“Trade War with China in Aisle 12”
This was the headline for a WSJ article that expands the impact trade tensions are having not just on global trade, but also financial markets. The fight with China might soon involve Walmart, Best Buy, and Costco because the escalating tariffs are moving from goods bought by businesses to consumer goods like electronics, food, tools, and housewares. Though the recently proposed $200 billion in tariffs are lower at 10% than the 25% rate on the original $36 billion of goods, they will have more impact on prices paid by consumers, possibly stoking inflation.
The impact on financial markets is most evidenced in products like the benchmark ten-year Treasury note, which continues to attract buying interest as a safe-haven trade. It ended the week at 2.83%, virtually unchanged week to week, and 14 bps lower than when the Fed last raised rates on June 13. Continued demand for it was seen in last week’s $22 billion auction where 67% of the awards went to indirect/foreign bidders. This was the strongest of Treasury’s three term auctions and further flattened the 2/10 curve; flatter at +25 bps from +98 bps at this time last year. Further evidence of this skewed demand was the tepid reception for last week’s $33 billion three-year note that was positioned primarily by dealers.
It’s not just outright buying of ten-year Treasuries that is driving this trend; the volume of trades in ten-year call options, which benefit when yields fall, has risen as investors seek insurance over worries about escalating trade friction. Over 7.7 million of these contracts traded in June, providing protection against falling yields. Positions in Treasury futures contracts, another way for portfolio managers to protect against lower yields, are near the all-time high set earlier this year. Taken together, this trend reflects market concern should proposed tariffs actually be put in place.
Other developments last week were:
The Week Ahead
Fed speak is confined to Chairman Powell, and economic reports are relatively light.
Monday - Treasury sells $96 billion in three and six-moth maturities; Retail Sales expected to show strong consumer demand. President Trump meets Vladimir Putin in Helsinki.
Tuesday – Treasury sells $26 billion one-year Bills; Industrial Production forecast to be -0.1%.
Wednesday – Chairman Powell testifies before the House Financial Services Committee.
Thursday – Treasury sells $13 billion ten-year Treasury Inflation Protected Securities (TIPS).
** An indication of how flat the curve really is – one-year T-Bills are yielding 2.34%, just 49 bps less than the ten-year Note.
Where to Start?
Last week saw:
Concerning the rates market, only trade tensions are having an impact. Friday introduced $34 billion in tariffs on 818 different Chinese product categories, with an additional $16 billion to be targeted in coming weeks, and possibly another $200 billion if China were to retaliate, which they have said they would. The impact of a trade war will not be identifiable for some time, but with domestic stock markets +3.5% YTD on average, Chinese markets are -16.9%.
Friday’s strong jobs report of +213,000 included:
The Week Ahead
Fed speak, inflation data, and Treasury sells $159 billion in debt
Monday – Treasury sells $90 billion short-term Bills
Tuesday – Treasury auctions $33 billion three-year Notes
Wednesday – Producer Price Index expected to be 0.2%; Treasury auctions $22billion ten-year Notes
Thursday – Consumer Price Index expected to be 0.2%; Treasury auctions $14 billion thirty-year Bonds
The Trend Continues
Trade tensions continue to dominate markets, keeping stocks in check and Treasury debt well bid in a risk-off trade that further flattened the Treasury curve by 12 bps since the 504-program priced 2018-20F on June 7. This performance creates an artificial value for the benchmark ten-year Treasury, forcing credit spreads wider to compensate for the enhanced worth of the benchmark.
“Might China Weaponize its Treasury Holdings”
That was the theme of a WSJ article that suggested China might respond to trade tariffs by not only retaliating with tariffs of its own, but also flood the market with some of its $1.18 trillion portfolio of Treasury debt. The answer is – not likely, as it would be counter productive for its global trading.
This trade imbroglio can slow global growth and that is why the benchmark ten-year Treasury has declined from 3.11% in May to 2.86% on Friday, reflecting the market’s concern for continued economic growth that is already evidenced by the S&P 500 index down 4.5% from its January high.
Fear of an escalating trade war has resulted in investors pulling $29.7 billion from equity funds in the week ended June 27, the second largest weekly outflow since the beginning of the millennium. Showing that it is not just the ten-year Treasury that is seeing increased demand, Bank of America Merrill Lynch reported allocations to Treasury bills among its private clients has surged to a 10-year high. The yield on the 3-month T-bill is 1.925%.
Inflation Target Hit - Twice
The Week Ahead
Economic data is focused on manufacturing, June’s jobs report, and the 504 program prices its first 25-year debenture.
Monday – Institute of Supply Management report is expected to remain elevated
Tuesday – Factory Orders expected be -0.1%
Thursday – SBA 504 program prices 10, 20, and 25-year debentures; minutes of the June 13 FOMC meeting are released
Friday – Non-Farm Payroll consensus is 190,000, with the unemployment rate unchanged at 3.8%, and average hourly earning increasing to 2.8%
More of the Same
Stocks weakened (DJIA had its worst week since March), trade tensions increased, and US Treasuries are firmly entrenched in a safe-haven trade. The benchmark ten-year Treasury still resists the Fed’s tighter monetary policy and the slope of the Treasury curve continues to flatten – another 8 bps since the 504-program priced 2018-20F just three-weeks ago.
Sharing the wealth, or pain as it is, President Trump on Friday announced trade tariffs against an entity other than China, imposing a 20% tariff on European Union car imports. That had the expected effect on the zone’s car makers, sending their stock prices lower and enhancing the value of, and demand for Treasury debt. This demand is opportunistic for Treasury as it continues to fund an increased deficit that was enlarged by recent tax cuts and has yet to be affected by proposed infrastructure spending.
Lurking in the background is an item that has already challenged municipal pension funds – accounting for retirement obligations, and the government is not exempt. Social Security manages two accounts, old-age and survivors benefits and another for disability benefits. The program has had a cash deficit each year since 2009 but the deficit was masked by interest income - until now. The system holds much of its investments in non-tradeable Treasury debt, essentially reducing the government’s funding cost, but at the same time being hampered by a low interest rate environment. Unless changes are made to the system – either increased payroll taxes or reduced benefits to future retirees, only 79% of projected benefits will be covered by 2030.
The Week Ahead
Fed speak, with Treasury to sell $206 billion in debt in a week light on economic data (some housing releases) but including the Fed’s preferred inflation indicator, Personal Consumption Expenditures on Friday, and it has a chance to hit the 2.0% target.
Monday – Treasury sells $90 billion in short-term Bills
Tuesday – Treasury sells $34 billion 2-year Notes
Wednesday – Treasury sells $36 billion 5-year Notes and $16 billion 22-month FRN’s
Thursday – Treasury sells $30 billion 7-year Notes
Friday – Personal income & Outlays; Personal Income forecast to be +0.4% with Core PCE +0.2% ex food & energy and 1.9%-2.0% YTD ex food & energy
Trade Tensions – “Buckle Up”
According to a WSJ article, that was the advice from a Chinese official to American executives in March when discussing simmering trade tensions. With the Trump administration announcing 25% tariffs on $50 billion in Chinese goods, China has said it would retaliate in “equal scale and equal strength.” The result is continuation of a safe-haven trade in Treasuries that keeps flattening its 10-year/2-year curve with the benchmark ten-year Note declining to 2.92% even after the Fed announced its most recent rate increase on Wednesday.
That represents the seventh rate increase since December 2015 and the Committee indicated it expects to raise rates twice more before year-end, and four times in 2019. The current range for Federal Funds is 1.75%-2.0% and if the intended path is maintained the upper end of the range will be 3.5% before year-end 2019.
Seemingly overlooked last week was the historic Singapore Summit that is expected to denuclearize North Korea and end economic sanctions. President Trump cut short his visit, details have been sketchy, and skepticism abounds. Other items of interest:
Economic reports were mixed with Retail Sales coming in double expectations at +0.8% and Industrial Production declining -0.1%. The week’s two inflation indicators continue to show strength ex food & energy: CPI was +0.2%/2.2% y/y, and PPI was +0.3%, 2.4% y/y. In his press conference Chairman Powell reemphasized the Committee’s focus on Personal Consumption Expenditures as their preferred gauge of inflation, stating it is expected to rise from its current 1.8% rate.
The Week Ahead
Fed speak resumes with the blackout period ended, Treasury sells $116 billion short-term Bills and $5 billion 30-year TIPS. The economic calendar is light with some housing data and a Purchasing Managers Index late in the week.
The G-7 meeting in Canada had enough trade tension even before President Trump recommended the group revert to being the G-8 by readmitting Russia, which had been expelled in 2014 for its annexation of the Crimea. The only support for this provocative idea came from Italy’s newly appointed Eurosceptic Prime Minister, Giuseppe Conte. Then, before departing for Singapore he refused to sign a previously agreed upon statement, further disrupting his relationship with major trade partners.
Markets mostly marked time, with the rates market flat, stocks, and the US$ slightly improved, and oil softening in advance of increased OPEC production.
The SBA 504 program priced its June 20-year debenture at 3.60%, an Effective Rate for small business borrowers of 5.32%, which is just 70 bps above Prime Rate, a measure that is expected to increase this week. As the rates market has responded to a tighter and ongoing monetary policy, and the Treasury curve has flattened, investors have demanded more spread for credit product. This increased pricing spread to Treasuries has been offset by the flatter Treasury curve as evidenced by the SBAP 2018-20F rate being 78 bps higher than the 2015-20L debenture rate of 2.82%, with the Fed having raised short-term rates by 150 bps since December 2015.
The Week Ahead
Is one of the busiest of the year: the North Korea-USA summit, the Federal Reserve Bank, European Central Bank, and Bank of Japan make policy announcements, and the World Cup begins. Fed speak will be focused on the Chairman’s press conference and Treasury will auction $158 billion in debt prior to the FOMC meeting’s conclusion.
Monday – Treasury to sell $90 billion in short-term Bills, $32 billion three-year Notes and $22 billion ten-year Notes. The on again, off again summit between President Trump and Kim Jong Un takes place in Singapore at 9:00 pm ET.
Tuesday – Treasury auctions $14 billion thirty-year Bonds; CPI expected to be +0.2%; 2.2% y/y. FOMC meeting begins.
Wednesday – PPI expected to be +0.2%; 2.5% y/y; FOMC announcement expected to include a rate increase to 1.75%-2.0% for Fed Funds, followed by the Committee’s economic forecasts and its dot-plot of interest rate projections, and then the Fed Chairman’s press conference.
Thursday – Retail Sales consensus is +0.4% and Russia hosts Saudi Arabia in the opening game of FIFA’s World Cup. European Central Bank is expected to identify the status of its €30 billion monthly bond buying program.
Friday – Industrial Production is expected to show a gain of just 0.1% and the Bank of Japan affirms its monetary policy.
A Short Week, Long on Angst
A safe-haven trade that saw ten-year US Treasuries rally as low as 2.78%, saw them reverse that move into a strong Non-Farm payroll report on Friday.
The Week in Review
Europe factored greatly in market performance as Italy, led now by a pairing of the anti-establishment Five-Star movement and the far-right League, eventually put together a government. Joining them was Spain with a vote of no confidence in Prime Minister Mariano Rajoy, who became the first Spanish prime Minister in the country’s democratic history to be removed by parliament. The Italian issue though is not going away as many challenges await the new government. As the Euro zone’s fourth largest economy it is plagued by low productivity and high sovereign debt, making it difficult to enact planned social changes. Not exactly a replay of Greece, but a challenge to the EU.
On the domestic front the US announced tariffs on steel and aluminum imported from the EU, Canada, and Mexico, some of our closest allies and largest trade partners. That immediately resulted in reciprocal tariffs which will challenge global trade.
Stocks cratered early in the week when the safe-haven trade in Treasuries was strongest, then recovered as it seemed the European political unrest was abating and were further helped by Friday’s report of the 92nd consecutive gain in employment; 223,000 jobs created with upward revisions to previous months. Highlights of the report were:
Other economic releases did little to discourage the probability of a June 13 rate increase by the Fed: 1QGDP was revised lower to 2.2% and the FOMC’s preferred inflation indicator, Core PCE, increased 0.2%, making its y/y gain 1.8%. Whether the Committee increases rates twice or three times more in 2018 is not that relevant, what is important is the total number of hikes through 2019. With the end of Quantitative Easing and the introduction of a tighter monetary policy, it is interesting to note how the SBA 504 program’s funding for 20-year debentures has changed in 4 ½ years:
December of 2013 was the tail-end of the taper tantrum that took place in anticipation of the Fed raising rates. The 150 bps increase in the FF rate has flattened the Treasury curve by 220 bps, increasing the borrowing cost of small businesses by 12 bps. The Fed is committed to gradually raising rates and the program’s funding costs will increase, but if the curve continues to flatten it is probable that future funding costs will not increase as much as short-term rates.
The Week Ahead
A light week for economic reports and no Fed speak as we enter a blackout period in advance of the June 12-13 meeting. Treasury supply is limited to short-term T-Bills and credit supply will be $900MM of a 15-year FRE, and the 504 program’s 2018-20F debenture sale.
Monday – Factory Orders expected to decline 0.4%, based on last month’s Durable Goods report
Tuesday – Institute of Supply Management forecast to gain 1.2 points to 58
Thursday – SBAP 2018-F is priced, for settlement June 13
The rates market last week shrugged off a heavy financing calendar, instead embracing modest economic releases, the geo-political tensions resulting from the uncertainty about the North Korea summit, the undefined status of announced tariffs, and some ambiguous inflation comments in the FOMC minutes. The result was a return to safe-haven trades in Treasuries and gold.
Risk aversion was also present in Europe as political instability in Italy and Spain produced selling of their sovereign bonds with some European bank shares declining as much as 7.5%. For the Euro zone that means German bunds attracted demand, with that ten-year maturity declining to 0.39%, 254 bps less than US Treasury debt.
This chart reflects the six-month rise for ten-year Treasury yield and its recent downturn toward its 50-day Moving Average, a level that should provide resistance as the Fed continues its tightening monetary policy.
Expectations are for two and possibly three more rate increases this year, with the next one projected for the June 12-13 FOMC meeting. The released minutes from May affirmed the Committee’s objective to maintain a course of gradual rate hikes, but did caution about “the possible adverse effects of tariffs and trade restrictions” on the economy. The incongruity of low unemployment and steady economic growth vs. persistently low inflation and global tension will keep markets offsides until there is more clarity.
The Week Ahead
Treasury auctions just $130 billion in short-term Bills, more Fed speak, plus some important economic releases.
Tuesday – Treasury auctions $130 billion in four-week, thirteen-week, and twenty-six-week T- Bills.
Wednesday – second estimate for 1Q18 GDP expected to be unchanged at 2.3%.
Thursday – Personal Income & Outlays forecast to be unchanged at 0.3% with the Fed’s key inflation indicator, Core PCE, expected to be 0.1%, reducing the y/y rate to 1.8%.
Friday – Non-Farm Payroll expected to increase to 185,000 with the Unemployment Rate unchanged at 3.9%, and average hourly earnings expected to increase 0.3%.
Rates Move Higher
The benchmark ten-year Treasury note cracked 3.0% and held above that level because:
The primary answer is probably market momentum, as investor confidence in the US economy supports the path to higher interest rates with at least two, and possibly three more rate hikes expected this year. At 3.06% CT-10 is at its highest level since 2011 while the shape of the Treasury curve has been flattening three-month Treasury Bills to now yield 1.89%, matching the trailing dividend yield for the S&P 500 Index.
While the US$ is up 4% since mid-April, countries that have been hit hardest by its strength, like Argentina and Turkey, are not big holders of Treasuries and unlikely to have been sellers. In fact, Argentina was able to rollover $250 billion of US$ denominated debt last week.
Domestically, the market easily digested this month’s quarterly refunding supply, and now must prepare for $231 billion of Treasury debt this week, with more to come as Treasury needs to fund the government’s deficit. This supply, and investor’s demand, will be linked to Fed policy as we approach the June 12-13 FOMC meeting.
Another development reflecting the balance of supply and demand was the impact of the Iran nuclear deal giving the price of oil a boost. Brent crude closed the week at $78 as the expected increased supply from Iran was cancelled, while OPEC and Russia continue to withhold 1.8 million barrels of oil a day. Reduced supply has given this commodity additional strength leaving global producers uncertain about maintaining this price level.
One report lacking in strength was Euro area growth being 0.4%, with Germany even lower at 0.3%, growth levels that are keeping global sovereign debt yields significantly lower than the US.
Bank loans are showing a 3% y/y rate of growth but that is far below the double-digit growth in the 2014-2016 period. Hedge funds, private-equity firms, and insurance companies are providing the competition and the first two categories exist in a lightly regulated environment.
Bill Demchak, CEO of PNC Financial Services Group, says he expects financial technology, or fintech, firms operating online to affect his bank’s small business lending: “fintech has decided to make things very simple for small business and to do it with a very low-cost base.”
The Week Ahead
There is a lot of Treasury supply and Fed speak, with Jerome Powell scheduled to talk on Friday. A light economic calendar will focus on housing data, Durable Goods, and the release of Fed minutes.
Monday – Treasury auctions $90 billion short-term Bills
Tuesday – Treasury auctions $26 billion 52-week Bills and $33 billion two-year Notes
Wednesday – Treasury auctions $16 billion 23-month Floating Rate Notes and $36 billion five-year Notes. Minutes of the FOMC meeting ended May 2 are released
Thursday – Treasury auctions $30 billion seven-year Notes
Friday – Jerome Powell speaks
“Energized” – an apt header for this WSJ chart, showing how the energy sector, +3.8% on the week, led the equity markets to their best performance since March after President Trump delivered on his promise to pull the US out of the Iran nuclear agreement.
As robust as equities were, the Treasury rates market held ground after softening after the quarterly auction of three-year Notes on Tuesday. Performance improved after Wednesday’s soft Consumer Price Index report showing core CPI up just 0.1% in April, 2.1% y/y.
By the time the SBA 504 program’s May debenture sales were priced on Thursday, benchmark ten-year Treasury Notes had stabilized but were trading 14 bps higher than in April, with Swap spreads and credit spreads wider. Those wider spreads reflect the continued flattening of the Treasury curve, as expressed by the spread between the Treasury two and ten-year maturities. At +43 bps it is the flattest since September 2007.
The above chart identifies the impact of the six rate increases since December 2015 as the economy continues on its ninth-year of economic expansion. Issue size for 2018-20E, at $375,113,000, was the largest since July 2013 while its 3.5% debenture rate was the highest since 3.46% in January 2014.
Expectations are for two more rate increases this year with the next one perhaps occurring at the June 12-13 FOMC meeting.
The Week Ahead
Fed speak and headline news will dictate activity, with light traffic in economic reports and mostly short-term Treasury supply.
