Rising Yields on Treasury Bonds

We've seen a startling and unexpected move to higher yields on the UST 10-year over the past two weeks, with yields rising from 1.87% on April 17 to 2.24% on May 6. Market professionals are scratching their heads to understand the backup in rates amidst weak Q1 GDP, durable goods, factory orders and most recently, ADP private payrolls. 

Much of the latest tantrum followed a prescient call by Bill Gross on shorting German BUNDs, for which those investors following his advice would have profited considerably. Soon to follow were prognostications by a variety of equity guys, including Warren Buffet, who while a demonstrated equity maven, might not be the best source of advice on bonds. Warren's a bit like your family doctor, who skilled in medicine seeks to give advice on a range of subjects beyond his expertise.

For his part, Warren is an old school cronie, not unlike John D. Rockefeller or J. P. Morgan, who built fortunes on the intersect of politics and business. But a bond trader, not so much. Equity guys fail to understand how bonds trade or the simple fact that bonds, unlike stocks, have terminal value.  

For those who make their living in the sector, bonds trade on price, not yield. The price reflects the ownership of a stream of future cash flows. As robust economic activity and the prospect of inflation discount the value of those cash flows, bonds diminish in value. Conversely, weak economic growth creates value. In the deflationary world that Bernanke so feared, bonds would scream.

All of which is to say, the weak level of recently reported economic fundamentals argues that the current tantrum may not have legs and, at least in this one instance, an investor might profit by taking the other side of Warren's trade.

Early Social Security Benefits and the Labor Participation Rate

Marketwatch reported today on the percentage of Social Security recipients taking "early" benefits from Social Security. A surprisingly high 73% of recipients or nearly three out of four, now elect to take benefits prior to full retirement age, thereby significantly reducing the benefits that they will receive in retirement.  

Full retirement age for those born between the years 1943-1954 is defined as age 66, with the date gradually increasing.  For those born 1960 or later, 67 becomes the new full retirement age. Social security benefits are available to those retiring earlier than these ages, but at a reduction of 13% for those electing benefits at 65, the age most commonly associated with retirement (reduced benefits are actually available as early as age 62, but at a 30% reduction). For those waiting until age 70 to take social security, benefits increase each year by 8% relative to the full retirement age, up until age 70 when they are capped. The benefit claimed at any of these ages, is then fixed for the duration of the person's retirement.

These changes were put in place as part of the Social Security Amendments of 1983 (HR 1900) when the Trustees of the Social Security Trust Fund first became concerned about the solvency of the Trust relative to future benefit payments. Interestingly, this act also expanded Social Security benefits to members of Congress and the White House and instituted the taxing of benefit payments to recipients. What Congress giveth with one hand, they taketh away with the other.

Most retirement planners advise people to wait as long as possible to claim benefits. But the point of this article is not to advise people on their selection, but rather to examine the social and economic issues that drive behavior. There are several reasons why people might take early, reduced benefits including illness, or because they believe they can invest the funds at a higher rate of return. The most common reason, though, is that they simply need the money. But there is another reason to consider: Social Security benefits are not guaranteed. The Trustees of the Fund can change the level of benefits going forward at any time.

Of these reasons, the fact that people need the money is both the most likely explanation and the most telling of the limp recovery following the financial crisis.  Along with the significant rise in disability claims over the past six years (and the vast expansion of the student loan program) early social security benefits likely explains the last piece of the puzzle in the pronounced and lengthy decline in the labor participation rate.

Rising Rents

There was an interesting article on Business Insider today about the rising cost of rental housing in America. If you rent your home or apartment, or know someone who does, you're well aware of what has happened to rents over the past five years. The article mentions one important factor driving demand, the shift from homeownership to renting following the financial crisis, with 36% of people currently renting versus 31% before the crisis.

This is a very compelling consideration, and raises some important questions about housing policy, the banking sector and the Federal Reserve. What's driving the increased demand for rental housing are several factors, including limited supply and cumbersome local zoning/approval requirements for new development. But also driving rents are the tightened mortgage approval standards of banks for home ownership, following the collapse of the shadow banking market. The shadow banking market (or the market for private label mortgage backed securities) fueled the growth of sub-prime loans, no-doc loans and other inventions of the early 2000s by providing a secondary market for banks to sell these newly originated loans. With this market still largely defunct and in an environment today of weak personal income growth and rising bank lending standards, those seeking new housing are increasingly forced into the rental market.

Now landlords, amidst this growing demand for rental housing are for the large part killing it. They've been able to finance new multi-family or refinance existing developments at historically low interest rates, while enjoying ever escalating rents from tenants. Nice work if you can get it. But this pronounced shift to rental housing once again highlights Fed policy, post recession and it's wealth effect on the average citizen.

Large corporations have been able to reduce borrowing costs dramatically since 2008, now borrowing 10-year debt at interest rates as low as 3.00%.  But small businesses have struggled to access financing for new projects. Owners of homes have been able to refinance their mortgages at generally lower rates, although bank standards have biased approvals to the wealthiest with the best credit in an environment of greater regulation. And let's not forget the wealth effect the Fed has created for the owners of stocks. But bear in mind, as with home refinancing and corporate financing, stocks are very narrowly held (with 80% of stock ownership held by the top 10% of Americans by wealth) thereby shifting this benefits of Fed policy to the wealthiest.

All this raises the very obvious question about who has benefited and who has not from the Fed's six-year policy of zero interest rates and whether it might be time to redress these imbalances that the Fed has created.