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Chart In Focus

High AMO Says Rates Should Stay Low

Chart In Focus
January 19, 2017

The Atlantic Multidecadal Oscillation (AMO) is a bit of data that climate researchers use in their modeling of global climate change.  And it turns out that it has interesting messages for us about the long term trends in interest rates. 

I will spare you all of the details of the AMO’s computation, but you can download the data yourself at NOAA’s web site, and read more about it at this page

What we can see in the chart above is that there does seem to be a relationship between interest rates and global temperatures as modeled by the AMO.  The data on AMO only go back to 1856, so we cannot yet see this relationship through multiple iterations of the 60-year cycle.  To help illustrate this correlation better, I have offset the AMO data forward by 6 years.  Why there is that 6-year lag is not something I can answer.

Climate scientists have long known that there is a 60-70 year cycle in global temperatures and other related data.  And bond market analysts have long known about the 60-year cycle in interest rates.  But these two groups of experts rarely talk to each other, nor look up this period’s other usages throughout the ages.  A quick Google search shows lots of other 60-year periods of interest to people. 

60-year cycles

My understanding is that the basis for the relationship between temperatures and interest rates lies in agriculture.  Warmer global temperatures are better for crop production, lengthening growing seasons and reducing drought length and severity. 

corn yields versus temperatures

Warming periods also seem to reduce the number and severity of hurricanes and other “extreme” weather events (contrary to what VP Al Gore has told you).

ACE Index versus GISS Temperature Index

Having better crop yields means lower food prices, which flows through into other commodities and then generally to the prices of almost everything.  When cooling brings poorer crop yields, that leads to higher food prices, and inflation generally.  That eventually affects interest rates as bond holders adjust their interest rate demands and expectations to reflect the changing inflation picture. 

Readers should understand that this is only true for the really long term trend in interest rates.  There are other factors which act in the bond market on much shorter time scales, and so measures of global temperature changes like AMO are not all that useful as a timing tool.  Here is a zoomed in look at just the last few decades of the relationship between the AMO and interest rates.

AMO versus interest rates

This chart still uses the 6-year forward offset of the AMO data.  There is a lot more noise versus trend strength in the AMO data versus in interest rates, although when meaningful trends develop in the AMO, they usually show up 6 years later in interest rates.

And this point about temperatures and interest rates being related is important now because we have not really seen the cyclical downturn in the AMO which is due according to that 60-year cycle.  Perhaps that is the effect of human influence on the climate system.  Perhaps it is a reflection of natural factors.  Ask me in about 50 years and I’ll give you a more precise answer.

Irrespective of the cause(s) of temperatures remaining aloft, the resulting expectation is that interest rates should remain low (high on this chart’s inverted scaling).  The next big peak for interest rates is due in 2040 according to the 60-year cycle, but seeing global temperatures stay high should mean that we won’t have to see bonds make a start toward that 2040 peak for a while.  Perhaps both will work extra hard to make up for lost time as 2040 gets closer.  High temperatures should mean low rates for a sustained period over the next few years, which will assuredly puzzle the Fed and classical economists who do not understand the real relationship between climate and the economy. 

Tom McClellan
Editor, The McClellan Market Report

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