consensus was for 215,000 new jobs, so the report was clearly stronger than expected. So far in 2014 the economy has gained an average of 231,000 jobs a month, 19% faster than the 2013 pace of 194,000.
Employment gains for May and April were also revised up by a combined 29,000 jobs, the Labor Department said. In June, virtually every major industry added jobs, led by professional services, retail, restaurants, health care, finance and manufacturing. Average hourly wages, rose 6 cents, or 0.2% to $24.45. Wages are up 2% over the past 12 months. The average workweek was unchanged at 34.5 hours.
The report last week did have some blemishes, however. The labor-force participation rate was flat at 62.8%, a 35-year low, for the third consecutive month. The number of people who had to take on a part-time job for financial reasons jumped by 275,000, offsetting a similarly sized decline in Americans who’ve been without a job six months or longer. And the fewest young adults entered the labor market in June in four years.
After climbing to a 15-month high in May, planned job cuts announced by US companies in June dropped 41% to 31,434, the lowest level of the year. However, in the 2Q, a total of 124,693 job cuts were announced, up 3% from the 121,341 job cuts announced in the 1Q and up 9.5% from the same period last year.
32 States Have Not Regained All Lost Jobs
Based on last Thursday’s employment report and the upward revisions of the April and May new jobs numbers, the Labor Department tells us that the US economy has finally regained the apprx. nine million jobs lost in the Great Recession. That’s a milestone, I suppose – just to get back to breakeven at the national level.
Yet five years after the Great Recession officially ended, most states still haven’t regained all the jobs they lost, even though the nation as a whole has. Actually, there are 32 states that still have fewer jobs than when the recession began in December 2007 – evidence of the unevenness and persistently slow pace of the recovery.
Even though economists declared the recession over in June 2009, Illinois is still down 184,000 jobs from pre-recession levels. New Jersey is down 147,000. Both states were hurt by layoffs at factories. Florida is down 170,000 in the aftermath of its real estate market collapse.
The sluggish job market could weigh on voters in some key states when they go to the polls this fall. A Quinnipiac University poll out last Wednesday found that voters named the economy by far the biggest problem facing the United States.
The states where hiring lags the most tend to be those that were hit most painfully by the recession. They lost so many jobs that they’re still struggling to replace them all.
Nevada, which suffered a spectacular real estate bust and four years of double-digit unemployment, has fared worst. It has 6% fewer jobs than it did in December 2007. Arizona, also slammed by the housing collapse, is 5% short.
By contrast, an energy boom has lifted several states to the top of job creation rankings. North Dakota is the #1 example and has added 100,000 jobs since December 2007 – a stunning 28% increase, by far the nation’s highest. It’s like its own little gold rush.
The state has benefited from technology that allows energy companies to extract oil from shale. Not surprisingly, the capital of North Dakota, Bismarck, has the lowest unemployment rate of any American city: 2.2% as of May.
Also benefiting from the energy boom is Texas, which has added more than one million jobs since December 2007, an increase of nearly 10%. For comparison, the nation as a whole has added only a net 113,000 jobs over that period.
Jobs in Washington D.C., where lobbying is an all but recession-proof occupation, are up 49,000, or 7% since December 2007. The gain was led by a 10% increase in hiring by private employers. Wall Street’s recovery from the financial crisis has helped New York gain 237,000 jobs since the recession ended, an increase of nearly 3%.
Dan White, senior economist at Moody's Analytics, says many states are struggling because the recession wiped out solid middle-class jobs – in manufacturing and construction – that haven't returned. He says it will take a stronger housing recovery to put significantly more people back to work building houses, installing wiring and plumbing and selling furniture and appliances to new owners of homes.
Housing has rebounded somewhat since bottoming a couple of years ago. But the industry's recovery has slowed. Home construction is running at barely half the pace of the early and mid-2000s. And the United States has lost nearly 1.5 million construction workers since the end of 2007 – a 20% plunge. Nevada has lost half its construction workforce.
Factories have added 105,000 jobs over the past year, but manufacturing payrolls remain down 1.6 million, or 12%, since the start of the recession. Manufacturing jobs in Michigan, for example, hit bottom in June 2009. Yet the state still has 45,000 fewer factory workers (down 7%) than it did in December 2007.
The bottom line is that while the nation as a whole has finally regained the roughly nine million jobs lost in the Great Recession, there are 32 individual states that have not. That is a testament to how weak this economic recovery has been.
Long-Term Interest Rates Are Down This Year – Why?
