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Why Real US Rates Have Been Climbing

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Dec. 4 2020, Updated 10:50 a.m. ET

Real US rates have been climbing, while rates are falling in much of the rest of the world. As Russ explains, this divergence has a number of implications for investors.

While US economic data continue to come in mixed, the numbers still point to decent US economic growth. That, along with some evidence of stabilization in international markets, has pushed the odds of a December interest rate hike by the Federal Reserve (or Fed) higher. As a result, real US rates have been climbing.

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I expect the rise in long-term rates in the U.S. will be contained, given several factors, including demographic trends and institutional demand for long-term, high-quality bonds. But the fact that US rates, both long- and short-term, are rising while rates are falling in much of the rest of the world has a number of implications for investors.

Market Realist – Much of the data today reinforces the fact that the US economy (VTI) is registering decent economic growth. The economy is now far removed from the afflictions of the US financial crisis (XLF) (IYF) of 2008, even though the data remains mixed. The above graph shows the monthly additions to US non-farm payrolls over the past year.

According to the BLS, job additions surged in October, growing by a robust 271,000 and shaking off the cobwebs of the recent slowdown. This marks a sharp increase from September, which showed an addition of 137,000 jobs. The unemployment rate ticked down to 5% in October, its lowest in almost seven years. The U6 unemployment rate ticked below 10% for the first time since the recession, coming in at 9.8% (Source: BLS). The U6 unemployment rate also accounts for discouraged and marginally attached workers and people working part-time for economic reasons.

Wage growth rebounded in October, with average hourly earnings rising by $0.09 to $25.2 per hour. Wages registered growth of 2.5% year-over-year—the highest in almost six years.

The labor market looks robust now, indicating that the US economy (VOO) may indeed be ready for a rate hike.

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Though the manufacturing sector is struggling, the service sector continues to look robust. The ISM manufacturing purchasing managers’ index or PMI came in at a two-year low of 50.1 in October. On the other hand, the ISM non-manufacturing NMI remained strong. It came in at 59.1 for October, up from 56.9 in September. The pace of growth in the service sector was the second-fastest in almost ten years, according to the Institute for Supply Management. Despite mixed data, the US economy looks ready to forfeit emergency-level central bank accommodation.

The Fed may postpone its rate hike timing in light of recent geopolitical tensions plaguing the global markets (ACWI). But there’s no doubt that a hike is coming. The question regarding policy normalization is no longer “if,” but “when.” As the odds of a rate hike continue to rise, investors are relinquishing rate-sensitive US Treasuries (IEF)(TBF). Real US rates have been climbing as a result.

This series explores how rising rates could affect investors and which areas investors need to avoid.

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