The downturn in the US 10-Year T-Note yield in 2019 confounded the pundits and media. As a result of the German Central Bank’s action to reduce their 10-Year Bund yield to a negative 71 basis points, the US 10-Year T-Note fell to 1.46%, therefore inverting the yield curve. The media and experts forecast a recession and the stock market lost leadership in a sideways trading pattern. On September 4th, the US 10-Year T-Note yield hit bottom and recovered, due to the cycle lows in the German 10-Year Bund yield, which, in turn, reflected the low of negative 93 basis points in the German 2-Year bund yield (a low also seen in 2017). The US stock market reacted to the reversal in yields with an upside breakout and new leadership of banks, industrials, and value stocks, indicating continued economic strength and higher growth.
Both Germany and China are using interest rates and currency levels to control their respective economies relative to the US economy, and therefore reducing the price of their exports, and increasing the price of their imports. However, only a low, followed by an increase in the German Bund has forecast the low in the US 10-year T-Note. This occurred in early September 2019.
The level of the Chinese yuan relative to the U.S. dollar also affects changes in the world economy. The yuan also hit a low in late August 2019. The highest valuation of the yuan at 6.3 coincided with the peak in the German 10-year Bund yield in 2018, while the devaluation to 7.13 in late August 2019 is concurrent with the low German yield (see Chart I).
Germany’s heavy reliance on trade at 47% of GDP is the greatest in Europe. It is estimated that Germany exports $21,000 of goods and services for each of its citizens. The comparable figure for France, the eurozone’s second-largest economy, is $12,388. For the U.S., it’s $6,800.1
Germany is experiencing negative growth in manufacturing and exports, causing the German Central Bank to reduce the yield on the German Bund. Yields have declined to a low of negative 93 basis points on the 2-year and a negative 71 basis points on the 10-year. This decline in German yields resulted in a drop in the benchmark 10-year U.S. Treasury note to a low of 1.46% as of September 4th. The Federal Reserve is expected to reduce the Fed Funds Rate to 1.75% in late September, following the European Central Bank rate cut of 10 basis points to a negative 50 basis points, both lagging the cycle lows and upturn in German and US yields (see Charts I & II).
Interestingly, the German Central Bank objected to the European Central Bank’s resumption of the ECB’s asset purchases of up to 20 billion euros. It appears the German Central Bank had already succeeded in reducing US interest rates and recycling US demand, thereby not requiring ECB asset purchases.
US Nominal GDP Influence Over 10-Year Yields
US 10-year T-Note yields normally reflect nominal US GDP growth. As an example, the acceleration in nominal US GDP from 3% to almost 6% under the Trump administration increased the US 10-Year T-Note yield from around 2% to over 3%. However, this decline in the German 10-year Bund since the beginning of 2018 has led to a decline in the US 10-year from over 3% to 1.46%, and since recovered to 1.90%.
World economic weakness was reflected in the decline in the US 10-year yield, as well as US nominal GDP growth declining from 5.5% to under 4% in the second quarter of 2019. However, the decline and subsequent recovery in US yields, should indicate a recovery of nominal GDP growth to 5% (given 3% real GDP and 2% inflation) by 2021, potentially increasing 10-year U.S. yields toward 3.0% (see Chart III).
The main drivers of bank profitability are (1) lending rates and (2) deposit costs. Loan rates are primarily driven by the 10-year T-Note yield and its impact on mortgage rates and business lending. The 10-year T-Note yield fell from over 3.0% to 1.46%, but deposit costs are held up by a firm 3-month T-Bill yield due to the Federal Funds rate (see Chart IV).
Bank profitability and bank stock prices benefit from the reduction in the Federal Funds rate in September 2019 to 1.75%, followed by a possible further reduction in October to 1.50%. The low in the US 10-year T-Note yield of 1.46%, and recovery to 1.90% and above, sets the stage for more favorable lending rates.
CD Rates Remain Attractive
Brokered CDs under $250,000 with yields above the Federal Funds rate, government guarantees and maturities in the 1 to 5-year range offer an attractive fixed-income alternative. Given the expectation of a continued U.S. economic growth and a positive resolution to the U.S.- China trade negotiations, U.S. 10-year yields should recover, rising toward 3.0% by 2021, and for principal safety and best yield, brokered CDs under $250,000 offer the best alternative.
Each quarter, IDC Financial Publishing (IDCFP) tracks and provides a forecast of outstanding balances of brokered CDs less than $250,000. The number of institutions issuing brokered CDs, as well as outstanding CDs issued, has grown at an accelerated rate in recent years, and we project this trend to continue.
1 - Wall Street Journal article, published July 24, 2019 https://www.wsj.com/articles/europe-gets-caught-in-the-u-s-china-crossfire-11563980001?mod=searchresults&page=1&pos=5
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