Show Me The Earnings

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The 10-Year U.S. Treasury yield has historically tracked closely to the change in nominal U.S. GDP.

Last Wednesday, the Fed noted that the recent weakness was ‘transitory’. The NFP report underscored that their assessment seems about right, and so solidified a Fed rate hike at the June meeting. Given the problems with Q1 GDP seasonals for a decade, it’s a reasonable expectation that Q2 will be stronger. The NFP report was solid all around, though wage pressures remain muted. April payrolls rose by 211k vs 190k expected, although average hourly earnings rose 2.5% from a (revised lower) 2.6% in March and 2.9% at end-2016.

Understandably, the market remains in a ‘show me’ state over the outlook. As the Fed statement alluded, business investment has firmed and the FOMC expects the economy to grow at a moderate rate. That’s in line with the consensus for a 2.1% growth rate in 2017 followed by 2.4% in 2018. That’s strong enough for the Fed to slowly keep reducing the amount of accommodation, while still leaving monetary policy accommodative. It’s strong enough to keep the unemployment rate moving lower. However, in order to break the moderate growth log-jam will require progress not only on deregulation (a major plus already) but also the promised tax reform of lower rates/wider base.

Stronger growth will expand earnings through the top line, raise wages and raise the growth rate. And it’s a stronger growth rate that will ultimately move bond yields higher. The current low levels of bond yields appear to be the result of low real yields, as bonds have been following inflation higher. A productivity revival is part of the key to generating higher bond yields. Of course, higher growth will accompany higher productivity. Please review page 33 of the Global Perspectives™ Book. - Special Guest Blogger: Tim Kearney

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