Monday – Treasury auctions $90 billion short-term Bills
Tuesday – Retail Sales expected to be 0.3%, following weak consumer spending in 1Q18
Wednesday – Industrial Production forecast to be 0.6%, with increased Capacity Utilization
Thursday – Treasury auctions $11 billion ten-year TIPS (Treasury Inflation Protection Securities), currently yielding 0.81%
The benchmark ten-year Treasury Note showed signs of climbing back to the 3.0% level mid-week but stabilized after the FOMC meeting concluded with no rate change, and then closed the week unaffected by Friday’s Non—Farm Payroll report.
The Week in Review
Monday’s release of the Fed’s preferred inflation gauge was as expected, showing the core rate for Personal Consumption Expenditures increasing to 1.9% y/y from the previous month’s 1.6% reading. That puts this indicator very near the Committee’s target of 2% but did little to encourage analysts who expect more than three rate increases this year.
With no change in policy the Fed identified their approach to inflation as being symmetric, meaning they can envision accepting an inflation rate above 2% without increasing the pace of rate increases.
Also helping the market was Treasury’s release of its quarterly funding plans, with an emphasis on increasing the size of shorter-term issues to fill its increased need. An additional $27 billion is needed for the quarter, raising all auction sizes with 2 and 3-year maturities being increased the most.
Friday’s NFP report came in below expectations at 164,000 with the Unemployment Rate declining to 3.9%, its lowest level since December 2000. Low is the best description for many economic readings; not only the Unemployment Rate but also wage growth (below forecasts at 2.6%) and also GDP in 1Q18 at 2.3%.
European Union inflation continues to disappoint, with its recent CPI report showing a 1.2% rate, with its core reading just 0.7%.
This WSJ chart shows how all unemployment categories from Friday’s report continue to improve.
The Week Ahead
There are few economic reports, lots of Fed speak, the Treasury’s quarterly refunding for $163 billion, and Thursday’s May debenture sales for the SBA 504 loan program.
Monday – Treasury auctions $90 billion short-term Bills
Tuesday – Treasury sells $31 billion three-year Notes
Wednesday – Treasury sells $25 billion ten-year Notes. At 2.95%, this benchmark is 13 bps higher than when 2018-20D was priced last month
Thursday – DCPC 10C and 20E are priced, and Treasury sells $17 billion thirty-year Bonds
Well, the 10-year treasury note yield finally did push above the psychological 3% barrier, touching an intra-day high of 3.03% on Wednesday. So take a guess at where the yield ended on the week? If you guessed hardly changed, you’re a winner. On Friday afternoon the yield was 2.96%, up just one basis point on the week. People who follow the charts had designated 3.05% as the more significant level and of course the yield fell short. For the rest of us non-star gazers, the focus was on 3%, and the market was not roiled much once that barrier was breached. Perhaps we are in for a period of consolidation.
Over the last couple of weeks we’ve been stressing among other things the deterioration of supply technical conditions in the treasury market. The combination of rising treasury supply from a growing U.S. budget deficit, and the desire by global central banks to pull back on purchases of government securities, means non-central bank buyers will need to pick up the supply slack. Along those lines, there was an article of interest in Bloomberg last week that discussed the rise in oil prices and foreign assets held in portfolios among the oil-producing nations. Chart 1, below, shows the price of Brent crude oil since 2006 (white line). Notice the recovery in the price of oil starting from the beginning of 2016.
Also on the chart, over the same time frame and shown in a blue line, is the level of net foreign assets for the Saudi Arabia Monetary Agency. We can see the net foreign assets started a fairly steep decline of over $1 trillion since the collapse in oil prices that started in 2014. But the level of assets has simply bottomed out and not started to recover. A useful question is, with the increase in the price of oil will the Saudis and other oil producers start putting petrodollars back to work in the liquid asset markets, such as treasuries, in order to build up foreign asset portfolios? If so, such activity would offer some needed supply support for treasuries and helped dampen a further rise in yields. It will be interesting to see what develops on this topic.
There was a good bit of economic data released during the week and in general it was stronger than expected. Stronger data included existing home sales, new home sales, headline durable goods and a first look at Q1 GDP growth. The Employment Cost Index came in a bit higher than expected. But the GDP price index posted a 2% y/y increase, which was not alarming.
This week data releases will be anchored by Friday’s employment report for April. Prior to that, on Wednesday, the FOMC will make a monetary policy announcement. Expectations are for the FOMC to stay on the sidelines this month before boosting the target rate at the June meeting. Market expectations are for two to three rate hikes over the balance of the year, and this is in line with FOMC guidance.
Last week interest rates rose, particularly in longer maturities, on a global basis. Chart 1 below shows the Bloomberg Global Aggregate yield index nearing a four-year high. This chart looks similar to a yield chart for the benchmark treasury 10-year note.
While there was some supply indigestion from overseas government bond auctions, another reason for the yield increase was evidence of price pressures related to the Trump metals tariffs. For example, the Philadelphia Fed index of business activity, released last Thursday, showed that prices paid by businesses increased to a seven-year high. Prices received by businesses increased to a 10-year high. In the Fed Beige Book, released last Wednesday, the topic of tariffs was raised by all districts reporting. In some cases tariffs had a “dramatic” impact on aluminum and steel prices due to stockpiling.
In the bond market, we can see the ramifications of this activity by looking at the inflation rate swap for five years in five years (the “five-in-five”). This is a swap contract that takes a position on the rate of the CPI in five years, over the succeeding five years. As we can see in Chart 2, this forward inflation level (blue line) reached 2.3% last week, near the top end of the range over the last three years.
In the same chart (red line) we also show the yield for the benchmark 10-year treasury note. Last week that yield approached the 2.95% year-to-date high. We can see that the note’s yield spread to the five-in-five inflation rate has expanded since the Fed started regular hikes in the target Fed funds rate in 2017. But the additional yield offered over the five-in-five inflation rate, not even 70 basis points, is quite skinny by long-term historical standards. Before the financial crisis, a spread of 200 basis points would have been considered a reasonable spread to be paid over expected inflation. Perhaps 200 basis points of spread is not required anymore with this post-crisis low inflation mentality among investors, but compensation of under 100 basis points certainly seems too lean.
Chart 2: T-note Spread to 5-in-5 Inflation Rate Jumped When the Fed Started Regular Hikes in 2017
The recent gain in the yield on the 10-year note shows signs of having been technically overdone. The stockpiling of metals by U.S. businesses could be a short-term phenomenon and industrial commodity prices will settle down. That could provide some relief of rising inflation expectations, which would support an opportunity for the yield to retrace a bit of the recent rise.
In the bigger picture, however, years of unprecedented purchases of government securities by the major central banks, combined with expectations for below-average global inflation, has had a lot to do with why long term U.S. interest rates have remained so low for so long. Central banks are still providing a lot of accommodation, but the Fed is finished adding to its portfolio. The ECB and the Bank of Japan are trying to reduce stimulus. The ECB is expected to announce the end of QE sometime this year and the BOJ has slowed bond purchases for over a year now. There is a growing U.S. budget deficit that must be funded by issuing more new treasuries across the yield curve each month.
The supply technicals that have supported extremely low interest rates for years finally have eroded. That said it is a time of periodic chaos and sustained volatility in U.S. political leadership. This will continue to provide an itchy bid for liquidity, and therefore treasury prices.
This week we will receive some important economic data. The most interesting include purchasing managers’ indices, new and existing homes, durable goods, and the biggest potential mover of the week in the advanced estimate of first quarter GDP.
Last week the risk-on trade made a comeback. U.S. large cap stocks gained 2% and the VIX large cap stock option volatility index fell 15%. Credit spreads were a few basis points tighter and government-guaranteed MBS passthrough spreads a few basis points wider. It was interesting to see the steady decline in expected stock price volatility amid increased geopolitical tensions and domestic political intrigue. It seemed that from the perspective of the capital markets, somewhat de-escalated trade tension between China and the U.S. was more important.
In the benchmark treasury market the monthly offering of three- and 10-year notes and 30-year bonds met with lackluster investor demand. The Street ended up owning the largest share of the auctions since later last year. Of note was a decline in appetite from foreign investors. After setting record high of $3.1 trillion in treasuries held at the Fed for foreign central banks, these investors have recently slowed the pace of purchases. This behavior comes at a time of increased expected U.S. budget deficits courtesy of tax cut and spend policy. The U.S. budget deficit halfway into the current fiscal year stands at $600 billion. Treasury will continue to increase the size of its market borrowings and ceteris paribus the auctions should have to clear at higher interest rates.
Other notable events in treasury-land included PPI and CPI data which supported the story of a gradual increase in inflation, and Fed minutes that supported expectations of at least two more rate hikes this year. That said, the w/w yield increased only several basis points in the benchmark 10-year maturity to 2.83%. The yield curve continued to flatten, however, as the two-year note yield increased 10 basis points to 2.37%. As this week’s chart focus shows below, the slope of the yield curve from 2 to 10 years, at 46 bp, is narrow by past standards, but still quite a bit shy of the inversion signal that has been an accurate forecast for coming economic dark clouds.
This week the economic calendar is full of second tier data including retail sales, housing starts and industrial production. The Fed Beige Book will be released. The Fed speaker of note this week is New York Federal Reserve Bank President William Dudley.
“Stocks Plummet Amid Rising U.S.-China Trade Tensions”
This is the WSJ headline reporting on Friday’s stock market activity as the tit-for-tat tariffs being announced by the US and China have escalated, leaving global markets in disarray. DJIA declined 2.3% (572 points) on the day and its YTD gains have been lost.
The day started innocently enough with a below consensus Non-Farm Payroll report that came in at +103,000, weaker than expected but with some positive components:
Besides pummeling stocks, the US$ weakened and investors returned to safe-haven Treasuries.
That return took place after the 504-program priced its April debenture sale, an event that took place on Thursday after stocks had recovered from previous tariff headlines and the rates market was softening.
Complicating the President’s tweets is conflicting commentary from Administration officials: Treasury Secretary Steven Mnuchin on Friday said there is “potential for a trade war” with China, followed by White House National Economic Council head Larry Kudlow saying the US is “not in a trade war.” However, Mr. Kudlow also admitted talks with China “have not really begun yet,” so markets have little substance to guide them.
Other than the NFP report there was little economic data and the Fed speak was cautionary, expressing confidence inflation would reach 2% and the economy would not overheat.
The Week Ahead
There is more Fed speak, $154 billion in Treasury auctions, and some inflation data, though not the indicator favored by the Fed. Minutes of the last FOMC meeting that raised interest rates are released, and 2018-20D funds on Wednesday.
Monday – Treasury auctions $90 billion short-term Bills
Tuesday – Producer Price Index expected to be +0.1%, 2.5% y/y; Treasury auctions $30 billion three-year Notes
Wednesday – Consumer Price Index expected to be +0.2%, 2.0% y/y; Treasury auctions $21 billion ten-year Notes; Minutes of the March 21 FOMC meeting are released; SBAP 2018-20D funds
Thursday – Treasury auctions $13 billion 30-year Bonds
The Resilient Rates Market
At least part of it is. As we approach the April debenture sale for the SBA 504 loan program, it is clear the market has reacted to the six rate increases by the Fed since December 15, 2015. Short-term rates (Federal Funds), the only ones that the Fed policy makers control, have risen in response to the rate hikes while longer dated maturities have help firm.
The ten-year benchmark Treasury is actually 14 bps lower in yield since the most recent hike on March 21, continuing the curve flattening trend on this chart that dates back to December 30, 2013, two-years before the Fed began its most recent series of rate increases.
The slope of the yield curve is considered an indicator of expectations of future economic growth and inflation. The current flattening is believed to represent continued modest economic growth but potential skepticism for the stock market and inflation.
Here is a table of rates dating back to that December 2013 date, with the current FF rate now even higher at 1.625% than when 2018-20C was priced. It is clear how the 504 program has benefitted from the Fed’s accommodative interest rate policy, and now the flattening curve serves as a benchmark to provide small business borrowers the cheapest source of fixed rate long term debt.
Other market developments that are influencing market performance are a continued weaker US$, rising oil prices, and wider credit spreads as investors demand more spread for product being priced off expensive benchmarks.
The Week in Review
The largest weekly auction of Treasury debt was well received, the important inflation indicator came in as expected, and stocks ended March with the first quarterly loss since 2015. The S&P 500 index was down 1.8%, though less a decline than European and Asian indexes.
The Week Ahead
Treasury sells just $90 billion short-term T-Bills, more Fed speak, the 504 program prices 2018-20D on Thursday, and employment data on Friday.
Monday – Institute of Supply Management manufacturing index expected to decline after the February reported marked a 14-year high.
Wednesday – Factory Orders expected to be +1.5, following up a strong Durable Goods report.
Thursday – the 504 program prices 2018-20D.
Friday – Non-Farm Payroll consensus is +167,000, following two strong months of gains. Unemployment expected to be 4.0%, and average hourly earnings to be +0.2%.
Market Reaction to Wednesday’s 25bps Rate Hike – Meh!
Stocks were unchanged, Treasury rates declined slightly, and US$ strengthened a bit. And then, after the close President Trump announced $50 billion of tariffs against China over intellectual property violations on numerous products. That sent the DJIA down almost 3% (724 points) on Thursday, with the benchmark ten-year Treasury rallying 8bps to close at 2.83%, evidence of a flight to safe-haven trades as gold also strengthened.
Other developments last week included:
Circling back to what the market expected to matter most last week, Fed Chairman Powell provided a departure from past press conferences with both his candor and the brevity of his conference. Mr. Powell indicated he will be guided by the economy’s performance and less by theories and models, not unusual for the first Fed chairman in 40-years without a PhD in Economics. Items included in the release were:
Economic reports last week were constructive, though mostly ignored:
The Week Ahead – Fed speak returns in a holiday shortened week, stock market futures are poised for a rebound, Treasury is conducting its largest weekly sale in history ($229 billion), plus the key inflation indicator:
Monday – Treasury auctions $96 billion short-term Bills and $30 billion two-year Notes
Tuesday – Treasury auctions $24 billion 4-week Bills and $35 billion five-year Notes
Wednesday – the third estimate of 4Q17 GDP expected to increase to 2.7%; Treasury auctions $15 billion two-year FRN’s and $29 billion seven-year Notes
Thursday – the FOMC’s preferred inflation gauge is part of the Personal Income & Outlays report. PI&O is expected to be 0.4%, with core Personal Consumption Expenditures forecast again at 0.2% (1.5% y/y), holding firm below its 2.0% target
Risk Off, for a bit
Markets bounced around last week; bonds rallied and stocks weakened, in response to:
The Week in Review
The result was a down week for stocks and improvement in Treasury prices until late in the week. At that time the market appeared to turn its attention to Wednesday’s Fed announcement, where the Committee is expected to raise their interest rate target by 25 bps. Analysts are also expecting a possible forecast change, increasing the number of expected rate hikes this year to four.
Economic reports were mostly below forecast:
The Week Ahead – will focus on Wednesday’s conclusion of the Federal Open Market Committee meeting, with light US Treasury issuance, and some individual Fed speak on Friday
Monday – Treasury auctions $96 billion in short-term Bills
Wednesday – the FOMC meeting concludes with a 2:00PM Eastern Announcement and Forecast, followed by Jerome Powell’s first press conference as Fed Chairman at 2:30 PM Eastern
Thursday – Treasury auctions $11 billion 10-year TIPS (Treasury Inflation Protected Securities), currently yielding 0.76%
Friday – Durable Goods expected to show an increase of 1.7%, rebounding from January’s -3.7% report
Equities recovered, as seen in this WSJ chart, as President Trump modified his tariff proposals to possibly exempt key US allies. Additional strength was provided by an upbeat jobs report that had no reservations and helped the S&P 500 improve by 3.5% on the week.
The Non-Farm Payroll number of 313,000 was significantly above consensus, with the Unemployment Rate holding at a 17-year low of 4.1%.
The report supports the Fed’s proposed plan for three-rate hikes in 2018, with the first of them expected to be at the conclusion of this month’s meeting on March 21.
Treasury prices had little movement with SBA 504 pricing on Thursday showing a slight improvement in the 20-year debenture rate at 3.20%, and the ten-year debenture rate identified this year’s move higher as it was priced at 3.0%, 45bps higher than in January. This was the first time since January 2010 that this series was priced ≥3%.
Corporate bonds were in the news as CVS sold $4 billion in debt to fund its purchase of Aetna. It was the third largest corporate issue in history, represented by 9 bonds that may face mandatory redemptions if the deal does not close by mid-2019. Other corporate bond news was supplied by the ECB, which dropped its pledge to accelerate its €30 billion a month purchase program if the region’s economy softens. The bank had already trimmed its government bond purchases which are expected to end in September. In its policy statement, the bank held its financing rate unchanged at 0%.
The Week Ahead
Treasury will sell $158 billion in debt, no Fed speak during this blackout period leading up the March 20-21 meeting, and a few economic reports. Interest will focus on the bid to cover ratio for the Treasury auctions, which is at the lowest level for the ten-year series since 2009. This gauge reflects the number of bids submitted vs. the amount sold.
Monday – Treasury sells $96 billion in short-term Bills, $28 billion three-year notes, and $21 billion ten-year notes
Tuesday – Treasury sells $13 billion thirty-year bonds and the FOMC meeting commences
Wednesday –Producer Price Index expected to be 0.2%, 03% ex food & energy and 2.2% y/y. Retail Sales projected to be 0.4%.
Friday – Industrial Production expected to be 0.3% with Capacity Utilization forecast to increase to 77.7%
Trump’s Tweets and Tariffs
It was an interesting week that saw economic reports come in mostly as expected, hawkish testimony from the new Fed Chairman, and the President’s call for tariffs that left the DJIA lower by 4% w/w.
Durable Goods was weaker than forecast at -3.7%; 4Q17 GDP was revised lower to 2.5% as forecast, and core PCE was unchanged at +1.5%.
In his Senate testimony, Jerome Powell hinted at a faster pace of interest rate increases saying the economy has been stronger this year than expected and the Committee would proceed with gradual rate increases to avoid an “overheated economy.” The initial market reactions were to reverse a gain in stocks, send Treasury prices lower, and strengthen the US$. Mr. Powell expects more wage gains this year as the labor market continues to tighten, identified price stability being at the heart of what the FOMC does, and hinted at four rate hikes in 2018, cautioning they would be gradual. That is one more increase than has been identified and set the tone for the rest of the week.
There was nothing gradual though about how equity exchanges traded, with the DJIA reacting sharply to presidential comments about a 25% tariff on steel imports and 10% on aluminum.
Analysts cautioned about starting a trade war that would weaken the President’s business agenda, resulting in job losses. James Bianco, of Bianco Research, identified concern about inflation and an end to what has been an uninterrupted stream of stimulus by central banks, issues that will be aggravated by the tariff talk. Bianco went on to say, “we’re emotionally spent with Trump, we’ve thrown so many shoes at the TV, we’re about out of shoes.”
The Week Ahead
We can look forward to a lot of Fed speak, short-term Treasury Bill auctions, the SBA 504 program pricing its March debenture sales, and Non-Farm Payroll.
