Of course, looking back on 2014, we noticed that the move to sub-2.0% 10-year yields did not begin right away. Rather, it began when 10-year yields were not able to move above 3.0% after the Fed decided to delay tapering at the December 2013 FOMC meeting. Unfortunately, that proved to be its last chance to taper. Instead, the Fed lowered the unemployment rate threshold to 5.5% at its January meeting in an effort to defend the credibility of the threshold. Given the continued decline in the labor force participation rate, due to both underlying trends and the changes to the emergency unemployment compensation benefits, the Fed did not want to be seen as moving the goal posts at the last second.
As the year progressed, realized inflation data remained subdued and the growth data stopped accelerating. Monthly surveys of manufacturing activity began to turn lower, which raised eyebrows within the FOMC (see Exhibit 3). Not feeling comfortable with a possible growth deceleration while realized inflation remained low, the Fed decided to implement the inflation floor at 1.5% in order to finish the specification of its rate guidance framework. While the Fed achieved some success in supporting intermediate breakeven inflation expectations through both lowering the unemployment rate threshold and introducing an inflation floor, the decline in real rates dominated. Net, nominal rates moved substantially lower.
In addition, with global investors having placed faith in the US recovery, the return to muddle-through growth reignited the worst fears in Europe, and solidified those in the emerging markets. Treasuries regained their long-lost flight-to-quality status, and investors will now gladly exchange default risk for non-AAA 10-year US Treasuries below 2.0%.
Morgan Stanley recently proposed ten events for the new year that would catch markets by surprise. This one caught our attention as it appears to be particularly out of consensus. In fact, according to a recent Bloomberg survey, almost every one of the 62 economists surveyed would be shocked – SHOCKED – if the ten year closed the new year below three percent.
“As they set their nets, two unnoticed mishaps would have devastating effects on their trip and would be followed by a series of deadly mistakes. As the trio circled the bay, they made the mistake of putting the heavier led weights on one side of the boat, creating an uneven distribution of weight on one side. The boat was now tipping to the weighted side and they would soon realize another mistake: the plug had accidently been kicked out, letting the frigid ocean water flood the boat.
“They all kept on with their work, un-phased by the leaning boat, until it was too late. When they realized what was happening, the boat was completely swamped. Pumping furiously to rid the water from the boat, Jason, Lucy and David all gathered to one side of the boat – the same side of the boat where all the weights were placed. Overwhelmed, the boat rolled, bobbed for a few moments and then the bow turned straight for the sky.”
– True story brought to you by the Alaska Office of Boating Safety