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The Economy is Picking Up, But Bond Yields Are Falling—What’s That About?

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RANDY FREDERICK: Corporate earnings, the labor market, even GDP growth are all doing quite well—yet bond yields have been coming down. Kathy Jones joins me for the September 11 Schwab Market Snapshot to give us her take on the apparent disconnect between the fixed income markets and the economy.
 
So, Kathy, as I just mentioned, it seems like the economy is doing really well, in fact, it might even be getting better, and yet lately, we’ve seen bond yields come down. What is that all about?
 
KATHY JONES: It’s really all about inflation, Randy. Bond yields track inflation much more closely than almost any other factor. And, right now, by most measures, inflation is running at about 1½ %. And it’s not just in the U.S.—it’s falling globally.
 
And despite that, though, we think that there’s still a chance that the Fed could raise rates later this year at the December meeting. And, don’t forget, they are still tightening policy via the balance sheet reduction that’s going to start probably in October.
 
RANDY: Well, since you mentioned the Fed, we’ve talked in the past about how many vacancies there are at the Fed, and yet just last week Vice Chair Stanley Fischer announced that he’s going to be leaving in October before his term is up. What are the implications of that change?
 
KATHY: Well, it leaves a lot of openings at the Federal Reserve right now. Currently, there are three out of the seven seats at the Board of Governors are open. And when Fischer leaves that will mean four out of seven, and if Yellen leaves after her term expires early next year, that would be five out of seven. So it would be really down to a small number of people.
 
Now, there is one nominee, Quarles, for the regulatory positon, and his nomination is working through the system, so that will fill one of those seats, most likely. But it opens up the possibility of a whole new view of how the Fed conducts policy and regulation. One of the things we know about the administration is that they favor less regulation. Quarles has said that he favors less bank regulation, or rolling back some of the regulations that have been put in place.
 
So I think the only assumption we can make right now is that nominees will likely be in favor of reduced regulation of the banking system. But other than that, it’s a whole new world at Central Bank.
 
RANDY: Yeah, it will be interesting. You know, another trend that’s happened lately, kind of shifting gears here a little bit, is that the dollar has been losing ground for a really long time. Normally, when the Fed is hiking rates the dollar goes up, but instead, it’s been coming down. Why has that been happening?
 
KATHY: It has been an unusual move year-to-date with the dollar falling against the basket of currencies by about 10%. Now, that’s after it increased by 30%. I think that a number of factors came into play. We didn’t get the growth in the first half of the year that we expected to get from fiscal stimulus like tax cuts and infrastructure spending. Those have been postponed or pushed back.
 
And, also, we’ve seen stronger growth abroad. Europe, even Japan, is growing more strongly, so that’s shifted people’s expectations about what those central banks will be doing. But having said that, after the decline year-to-date, I think that the dollar has gone pretty far pretty fast in this correction, and it may be due for a rebound from current levels.
 
RANDY: Great. Kathy, thank you so much for that information. We’re out of time.
 
Listen, if you want to read more from Kathy, you can do that in the Fixed Income and Insights section of Schwab.com, and you can follow Kathy on Twitter @KathyJones. And, of course, you can always follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.

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