Monday – Treasury auctions $96 billion of short-term T Bills
Thursday – DCPC 10B and 20C are priced. Benchmark Treasury yield is opening today close to unchanged from February
Friday – Non-Farm Payroll expected to be around 205,000, with the Unemployment Rate declining to 4.0%, and average hourly earnings at 0.2%, 2.9% y/y
The rates market survived a turbulent week as Treasury auctions were met with tepid demand and the minutes of the FOMC's January 31 meeting were released, signaling the Committee's growing confidence in the economy. Three rate hikes remain in their plans for 2018, with the first expected at the conclusion of their March 20-21 meeting. This WSJ chart shows the 504-program's benchmark Treasury yield closing Friday after the market digested $258 billion in US Treasury auctions at the same level where 2018-20B was priced on February 8.
Also, on Friday the Fed released its semi-annual monetary policy report to Congress, identifying equity prices as still being elevated and offering comment on the recent wage growth report that sparked a rise in Treasury yields. The report said the Fed continues to view wage growth as moderate because it is likely held down in part by the weak pace of productivity growth.
The new Fed Chairman Jerome Powell will testify before Congress as part of this report and while it is expected for him to maintain policy gradualism the markets will be on guard for any deviation from that stance.
There are several reasons why expectations are growing for higher inflation readings: Producer Prices have been reported as growing at 2.5% (a cost that is soon to be passed on to consumers), weak readings from last March & April will soon drop off the y/y calculation, and the larger than expected Government spending plan announced after the Fed's last meeting is viewed as potentially spurring stronger economic growth. No change in the Fed's preferred inflation gauge, Personal Consumption Expenditures, is expected this week, leaving it at 1.5% y/y.
It's Not Just Inflation
Part of the recent concern, other than the wage growth increase, has been infrastructure spending in excess of the previously mentioned spending plan, which would increase the need for Treasury to issue more debt, and that supply could pressure rates to move higher.
The Week Ahead
The market gets relief form Treasury supply, it will closely analyze Chairman Powell's testimony, and also look for any surprise in Wednesday's inflation report. There is plenty of Fed speak, only short-term Treasury Bill auctions, and some important economic releases.
After renewed fears of inflation roiled the markets in previous weeks, bonds stabilized and equities recovered, with the S&P 500 Index gaining 5.8% in five-days. These improvements were from a four-year high in Treasury rates and a 10% correction in equities. One sector of the S&P 500 that lagged behind was energy, an area that was subject to volatile cruse oil prices, and an example of why inflation gauges are measured ex food & energy.
The report that spurred inflation fears was a 2.9% gain in wages two-weeks ago, yet the two inflation reports last week did little to increase that fear.
Consumer Price Index showed a 0.5% gain, 0.3% ex food & energy m/m and 1.8% y/y. Producer Price Index was 0.4%, and also 0.4% ex food & energy m/m and 2.2% y/y. What this disparity might represent is an inability for wholesale costs to be passed on to consumers. The Fed’s key inflation gauge is Personal Consumption Expenditures which was last reported to be 1.5% y/y ex food & energy. Its next report is scheduled for March 1 and that rate is expected to be unchanged.
Other economic reports last week included Industrial Production, which was lower than forecast at -0.1%, with the previous month’s initial strong report of 0.9% revised down by 0.4%.
The rally in Treasury prices was well under way when a Friday report identified a quote from Mark Kiesel, global credit investment officer at PIMCO, “We think most of the backup in rates is over.” A factor in that statement is the belief that inflation will not exceed 2.0% and the Fed may lift rates no more than twice this year.
With the official Fed Funds rate now pegged to 1.38% and US Treasuries yielding from 2.19% in two-years to 2.88% in ten-years, and global sovereign debt yielding significantly less, the rates market may be properly priced. All of that could change if the proposed infrastructure spending plans were to be approved.
The Week Ahead
Fed speak, a lot of Treasury debt, $2.5 billion MBS, and FOMC minutes from the January 31 meeting. Treasury will sell $151 billion in short-term Bills, $28 billion two-year Notes, $15 billion two-year Floating Rate Notes, $35 billion five-year Notes, and $29 billion seven-year Notes. Freddie Mac will sell $1.2 billion 10-year MBS and $1.2 billion 10-year Floating Rate Notes.
Wednesday – minutes of the FOMC’s January meeting will be released
A word that was rarely mentioned during the steady, nine-year up trade in Equities became the most common word used by analysts last week.
Friday’s eventual correction allowed the DJIA to bounce from an indicated correction level for the recent bull market, but the index still closed down 5.2% on the week. The concern than originated with the 2.9% wage growth report had been confined to the rates market, causing the ten-year rate to increase as high as 2.88%, while causing some weakness in equities. That changed quickly, spurring investors to pull $33 billion from equity funds through Wednesday, a contributing factor for the Dow to swing 1,000 points in all but one-day last week.
Not only did that violent price action push the VIX (the Chicago Board Option Exchange’s “fear index”) to a high level, it triggered a powerful trade in an inverse volatility product that allowed traders to short the VIX, a popular trade that had made traders complacent about volatility. When VIX spiked higher it forced traders with short positions in volatility to cover, pushing VIX higher still and putting more pressure on stock prices. The largest short volatility trading platform, run by Credit Suisse and known as XIV, was forced to shut down on Monday. To show how profitable it had been to short volatility, if you bought this index at the start of 2015 and held it the end of the 2017, you generated a 320% profit. When measured through Monday, the result was a total loss of 85%.
Attention is also being focused on the potential impact of the increased deficit caused by the tax cuts and potential infrastructure spending, joined by the recent budget agreement that postponed a government shutdown. This will result in a $1.2 trillion deficit in FY19, prompting Mark Zandi of Moody Analytics to comment: “This is exactly opposite of what the economic textbooks say lawmakers should be doing in a full employment economy.” President Trump’s spending plan on this is scheduled for release today.
This last chart from the NY Times identifies the market’s concern for the projected amount of debt needing to be financed, compared with its status prior to the financial crisis in 2008, and illustrates how limited the Fed may be to resolve a future crisis.
What has been the impact of five rate hikes by the Fed, the end of Quantitative Easing, and an improving economy on 504 debenture pricing? This table charts the change from February 2014.
The 504 program has benefitted from these historically low Treasury rates, even more so in 2012 when 20L was priced at 1.93%. One comparison that stands out is 2018-20B was priced 1bps lower than 2014-20B with the Treasury benchmark 18bps higher in rate. Swap spreads have tightened, as has DCPC pricing spreads to the Treasury benchmark, reflecting strong demand for a high-quality asset.
The Week Ahead – besides anxiety, has short-term Treasury Bill auctions, some Fed speak, and some inflation reports mid-week that can provide more insight on inflation.
Monday – The Administration’s spending plan is released.
Wednesday – Consumer Price Index expected to be 0.2%, ex food & energy; 1.7% y/y; Retail Sales forecast to be 0.3%.
Thursday – Producer Price Index 0.2%, ex food & energy, 2.3% y/y; Industrial Production expected to be 0.2%
Even though Monday’s Personal Consumption Expenditures report came in below consensus at 1.5% y/y, Friday’s jobs report showing a 2.9% gain for wage growth, accelerated down trades in Equities and Bonds. Also affected was the CBOE Volatility (Fear) Index which spiked higher.
The market has been primed to expect more rate hikes from the Fed this year, so a move to higher rates was expected, but not this sudden. The slow-motion trend of January showed increased momentum early in the week, culminating in Friday’s more volatile price action.
On Wednesday, at Janet Yellen’s final press conference, the word “further” was added to existing commentary about gradual rate increases. Adding to this theme, former Fed Chair Alan Greenspan was quoted as saying: “We’re working obviously, toward a major increase in long-term interest rates, and that has a very important impact on the whole structure of the economy. There are two bubbles; we have a stock market bubble and a bond market bubble.” He attributes this to significant increases in debt. With the increased federal deficit due to tax cuts, and the anticipated increased spending for infrastructure, US debt will increase even more, increasing the need for Treasury to finance that debt.
Ignoring elevated P/E ratios, the strong equity market performance prompted investors to pour $25.7 billion into the market in the week ending January 31, bringing the total to $102 billion for the month. Adding to market nervousness, on Thursday a Bank of America Bull/Bear indicator was reported calling for a 4.8% correction in the S&P 500 Index by the end of the first quarter. Friday’s decline for the index was 2.1% and global equity markets are lower this morning.
The bond market selloff was global, but proportionately and for different reasons. The US market is responding to hints of inflation and more supply while European markets are weakening due to improved economic growth as they are earlier in their recovery. Japan is a different case because of continued central bank purchases of its debt and inflation that is barely 1%. The comparison below shows how cheap US debt remains vs. other sovereign issuers, so coupled with a weak US$, Treasury debt should still attract foreign demand. Here is a comparison of 10-year sovereign rates:
2.84% - USA
0.77% - Germany
0.09% - Japan
The Week Ahead
With the end of the FOMC meeting Fed speak resumes, plus the Treasury’s quarterly refunding, in addition to $116 billion short-term Bills, and the 504 program’s February debenture sale. Economic reports are minor and few.
Tuesday – Treasury auctions $26 billion three-year Notes
Wednesday – Treasury auctions $24 billion ten-year Notes
Thursday – Treasury auctions $16 billion thirty-year Bonds and the 504 program prices its February 20-year debenture sale. At 2.84%, the benchmark ten-year Note is 28 bps higher than when 2018-20A was priced
Treasury rates ended the week where they started, after a failed rally on Thursday. They are captive to the equity euphoria and increased confidence that it may continue.
The Treasury curve, as measured by the spread between the 2 and 10-year maturities, continues to flatten; closing at +54.4 bps on Friday, 5 bps flatter than when 2018-20A was priced on January 11.
US equities on Friday had their strongest one-day gain in eleven-months, and the S&P 500 Index is experiencing its strongest January since 1987. That 4Q17 GDP came in below estimates didn’t stop the index from gaining 1.18% because the market appreciates the 2.6% annualized gain as being solid and the strong Durable Goods number was encouraging.
The Week in Review
Durable Goods came in above consensus at 2.9%, led by aircraft and vehicles
GDP was below forecast at 2.6%, but with a strong 3.8% increase in consumer spending
The Week Ahead
Has no Fed speak until the conclusion of this month’s FOMC meeting, and just $110 billion in Treasury Bill auctions on the calendar, with the Quarterly Refunding announcement on Wednesday, to take place during our February debenture sale.
Tuesday – Personal Income & Outlays projected to be 0.3%, with the Fed’s preferred inflation indicator, Personal Consumption Expenditures, forecast to be 1.6%, ex food & energy. FOMC meeting begins.
Wednesday – FOMC meeting concludes with an official announcement at 2:00. No policy change is expected at Janet Yellen’s final meeting.
Thursday – Institute of Supply Management report is expected to show a decline to 58.7.
Friday – Non-Farm Payroll is expected to be 176,000, and Factory Orders should show a gain of 1.5%, based on the 2.9% Durable Goods report.
Momentum – (n.) a force of speed or movement.
An apt description of the rising rate sentiment this year as Treasuries continue a slow-motion move to higher rates. Aiding this move are:
Industrial Production came in stronger than expected at 0.8%, and the threatened Government shutdown became a partial reality Friday night.
Government Shutdown – a slow-motion shutdown where there has been a partial closing of most government offices. Another vote is scheduled for noon today, but its objective is to temporarily fund the government for just three weeks.
Treasury has approximately half of its personnel in office as it is scheduled to auction $193 billion of debt, $90 billion of it in short-term Bills. If the shutdown continues in effect, then many economic reports will be delayed.
Stocks continue to set record highs and Treasury yields continue to rise. The benchmark ten-year Note closed the week at 2.55%, up 14 bps since year-end and that level triggered comment from Bill Gross, founder of PIMCO, to declare we are in a bear market. After being challenged, Mr. Gross modified his comment by saying he thought ten-year Treasuries could reach 2.70% by December, but did say the 35-year bull market is over.
His comment did trigger several pro and con articles on the topic. Two of them were in the Financial Times and offered strong support for both arguments.
“Is the Bull Run Over” stated the year-to-date weakness and referenced Mr. Gross’ call. Some of the points it made to reinforce that view are:
“Don’t Bet on Higher Treasury Yields Yet” referenced calls for higher yields. When the Brexit vote took place in 2016, CT-10 was yielding 1.36% and it has almost doubled since then, to 2.55%, but is only about 1% higher, to a level that is not very high.
So, maybe we have finished this bull run but rate increases are projected to be gradual and if Mr. Gross and others are correct, another 15 bps over the next 12-months seems pretty tame. Of course, that assumes no spike in inflation and central banks maintain their support.
The Week in Review
Indicators came in near consensus.
PPI was -0.1% and 2.3% y/y ex food & energy
CPI came in 0.3% and 1.8% y/y ex food & energy
Retail Sales was 0.4%, reflecting a good, not great, holiday shopping season
The Week Ahead
There is Fed speak, short-term Treasury Bills, and January debenture sales for the 504-program fund on Wednesday.
Tuesday - $155 billion short-term Bills are auctioned
Wednesday – Industrial Production expected to be solid at 0.4%; 2018-10A and 20A fund
Thursday – Treasury auctions $13 billion of ten-year TIPS (Treasury Inflations Protected Securities) currently yielding 0.52%, a product that has seen renewed interest lately. This level, compared to the 2.55% CT-10 yield, represents a breakeven rate in excess of 2%, which triggered additional bearish sentiment.
It’s All About Equities
Low interest rates, low inflation, global growth, and strong earnings have created a perfect storm for stocks; and longer-term bonds have done pretty well, too.
DJIA is off to its best start since 2003, closing at 25,295 after a 0.9% gain on Friday while Treasury rates have crept higher since mid-December, but are still relatively unchanged in the ten-year sector Y/Y.
The Week in Review
Two events were of primary interest: Wednesday’s release of the minutes from the December FOMC meeting and Friday’s Non-Farm Payroll Report.
The minutes proved to be inconsequential with the vote to raise rates being 7-2, with dissidents citing low inflation as the reason for their dissent. The next meeting is January 30-31 and no rate hike is expected. The Committee also indicated they are uncertain as to the economic impact of recent tax cuts. Three more rate increases are on schedule for 2018 and factors like the Fed’s reinvestment of portfolio proceeds, a bigger than expected deficit, and infrastructure spending that will require more Treasury financing will all impact supply and the shape of the Treasury curve.
Friday’s jobs report came in at 146,000, far below consensus, but if coupled with November’s gain of 252,000 it is clear that job growth is on track. Affirming that comment is the annual gain of 2.1 million which represents the seventh consecutive year of yearly gains of 2 million or more.
The Week Ahead
Fed speak resumes, Treasury to auction $146 billion, including $90 billion in short-term T-Bills early in the week, plus some end of week economic reports. Additionally, the 504 program sells its first debentures in 2018.
Tuesday – Treasury auctions $24 billion three-year Notes
Wednesday – Treasury auctions $20 billion ten-year Notes
Thursday – Treasury auctions $12 billion thirty-year Bonds and the 504 program prices its first ten and twenty-year debentures of the year
Friday – CPI expected to be +0.1%, +0.2% ex food & energy which is +1.7% y/y; Retail Sales expected to be +0.5% after November’s +0.8% report
Peaks and Valleys
Were what the ten-year Treasury reached before ending 2017 3 bps lower then where it began the year, even after three rate increases by the Federal Open Market Committee.
The Year-to-date change (or little change) in CT-10 was the result of the Treasury curve flattening, as longer-term rates barely budged while the Fed raised short-term rates by 75 bps.
|Period||Avg. 20-year Debenture %||Avg. CT-10 Yield||Total # of Debentures||Total $ Amount of Debentures|
Year over year, the program saw a 5% increase in the amount of loans, with an 8% increase in dollars funded, while 20-year debenture rates increased by 50 bps.
While it is normal to expect both 20-year debenture and ten-year Treasury rates to increase as the Fed tightens, much of the move was a market reaction to the 2016 Presidential election before the three rate hikes took place in 2017. The week prior to Donald Trump’s victory (and before a December 2016 rate increase), ten-year rates were 1.74%, spiking as high as 2.56% in 1Q17 in anticipation of tax reform, increased infrastructure spending, and a tighter monetary policy by the central bank. A reversal of that move took place through the summer, ending in September when it became clear that some sort of tax package would be passed. The Fed will maintain its tighter policy and infrastructure spending will be pursued; what remains to be seen is what shape the Treasury curve will assume.
The Year Ahead
What we do know about Fed policy is there should be little change to what has been announced:
This Financial Times chart shows how the Fed proposes to shrink its $4.5 trillion Balance Sheet, with a formula that will cap the monthly reduction of securities, meaning they could be occasional buyers of Treasury debt. The plan is to reduce the portfolio by 11% per year, over the next five-years.
The Week Ahead
Wednesday – Institute of Supply Management report, expected to be 58.2; Construction spending at +1.4%; release of minutes of the December 13 FOMC meeting
Friday – Non-Farm Payroll expected to be +228,000 with the Unemployment Rate remaining at 4.1%; Factory Orders projected to be -0.1%; Eurozone inflation data is released, expected to be +1.5%
It was no surprise that the FOMC raised short-term rates by 25bps on Wednesday, creating a new band of 1.25-1.50% that further flattened the US Treasury curve (short-term rates rose while longer-term rates did not). This Financial Times chart illustrates the trend back to the financial market collapse, leaving the spread at +51bps on Friday.
Along with cash rich investors seeking quality assets, this reshaping of the Treasury curve has benefitted small business borrowers using the SBA 504 program. With interest rate hikes of 100-bps dating to December 2016, here is a scorecard of rates and spreads.
Expectations are for the FOMC to raise rates three-times in 2018 and many analysts believe the curve may flatten further. While that has been beneficial for 504 borrowers, there could be a point where pricing spreads may widen due to the technically expensive benchmark Treasury.
At her final press conference on Wednesday, Janet Yellen laid out the Committee’s expected path for year-end short-term rates:
2018 - 2.1%
2020 – 3.1%
She also expects “some market lift” to GDP growth from the proposed tax changes.
The Week in Review – on economic releases.
PPI – came in 0.4%, and 3.1% y/y. Ex food & energy it is 0.3% and 2.4%
CPI – was 0.4% and 2.2% y/y. Ex food & energy it is 0.1% and 1.7%
Industrial Production – came in below forecast at 0.2% but October was revised up to 1.2% from 0.9%
The Week Ahead – has little Fed speak and some economic releases late in the week.
Thursday – 3Q GDP expected to be unchanged at 3.3%.
Treasury auctions $14 bln of 5-year TIPS, plus the weekly T-Bill supply
Friday - Durable Goods forecast at 2.0% after October’s -1.2%
Personal Income & Outlays – contains the Fed’s preferred inflation indicator, Personal
Consumption Expenditures, whose core rate is expected to be 0.1%, and 1.5% y/y
There will be no Commentary next week, next posting will be January 2.
