Where fools (should) fear to tread
For many of us, one of the factors which can have a huge influence on our lives– and yet is totally mystifying– is the direction of interest rates. If consumers are in good financial shape and want to borrow, and if banks are flush with funds willing to lend– all big ifs these days– then changes in interest rates may be the final determining factor in bringing all parties together. But understanding and properly predicting the influences that set interest rates may be nearly as difficult as figuring out the price of gasoline from one day to the next.
Events of the past month, including last week, seemed to provide fine examples of the utter folly in supposing economists understand those factors giving them the ability to forecast interest rates with any degree of accuracy.
One particularly important interest rate is that associated with the ten year Treasury note. The yield on the ten year T-note is used as a benchmark for many intermediate and longer-term interest rates, including 15 and 30 year mortgages.
As recently as April 11th of this year the yield on the ten year T-note was 3.59 percent and the associated interest rate on 30 year fixed rate mortgages stood above 5 percent. At that time, the general belief was that rates on the ten year T-note would likely continue to march upward, with consumers and businesses probably facing marginally higher interest rates as time progressed. Well, not quite.
Since that time rates have been on the decline, and last week was indicative of the seeming chaos that economists– not to mention consumers and businesses– face as they try to determine events which will shape the economy and interest rates.
As last week began, two reports on the manufacturing sector got the week off to a decent start, with the Institute of Supply Management (ISM) Index rising to 60.4 and factory orders advancing 3.0 percent, both well above the economists’ expectations. One would suppose this suggests good economic growth, which typically produces a drop in the price of the ten year T-note (or stated differently, a rise in yields, given that they move in opposite directions) as investors exit the market for fixed income securities and move into stocks.
So what happened? The yield on the ten year T-note fell slightly from 3.31 percent to 3.28 percent between Monday and Tuesday. Oh well, that small of a drop can likely be explained by other factors and doesn’t mean much, right?
Then came Wednesday and the much-anticipated report from ADP (the payroll data processing folks) which provides an early glimpse regarding the market-moving employment/unemployment report that would come out on Friday. Markets expected a healthy increase of at least 200,000 new jobs, but came away with a slightly disappointing 179,000 new jobs. Not a bad number, but not the bigger number anticipated. Adding to the disappointment was a let-down in the ISM Index for the services sector, suggesting very slow growth in this huge sector of the economy. As a result, another drop in the T-note yield on Wednesday to 3.25 percent.
But not yet worried, many economists declared that the important number for Thursday, the number of new claims for unemployment insurance– effectively, the number of newly unemployed– would drop nicely from the elevated levels of the previous couple of weeks. So, what happened? You guessed it. There was a large jump upward in new claims, suggesting that labor markets were softening as April came to a close. That day, yields fell even further (to 3.18 percent) and some analysts started tapering back on their expectations for the payroll employment report the following day.
So, Friday rolls around and the biggest report of the month was released, the number of new jobs created in April according to an employer survey (expectations of about 185,000 jobs) and the unemployment rate from a household survey (expected to remain at 8.8 percent). And how did economists do with their 11th hour outlooks? Once again, they blew it. The number of jobs created was 244,000 and the unemployment rate rose to 9.0 percent.
Well at least, with the big gain in payroll jobs, the much-anticipated rise in yields on the T-note should occur, right? Nope. They fell yet again (to 3.16 percent) on Friday when a rumor started circulating that Greece may drop out of the 17 nation euro zone (a report since denied).
All-in-all, it amounted to what should have been a humbling week for economists. But fiddle-dee-dee, tomorrow is another day.
Dr. James Newton serves as Chief Economic Advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at Ohio State University-Marion.