The unemployment rate is at a cycle low of 5.3 percent, nonfarm payrolls are increasing at over 200k per month, and average hourly earnings are rising — all of which point to the Federal Reserve raises interest rates in September. And yet, long-term interest rates are falling. What gives?
The lower interest rates on 10- and 30-year U.S. bonds reflect a strong dollar and a weak global economy.
Wait, what? Doesn't a strong dollar reflect a strong economy? Not necessarily.
The strength in the U.S. dollar does not just reflect a strong U.S. economy, it also reflects weakness in other economies. The U.S. dollar exchange rate is nothing more than a relative value index — if the U.S. dollar index is up, it could either mean the U.S. economy is strong OR other economies are weak. The current economic environment features a U.S. economy that is chugging along at about 2-percent growth and a global economy that is showing signs of weakness. For example, German industrial production has been falling for most of 2015 and the most recent report (Aug. 7) showed a monthly decline in industrial production.
The drop in German industrial production is a direct result of the Chinese economic slowdown. In fact, this drop was the primary reason JP Morgan cut its outlook for German GDP from a growth rate of3 percent to just 1.5 percent. Viewed in this light, it is clear to see that the strength in the U.S. dollar is a reflection of investors expecting more monetary stimulus from the European Central Bank.
Weak global economy
At the same time the global economy is slowing, the U.S. economy appears to be strong enough to allow the Federal Reserve to extricate itself from the emergency policy stance it has held for six years - this is the so-called Fed "liftoff." Anticipation of such a move is adding to the strength of the dollar and is attracting international investors into the U.S.
And what do international investors buy once they hold U.S. dollars?
Yep, you guessed it ... 10- and 30-year U.S. bonds. It is this international capital-flow dynamic that is driving longer term interest rates lower — and it is this international capital flow that leads me to conclude that if/when the Fed raises rates, long-term yields will continue to fall and the yield may even invert.
Brian Kelly is founder and managing member of Brian Kelly Capital LLC, a global macro investment firm catering to high net worth individuals, family offices and institutions. He is also the creator of the BKCM Indexes, benchmarks for multi-asset money managers. He's also the author of the upcoming book, "The Bitcoin Big Bang: How Alternative Currencies Are About to Change the World." Kelly, a CNBC contributor, often appears on "Fast Money." Follow him on Twitter @BKBrianKelly.