The Week in Review
The SBA 504 program continued to fund near historically low rates and pricing spreads to US Treasury debt, even with expectations of another interest rate hike this week. On Thursday, SBAP 2017-20L was priced at 2.78%, and an ongoing Effective Rate for small business borrowers of 4.50%. The chart below shows how this debenture series has been priced over the last five-years.
The high rate in this series was an after effect of the Ben Bernanke “taper tantrum” that rocked the rates market in 2013, more than 2-years before the Fed’s first-rate hike. The range of Pricing Spread to benchmark Treasuries is fairly well contained at +41-60 bps, and is a function of supply/demand and market sentiment. Historically, the tightest spread was in January 2013 (Quantitative Easing program) at +23 bps and the widest spread was in December 2008 (financial market collapse) at +348 bps. I mention that simply to recognize how volatility can impact markets.
The significant economic release last week was the Non-Farm Payroll report of 228,000 job gains, well above forecast, that maintained the Unemployment Rate at 4.1%, holding this rate at its lowest level in 17-years.
Even that had little impact on benchmark Treasury rates, with CT-10 ending at 2.37% on Friday and equity indexes hitting record levels. S&P 500 was up just 0.1% on the week, but financial stocks were better by 1.5%, buoyed by the jobs report and this week’s projected rate increase.
The Week Ahead – no Fed speak, other than Wednesday, $68 billion of term Treasury debt, and some economic releases.
Monday – the usual T-Bill auctions plus $44 billion of three-year and ten-year debt
Tuesday - $24 billion auction of thirty-year debt and PPI, expected to be 0.3%
Wednesday – the FOMC announcement and forecast. A 25-bps increase is expected
Thursday – Retail Sales forecast to be 0.3%, lower than the previous month’s spike from the hurricane season
Friday – Industrial Production expected to be 0.3%, showing recovery from the hurricane season
After eleven-months of posturing and negotiating, the Administration achieved a sweeping tax change that propelled equity markets to new, record highs. Its performance did lag a bit on Friday after Michael Flynn pleaded guilty to lying to the FBI and that promises to ensure continued drama over the Russian probe being conducted by a special prosecutor. Equities are expected to remain well bid because of the proposed tax cuts, in particular, the reduction of the corporate tax rate to 20%.
While that guilty plea, and its implication of additional charges, did soften equity prices Friday, it helped rates recover to close the week just 2 bps higher than when we priced 2017-20K on November 9. That is a strong indication of how stable long-term rates have been, with the rates curve (2/10’s) flattening from +125 bps twelve-months ago, to +70 bps when 20K was priced, and to close at +60 bps on Friday. To be sure, there will be pressure on that sector of the curve, but if the projections are correct it will move less than the front-end.
Here is the Year-to-Date chart from the WSJ, showing CT-10 is trading exactly where it began the year, after two-rate increases this year, with one more expected next week.
Regarding the rates curve, in addition to some analysts calling for it to be totally flay in 2018, St. Louis FRB President James Bullard cautioned about the possible risk of a curve inversion if the Fed continues to raise short-term interest rates as fast as has been projected. If so, that would mean the 2/10’s curve would be at a negative spread from its current +60 bps level. Earlier in the week, Janet Yellen said the Fed would continue with its path of gradual increases because the economy is performing mostly in line with expectations.
The Week in Review
There was the usual mix of good news, bad news. The good news was 3Q17 GDP was revised up by .03 to 3.3%, the strongest quarter in three-years. The bad news was Y/Y PCE inflation came in at 1.4%, far below the Fed’s target of 2.0%.
The Week Ahead
There are weekly T-Bill auctions, a lot of Fed speak, about $1.7 billion CMBS sales, the 504 program’s 20-year December sale, and Employment data.
Thursday – SBA 504 program sells its December 20-year debenture.
Friday – Non-Farm Payroll expected to be +185,000 after gains of 261,000 in October and just 18,000 in the storm ravaged September
Unchanged – at least week over week. The rates market ended the week where it began, as economic reports were mixed, and the FOMC minutes that were released on Wednesday indicated officials believe inflation will remain below their 2% target. That said, the market assigns a 100% probability of a rate increase at the end of the December 12/13 meeting.
In a speech on Tuesday, according to a WSJ article, Janet Yellen stated she finds low inflation “more of a mystery,” saying she could not say that the Fed clearly understood its causes.
Late in the week economic reports from Europe softened prices as Eurozone jobs growth and new economic orders reached a 17-year high, with goods exports at record levels even as the € has appreciated 12% vs. the US$ this year.
Loan Extension - this Financial Times chart shows US banks have scaled up the proportion of long-term, fixed income lending, with the sharpest rise in assets that don’t mature for at least 15-years. That category now represents about 13% of the industry’s overall balance sheet.
The Week Ahead – has the weekly short-term Bill auctions, plus $88 billion of intermediate notes, and a lot of Fed speak.
Monday – Treasury auctions $60 billion of 2-year and 5-year notes
Tuesday – Treasury auctions $28 billion 7-year notes
Wednesday – second estimate of 3Q2017 GDP expected to increase to 3.3% from 3.0%. Janet Yellen testifies before the Congressional Joint Economic Committee
Thursday – Personal Income & Outlays includes the Fed’s preferred inflation gauge, Personal Consumption Expenditures, and it is expected to show a core rate of 0.1%, with the y/y rate at 1.4%
Friday – Institute of Supply Management is expected to reflect continued growth
It’s All About the Curve
The only monetary tool available to the Federal Reserve Bank is the overnight cost of funds (Fed Funds), and they have raised that four times since December 2015, pushing all short-term interest rates higher (except what you are paid on your Money Market deposits.) The current spread differential between the CT-2 and CT-10-year Treasury is +65bps. The week that the Fed began raising interest rates it was +125 bps, and this outperformance by the back-end of the Treasury curve is what has helped the 504 program continue to fund near all-time low rates.
While analysts continue to predict higher long-term rates because of growing global economic strength, the rates markets keep defying predictions.
Some market headlines this past week:
Fed speak remained mild with several central bankers agreeing that Forward Guidance will remain a policy tool. Economic releases, especially on inflation, came in as expected, with CPI registering a +1.8% gain y/y, ex food & energy. Retail Sales showed a +0.2% gain, greater than consensus and September was revised upward to +1.9%.
Part of the explanation for the improved Treasury prices is the uncertainty concerning the tax cuts, for which no definitive economic analysis has been provided. The market is skeptical of the bill’s passage which, if it did happen, would pressure rates because it is not revenue neutral and more Treasury debt would need to be funded.
The Week Ahead – is holiday shortened, with only release of the FOMC minutes on Wednesday, from their November 1 meeting, of interest.
Though the below chart shows CT-10 ending trading on Thursday because of the Veterans Day holiday, there was some trade activity on Friday that reflected growing concern over an uncertain Republican tax plan and optimistic growth reports from Europe. Those actions moved the benchmark rate to close at 2.40%, 6 bps above where the program priced 2017-20K on Thursday, and paused the eight-week rally in equities.
That debenture sale was very well received and allowed the program to tighten its pricing spread to the ten-year Treasury to +45nps, its tightest spread since February, and lowered its month-over-month debenture rate by 6bps, even though Treasury rates were unchanged. Another contributing factor in the pricing was the continued flattening of the Treasury curve, as measured by the changed yield spread between two and ten-year Treasuries. Since the 504 program’s October 5 debenture sale that spread tightened from 85 bps to 70 bps, meaning two-year Treasury yields increased 15bps while ten-year yields were unchanged. A move like that reflects market concern for additional rate hikes from the Fed (CT-2 ended the week at 1.66%, a new nine-year high), like the one that is expected at the conclusion of the December 12-13 meeting.
The ongoing Effective Rate for 20-year small business borrowers declined to 4.58%, 4 bps lower than its 12-month average, and just 33 bps above the Prime Rate. This cost of funds measurement will improve even more once the FY2018 guarantee fee is applied to processed loans.
Other Items in the Week in Review
The week was light on economic data, all the Fed speak was tame, and the Treasury saw strong demand for its quarterly refunding auctions.
The Week Ahead
There are the usual short-term T-Bill auctions, plus a 10-year TIPS sale, a lot of Fed speak, and some inflation data.
Monday – Treasury auctions $78 billion in 13 and 26-week Bills, and releases its Fy2018 budget
Tuesday – PPI is expected to show a 0.1% increase, 0.2% ex food & energy
Wednesday – CPI is released, and the consensus call is 0.1%, and also 0.2% ex food & energy. The y/y rate ex food & energy is 1.7%
Thursday – Industrial Production is expected to show a gain of 0.5%, Treasury auctions $11 billion 10-year Treasury Inflation Protected Securities
Friday – Housing Starts and Capacity Utilization, which should remain around 76%
More Jobs but less Wage Growth
And that translates into reduced inflation fears which helped Treasury prices move higher Friday, ending a week of solid gains and remaining below its 2.42% resistance level.
The Week Ahead
There is renewed Fed Speak, multiple short-term Treasury Bill auctions, Treasury’s quarterly refunding, scheduled Freddie Mac sales of $2.3bln fixed-rate and floater MBS, and the SBA 504 program’s November debenture sales; with a light calendar for economic reports.
Tuesday – Treasury auctions $24bln three-year notes
Wednesday – Treasury auctions $23bln ten-year Notes, that are the benchmark for the 20-year DCPC to be priced Thursday
Thursday – Treasury auctions $15bln thirty-year binds and SBAP 2017-10F and 20K are priced. At 2.33%, CT-10 is exactly where it was when the October sale was priced; that can change before Thursday.
Friday – Treasury releases its expected FY2018 budget
The Week in Review
A week of strong reports was capped by Friday’s 3Q2017 GDP being 3.0%, despite the hurricanes that were expected to hold it down. In addition to it representing two consecutive quarters above 3%, it is the best six-month stretch in three years.
Earlier reports showed:
Other developments might be characterized by initials:
ECB – Mario Draghi announced the central bank would buy less bonds, but for longer. The monthly purchase will decline by half, to €30 billion per month, but extend through September 2018, and possibly longer. This prompted renewed interest in European stocks.
SALT– State and Local Tax deductions might be lost to taxpayers. The House passed a $4 trillion budget, clearing the way to tax reform that is expected to create a $1.5 trillion shortfall that would need to be funded. These deductions are important to residents in high tax states and prompted several Republicans from New York, New Jersey and California to vote against it. The vote on the budget was just 216-212, a slim margin.
401(k) – like SALT, a reduced limit for deferred retirement savings would be a source of revenue to offset the tax cuts. By passing the budget with a simple majority vote, the tax bill must have no impact on the budget in ten years. That means to make it work the lawmakers need increased sources of revenue sooner rather than later, and one way might be to leave Roth IRA amounts unchanged. That would result in taxable contributions that are tax free later on.
DJIA – keeps on rolling; rising 33 points on Friday to show a year-to-date gain of 18.4%. Tech stocks reported better than expected earnings and Amazon rocketed to close at $1100 per share, gaining 126 points on the day.
Surprisingly, Friday’s strong GDP report did not add to fixed-rate weakness that existed leading up to the release. Rates had risen in response to previous economic releases and Treasury supply, closing above 2.40% for the first time in five months.
The Week Ahead- has short-term T-Bill supply, the Fed’s preferred inflation gauge, an FOMC announcement, and jobs data. Mortgage-backed securities size is relatively light, a $1.3 billion 7-year deal.
Monday – Personal Income & Outlays report contains the PCE report that is expected to be +0.4%, but just +0.1% ex food & energy. The annual rate is +1.4%, +1.3% ex food & energy. Though this rate remains well below the Fed’s inflation target, the Committee seems resigned to this level as long as economic reports show strength
Tuesday – Consumer Confidence is expected to remain high
Wednesday – Treasury announces its quarterly refunding auction terms for sale next week when the 504 program will price its November debentures; FOMC announcement at the conclusion of its 2-day meeting, where no change in policy is expected
Thursday – Fed speak commences now that the FOMC meeting is over
Friday – Non-Farm Payroll should rebound strongly from September’s hurricane affected report of -33,000. The consensus is for a gain of 323,000
The 2018 Budget Resolution – that was passed by the Senate late Thursday, impacted the rates market on Friday. Passage of the resolution may lead to a rewrite of the U.S. tax code which is expected to result in a $1.5 trillion reduction in projected future revenue. This shortfall would require Treasury to issue more debt, pressuring prices and raising rates, which is what the market perceived after last November’s election. That move to higher rates faltered once it became clear that tax cuts and infrastructure spending were not happening, and rates reversed much of the move. Now, with the Republican controlled Senate able to revise the tax code with a simple majority vote, the market is becoming more cautious.
Stocks like tax reform, bonds don’t. The DJIA closed at 23,328, extending the third longest bull market (starting in 2009) in the index’s history.
The pending December rate hike and the reduced reinvestment of proceeds by the Fed will also influence this bearish sentiment, though global demand for high quality assets should continue to modify any rise in rates.
The Week in Review – saw Industrial Production come in as expected at +0.3%, but with negative revisions to July, and August was revised to -0.7%. Existing Home Sales posted its first gain in 4-months in a market with limited supply, with median prices showing a 4.2% annual gain.
In Janet Yellen’s speech on Friday she said the economy has made “great strides” but that policy makers may not be able to raise short-term rates very far as the recovery proceeds. A Financial Times article quotes her saying: “The probability that short-term interest rates may need to be reduced to their effective lower bound at some point is uncomfortably high, even in the absence of a major financial and economic crisis.” Ms. Yellen mentioned the Committee only expects to raise the Federal Funds rate to 2.75% in coming years, leaving it little room to reduce rates, if needed. The current rate for overnight funds is a range of 1.0-1.25%. The MBS market saw strong demand for $2+ billion of floating-rate and fixed rate debt.
The Week Ahead - $78 billion in short-term Bills; $88 billion in fixed-rate Notes and a 2-year FRN. No Fed speak, as we enter the blackout period ahead of the October 31 meeting, where change in policy is expected. We also get an ECB announcement on Thursday.
Tuesday – Purchasing Managers Index is expected to show continued growth. Treasury auctions $26 billion 2-year Notes
Wednesday – Durable Goods expected to be +1.0%; New Home Sales may be impacted by recent hurricanes; and Treasury auctions $15 billion 2-year Floating Rate Notes
Thursday – Treasury auctions $28 billion 7-year Notes. Mario Draghi is expected to announce a tapering of the bank’s €60 billion monthly bond purchases.
Friday – GDP sees a 3Q2017 revision, expected to be revised down to 2.5% from 3.1%
The Treasury market was marking time in a holiday shortened week until Friday’s soft inflation data trumped a strong Retail Sales report. Additional support could be found in the President’s Executive Order to end subsidy payments to insurers under the Affordable Care Act. That may have contributed to Treasury strength but it definitely hurt health care companies, even as equity indexes set new record highs.
Our benchmark ten-year Treasury held its 200-day Moving Average level of 2.32% and now sits between there and a 2.23% resistance level.
Matching the decline in the ten-year yield was a further flattening of the yield curve as short-term rates held firm in anticipation of a probable rate hike in December. For the week, the 10-2 curve flattened 8 bps, and year-to-date it is flatter by 39bps.
The Week in Review - the FOMC minutes released on Wednesday showed a unanimous vote of 9-0 to begin normalization of the bank’s Balance Sheet by reducing its purchases by $10 billion this month. Ironically, that began on Friday as prices rallied.
CPI was +0.5%, propelled by a 13.1% gain in gas prices (the largest one-month gain since 2009). Food was up just 0.1% and ex food & energy the monthly gain was only +0.1%.
Retail Sales came in +1.6%, aided by car purchases to replace those damaged by Hurricanes Harvey & Irma. Ex gas and autos, the report was +0.5%. The damage to Puerto Rico and the US Virgin Islands was devastating but those territories are not included in most national level reports.
The Week Ahead – has much Fed speak, $78 billion in short-term Bill supply, and not much economic data.
Tuesday – Industrial Production expected to be +0.1% after a -0.9% report in August
Thursday - $5bln 30-year TIPS to be auctioned (currently yielding 0.87%)
Friday – Janet Yellen has a scheduled speech
Not Much Change – in rates, but Friday’s Non-Farm Payroll report was complex.
The US shed 33,000 jobs in September, the first negative report in seven-years, driven by two significant hurricanes that account for the headline number. Other significant items in the report were:
The Week in Review – other than the jobs report, the item of most interest was SBAP 2017-20J being priced at 2.85%, just 3 bps higher than the December 2015 debenture sale that preceded four rate hikes by the Fed. We’ve seen the cost of funds increase by 100 bps but moderate global growth, low inflation, and global $ seeking high quality assets have held rates in check. That is poised to change with the Fed committed to its dot-plan for more rate increases and the normalization of its Balance Sheet, but if Chairwoman Yellen is correct, the change should be gradual.
The Week Ahead – a lot more Fed speak, short-term Bill auctions on Tuesday, and term supply later in the week.
Wednesday – Treasury auctions $24bln three-year Notes and $20bln ten-year Notes. Fed releases minutes of their September 20 meeting
Thursday – Treasury auctions $12bln thirty-year Bonds
Friday – CPI expected to be +0.6%, +2.3% Y/Y. Ex food & energy +0.2%, +1.8% Y/Y; and Retail Sales should be +1.9%, driven by strong auto sales as hurricane victims replace damaged cars
The Week in Review
As we approach this week’s sale of 2017-20J, the market fully expects another rate hike this year, almost certified by Janet Yellen’s speech last Tuesday when she said, “it would be imprudent to keep monetary policy on hold until inflation is back to 2%,” and that she is “wary of moving too gradually.” With that in mind, the market puts the likelihood of a December rate hike at 70%.
The Week Ahead – will be focused on headline news and Friday’s payroll report; has a lot of Fed speak, including Chairwoman Yellen, and Treasury supply of short-term Bills only.
Monday – PMI Manufacturing Index is expected to continue its moderate growth
Wednesday – Janet Yellen speaks in St. Louis on Community Banking in the 21st century
Thursday – 2017-20J is priced to fund on October 13
Friday – Non-Farm Payroll is expected to be very low, showing the effects of both Hurricane Harvey and Irma. The unemployment Rate is expected to be unchanged at 4.4%
The Week in Review – was highlighted by the FOMC meeting and press conference, and then heightened tension from North Korean dialogue.
As expected, there was no change in policy at this month’s meeting and there was confirmation the Fed would reduce its monthly Balance Sheet reinvestments by $10bln starting next month. The monthly caps will increase on a quarterly basis, scheduled to reach $50bln in October 2018.
Other points of interest from the meeting:
Regarding inflation, the comment was - “if it’s recent softness doesn’t prove to be transitory,” the Fed could have to reassess its plans to raise interest rates at a gradual pace. With brick and mortar stores closing, and recent bankruptcies (Toys R Us), can improved pricing online explain some of how inflation’s muted increase is measured?
