According to Goldman Sachs Group Inc. Analyst Elad Pashtan, elevated levels of economic policy uncertainty following the Brexit vote and the run-up to the U.S. election belie what has actually been an increasingly rosy outlook (based on survey and market-based metrics) for the American economy, interest rates, and inflation.
In a note published on Wednesday of this week, Pashtan says that “Measures of option-implied interest rate volatility—a proxy for interest rate uncertainty—have fallen meaningfully in recent months.” Prices of the one-year options that give investors the right, but not the obligation, to enter into a two-year or 10-year interest rate swap have been trending downwards after February’s bout of market turmoil, implying that daily interest rate volatility has slipped to “remarkably low” levels.
Pashtan cautions that other factors, namely, “structural shifts in hedging demand,” may be influencing the drop-off in swaption volatilities, but since the factors that drive interest rate volatility are broadly similar to those that drive the absolute level of interest rates, the fall in swaption prices reflects increased confidence in the macroeconomic outlook.
This hypothesis is supported by the strong consensus among analysts’ forecasts for how inflation and economic growth will unfold in the U.S. over the next year. Pashtan notes that the standard deviation among those surveyed by Consensus Economics “are at or near historical lows.”
Estimates of the year-ahead three-month Treasury yield forecast — a proxy for how much analysts expect the Federal Reserve to raise its policy rate — have also been converging.
Pashtan writes that these trends are “partly explained by the decline in economic uncertainty” as experts anticipate that the Fed “is less likely to surprise investors with unanticipated hikes and/or cuts. However, explicit policy rate guidance—whether through the Summary of Economic Projections (SEP) or communication that any rate increases will be gradual—may also be playing a role.”
To a certain extent, however, such clustering is a function of the degree to which a lower-for-longer environment narrative has become entrenched in markets. When the ceiling for variables like growth and inflation come in, it makes intuitive sense that the standard deviation amongst forecasters drops.
But perhaps the best proof that the U.S. economy isn’t currently wrestling with an uncertainty shock lies in hard data provided by September’s retail sales numbers. “So, people are eating out (up 0.8 percent month-over-month), renovating their homes (1.4 percent), and buying cars (1.1 percent) – two months before the election,” writes Neil Dutta, head of U.S. Economics at Renaissance Macro LLC, sarcastically adding, “Yup, lots of election related uncertainty delaying discretionary spending.”