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A possibly problematic U.S. yield curve and lessons to be learned from Australia

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Alex Carrick

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Alex Carrick is Chief Economist for CanaData, Reed Construction Data’s Canadian economic forecasting and statistical service.

Economists

The compromise that President Obama has reached with the Republicans on taxes is playing out in U.S. interest rates in interesting ways. It is one among several factors working to raise U.S. long-term bond yields. This article also contends that Australia’s economy has much to teach Canada about the changing world order.

The compromise that President Obama has reached with the Republicans on taxes is playing out in U.S. interest rates in interesting ways. At 3.25%, the benchmark 10-year Treasury note has climbed to its highest level in six months. The agreement will extend the Bush-era tax cuts on rich and poor alike for two years, lower the payroll tax by two percentage points and lengthen benefits for the long-term unemployed by 13 months. These measures combined will provide additional stimulus for an economy that has been reporting better numbers of late anyway. For example, initial jobless claims for the week ending December 4 were 421,000, a decrease of 17,000 from the previous week’s revised figure of 438,000. The benchmark level for first-time jobless claims is 500,000. Below half a million, more people are being hired than are being newly released from their positions. The figure of 427,000 is quite encouraging with respect to overall employment. The lowest number post-recession so far has been 410,000 in the week leading up to the Thanksgiving Day holiday. The only other time the level has been as low in the past two years was the same 427,000 for the week ending July 10. In the latest week, the largest declines in initial jobless claims occurred in Texas (-8,742), California (-8,320), Florida (-7,027), Georgia (-5,823) and North Carolina (-4,171). Enthusiasm concerning better growth prospects has caused investors to move out of bonds and give greater weight to equities. The drop in demand for bonds has lowered their price, sending rates higher. In resale markets, the yield from a bond moves in the opposite direction to its price. There have been several other factors working to raise long-term bond yields. Given an improved expectation for U.S. real (inflation-adjusted) gross domestic product (GDP) growth in 2011 – some analysts are upping their forecasts to +4.0% from +3.0% - the Federal Reserve may not feel the need to carry out the full extent of its $600 billion addition to the money supply. Scaling back the monetary pump priming would also lower the demand for long-term bonds, again taking the pressure off prices while providing a lift to yields. Finally, there is the question of the international community’s views on the latest U.S. government moves. Washington is taking a direction opposite to nearly every other nation. It is expanding its deficit at a time when austerity has become the byword of the public sector in most sovereign states. To the eyes of the world, the U.S. does not appear to be seriously tackling its 1.3 trillion deficit. Worry on this front may cause international investors to demand higher U.S. interest rates if they are to be enticed into holding more of America’s debt. This will place Washington in a bind. When long-term bond yields rise, there is a corresponding increase in the cost of deficit financing, making it harder for government to pay back its borrowings. At the short end, Canadian interest rates are higher than in the U.S. The Bank of Canada’s overnight rate stands at 1.00% while the Federal Reserve’s key policy-setting rate is in a range of 0.00% to 0.25%. But the rate on U.S. 10-year notes has now marginally surpassed what Ottawa has to pay over the same time frame. Relative levels of interest rates, particularly at the short end, between Canada and the U.S. have contributed to the Canadian dollar moving up to parity with the U.S. greenback. There is another country that traditionally has a currency valued well below the U.S. dollar, but which has seen a dramatic shift to parity with the greenback, the “land down under.” Australia’s economy has much to teach Canada about the changing world order. The two countries bear many similarities. Most notably, they have small populations concentrated in a limited number of large urban areas while vast expanses of land are given over to resource development. The population of Australia is approximately two-thirds that of Canada, 21.5 million versus 34 million. The raw material extraction that is taking place mainly in Western Australia is being shipped to the Chinese marketplace. Canada’s trade ties, while slowly shifting eastward, continue to have a mostly north-south orientation. In 2008-2009, Australia never really fell into recession. The Reserve Bank of Australia (RBA) was one of the first globally to raise interest rates after the world slowdown. The RBA’s benchmark interest rate now stands at 4.75%. Australia’s employment gain in November was +55,000, causing the unemployment rate to fall to 5.2%. In Canada the jobless rate is 7.6% and in the U.S., 9.8%. The latest reading on Australian inflation is +2.8% year over year, which is somewhat elevated but still within reason. There is an ongoing debate in Australia about possibly too much attention being paid and too many concessions going to the giant resource firms. In fact, a proposal to place an onerous super-tax on mining companies’ extraordinary profits brought down a Prime Minister. Nevertheless, if a low jobless rate is taken to be a top priority for success, then Australia has to be considered a winner. Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.

by Alex Carrick

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