This Financial Times chart makes an interesting point – digital prices are declining faster for most products than as measured in the CPI.
The Week Ahead – a lot of Treasury supply with Fed speak scheduled for every day, including Janet Yellen discussing prospects for growth, on Tuesday
Monday – Treasury sells $78bln 3 and 6-month Bills
Tuesday – Treasury sells $26bln 2-year Notes
Wednesday – Treasury sells $34bln 5-year Notes and $13bln 2-year FRN’s
Thursday – Treasury sells $28bln 7-year Notes; third revision of 2QGDP expected to be 3.1%
Friday – Personal Income & Outlays expected to be +0.3%, with the Fed’s Personal Consumption Expenditures measure rising 0.3%, 1.5% y/y, and its core rising 0.2%, 1.4% y/y (slightly below the Fed’s revised projection)
Equities hit record highs and Bonds sold off from a broad improvement in risk appetite.
S&P 500 index gained 1.6% for the week and the benchmark ten-year Treasury sold off 15bps to close Friday at 2.20%, just below its 50-day Moving Average of 2.229%. This chart below identifies the Note’s six-month journey, revisiting its closing level from mid-April, two months before the Fed raised its overnight Fed Funds range to 1.25%.
These moves were helped by Hurricane Irma having a less severe impact than feared and North Korean threats generating less concern. This temperament was affirmed by performances on Friday after a terrorist attack in London that fortunately failed.
The week had its usual share of good and bad economic reports to go along with Central Banker commentary, but not from Fed officials as they prepare for this week’s meeting that includes a Summary of Economic Projections and a press conference with Janet Yellen. That meeting concludes on Wednesday and the Chairwoman’s press conference is at 2:30. While no change in policy is expected, the market is anxious to hear details about Balance Sheet normalization which is expected to begin shortly. The pace of reduction has been advertised as deliberate so the shock would be any acceleration to that schedule.
Wednesday’s release of the Producer Price Index came in lower than expected at +0.2%, with higher gasoline prices accounting for most of the increase. Ex food & energy, the gain was just +0.1%
Thursday’s release of the Consumer Price Index showed a gain of 0.4%, its biggest gain since January, giving the market cause for concern about increased inflation. Y/Y it shows a gain of +1.9%, with its core rate a bit lower at +1.7%. Adding to rate concerns was a comment by a Bank of England policy maker that “the central bank may need to raise interest rates in coming months.”
Both of those events weakened bond prices but Friday’s soft report for Retail Sales, -0.2%, stabilized prices.
The Week Ahead – has some short-term Bill auctions, housing data, the FOMC meeting, and then some Fed speak later in the week.
Monday – Treasury auctions $78bln three and six-month Bills
Tuesday – FOMC meeting begins
Wednesday – FOMC announcements and Forecasts are released at 2:00 and the press conference follows
Thursday – Leading Indicators expected to show a 0.2% gain, and Jobless Claims are announced
Friday – Purchasing Managers Index expected to show a decline
The Trend Continues – as Treasuries complete a two-month rally with the benchmark ten-year Note closing at its lowest yield since the election, and stocks ended two-weeks of gains.
North Korean tensions remained a major focus and was joined in the headlines by:
Stuck in Neutral – but it is good for small business borrowers. Since December 2015 the Fed has raised the Federal Funds rate 4-times, yet the benchmark Treasury and 20-year debenture rates are lower, with an improved pricing spread.
The 2017-20 I debenture sale was met with strong investor demand amidst this risk-off, safe haven trade that is a contributing factor to current rate levels. Another factor is the above-mentioned QE programs still in effect with the Fed poised to announce its balance sheet normalization later this month.
The Week Ahead – No Fed speak, as we are in the 2-week blackout period ahead of the September 19-20 meeting. In addition to Treasury supply, Fannie Mae and Freddie Mac both have deals out this week, so there could be some consolidation.
Monday – Treasury auctions $72bln short-term Bills and $24bln three-year Notes
Tuesday – Treasury auctions $20blm of a 52-week Bill and $20bln ten-year Note
Wednesday – PPI expected to be +0.3%, and Treasury auctions $12bln thirty-year Bonds
Friday – Retail Sales expected to be +0.1%, and Industrial Production also expected to be +0.1%
Choppy – would be a good word to describe performance in the Treasury market last week as political tensions gave way to strong economic data.
The ten-year rate touched a low of 2.08% on Tuesday after North Korea launched a missile that flew over Japan, reigniting a safe haven trade that generated strong foreign demand in the Treasury’s auctions, evidenced by a 2.5X subscription rate for Tuesday’s $34bln five-year note auction.
While Treasuries held their safe haven bid, gold gained 2.5% and equity markets like NASDAQ ended the week at a record high.
On Wednesday, the 2QGDP estimate was revised upward to 3.0%, with a usual push/pull dynamic:
Friday’s Non-Farm Payroll report came in below estimates at +155,000 with the previous two-months’ number revised downward, the Unemployment Rate ticked up to 4.4%, and annual wage growth held firm at +2.5%.
The Institute of Supply Management report reached a six-year high in August, exceeding expectations. Manufacturers are also reporting higher prices for raw materials, hinting at growing inflation pressures. “This is probably pent-up demand over many, many years,” said Timothy Fiore, head of the ISM survey, in a WSJ article. And, the European Union reported a strong Purchasing Managers Index that continued the zone’s surprising success in 2017. Readings for France, Austria, and the Netherlands were at their highest levels in six-years, yet even this positive report reflects concern about the Euro currency’s 13% gain vs. US$ which could threaten the competitiveness of Euro zone exporters and put downward pressure on inflation.
Fears of a government shutdown eased a little after the White House removed its demand for $1.6bln to build the border wall as part of an increased debt ceiling. Additionally, the need to provide funding and assistance for Hurricane Harvey relief may insure the government staying open to provide that aid.
The Week Ahead – has Fed speak, T-Bill auctions and the 504 program’s September debenture sale.
Tuesday – Factory Orders expected to be -3.1% offset June’s +3.0%
Thursday – Productivity & Costs report is expected to be driven by 2Q GDP’s 3.0% report, with an upgrade in productivity and a downward revision for labor costs.
SBAP 2017 10E and 20I will be priced for settlement on Wednesday September 13. European Central Bank meeting is expected to deal with issues they have in common with the Fed – modest growth, with low inflation and a need to wean itself off its Quantitative Easing program.
The Week in Review – was dominated by political commentary and then Central Banker speeches.
The political commentary was from the White House on Tuesday when President Trump threatened to shut down the government if Congress did not approve some initial funding to build the proposed border wall. Talk of a government shutdown drives safe haven trades and weakens equities, and this was no exception; though the improvement in Treasury prices was muted because we are at such artificially low rates already. And not all Treasury prices improved; short-term T-Bills weakened as investors opted to avoid the uncertainty of the government paying its bills after October 1. This is a week in review and weeks ahead topic as both raising the debt ceiling and passing a budget for FY18 need to be addressed by the end of September.
Later in the week, Janet Yellen and Mario Draghi spoke at the Kansas City Fed’s Symposium and their comments were directed to financial stability, not rates, but did help the Treasury market hold its gains. In her speech, Ms. Yellen identified post-crisis rules as having made financial markets stronger, something the President disagrees with as he intends to reverse many of them in hopes of expanding the economy. With Ms. Yellen’s term expiring in February it will be interesting to see how strongly she continues to speak out on policy.
Mario Draghi followed Ms. Yellen and took aim at the President’s protectionist approach to trade, advocating free trade to boost global growth. Both bankers are faced with the challenge of winding down their Quantitative Easing programs but Ms. Yellen’s is complicated by a fractious political environment.
There is some doubt about the Fed’s planned December rate hike but implementation of Balance Sheet normalization seems to be on target for a September announcement. In a market fraught with political discourse, diminished liquidity, and the Fed reinvesting fewer proceeds from its portfolio, the market now has to wait out the debt ceiling and federal budget issues.
The Week Ahead – is light on Fed speak but contains 2Q GDP revision and NFP, plus several Treasury auctions.
Monday – Treasury auctions $26bln 2-year and $34bln 5-year Notes, in addition to $72bln 3 and 6-month Bills
Tuesday – Treasury auctions $28bln 7-year Notes, and four-week T Bills
Wednesday – second report for 2Q17 GDP expected to increase to +2.8%
Friday – Non-Farm Payroll for July is expected to be +180,000 with the Unemployment Rate remaining at 4.3%, and a possible improvement in wage growth; and with an early close to the market ahead of a holiday weekend.
Rates moved higher in response to strong economic reports like Retail Sales +0.6%, its sharpest increase this year; Japan posting an annualized GDP rate of 4.0% for 2Q17; and Amazon selling $16bln of debt to finance its purchase of Whole Foods. Then, events in Charlottesville, Barcelona, and Finland happened, sending rates lower as investors sought safe haven trades like Treasuries and gold. CT-10 closed the week at its 2.19% resistance level and awaits further news headlines that include contentious political oratory.
Wednesday’s release of minutes from the FOMC’s July 26 meeting identified a Committee split on the next rate increase as members struggle to understand why inflation has been so weak. Market sentiment has become skeptical of the planned December rate hike but is certain a September announcement is planned to announce Balance Sheet normalization.
The Fed’s holdings have increased from slightly less than $1tln bonds in 2008 to $4.5tln today, and the Financial Times chart below shows four central banks hold more than $14tln of debt. This concerted initiative has been a major factor in why global interest rates are so low, and identifies $9tln of the other banks’ holdings are at negative yields. That statistic, plus ongoing demand for safe haven securities, explains why US$ denominated debt has been such an attractive global asset.
The Week Ahead – some housing data and Fed speak, plus short-term Treasury auctions.
Monday – Treasury auctions $72bln of 3 and 6-month Bills
Tuesday – a yet to be determined amount of four-week Bills
Wednesday – Treasury auctions $13bln of a two-year Floating Rate Note
Thursday – The Kansas City Fed’s Jackson Hole Symposium meets
Friday – Durable Goods is expected to reverse the +6.5% report for June, and Janet Yellen speaks at Jackson Hole on financial stability
Fire & Fury begets a Safe Haven Trade – aided by weak inflation data.
Geopolitical threats gave the market a bid throughout the week, and were aided by strong demand for MBS and Treasury issuance, plus dovish inflation data. In addition to short-term Bills the Treasury sold 61% of its, three, ten and thirty-year securities ($62bln in total) to foreign buyers, with all auctions seeing good interest.
Producer Price Index, forecast to be +0.2% came in at -0.1%, reflecting weakening inflation pressure, and sits at +1.8% y/y, ex food & energy. PCE, the Fed’s preferred measure, is at +1.5% y/y.
SBAP 2017-20H was priced at 2.75%, its lowest rate since November and just 4bps above the twelve-month average rate. If nothing else, this identifies how range bound the market has been and what an excellent time it is for small businesses to lock in fixed-rate term money.
Adding to dovish inflation sentiment was NY Fed President William Dudley’s comment, that “it’s going to be some time” for headline inflation data to return to the bank’s 2.0% target. The week ended with a +0.1% release for July CPI, below the +0.2% consensus. Ex food & energy this measure shows +1.7% y/y.
Additional Fed speak from Dallas Fed President Kaplan, “wanting to see more evidence” that inflation is on track for 2.0% before supporting another rate increase this year helped reduce the market’s odds for that hike. Fed Funds futures (used to gauge the Fed’s rate policy) closed Friday with a 36% chance of an increase, down from 47% Thursday, and 54% a month ago.
Finally, safe haven trades end when headline news calms down so the bid for Treasuries can fade with normalization of talks on N. Korea, but the persistently low inflation readings have a more lasting impact. Even if the Fed doesn’t pursue a December rate hike it is likely to make a September announcement on reduced reinvestment of its balance sheet holdings. That too, is a form of tightening, and coupled with increased MBS issuance can be expected to put pressure on spread product.
The Week Ahead – has some Fed speak economic releases.
Tuesday – Retail Sales is expected to show strength after a -0.2% report for June
Wednesday – minutes of the July 26 FOMC meeting are released
Thursday – Industrial Production is expected to be +0.3% and Leading Indicators should continue to show strength
Inflation is proving an elusive target, but job growth remains strong
This Financial Times chart shows consistent growth in jobs post-recession, and a current Unemployment Rate of 4.3% that is tied for the lowest in sixteen-years. Other positive aspects of the report:
This report nudged Treasury rates higher after earlier reports in the week had moved them lower. Those reports were the Fed’s preferred inflation indicator, Personal Consumption Expenditures, with a core rate of +1.5%; and auto makers showing sharply lower sales in July, with GM reporting a 15% decline. At week’s end, the benchmark ten-year Treasury was unchanged on the week, at 2.27%, 11bps lower than when the program priced 2017-20G.
Of note, is how little some things have changed as the FOMC has raised rates 100bps since December 2015.
|Date||FF range||5-year Note||10-year Note||20-year SBAP Spread|
Even with inflation remaining below target, the FOMC remains on track to commence shrinking its balance sheet and raising rates again by this year-end.
The Week Ahead – has a lot of Fed speak, with CMBS and Treasury supply, plus this month’s SBAP 2017-20H.
Monday – Treasury auctions $72bln short-term Bills
Tuesday - $24bln three-year Notes are auctioned
Wednesday - $23bln ten-year Notes are auctioned
Thursday – SBAP 2017-20H is priced, and $15bln thirty-year Bonds are auctioned
Friday – CPI is expected to +0.1% to +1.8% y/y
Where to Start?
Monday – the worst day for bonds since Mario Draghi’s comments on June 27. Euro yields sold off, which bled into US trading, and stocks rallied.
Tuesday – Health Care chaos as the Senate votes, with help from a John McCain aye and the vice president’s tie-breaking vote, to approve debate on repeal and replacement for the ACA.
Wednesday – UK reports 2Q17 GDP as +0.3%; announces that Libor will be phased out by 2020, joining the US which will discontinue its use next year. In addition to absorbing the Treasury’s auction sizes, Treasury prices fade with AT&T’s announcement of a $22.5 billion sale to finance its purchase of Time Warner Inc. An indication perhaps of how resigned portfolio managers are to this range bound market is found in the $63 billion of orders that were placed for the bonds. A reflection of economic strength could be taken from a Durable Goods report that was double consensus at +6.5%. Announcement of next week’s Treasury auctions for 3, 10, and 30-year debt to take place during the sale for SBAP 2017-20H.
Thursday – French GDP is reported at +0.5% and the Senate prepares to vote on its “skinny” revision for ACA; the Senate passed legislation to penalize Russia for its interference in the 2016 presidential election.
Friday – long before 2Q17 GDP was released (+2.6%), results of that morning’s Senate vote, failing to pass the scaled down version to replace ACA had circulated. By the time GDP was released the market was fatigued and then it was reported that in a letter to lawmakers, U.S. Treasury Secretary Steven Mnuchin said the federal borrowing limit needed to be raised by Sept. 29 or the government risked running out of money to pay its bills. That topic is one that always supports stronger Treasury prices and is an issue that probably will linger to its 11th hour.
That recap does not even include the administrative in-fighting, dismissal and replacement of the President’s chief of staff, and then Sunday’s announcement that Russia will expel as many as 755 US diplomatic and technical personnel in country, in response to the sanctions.
We begin the week with the benchmark 10-year Treasury resting just below its 200-day Moving Average of 2.30%, a level of support that failed just two weeks ago.
The Week Ahead – has some fed speak and key economic reports.
Tuesday – Personal Income & Outlays – which includes the Fed’s preferred inflation gauge that is expected to be +0.1%, +1.5% y/y. Purchasing Managers Index is expected to be flat, and the Institute of Supply Management index should show a slight decline after a year of growth
Thursday – Factory Orders should rebound after two consecutive declines
Friday – Non-Farm Payroll is expected to be + 180,000 with the Unemployment Rate declining to 4.3%
The Week that Was – began with the health care revision faltering and pulled from a vote, joining tax reform and infrastructure spending initiatives that are in suspension. Prospects for all three items were responsible for the post-election increase in rates that has been reversed by half since March.
With Fed officials restricted by blackout rules leading up to this week’s FOMC meeting, central bank commentary focused on the European Central Bank and they did not disappoint. Bond prices strengthened with Thursday’s announcement that interest rate policy and the bond buying program would not change. Comments from Mario Draghi that inflation is not showing any sign of picking up were enhanced by the bank’s report that eurozone inflation is expected to average 1.5% for the next three-years, far below their 2.0% target. Mr. Draghi’s somewhat dovish comments softened his late June hawkish comments that had weakened bond prices.
The stockcharts.com chart below shows how rates have improved, in an irregular pattern, since peaking in March and we now sit at the 50-day Moving Average (2.24%), which should provide resistance.
The S&P 500 index produced its 27th record close of the year as investors seem confident that economic strength is sufficient and perhaps central banks are not united in a tightening program. Such was the concern earlier this month but weak reports and central banker acknowledgements about persistently low inflation have changed market perception.
In other central bank news, the Bank of Japan announced it did not expect to hit its inflation target of 2.0% until 2020, and it too would continue its bond buying program.
The Week Ahead – has a sizeable amount of Treasury debt being sold, but the focus will be on the FOMC meeting that concludes Wednesday, with an afternoon announcement. The economic calendar is light, with Friday’s 2Q17 GDP report of most interest.
Monday - $72B short-term Bills are sold
Tuesday - $26B two-year Notes
Wednesday - $15B two-year FRN’s and $34B five-year Notes. The FOMC announcement will be closely watched for comments on inflation and any commentary on unwinding the Fed’s balance sheet
Thursday - $28B seven-year Notes
Friday – the first estimate for 2Q17 GDP, expected to be +2.6%, almost double the 1Q 17 performance. Consumer spending is expected to be the driver of this strength
Three Steps – the rates market improved for the first time in three weeks:
1. CT-10 held at 2.40% support on Monday
2. In Congressional testimony, Janet Yellen admits that low inflation is still a major source of uncertainty
3. Weak Retail Sales, CPI data and Consumer Sentiment on Friday
So, we end the week near 2.30%, which two-weeks ago had been a support level that failed, but now is a level of resistance. The market saw good demand for the Treasury auctions as well as strong CMBS issuance.
The Week in Review – saw stocks hit record highs and US banks report stronger profits than expected. Two weeks after mentioning “somewhat rich asset prices,” Chairwoman Yellen’s dovish commentary about the transitory nature of inflation remaining lower than expected gave strength to the rates market, even as she stated the economy should continue to expand. However, it is the rate of expansion that is of concern, as evidenced by the CBO’s interpretation of the federal budget released by the White House, projected over ten-years.
The difference rests mainly on the economic impact of proposed tax cuts that, like health care reform, has not been advanced and whose benefit is considered very optimistic.
