Thoughts...14.12.08

US treasury rate re raised over 2.3 percent again. The rate bottomed up at the 2.3 and increased up about two months ago. And then as you know rate started to decline rapidly as the woes about deflation in Euro area were intensified. The rate reached under 2.0 percent at once and many market participants anticipated re decline in US treasury yield again.

However 10 year yield remain about 2.3 for some time due to two possibilities or concerns between to drag down to deflation like or by Europe and own reflation except for deteriorating external environment.

As the oil price dropped because the OPEC committee failed to decrease their supply, US rate decline under 2.3 again. In line with this, US TIPS breakeven dropped to 1.8 as well.
I thought the bull market does not finish yet. The rates seem to lower than 2.0 again under mitigated inflation expectation. Namely secular stagnation scenario including savings glut, constraints of zero bound interest rate, a lack of safety asset such as governments bond and slowing demand due to income inequality seems to be real for some time. If then, the rates will continue to be lower and lower by next year at least.

On the other hand, I have been somewhat doubtful about this, too. Because I look at the possibility of super cycle on equity market in US. And it would be so called reflation under tempered inflation. Recently I consider lowering oil prices as a way to boost the economy on the aggregate supply side contrary to secular stagnation scenario based on aggregate demand side.

So I've thought if we have long position on bonds we should be very cautious whether the rate could be turn up.

And then last weekend?
The US 10 year rate came to over 2.3 percent. And how can we see this?

US, lower oil prices...

Oil prices have declined sharply over the past few months, falling roughly 25% from their average level during the first half of 2014. Our commodities team expects the drop to be sustained. While lower oil prices would historically have been seen as a clear positive for the economy, the growth role of US energy production suggests at least a partial offset.

For the consumer, we see the recent drop in gasoline prices as equivalent to a roughly USD 75 bil. tax cut. Based on a simple back-of-the-envelop calculation, corroborated with a VAR analysis, we think the impact of lower energy prices through this channel should be a benefit of about 0.3pp on GDP growth over the coming year. The total positive "tax cut" effect for the whole economy may be as much as +0.4pp.

However, the energy sector is more important to the US economy than it once was due to the shale boom. Based on the recent drop in prices, our analysts anticipate slowing, but still positive growth in production during 2015. Energy related capex should also slow a bit. The GDP growth headwind from this shift should be around 0.1pp over the next year, mainly seen in a slightly wider petroleum trade deficit that would otherwise occur.

The net effect of lower energy prices on employment should be positive. We do not anticipate job losses in the energy sector to move the needle significantly on aggregate employment outcomes. While energy sector jobs have grown at a rapid rate, they remain a small share of total US employment. Any energy industry job losses due to lower oil prices would probably be more than made up for with diffuse growth-induced job gains elsewhere.

Out bottom-up analysis suggests a net positive impact of lower oil prices on GDP growth of around 0.2 to 0.3pp over the coming year. A cross-check with the Fed's FRB/US model suggests a slightly smaller, but still positive, effect. While modest in size, we think this tailwind should offset much but not all of the growth drag from the stronger dollar and a slightly dimmer global growth outlook.