Since this is all anyone seems to want to talk about on Monday, I suppose it’s worth running another piece on the extent to which market participants may be wrong to incorporate hurricanes into their assessment when trying to determine whether the bond rally has more room to run.
On Friday, with the yield on the 10Y looking like it wanted to break below 2%, it seemed to dawn on everyone all at once that the last vestiges of the once-consensus reflation narrative were about to vanish.
To be sure, everyone was well aware that the Trump agenda had been largely priced out whether in yields, the dollar or, if you like equities better, in baskets of stocks assumed to benefit from lower taxes, in small-caps, and on and on. Point is, if what you want is to find evidence that markets have priced out Donald Trump’s platform, you don’t have to look very hard.
But it kind of seems like everyone took some comfort in knowing that there were still at least some believers around. After all, when there are no dissenting voices left, that’s usually when the tide turns – just ask the reflation trade itself, which was just as consensus in January as its opposite has become today.
So when it looked like the last, lonely U.S. reflationist was about to throw in the towel, it felt like everyone was suddenly scrambling around to explain why yields were too low – maybe in an attempt to appease the market Gods who are thought to dislike crowded trades.
Whatever the case, the tone has become almost shrill when it comes to crying foul on sub-2% 10Y Treasury yields. The risk-on sentiment that dominated Monday’s market action has hopefully gone some ways towards appeasing those who, over the past 72 hours, have discovered that something about 1 handle yields on the U.S. benchmark is offensive.
Of course part and parcel of the argument for even lower yields and an even more pronounced bond rally is the notion that due to Harvey and Irma, the incoming data will simply be too noisy for the Fed to divine anything about the economy ahead of a December meeting that just happens to line up with the new date for the fiscal apocalypse.
Well, whatever you want to believe about all of this, Bloomberg’s Cameron Crise thinks hurricanes probably shouldn’t be a big part of the calculus and here’s why….
Last week bore all the hallmarks of a towel-chucking exercise from the few remaining dollar bulls and bond bears that remain alive. The rationale is easy enough to understand: fresh on the heels of Harvey, Hurricane Irma was another disaster in the making that would damage U.S. economic momentum just as growth prospects appeared to brighten. Surely the Fed would declare a force majeure and cancel all monetary tightening for the foreseable future? While the FOMC may indeed rein in its tightening campaign relative to the dot-plot projections, history strongly suggests that it won’t be the hurricanes that force them to do so. As markets come to grips with the reality of the storms’ impact, risks strongly point toward a further tactical bounce in yields and the dollar.
- Let’s be clear: both Harvey and Irma are legitimate disasters that have impacted millions of people. That being said, it is almost inevitable that human beings overestimate the macro magnitude of the storms based on images from their television screens.
- It is still too early to accurately assess the damage exacted by Harvey and Irma — though in the case of the latter, at least one estimate dropped from $200 billion to roughly $50 billion. The combined damage of the two storms would need to exceed $220 billion to overtake the 2005 hurricane season as a percentage of GDP.
- However, if we look at the GDP effect of prior large storms, there is relatively little discernible impact on current or future growth. Excluding Hurricane Ike (which occurred during the financial crisis), over the last 30 years US GDP growth has dipped about 0.2% in the quarter of major hurricanes — and then accelerated half a percent thereafter.
- There is a similar impact felt in the more timely nonfarm payroll data. On average, payrolls have dipped by 15k in the first month impacted by non-Ike hurricanes — and then accelerated by 67k over the following three months.
- You can be pretty sure that the Fed has similar information at the their fingertips. A rate hike was never going to happen this month — December and beyond are the more appropriate time frames. By that juncture, there should be plenty of information to confirm (or deny) that the historical precedent has held.
- If you want to own bonds or sell dollars because you think this week’s CPI will be weak, go right ahead. If you think that the Street has a general aversion to the U.S. that mandates a weaker currency and lower yields, go crazy. But if you’re trading on the basis of the hurricane impact staying the Fed’s hand, be very careful, particularly with so little priced for the future.