Weak reports on Friday did nothing to support possible increases in inflation. The Consumer Price Index, ex food & energy, came in below forecast at +0.1%, +1.7% y/y. Retail Sales, at -0.2%, was far below the consensus of flat to +0.4%, and then, the University of Michigan’s Consumer Sentiment reading reported another decline, a downward trend since peaking in December.
The WSJ chart below captures the trend for these indicators.
As well as the supply of Treasury and MBS debt was received, market focus is on the Fed and its plan for discontinuing reinvestment of proceeds in its $4.5T portfolio. It is expected a start date could be announced at its July 26 meeting and removing this buyer from the MBS market in 4Q2017 could pressure credit spreads going into year-end.
The Week Ahead - has no Fed speak, as they enter their blackout period before their July 25-26 meeting. Treasury supply is short-term Bills and 10-year TIPS, while economic reports are of relatively minor importance.
The holiday shortened week saw market sentiment continue to weaken as the impact of central banker comments heralding the end of easy money policies dominated activity.
The slope of the Treasury curve (2/10’s) steepened 8bps early in the week as longer-term rates rose faster than the front-end which is most affected by Fed policy.
Upon returning from a long weekend, traders digested the minutes from the ECB’s last policy setting meeting where policy makers believed that deflation risks had “largely vanished.” While they might believe deflation risk to be minimized, euro zone inflation at 1.3% is even lower than in the US, meaning both central banks are satisfied that their economies slow growth performance is sufficiently strong to manage with less support. Joining the central bank chorus is the Bank of France, whose spokesman said that “interest rates are set to rise.”
Doing Well Enough – seems to capture economists attitude about economic strength after Friday’s Non-Farm Payroll report. At 222,000 it was stronger than forecast and showed a 0.1% gain in the Unemployment Rate to 4.4% (more people joined the work force), as well as 0.1% gain in the Labor Force Participation Rate. Additionally, April and May reports were revised upward by 47,000. More solid employment data, but it was diluted somewhat by weaker than desired wage growth; at +2.5% y/y it is far below the 3% gains that workers enjoyed prior to the recession.
Low inflation and wage growth are unlikely to move the Fed from its course of action – one more rate hike in 2017, and a reduction in its portfolio. We can expect more details on that plan after the next FOMC meeting on July 26.
The Week in Review – focus was on ECB comments and the NFP report. On Thursday, the SBA 504 loan program priced its July debenture sales.
The upward trend in rate during this tightening cycle is confirmed by the 12-month averages but it is important to note that the July 20-year debenture represents a 4.77% effective cost of funds to small business borrowers.
The Week Ahead – has much Fed speak with Janet Yellen providing her semi-annual Monetary Policy Report to Congress; plus Treasury auctions of intermediate/long/term debt.
Tuesday – Treasury auctions $24B 3-year Notes
Wednesday – Janet Yellen appears before the House Financial Services Committee; Treasury auctions $20B 10-year Notes
Thursday – Janet Yellin appears before the Senate Finance Committee; Treasury auctions $12B 30-year Bonds
Friday – has several releases:
Consumer Price Index – consensus 0.1% vs. -0.1% in May
Retail Sales – consensus 0.1% vs. -0.3% in May
Industrial Production – consensus 0.3% vs, flat in May
Consumer Sentiment – last month’s reading was the lowest since the November election
A Collaborative Effort?
It started with comments from Mario Draghi, President of the European Central Bank – “there is investor vulnerability when major central banks pivot to a less accommodative policy.” Followed by Janet Yellin saying there are – “somewhat risky asset prices.” And concluding with Mark Carney, Governor of the Bank of England, saying he is prepared to raise interest rates soon, as is the Bank of Canada.
Collectively, these comments got the market’s attention and prompted a selloff in global sovereign debt. Not quite as abrupt as the 2013 “taper tantrum,” but enough for investors to fret that the period of ultra-low monetary stimulus is coming to an end. The 14bps rise in ten-year Treasury rate puts the note near its one-month high, and just below a key support level of 2.305%.
Equity markets have registered the best first-half year performance in years; Nasdaq was better by 14%, while DJIA and S&P 500 were improved by 8%. The energy component of those indexes did not participate as the energy sector declined 13.8% and US crude oil was down 15.7%.
Even lackluster inflation data on Friday did little to improve the rates market’s reversal. Personal Income was reported as +0.4% but wages and salaries gained only 0.1%. Consumer spending increased by just 0.1% and the core Personal Consumption Expenditures index gained 0.1%, with its y/y rate declining to 1.4%. The Wall Street Journal chart below shows how this ex food & energy estimate has been unable to gain traction towards the Fed’s 2.0% target. While that underperformance could complicate the FOMC’s plan for additional rate hikes, any such concern can be offset by global central bank action, like what was broadcast last week.
The market’s performance reflects the liquidation of long positions that had been accumulated over recent weeks and its continued weakness after the disappointing PCE data (usually a prompt to buy) means the market will probably test the above mentioned support level.
The Week Ahead - is holiday shortened, especially with many people taking off Monday. There is Fed speak but no Treasury supply on the calendar.
Monday – Institute of Supply Management gains should remain steady
Wednesday – Minutes of the FOMC meeting on June 14 are released
Thursday – the SBA 504 program prices 2017-20G and 2017-10D
Friday – Non-Farm Payroll report is expected to show a gain of 170,000 jobs with the Unemployment Rate remaining at 4.3%
Rates continue to decline – modestly, and equities marked time in the absence of any major reports and ambivalent Fed speak. As seen in this Financial Times chart linking this year’s equity rally to cheap money, the ten-year Treasury has broken through its 200-day Moving Average as the market awaits the next batch of inflation data.
And that data arrives on Friday as part of the Personal Income & Outlays report, when Personal Consumption Expenditures is expected to show a gain of +0.1% which could move its core rate to +1.6% y/y. That would still remain below the Fed’s target of 2.0% but would offer encouragement to the Committee about its tighter monetary policy.
The Rest of the Week Ahead – has more Fed speak and a lot of Treasury supply.
Monday – Durable Goods orders expected to be -0.4% after April’s report of -0.7%. Treasury auctions $72 billion short-term Bills and $26 billion 2-year Notes
Tuesday – Treasury auctions $34 billion 5-year Notes and Janet Yellen speaks at a forum on global economic issues and Mario Draghi speaks on EU economy
Wednesday – Treasury auctions $28 billion 7-year Notes
Thursday – the third estimate for 1Q17 GDP is expected to be unchanged at +1.2%
Friday – Personal Income expected to be +0.3% and PCE is part of the release
No Impact - FOMC acted as advertised and the market shrugged it off. In fact, the market rallied the morning of the rate increase in response to weak Consumer Price Index and Retail Sales reports, and then gave back some of that move later in the week.
Leading up to Wednesday’s announcement CPI came in -0.1% m/m and its core rate declined to +1.9% y/y. CPI is not the primary inflation indicator used by the Committee but that core rate is even lower, +1.5%. Retail Sales was -0.3%, a bit more negative than expected.
To recap Wednesday’s announcement:
Essentially, the current environment pits Reflationists vs. Deflationists with the Fed being in the former camp and the market in the latter. The breakeven rate for ten-year Treasuries (a measure of the yield premium for ten-year Treasuries vs. the yield on ten-year Treasury Inflation Protected Securities) is 1.67%, meaning that is what the market expects inflation to be for the next ten-years. Last month, that premium was 1.82% and it is shaping up for inflation data to drive price action as the market is indicating we are in a low growth, low inflation situation.
The Week Ahead – has a lot of Fed speak with housing data and the Purchasing Managers Index on Friday. Treasury supply will be $92 billion of Treasury Bills and $5 billion of 30-year TIPS.
Lower for Longer – has been the case for interest rates so far. Will it continue?
The market digested the Comey testimony, ECB policy announcement, and unexpected Tory shock in the UK election with only a small increase in rate. The UK election continued a losing streak for pollsters as Mrs. May’s party failed to maintain its majority and needs to form a coalition with a fringe party from Northern Ireland. It has serious implications for the Brexit negotiations which have almost two-years to run.
As we approach Wednesday’s probable rate increase from the FOMC, here is where official and consumer rates stand compared with one-year ago.
What is of interest in the above chart is that the benchmark ten-year Treasury has tracked the higher cost of funds after two recent rate hikes, but is actually 0.09% lower in rate from before the first rate hike in December 2015. Depositors are still not being compensated for savings and a higher yet cost of funds will not provide them any relief.
While not as low as before the presidential election, Treasury rates stubbornly remain low while equities are near all-time highs, the dollar has weakened 7% this year, and gold (another safe-haven investment like Treasuries) is on a tear.
So, how does the Fed interpret all this? It seems they are totally focused on employment which appears to be strong, while tolerating the below target rate of inflation and that is why Wednesday’s rate increase is likely. Similar conditions exist across the pond – Eurozone unemployment is at its lowest level since March 2009 (9.3%, compared to the US rate of 4.3%) and core inflation remains below target with slow wage growth, just like in the US. Additionally, the ECB will need to address its Quantitative Easing program, just as the Fed will need to take action to reduce its $4.5 trillion Balance Sheet. Both initiatives have provided strong support for fixed-income securities and changes in policy will pressure rates to move higher.
On Thursday, $338,673,000 of 2017-20F was priced at a rate of 2.81%, 6 bps below the program’s 6-month average rate through May, and with an Effective cost to small business borrowers of 4.60%.
The Week Ahead – starts with Treasury auctioning $71 billion of 3, 10, and 30-year securities on Monday and Tuesday.
Wednesday has reports on Retail Sales and CPI but all focus will be on the FOMC rate decision, new forecasts, a Yellen press conference, and potentially some information on the plan to reduce the Bank’s balance sheet.
The rates market’s resilient performance after the release of the FOMC’s May minutes pointed toward a June rate hike and its continued improvement was boosted on Friday by a weaker than expected Non-Farm Payroll Report. Like many economic reports it contained good news and bad news, though it was weighted to bad news.
The good news was the Unemployment rate declined to 4.3%, its lowest level in 16-years, and far below the Committee’s 5.0% target.
The bad news was:
Continuing to rally in the face of an expected rate hike on June 14, the weekly chart below reflects the ten-year Treasury’s odyssey from the Presidential election to now. The nearly 80 bps move higher has been halved in the wake of two rate increases, with an expected third move on the calendar for later this month. Even with inflation (PCE at +1.5%) below target, many analysts still expect the Fed to maintain its tightening policy.
The Week Ahead – is light on economic data, Fed speak, and Treasury supply (just short-term Bills)
Monday – Factory Orders have been improving but this report is expected to be -0.2%
Thursday – 2017-20F is priced. Debenture sales continue to benefit from this recent drop in benchmark Treasury rates.
European Central Bank meets and releases its updated forecast profile
It was a quiet week for the rates market as it prepared for a holiday weekend, moved neither by mixed data from economic releases nor the minutes from the Fed’s May meeting.
There was a brief move higher in rate going into Wednesday’s release of the minutes but their tone was not overly hawkish, calling any slowdown transitory while signaling the bank’s intent to raise rates another 25 bps at their June 14 meeting. What has changed since the March 15 rate increase is the slope of the Treasury curve, with the 2/10 segment flattening from 119 bps to 95 on Friday, and from 130 bps when rates rose in December 2016. This is standard behavior in response to a tighter monetary policy and seems to indicate that next month’s hike is mostly built into the market.
Less than Good News
The Week Ahead
Tuesday - Personal Income & Spending, which contains the Committee’s favorite inflation indicator (PCE). Consumer spending is expected to grow but with little effect on the PCE rate
Wednesday – Chicago Purchasing Manufacturing Index
Friday – Non-Farm Payroll expected to be +185,000 with Unemployment remaining at 4.4%
A very interesting week as Trump tweets surpass Fed speak with their impact on financial markets. Contradictory explanations for the firing of FBI Director Comey, disclosure of classified information to Russia’s Foreign Minister and Ambassador, and the appointment of a special prosecutor to investigate Russia’s alleged interference in the 2016 presidential election combined to weaken equities and give safe haven assets a boost.
This was the Treasury market’s best performance in a month and reflected not just the fear regarding the President’s actions and explanations, but also the concern over his planned fiscal stimulus proposals, tax cuts, and health care replacement. Spending for those initiatives would come from increased issuance of Treasury debt, so as their approval becomes less likely so does the anticipated supply of bonds.
Expectations for another rate hike at the conclusion of the FOMC’s June 13-14 meeting are still in place, but not a unanimous sentiment. St. Louis Fed President James Bullard, citing the weaker than expected core PCE reading of +1.6%, does not see enough reason for a June increase. Even though Unemployment, at a better than targeted 4.4%, reflects labor strength, he was quoted as saying “Low unemployment readings are probably not an indicator of meaningfully higher inflation over the forecast horizon.” Sluggish wage growth is another hurdle for inflation to overcome and though it is not one of the variables included in this WSJ chart it is of concern. These categories indicate market positions expect Treasury Note yields to decline while short-term rates increase (standard performance with a tighter monetary policy), consumers’ expectations for inflation to remain low, the Treasury yield curve will continue to flatten (restatement of the first point), and the $US continues its 2017 weakness.
An indication of this flattening yield curve is that on December 14, 2016 when the Fed last raised rates, the Treasury’s 2/10 spread (yield difference between the 2-year and 10-year Notes) was +130 bps. On Friday, it closed at +96 bps, a significant out-performance by the benchmark Note used for our Debenture sales, and helps explain why May’s 20-year rate of 2.88% was only 7 bps higher than in December.
The Week Ahead – several Fed speakers, early in the week.
Tuesday – New Home Sales + $26 billion 2-year Note auction
Wednesday – PMI plus Existing Home Sales; $36 billion 5-year Note auction; FOMC minutes from the May 3 meeting
Thursday - $28 billion 7-year Note auction
Friday – Durable Goods expected to reverse March’s strong 0.7% gain; 2QGDP expected to be revised up by 0.1% to +0.8%
After selling off to absorb $52 billion of notes and bonds in the Treasury’s quarterly refunding the rates, market rallied to close 1 bps lower on the week, at 2.33%. Helping this move was soft data for Consumer prices on Friday, +1.9% y/y ex food & energy, a reading below 2% for the first time in 1 ½ years.
Earlier in the week Retail Sales showed a +0.4% gain, a nice recovery from March’s -0.2% but not as much as was expected.
Thursday saw the sale of the SBA 504 program’s May debentures priced in line with expectations.
$17,713,000 2017-10C @ 2.33%, + 41 bps to Treasuries
$361,901,000 2017-20E @ 2.88%, + 49 bpw to Treasuries
While the number of additional interest rate hikes this year may be in question, the planned reduction of the Fed’s balance sheet seems to be drawing more attention. Discontinuation of reinvestment from portfolio proceeds would remove a significant buyer from the market and could result in more pressure on rates. This condition is not limited to the U.S., as the Bank of Japan also holds $4.4 trillion of its sovereign debt and these totals are exceeded only by the European Central Bank’s holding of $4.5 trillion. Should the global economy recover in sync, central bank buying would no longer be present.
The Week Ahead – is relatively light on speeches and data.
Tuesday – Industrial Production is expected to recover from March’s -0.4% report, and Housing Starts should continue to be strong, led by Multi-Family units.
Friday’s Non-Farm Payroll report was anti-climactic, as far as Treasury price action was concerned. By the time we got to the report of +211,000 gains, we had already been subjected to:
Even with mixed economic signals, below target inflation data, and sluggish wage growth, market analysts still expect an interest rate hike in June, and another one later in the year. Tighter monetary policy can also be achieved by a reduction of the Fed’s current balance sheet position that totals $4.4 trillion. This figure has been stable because the Fed continues to reinvest interest payments and maturing debt, thereby continuing its QE like support of the bond markets. Of concern is the timing and extent of withdrawing this support, especially with $1.75 trillion of the holdings being in mortgage-backed securities. At its most recent meeting the Fed announced its desire to begin reducing its holdings and two Fed bank presidents amplified that statement late in the week. James Bullard and John Williams would like this balance reduced by as much as half, to a level seen just after the great recession and before QE2. As apolitical as the Fed is, they must be sensitive to the possible impact from tighter monetary policy, reduced balance sheet support, increased deficit from tax cuts, plus planned infrastructure spending.
The week Ahead – has several Fed speakers, plus:
Sunday – second round of French presidential election. Pollsters finally get one right as Emmanuel Macron defeats the far-right candidate Marine LePen. This will soothe European concern about a Frexi and allow the EU to focus on Great Britain.
Tuesday – PPI expected to be +0.2%, +1.7% y/y. Treasury auctions $24 billion 3-year Notes
Wednesday – Treasury auctions $23 billion 10-year Notes (the benchmark for our 20-year debentures)
Thursday – we price 2017-20E and 10C. Treasury auctions $15 billion 30-year Bonds and PPI is expected to +0.2%; +2.3% y/y
Friday – Retail Sales expected to be +0.6% vs. March’s -0.2%. CPI expected to be +0.2%; 2.0% y/y
The 15% Solution
Spurred initially by Marine LePen’s failure to win the first round of the French election, the stock market received an additional boost from strong earnings and the administration’s restatement of its proposed tax plan, lowering the corporate and pass-through tax rate to 15%.
This performance initially pushed prices in the rates market lower but the benchmark ten-year Treasury improved to close the week almost unchanged at 2.28%, lower by 7 bps from when we priced the April debenture sale. Surprisingly, Treasuries did not improve more after Friday’s +0.7% report on 1Q17 GDP. This compares to the 4Q16 performance of +2.1% and is the slowest rate in three-years. A 0.3% increase in consumer spending, the weakest level since 2009, was identified as a major contributor to the disappointing report.
This performance reflects the divergence between soft data and hard data – strong consumer and corporate sentiment vs. sluggish retail sales and the recent GDP report. Weak first quarter growth is becoming a common occurrence and economists do forecast a strong rebound in Q2.
The Week in Review
Durable Goods Orders were +0.7%, due mostly to strong airplane orders; ex transportation though the number was -0.2%
New Home Sales were stronger than expected at 621,000
Foreign Demand for Treasury debt was evidenced by 81% of Thursday’s $28 billion 7-year note going to indirect bidders
European Union affirmed a tough stance on divorce proceedings with the UK. Britain has expressed hope that trade terms can be negotiated now, while the EU has stated no discussions will take place until the exit penalty is paid.
Shutdown averted as Congressional leaders reach a deal to fund the government through September 30
The Week Ahead
Monday – Personal Income & Outlays is forecast to be +0.3%, with the Fed’s favorite inflation measure, PCE, expected to weaken. Institute of Supply Management report is expected to soften after seven consecutive strong reports
Wednesday – FOMC meeting announcement with an updated forecast profile. No change in policy is expected.
Friday – Non-Farm Payroll report is expected to rebound from March’s disappointing +98,000. Consensus looks for +185,000.
Losing Faith in the Economy
After the post-election surge in rates, the bond market has reversed course and rests near the mod-point of that 80 bps move.
An illustration of just how contrarian this move has been is the amount of debt that has been issued while rates declined; the supply had little impact.
