In June, the Labor Department announced that employers added 195,000 jobs to their payrolls. However, the unemployment rate held steady at 7.6 percent, as new entrants to the workforce offset the job gains. Despite this, market reactions were positive.
The DOW ended the day up by 147 points, and the S&P 500 experienced a rise of one percent. But does this truly indicate economic improvement?
A closer inspection of the data reveals a less optimistic outlook. The underemployment rate, which encompasses individuals who want to work but have abandoned their job searches, as well as part-time workers desiring full-time positions, increased from 13.8 percent in May to 14.3 percent. Furthermore, most of the newly added jobs are not the kind that boosts economic growth.
“More than half of the jobs were in the retail and leisure and hospitality sectors, which tend to be low-paying,” reported Reuters.
“In contrast, manufacturing payrolls fell by 6,000 jobs, marking a decline for the fourth consecutive month, while construction jobs saw a modest increase of 13,000.”
Flow Reversal
On the other hand, the debt market was uncertain in its response to the Labor Department’s report. It absorbed the information and reacted with a substantial shift. The yield on the 10-Year Treasury note rose dramatically from 2.50 percent to 2.71 percent, a significant jump from a yield of 1.65 percent in May.
Could we be witnessing the bursting of the Treasury bond bubble?
“When the financial history of this decade is written,” said Warren Buffett in February 2009, “it will certainly mention the Internet bubble of the late 1990s and the housing bubble of the early 2000s. However, the U.S. Treasury bond bubble of late 2008 could be considered equally remarkable.”
After 30 years of inflation, it seems that the flow of capital may be reversing. In June, record amounts were withdrawn from bond mutual funds and exchange-traded funds. According to TrimTabs, “bond mutual funds lost $70.8 billion in June through Thursday, June 27, while bond exchange-traded funds experienced a loss of $9.0 billion.”
Will we see a mass exodus from the market?
It’s uncertain. Yet, it is evident that a crucial turning point has been reached. The era of federal, state, and local governments, along with businesses and individuals continuously refinancing their debts at declining rates to alleviate financial burdens is over. In the future, borrowing will become increasingly costly.
Rising yields may also indicate inflation on the horizon. Here’s why.
Safe Investment Losses
When investors buy a Treasury note, they effectively lend money to the government for a specified duration (ranging from 30 days to 30 years) at a fixed interest rate or yield. Historically, the risk of default on treasuries has been perceived as virtually nonexistent; the federal government can always print additional money to meet its obligations.
However, this practice leads to a devaluation of the dollar. While nominal returns may remain intact, inflation-adjusted returns may turn negative.
In essence, inflation undermines Treasury values for investors. To account for rising inflation expectations, yields increase. Unfortunately, this poses a challenge for long-term Treasury investors.
When Treasury yields rise, Treasury prices fall, resulting in a loss of value. Since May, yields on the 10-Year note have surged from 1.65 percent to 2.71 percent—an increase of 64 percent. Consequently, if current market rates are 2.71 percent, a Treasury yielding 1.65 percent must see its price decline by approximately 40 percent.
Pension funds and insurance companies, heavily invested in Treasuries and bonds, are likely to experience significant losses. But this is just the beginning…
“The flight from bonds could intensify,” warns research firm TrimTabs, indicating that more bond investors might exit after reviewing their quarterly statements in the upcoming weeks, as they realize their ‘safe’ bond funds are generating losses rather than gains.
Sincerely,
MN Gordon
for Economic Prism