2015 Rate Hikes Are A Myth

According to economic data, as translated by the Federal Reserve, the US economy is no longer struggling. During 2014, 1.7 million jobs were added and GDP is expected to expand by 2.6%. In contrast to the rest of the developed world, the US is the belle of the ball. However this is only because the other partygoers are ugly as sin. The European Central Bank decided to embark on quantitative easing two years too late and Japan has been faced with consistent deflationary pressures. As a result, the Federal Reserve is considering making the US economy the only one to normalize interest rate policy in 2015. Does the Fed actually believe the US is sheltered from the global economy? If so, then why do the structures of the yield curve, credit spreads and the current level of volatility paint a different picture?

Yields Indicate Deflation and Sub-par Growth

Global bond yields are all dropping and racing towards 0% (below). US 10-Year Treasury has collapsed below 2% thus far in 2015, while German and Japanese bonds are sub 0.5%. This significantly caps central banks as there aren’t many alternative options to encourage economic growth.

global yields

Yields are driven down and flattened when investors seek risk-free assets ahead of an economic downturn.  Oil’s decline and the fact that economies overseas are struggling to find their footing have fueled bets that inflation will slow even more than it already has. Eurozone is nearing deflation and the US is circling the same result.

The gap between 2yr and 30yr Treasury yields flattened to 186 basis points, down from around 329 basis points a year ago. Treasury yield curve is at the flattest levels in six years due to global growth concerns and the perceived rate hike.

Even more concerning is that rates are running below mandated central bank targets.  The Federal Reserve has a policy of stable pricing, which constitutes inflation targeting at 2%. If the Fed stays true to its word and raise rates, then that indicates that inflation should be nearing the mandated 2%.  However, recent data (below) shows inflation moving away from the 2% target, rather than towards it.

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