And this is in addition to the weekly issuance of Treasury debt, which will be $88 billion in 2, 5, and 7 year maturities this week. That is in addition to $88 billion short-term Treasury Bills.
During this rally, equity prices have retreated as investors view that product’s value to be stretched, especially since there is an absence of clarity on the administration’s promised programs; that could change on Wednesday when a tax overhaul is scheduled for release.
Other items of interest last week:
The Week Ahead – some Fed speak, with economic reports and Congressional negotiations on government spending.
Sunday – Centrist Emmanuel Macron and far-right candidate Marine LePen are headed for a decisive second vote on May 7. These selections are a rebuke to France’s traditional political parties and have influenced US markets – CT-10 yield has moved to 2.30% overnight and Dow Futures are sharply higher.
Tuesday – New Home Sales should remain steady at 584,000
Wednesday – (or shortly thereafter) is the day President Trump plans to announce his tax plan, but his budget director said it might be June before details are available
Thursday – Durable Goods orders have generally been soft, aided mostly by strong aircraft orders
Friday – 1Q17 GDP expected to be +1.1%, down from 2.1% in 4Q16. Partial government shutdown looms for the President’s 100th day in office if a spending bill cannot be agreed on
Written by: Steve Van Order
Risk off: Treasury yields fell last week.
Treasury yields fell over the first three days of the holiday-shortened week before settling in on Thursday. The benchmark ten-year T-note yield fell 12 BP w/w to 2.24%. Flows continued from equities into bonds which supported Treasuries, despite generally sloppy results for the monthly set of $56 billion in three-, ten- and 30-year auctions.
Economic data was generally mixed until the Thursday release of the PPI that was weaker than expected. On Friday morning, while the bond market was closed, the CPI for March fell m/m for both headline and core figures. The y/y growth rates were 2.4% and 2.0%, respectively. The chart below shows the behavior of the CPU headline y/y measure over the last decade. We can see the steady rise in the post-crisis CPI rate since it bottomed around zero in 2015. The latest measure shows a small retreat in the trend. This may help bond market animal spirits this week.
Also assisting the bond rally last week were Fed Chair Yellen’s comments on Monday that were pretty neutral and did not signal any hawkish bent. Continued geopolitical tensions in Syria and North Korea combined with President Trump’s flip-flopping on security and domestic issues kept investors confused on where U.S. leadership is headed. Confusion almost always helps bond yields move lower.
This week there is a lot of economic data to be released but it is all of a second tier nature. The parade of Fed speakers will continue as well.
Risk Off – resulted in an eventful week that left markets basically unchanged – which is surprising.
Events that usually result in market volatility were:
Safe-haven Treasury securities rallied Friday morning in response to the airstrike but quickly settled back and closed lower on the day. Rates seem range bound as market forces, Fed policy, and legislative gridlock compete for headlines. During this reversal, the Non-Farm Payroll report came in 100,000 below consensus, at +98,000 with 38,000 jobs reduced from the previous two-months’ reports. Offsetting this weak number was an Unemployment rate showing a reduction to 4.5%.
Together with the additional rate hikes, the Fed has projected for this year is speculation over how it will normalize its $4.2 trillion balance sheet. Minutes from the recent meeting disclosed “rollover tapering would likely be appropriate later in the year.” It is expected the process would consist of no longer reinvesting proceeds from interest income and maturing Treasury and MBS debt, allowing the bank to achieve a portfolio of approximately $2.8 trillion by 2021. The European Central Bank has already reduced its QE policy from €80 billion to €60 billion and amid Brexit negotiations and national elections the WSJ reports that investors are concerned that Europe’s biggest buyer may further reduce its support.
Details of a previous investigation regarding the possible leak by Dr. Lacker were omitted from an original report that has been prepared before the FRB of Richmond reappointed him in 2015. The leak took place in 2012 and contained “potentially market moving information.”
Other than these items the market also saw the 504 program’s April debenture sale price on Thursday, for settlement on Wednesday, April 12. Priced at 2.84%, and a spread of +49 bps to the ten-year Treasury, 2017-20D was 20 bps lower than the March sale and just 3 bps higher than the December 2016 debenture which priced prior to two Fed rate hikes. In the chart below it is clear how the market anticipated the recent interest rate increases but what is most impressive is that small business borrowers now are locking in 20-year fixed-rate 504 loans just 63 bps above the Prime Rate.
The Week Ahead – is shortened by Friday’s holiday in advance of Easter, and has reduced Fed speak with Charwoman Yellen talking Monday at U. of Michigan.
Monday – auctions for $72B T-Bills and $24B 3-year Treasury notes
Tuesday - $20B 10-year Treasury notes
Wednesday - $12B 30-Treasury bonds and Closing for 2017-20D
Thursday – Producer Price Index, expected to be flat
Friday – markets are closed, bur Consumer Price Index and Retail Sales are released, and expected to be flat to slightly negative
It was an interesting week:
Though core PCE (ex food & energy) at 1.8% remains below the Fed’s 2% target, the overall number crept above that level for the first time in five-years, joining the Bank’s other objective of an unemployment rate ≤ 5% that drives its higher interest rate policy.
Fed speak was very active last week with comments ranging from FRB Vice Chairman Stanley Fischer saying two more rate hikes this year “seems about right,” to Chicago FRB President Charles Evans seeing four rate hikes “if there is a stronger lift in inflation.” Additionally, there was speculation of how, and when, the Fed might return to normalization for its portfolio. Though no longer actively pursuing its QE2 policy, reinvestment of interest income and maturing debt is ongoing and ending that would have an effect on longer-term rates.
Though equities have declined 2% recently as the Trump rally has lost momentum, that sector had a very healthy 1Q17 performance. Without any advance on tax reform or infrastructure spending, further significant gains are unlikely.
Treasury saw strong demand for its auctions last week, especially from indirect (foreign) bidders who bought as much as 71% of the seven-year auction. The ten-year Treasury benchmark that is used for our debenture pricings closed the week at 2.39%, lower by 19 bps from our March sale.
The clock is now running for the UK as it submitted the required Article 50 to the EU, commencing the two-year window in which negotiations for its exit must occur. While the UK wants to negotiate trade terms with its former members, the Union is adamant that a prescribed fine be paid before any negotiations take place. Additionally, the UK must deal with Scotland’s renewed desire to secede and maintain its membership in the EU.
The President’s move to pull the repeal and replace action for the Affordable Care Act was a crushing defeat, and brings into question the administration’s ability to pursue its aggressive tax reform and infrastructure spending plans. Further weakening those plans is the need for the Senate to exclude the President’s request for funding to increase military spending, and construction of the wall at the Mexican border in its resolution to avoid a government shutdown later this month. Including those funding requests would most certainly result in a legislative stalemate.
The Week Ahead –
Monday – Institute of Supply Management
Tuesday – Factory Orders expected to show a gain of 1.2%
Wednesday - Release of minutes from the March 15 FOMC meeting
Thursday - *** Pricing for 2017-20D and President Trump meets with Chinese Premier Xi Jinping in Florida
Friday - Non-Farm Payroll report expected to show a decline from the elevated levels of the previous two-months. Consensus forecast is 178,000
Relief Rally Continues – relief that the rate increase finally happened on March 15, that is. The FOMC still projects two more increases in 2017, and some analysts predict three more.
The benchmark 10-year Treasury has rallied 17 bps since 2017-20C was priced on March 9, and was poised for further gains at week end. Helping the move has been the selloff in Equities, as the Trump effect has waned and the health care act was pulled from a House vote; an ominous development for a market expecting its change, plus tax reform and infrastructure spending. If Treasuries are up then it usually means stocks are down, and through March 22US stock funds saw $9 billion of withdrawals, the largest weekly amount since June 2016, whch began a negative trend that contiued until the presidential election (Financial Times chart).
As for performance, stocks continue in a choppy market with the S&P 500 index down 1.4% for the week, and about 2.5% off its highs. All of this leaves us in an uncertain environment, dependent on headline news and the Republicans needing cross-over Democratic votes to pass legislation.
Last Week – contained second tier reports and muted Fed speak, with Chairwoman Yellen addressing education, and not fiscal policy, in her speech. A strong new home sales number affirmed the strength of housing and residential mortgage credit.
The Week Ahead – a lot of Fed speak, plus:
Monday through Wednesday – will see Treasury auction $86 billion of short and intermediate term debt. Since there is $81.4 billion of maturing debt, the supply should not be a problem.
Consumer Confidence on Tuesday may decline from its post-election highs.
Thursday – gives us the third revision of 4Q16 GDP and is expected to rise slightly from 1.9%.
Friday – Personal Income and Outlays includes the Fed’s favorite inflation gauge, PCE, and it is expected to finally reach the targeted 2% level y/y.
A Reversal of – Buy the Rumor, Sell the Fact
In the rates market last week, it helped if you bought the fact that lending rates had just increased. Leading up to Wednesday’s move the rates market has built in the 25 bps increase, and more. Offsetting that sentiment was somewhat dovish commentary from the Committee, with one member dissenting on the move. Kept intact was the Committee’s “dot plot’ calling for two more hikes this year.
Friday’s close puts the benchmark ten-year Treasury 8 bps lower than when 2017-20C was priced on March 9th.
The sale saw an increase in rate, issue size, and number of debentures vs. the program’s twelve-month averages.
The Week Ahead – contains much Fed speak, including Janet Yellen on Thursday. The only Treasury supply is short-term Bill auctions.
Wednesday – Existing Home Sales are expected to continue January’s strong report
Thursday – New Home Sales should rebound from a sluggish January level
Friday – Durable Goods are expected to show a 1.5% gain after a 1.8% gain in January
Markets Move Ahead of the Fed – Last week, stronger-than-expected labor market data pushed U.S. interest rates higher in anticipation of a Fed rate hike this week. The February ADP Employment Report, released on Wednesday, came in far above consensus at 298,000 sending Treasury yields and mortgage rates to their then-highest levels this year. That ADP report presaged a strong February employment report released Friday by the BLS. Non-farm payrolls rose 235,000 and handily beat the 190,000 consensus. The unemployment rate fell to 4.7% and now has been under 5% for nearly a year. Average hourly earnings increased a solid 2.8% y/y. Other data also suggest a tightening labor market. For example, the latest four-week moving average of weekly jobless claims, at 236,500, is the lowest reading of this economic cycle. The number of job openings (per the last JOLTS survey) is high.
In reaction to, and anticipation of, stronger data releases, U.S. Treasury yields rose. The benchmark ten-year note yield settled at 2.57% late on Friday. On Thursday it reached 2.60%, edging out the high from last December 16. A move above 2.61% would take the yield back to the September 2014 high. Amid rising rates, the SBA 504 20-year debenture rate in March was set at a still-relatively low historical level, and featured one of the larger pools ($333 MM) in some months. At 3.04%, 2017-20C was near the April 2014 level (3.11%), but still delivered an Effective Rate to small business borrowers of 4.83%.
Entering this week the market is poised for what it now believes to be what the FOMC has predicted – three rate hikes in 2017.
The Week Ahead. Market activity will center on Wednesday’s announcement at the conclusion of FOMC’s two-day meeting, and there are several economic reports to be released throughout the week.
Attention Shifts from Trump to the Fed – and the message was very clear.
The rates market gave ground last week after strong inflation data and some hawkish Fed speak, none as forceful as the title of Janet Yellen’s Friday speech – “From Adding Accommodation to Scaling Back.” The 17-bps weekly move heralds the first of three proposed rate increases for 2017, and the market has assigned a 90% chance of it occurring on March 15th.
As reported in the Wall Street Journal, Ms. Yellen was quoted as saying “if inflation and employment data continue to meet the central bank’s expectations, “a further adjustment of the federal-funds rate would likely be appropriate” at this month’s gathering.
The Fed has consistently identified three markers for them to have confidence in raising rates: unemployment at 5% (4.8%); inflation as measured by Personal Consumption Expenditure at 2% (1.9%); and steady global growth. The first two are at, or near enough, to justify an increase and improved European performance is encouraging talk of the ECB’s Quantitative Easing being curtailed. Even with stock indexes trailing off late last week they remain near record levels, as evidenced by the S&P 500 indexes’ 13% gain since the November election.
The Week Ahead – is light on data and contains no Fed speak as the Committee prepares for its March 14-15 meeting and announcement. Treasury will auction $56 billion of intermediate and long-term debt, with our benchmark ten-year note scheduled for sale the day before the March debenture sale.
Thursday – 2017-10B and 2017-20C to be priced at 10:30, for funding on March 15th
Friday – Non-Farm Payroll expected to show a gain of 190,000 with the unemployment rate possibly declining to 4.7%, and average hourly earnings gaining 0.3%
Reversal, for now
An unexpected rally late in the week reduced the benchmark ten-year note’s yield to its lowest closing level since November. Analysts were hard pressed for a reason, especially in the face of hawkish Fed comments, stronger inflation data, and Treasury Secretary Mnuchin’s comments re: issuance of 50 and 100-year debentures.
The Week in Review
In reverse order, any initiative to issue debt with such maturities will take some time to implement, just like proposed infrastructure spending. For example, the Treasury’s path to issue floating rate notes took three years, and though this administration is focused on change it will require much market study to examine its possible effects.
The recent strong CPI and PPI releases may be reinforced by Wednesday’s Personal Income & Outlays report that includes the Fed’s preferred inflation gauge – Personal Consumption Expenditures, also expected to be strong. A consensus forecast of +0.4% might put this indicator at the Fed’s 2.0% target.
Wednesday’s release of minutes from the January FOMC meeting offered no clear signal of an imminent interest rate increase, but many participants believed a rate increase could come “fairly soon.” On Thursday, four Primary Dealers in the Treasury market had joined in calling for a May rate hike, though most others are on record for an increase in June.
The Week Ahead – data, the President, and more Fed speak, highlighted by Janet Yellen’s speech Friday night. Treasury supply consists of short-term T- Bills with announcements of 3,10, and 30-year auctions for the week of the March debenture sales.
Monday – Durable Goods – occasionally volatile but improving, expected to be +1.8%
Tuesday – GDP – second revision to 1.9% 4Q growth; consensus is 2.1%; and President Trump speaks to Congress, a speech that is expected to include some insight on fiscal policy
Wednesday – PI&O – income is expected to be +0.3%, with the PCE at +0.4%
Friday - two Fed Presidents (Evans and Lacker) speak on inflation; and Chairwoman Yellen speaks to the Executive Club of Chicago
Strong Headline News – is what drove the markets last week, but left Treasury rates mostly unchanged by Friday.
A combination of better than consensus economic releases, aided by more hawkish comments from Chairwoman Yellen, moved rates higher midweek, only to reverse trend by Friday.
Recent French polls put Marine Le Pen in a lead over opponents, causing concern about her nationalistic views to leave the European Union and pressuring French bond rates, which still remain low. French rates have recently risen but this table shows how cheap US Treasuries remain to other sovereign debt.
The Week Ahead – is fairly light on economic data.
Stock Indexes at New Records – and most of the week’s gains occurred after President Trump announced a “phenomenal” corporate tax announcement to be made in the next couple of weeks. The president seems to be borrowing a page from ECB president Mario Draghi, whose undated profession to do “whatever it takes,” without actually doing anything immediately, helped the European markets in the lead up to its QE program.
The expected tax cuts and fiscal spending are driving stock and US$, values while putting a cap on any Treasury gains. Fulfilling these initiatives falls to Congress, not Presidential decree, and there is a question as to how long this will take.
In the meantime, the Greek debt crisis has returned to form, a hard Brexit is yet to be defined, a possible Frexit is of concern if Marine Le Pen is victorious, and though there was good indirect bidding for last week’s $62 billion of Treasury debt, foreign investors are holding a smaller total amount of U.S. Treasuries. As evidenced by the Bloomberg chart below, this is not a new trend but did accelerate during the presidential election year and has continued into 2017.
Also, it was mentioned last week that the Fed has policy options other than just raising rates, e.g. reduce the reinvestment of maturing bonds and P&I payments from its mortgage backed securities, something that James Bullard, President of the St. Louis Fed, mentioned in a Thursday speech. Taken together, these items identify global caution about buying U.S. government debt due to political uncertainty. At $5.64 trillion that amount is formidable but its 43% of outstanding supply is down from a 56% share in 2008.
The Week in Review – saw rates improve, though not as much as stocks. 2017-20B was priced at 2.82%, vs. a 12-month average of 2.35%.
The Week Ahead – we’ll see some economic data like Producer Price Index and Retail Sales, but scheduled appearances by Janet Yellen before Congress will be of most interest. On Tuesday, she speaks before the Senate Banking Committee and then Wednesday’s appearance is before the House Financial Services Committee.
With Treasuries becalmed, specifically the ten-year Note closing around 2.48% for the third consecutive week, let’s turn our attention to stocks, where the DJIA had its best one-day performance in two months thanks to the most recent Executive Order to review the Dodd-Frank legislation.
The index’s 187-point gain on Friday was driven by potential regulatory rollbacks and the headline value of Friday’s report of 227,000 job gains in January. The banking sector was a driving force as the index that represents big banks is +24% since the election.
The Week in Review
Sensing a higher rate environment, corporate treasurers are marching to market in force: $17 billion for Microsoft; $10 billion for AT&T; and $8 billion for Apple. Amidst this wave of issuance, corporate bond trading hit a record high of $38 billion on Tuesday alone. Two of the above names have large cash positions with little need to fund operations, as Microsoft recently reported $5 billion in quarterly profit. Looking back to 2008, the firm had zero debt, but taking advantage of historically low interest rates that total is now $76 billion. Wednesday’s announcement from the FOMC was as expected; no change in policy with a unanimous vote.
And then Friday’s NFP report came in stronger than expected but disappointed with a weak wage growth number (2.5%) with last month’s gain revised down. So, we had a stronger than expected number of jobs created, with the Unemployment Rate increasing to 4.8%, and wage growth declining 0.02%. A 46,000 gain in retail jobs was the best number of all categories, leaving the regulatory rollback as the real catalyst for Friday’s strength in stocks.
Though the Fed has projected three rate hikes this year most analysts expect just two, probably occurring in June and December. Rate hikes alone aren’t the only tools to influence policy, as the Fed could temper its current reinvestment policy to shrink its $4 billion balance sheet. It is expected to see $195 billion of Treasury debt mature in 2017 and is currently reinvesting that and proceeds from about $30 billion in monthly P&I payments on its mortgage backed bonds. Yes, Quantitative Easing still lives to some degree. In a footnote to a recent Janet Yellen speech, she admitted that the portfolio’s duration has shrunk to 6 years, down from a 7.5-year duration four-years ago.
The Week Ahead
Marking Time, Again
After an initial drop in rate, the Treasury market eased back to close the week 1 bps higher as the market absorbed $88 billion in 2, 5, and 7-year Treasury debt. All issues were strongly oversubscribed, including foreign demand which topped out at 74% for the $28 billion 7-year maturity.
