Bonds Yields Can Go Higher

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The January non-farm payroll report was a bit of a joy to behold, indeed. Payrolls of 200k outperformed and December was revised upward. Both the unemployment rate and labor force participation remained unchanged. But the big star of the day was average hourly earnings of 2.9% with December upgraded to 2.7%. About time, I’d say. The report set off alarm bells throughout the markets, with the bond market beginning to see what it expects: a working Phillips Curve. But frankly, bond yields have been steadily rising since mid-2016, and especially from Q4 2017. This looks like the sort of normalization that we should expect to see: if indeed higher growth is on the way higher bond yields will be on the way – in a good way. The swing up in yields from the September lows are a 44bp increase in real yields to 0.7% with implied CPI up 36bp to 2.1%. So bond yields are consonant with a 2% inflation rate and a sub-1% trend growth rate. If the economy moves to a higher growth trajectory (which is my expectation), then bond yields will continue to rise.

And more growth appears to be on the way. Start with the Atlanta Fed NowCast is calling for a 5+% Q1. There are a couple of arguments against that sort of growth, from poor seasonal adjustments in Q1 to the likelihood that net exports will be a drag as capital is drawn back to the USA to the fact this is a volatile series. By comparison, the consensus seems to be 2.5% Q1 GDP growth. Note also that the NY Fed Nowcast is also printing above 3% for Q1. Taken together, we have early indications that an upswing could be in the making.

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