Back in December when the Fed started its “tapering” operation, with the goal of terminating it by the end of 2014, it was only natural to assume that the Fed’s retreat would result in higher yields this year, especially on long-maturity Treasuries and mortgage-backed securities (MBS).
After all, the Fed has been the largest buyer of Treasuries and MBS in the history of the world since it began its “quantitative easing” (QE) program in late 2008. At that time, the Fed had apprx. $750 billion worth of Treasuries and MBS on its balance sheet. Today, that number is north of $4 trillion! Of this amount, over half ($2.4 trillion) is in long-dated Treasuries. QE has been the largest central bank asset purchase program ever recorded by far.
By late 2012, the Fed’s purchases of long-dated Treasuries and MBS climbed to a staggering $85 billion per month – just over $1 trillionadded in 2013 alone. The Fed has been reducing these monthly asset purchases by $10 billion at each policy meeting since last December. Following the last policy meeting on June 17-18, the Fed’s QE purchases are now down to $35 billion per month. The plan is that these purchases will wind-down to zero before the end of this year.
Virtually every forecaster I read predicted that the Fed’s withdrawal from QE would result in higher interest rates for long-dated Treasuries and mortgage rates. Yet to the surprise of just about everyone, longer-term Treasury yields have plunged this year.
The Problem: A Shortage of Long-Dated Bonds
One reason that Treasury yields have fallen significantly this year is that there is a shortage of long-dated Treasuries. The Fed is partly to blame. Through its massive QE purchases of Treasuries and MBS, the Fed now owns about 20% of all Treasuries, or $2.4 trillion. Banks, on the other hand, hold only $547 billion of tradable Treasuries and government agency-related debt.
In addition, the Fed’s holdings have shifted in ways that leave fewer central-bank-owned Treasuries available to be borrowed. This shift was caused by “Operation Twist” during the November 2011 to December 2012 period when the Fed sold shorter-dated Treasuries and bought more longer-dated bonds, which reduced the available pool of long bonds even more.
Adding to the problem, major US banks have also increased their purchases of Treasury debt, in part due to the Dodd-Frank law that was supposedly designed to limit risk taking by large US banks. Demand for Treasuries from large pension funds and foreign investors has also increased this year. Also, some of the outsized gains from the stock market last year have made their way into Treasuries.
Finally, the government itself has been selling fewer Treasuries in recent years as the federal budget deficits have fallen significantly. During the Great Recession, budget deficits ran over $1 trillion a year. The budget deficit for FY2012 was $1.1 trillion. However, in FY2013 the deficit fell sharply to $680 billion, down 37%.
For FY2014, the Congressional Budget Office estimates that the deficit will fall even further to $492 billion, and many believe it will be closer to $400 billion, as the economy shows more signs of strength. For FY2015, the deficit is expected to be $462 billion or less.
The point is, with budget deficits less than half of the $1 trillion or so that they were in President Obama’s first term, the government is selling less than half the amount of Treasuries it was just a few years ago. This, too, adds to the shortage of Treasuries.
The bottom line: When Treasuries are in short supply and demand is strong
as it has been this year, buyers bid up the prices of these securities. When
bond prices go up, yields fall.
This helps explain why interest rates have come down this year at a time when almost everyone expected them to rise. It also explains why the Fed would like investors to sell their bonds to help alleviate the shortage. Of course, Fed Chair Janet Yellen would never say that!
It remains to be seen if this trend of lower interest rates will continue as the economy gathers momentum. While I didn’t mention it above, no one expected the economy to tank 2.9% in the 1Q and this, too, helped bring interest rates down more than expected.
As you can see in the chart above, the 30-year T-bond yield bottomed in late May at 3.30% and has been rising since then. If the first estimate of 2Q GDP comes in above 3% on July 30, I would expect that we’ve seen the bottom in long rates for this cycle.
Hope You Had a Happy 4th of July Weekend!
I hope everyone enjoyed the holiday celebrating our nation’s birthday. For Debi and me, it was a very busy weekend. Our daughter came home from college and brought 22 of her friends to spend the weekend on beautiful Lake Travis where we live just northwest of Austin.
We had our hands full cooking for this bunch even though we were well prepared in advance. I had both of my BBQ smokers and two large grills going. There were people sleeping just about everywhere in our house and guest house.
They were a great group of kids, very polite and helpful as needed. Best of all, they did a great job of cleaning the place up before leaving on Sunday afternoon. It was a lot of work but also a lot of fun. Our place on the lake has long been a popular gathering place for our kids’ friends.
Gary D. Halbert