Tepid – was the word the WSJ used to describe 4Q16 GDP growth. At 1.9% it dropped dramatically from the 3Q rate of 3.5% and is closer to the 2.1% annual growth rate since 2009.
CBO projects this unspectacular trend to continue, citing structural trends like baby boomer retirements and the increasing trade deficit. Slow growth in the labor force and sluggish worker productivity were cited by Janet Yellen as “some of the variety of forces affecting supply and demand.”
Intense – was the reaction to many of President Trump’s executive orders during his first week in office. Many of them are controversial, and it remains to be seen if he attempts to seek common ground with Republican lawmakers – individual and corporate tax reform, deregulation, and stimulative economic policies, or continues to adhere to campaign pledges.
Last Week in Review
The Week Ahead –
The post-election equity rally has stalled, and the bond market selloff regained momentum, as global markets are at a crossroads awaiting details on President Trump’s proposals.
Closing the week below the December high of 2.60%, the CT-10 rate increase was part of a curve steepening trade after more Fed speak. One particular speech by Chairwoman Yellen on Wednesday simply stated that interest rates could be raised “a few times a year” through 2019. The FOMC has already outlined that path but hearing it again from the Fed chair clearly upset the bond market.
Helping that sentiment was the Consumer Price Index release that showed a 2.1% gain Y/Y, and a very strong auction for $13 billion of 10-year TIPS (Treasury Inflation Protected Securities). Indirect (foreign) bidding for the issue totaled 77.1%.
The Week Ahead – has no scheduled Fed speeches, but several economic releases:
Marking Time – The market took a run at lower rates, but met resistance, and ended the week near where it had started; as did Equities, whose post-election rally tapered off.
We are four days away from the new President’s inauguration, and even further away from the proposed tax, and spending initiatives that have been forecast. Marking time is expected to continue until there is some definition to these proposals.
The Week in Review
The Week Ahead
This is how rates change when an economic report contains stronger data that expected. The item in this case was part of Friday’s Non-Farm Payroll Report, and it was Average Hourly Earnings (wage growth) that was +0.4%, bringing it to a post-crisis high of +2.9% Y/Y. Wage growth bodes well for consumer spending, which reflects demand for goods, resulting in inflation, which is bad for fixed rate securities. By itself, it does not mean we are at the Fed’s inflation target of 2.0%, but reflects how sensitive the market is during the transition to a new administration that promises tax cuts and increased spending.
In its entirety, the NFP report was:
The Week in Review – other than the already mentioned NFP Report:
The Week Ahead – has A LOT of “Fed speak;” most importantly, Janet Yellen on Thursday night.
The final week of trading for 2016 saw prices improve, and yields decline, as the Treasury saw strong demand for its auctions of intermediate-term debt. Indirect (foreign) purchases of the $34 billion 5-year maturity were the strongest, with 71% of the issue accounted for that way. This action took place as the DJIA failed in its attempt to reach 20,000; closing the week down 146 points at 19,763.
Considering the volatility, it is interesting to note that the ten-year Treasury yield increased just 17 bps Y/Y, resulting in the second consecutive year that yields increased. Most of the move was driven by the election results, as market analysts expect inflation to rise as a result of increased spending to spur infrastructure growth.
At 4.6%, the Unemployment Rate has surpassed the FOMC’s target; Personal Consumption Expenditures are at 1.41%, below target but showing signs of strength; and while the third target of global growth is spotty, focus is more closely centered on expected policies of our new administration.
The FOMC has identified three potential rate hikes in 2017, moves that would increase the overnight cost of funds to 1.375% from the current level of 0.625%. With that in mind, this Financial Times chart projects rates out to 2020, and a target of 2.0%.
The Week Ahead
The Year Ahead – will be driven by these topics:
Let the trend be your friend – reinforced bearishness as Treasury rates rose for the sixth consecutive week, with the two-year Note reaching its highest yield since the financial market collapse (1.26%). Equities and US$ rallied, bonds and commodities sold off, though with reduced volume as holiday staffing has already been introduced to the markets. At some point, substantive detail for regulatory and legislative change, as well as higher inflation readings, are needed to support this move. For now, we are light on data into year-end and yield seekers have been in short supply.
A couple of points on rates:
Fixed vs. Floating - As rates rise, with the international benchmark lending rate of 3-month Libor trading at 0.997%, a flood of money has found its way into loan funds, as investors seek out the higher income paid by floating rate loans, unlike fixed rate debt. Bank loan funds have counted more than $3bn of inflows over the past two weeks, the greatest haul for a two-week period in more than three years.
The Dot Plot - during her recent press conference, Chairwoman Yellen identified expectations for three rate increases in 2017, vs. the previous projection of just two moves. It is that additional hike that pushed yields to their recent high, but this Financial Times chart shows its survey of 31 economists that identified June as the next likely increase, with only one more to follow. Such a pattern would be reminiscent of the Fed’s projection of four rate hikes in 2016, with last week’s move being the only one.
The Week Ahead – will certainly include Fed speak and has housing data, plus:
A quiet week in the rates market until Thursday, when Mario Draghi announced an extension of the European Central Bank’s Quantitative Easing program at the same time he announced a reduction in the principal amount of monthly bond purchases. The latter point won out as the market sold off towards its 2.50% support level, in anticipation of the FOMC’s policy announcement this Wednesday at 2:00.
The week in review – was very light on economic data but did show increases in Consumer Spending and Consumer Sentiment.
2016-20L was priced at 2.81%, +41 bps to Treasuries vs. the 12-month average of 2.33% at +56 bps.
The Treasury curve continues its bear market steepening, having widened 14 bps in the last two-weeks, to +133 bps.
The week ahead – delivers the long-awaited interest rate hike from the Fed. It would be a shock if there was no change and it seems the increase is already baked into the markets, at least in the front end of the curve.
Hesitant seems the best word to describe last week’s market activity:
Recent volatility is not new as this WSJ chart below identifies the frequency of 1% rate increases, dating back to the financial market collapse.
The Trump effect is still being felt as fear of inflation, not inflation itself, has asserted itself. And now, Treasury designate Mnuchin has proposed issuing debt longer than thirty-years to fund infrastructure needs.
The week in review
The week ahead is relatively light on reports and issuance.
Does this matter?
At 2.36% yield, CT-10 is at the largest premium to the S&P 500 index in over a year, yielding 2.36% vs. 2.11%. Price action this month points the issue to its steepest monthly decline since January 2009, and it remains oversold.
The answer should be yes, as investors (insurance companies and pension funds, in particular) have been starved for yield and this month’s selloff has preceded December’s almost certain rate hike. That FOMC meeting’s announcement is scheduled for the day our December sale closes, December 14th.
Last week’s supply of intermediate term Treasury debt was met with strong foreign demand and $US denominated debt maintains its wide spread to other global bonds. The longest dated of the three Treasury auctions, a 7-year maturity, saw the greatest foreign demand – 71%, and the $28 billion auction was 2.7X subscribed.
The week in review - was highlighted by the Treasury auctions, release of the November FOMC minutes, and a strong Durable Goods report occurring in a holiday shortened week.
This week – has more Fed speak, plus these reports:
Gradual might have been the Fed’s intent, but 98 bps in four months is how much we have moved since July, with no change in Fed policy; and that is certain to change on December 13th at the conclusion of the FOMC’s next meeting. The upward trend in rate that accelerated after the November 8 election was enhanced late last week by Fed speak: comments from Janet Yellen to Congress that a rate increase could “become appropriate relatively soon,” and the NY Fed President, William Dudley, who stated, “some further evidence” of inflation indicates the Committee’s inflation target is in reach.
The above chart reflects the weekly close for our benchmark ten-year Treasury, closing Friday well above its 50-week, and comfortably above its 200-week average. What the bottom chart shows is the “moving average convergence divergence” indicator that traders reference for when markets might be overbought or oversold. A definition of it is “moving average convergence divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of prices, functioning as a trigger for buy and sell signals.” By no means does it guarantee a correction since the current trend could continue, but it does indicate this market is oversold and rates are likely to decline somewhat. The qualifier somewhat was added because starting today the Fed will conduct auctions totaling $173 billion of Treasury debt, closely split between short-term T-Bills and longer term notes.
An indication of how sudden this move has been are the last three 20-year sales, plus an indication of what a sale could have been, if priced last Friday:
|20-year series||September||October||November||If 11/18/2016|
The week in review - adding substance to the Fed comments were mostly strong economic reports:
The week ahead – contains some reports on housing, and a durable goods report, but even though the market requires no more assurance of a December rate hike, we do get a Wednesday release of minutes from the meeting that concluded on November 2nd.
On the day after the election we saw market divergence as stocks rallied and bond yields surged, moving the benchmark ten-year Treasury yield dramatically higher, and increasing our 2016-20K to a rate 36 bps higher than in October. Wednesday’s jump in yield was the biggest one-day increase in three-years, partly affected by an auction for $23 billion of the benchmark ten-year Treasury note, and strongly influenced by the president elect’s intended infrastructure spending and tax cuts. The move to higher yield was then enhanced by Thursday’s auction of $15 billion thirty-year bonds and has continued into today’s opening, with CT-10 at 2.23% and the 30-year bond reaching 3.0% for the first time since January.
Where to begin, and how soon?
It is obligatory for newly elected presidents to have a 100-day plan and Mr. Trump’s challenge will be how to prioritize his objectives:
It is the last item that framed the recent move higher in rate and is also linked to Mr. Trump’s criticism of Fed policy. Chairwoman Yellen has repeatedly advocated a gradual increase in rates but legislative changes could challenge that approach. A key determinant will be how infrastructure spending is realized: an anticipated increase in Treasury funding contributed to last week’s move but Trump advisors have proposed private equity can fund projects in exchange for significant tax breaks. That approach believes the loss of tax revenue would be recouped by increased taxes realized from construction workers, plus increased tax revenue from contractors. And then there is the “deemed repatriation” of foreign profits, as much as $2.5 trillion. Relaxing the current tax rate on that could account for at least some of the required spending. It is important to note that infrastructure projects take considerable time to plan and initiate and most are done at the state and local level, making federal involvement even more complex and time consuming.
Although the Fed’s PCE model of inflation remains below its 2% target, fiscal stimulus in a tight labor market can result in inflation which, in turn, is harmful to bond investors. The type of inflation that could result is called “demand-pull” because it occurs when there is too much spending in an economy that can produce only so many goods and services.
Yields have moved sharply higher twice in the last three years, only to reverse course when conditions did not sustain economic improvement. It is improbable that we revisit dramatically lower rates and structural change is still many months away, but market sentiment has definitely shifted due to Mr. Trump’s mix of economic stimulus and protectionism that is expected to foster faster growth and inflation. With ten-year yields 50 bps higher than one-month ago the market has already priced in more than next month’s anticipated rate hike and steepened the curve, so we should see some stability but that will be influenced by the new administration’s announcements.
The Week Ahead – lots of Fed speak, including Janet Yellen’s Thursday testimony before the Senate’s Joint Economic Committee, plus speculation on President elect Trump’s agenda.
Randomness of Consequence
As we approach Tuesday’s Presidential election markets are at odds with each other: stocks ended last week with eight consecutive down days while Treasuries held firm, and even rallied. There is much speculation about the impact of either party’s victory as analyst’s debate the potential policy changes which, of course, will depend not only on the presidential vote but also the composition of Congress.
The Week in Review
The Week Ahead
Bonds on the Run
With one trading day left on All Hollows Eve, the ten-year Treasury yield has risen 25 bps since the end of September, marking the worst monthly performance for bonds in three years. Contributing factors have been: The Bank of Japan establishing a floor for its longer-term yields; the European Central Bank offering tepid encouragement for extending its bond purchase program; UK inflation unexpectedly rising; a stronger than expected report on 3Q16 GDP; and increased bond issuance in Europe.
Economic reports last week supported domestic growth and that helped to soften the market.
This isn’t the first time we have seen an improved quarterly report, as evidenced by the uneven performance dating back to 2009, but it seems the market senses more contributing factors to support a change in Fed policy. Whether it is a one-off move like in December 2015 is what will keep the market guessing.
A very quiet week with a lot of Fed speak and economic reports that were mostly flat.
A combination of Federal Reserve Bank Presidents, Governors and a Vice Chairman contributed more support for gradual rate hikes “if the economy is in good shape.” Adding to this theme of caution was Mario Draghi, President of the ECB, who hinted at extending the bank’s bond purchase program.
Last Week’s Events
Industrial Production and CPI came in as expected while Housing Starts showed a 9% decline, primarily because the volatile multi-family sector was down a dramatic 38%.
The Kingdom of Saudi Arabia found strong demand for its $17.5 billion offering of 5, 10, and 30-year debentures. The sale was almost 4X oversubscribed at spreads very attractive for a AA credit. One example is their 10-year series was priced at 3.40%, + 164 bps to CT-10. This is the first of many offerings that are expected to total $125 billion as the Kingdom looks to diversify an economy that is less dependent on oil exports.
The Week Ahead
Last week saw a continued erosion of investor confidence due to the release of FOMC minutes from the July meeting, new Treasury debt, a continued sloppy market for stocks, and sustained weakness in the British pound as the UK prepares to negotiate its EU exit.
The benchmark ten-year Treasury rose 8 bps, closing above its 200-day Moving Average of 1.75% and at its highest close yield since late May.
Fed minutes confirmed the decision to hold rates steady was a close call (7-3), but the vote was more divided than originally thought. The members voiced concern about labor market slack being affected by continued low interest rates, stating “a reasonable argument could be made to hike rates.” Such a policy change is unlikely before the November 8 election, but December is looking more certain.
Prices for US, German, and UK 30-year debt are on track this month for the steepest decline in a year. Yield increases of about 23 bps reflect investor concern with diminished central bank stimulus.
Exit, Stage Left – as the British pound weakens ahead of the UK exit negotiations.
Where is the money going? One beneficiary of this trend is government money market funds, which invest only in government assets. Their total assets now stand at $2.1 trillion, up from $1.1 trillion in January.
The week ahead– is pretty light on economic reports.
The market for CT-10 was unable to break through its 50-day Moving Average and now sits just below its 200-day Average.
There is rarely one reason for any event and we can look at several items that contributed to this recent move:
But, these events occurred later in the week, after bonds had already weakened in the face of new supply. If Japan is going to set a floor for long-term rates, and the UK might increase issuance, and the ECB has cautioned that it may not increase its monetary easing, then the market will become more cautious for reasons like the ones outlined by Martin Feldstein in in Op-ed piece in Thursday’s Wall Street Journal. Mr. Feldstein was chairman of the Council of Economic Advisors under President Reagan and is currently a professor at Harvard. Key points in his piece “Why the Fed should raise rates now” are:
Professor Feldstein added: “Abnormally low interest rates are also inducing banks and other lenders to reach for yield by lending to lower-quality borrowers and granting loans with fewer restrictions. If an asset-price correction causes an economic decline, these high-risk loans will suffer and the banks and other lenders will be in trouble. The current low bond rates have also removed the usual pressure on the government to deal with budget deficits. The debt-to-GDP ratio has more than doubled over the past decade, rising from 35% to 75%.”
The week in review:
The week ahead
The market made some attempt to rally but global concerns for Deutsche Bank, and skepticism over an OPEC agreement to cut production, combined to remove the momentum. Month-end buying on Friday helped stocks recover to where they started the month, while Treasuries gave ground to close the week better by just 2 bps.
The closing level for CT-10 is 4 bps above where we priced in September, and rests just above its 50-day Moving Average.
The week in review – modest continues to be an apt description for economic reports.
The week ahead –
No Change – in Fed policy resulted in modest gains for both bonds and stocks, while probably increasing the risk appetite of investors.
The benchmark ten-year Treasury improved by 8 bps on the week to close at 1.62%, 7 bps above where 2016-20I was priced, and should see some resistance at the 50-day Moving Average of 1.59%. The week’s performance was the best for this benchmark since late July.
Demand for Treasury debt will be tested this week with $88 billion of two, five, and seven-year notes being auctioned.
As for a future rate hike, the FOMC has two more meeting this year, with the pre-election November meeting unlikely to produce a change. But Wednesday’s no change announcement was not unanimous, and that is a reason why there is a 54% probability for a change after the December 14th meeting. Dissenters point to strong employment data with more people seeking work, and believe the Committee should not keep interest rates this low any longer. Their shared concern is that a rate increase now will commence a gradual path to higher rates and prevent the potential need for a rapid series of future increases.
The other central bank announcement last week came from the Bank of Japan which affirmed its zero interest rate target for its ten-year bonds.
The Week Ahead
Apple Inc. shares posted their best gain in five-years, up 11% on the week, as stocks in general, and also bonds, marked time. Marking time in advance of multiple central bank meetings this week; the Fed’s Open Market Committee in particular. They meet Tuesday and Wednesday with an update of their latest economic forecasts and the Bank of Japan has a similar schedule.
Central Bank Scorecard
Federal Open Market Committee
European Central Bank
Bank of Japan
The capital markets would appreciate a rate hike; banks and insurance companies in particular, as they have been forced to seek riskier investments due to the low rate environment of the last four-years.
The Week Ahead
A rather quiet week changed quickly after ECB President Mario Draghi announced no fresh stimulus and his comments were interpreted as indicating there could a cutback in current support. Market response was delayed (fortunately for our debenture sale) and kicked in on Friday with rates continuing to rise and equities suffering their first 1% selloff in two-months.
By Friday’s close, our benchmark U.S. Treasury rate had increased 11 bps from when we priced on Thursday, moving it sharply above its 50-day Moving Average of 1.54%. Friday’s price action continues this morning with global equity and bond markets in decline.
Fed Speak got Louder
While it was Mr. Draghi’s comments that put the market on notice, it was a Friday comment from the usually dovish Boston Fed President, Eric Rosengren, that accelerated the rate rise and a nearly 400-point decline in the DJIA.
Additional Fed sentiment may be provided by Fed Governor Lael Brainard in a Monday afternoon speech, just before the pre-meeting blackout period for commentary begins on Tuesday. The FOMC meeting is September 20-21, and while recent Fed speak has put the market on edge, it seems odd that Federal-funds futures show just a 24% chance of a U.S. interest-rate rise in September, rising to 55% by December. The takeaway from that is the market is probably overbought.
More than $13 trillion of global debt remains at negative yields but some longer-term maturities are easing back; like German bunds (10-year maturity) that regained positive territory, and JGB’s (Japanese 10-year notes), which are only -0.02% after trading as rich as -0.27%. An interesting development about Japan’s market is that in time the BoJ could run out of securities to buy. The bank already owns one-third of the country’s outstanding debt and though there is sufficient supply to accommodate near-term purchases, banks need to hold these high credit assets and may be reluctant to accommodate the central bank’s continued demand.
Last Week - was highlighted by the above mentioned official comments, but also included the program’s September debenture sales.
Demand remains strong for the product and fortunately, both issues were priced before the selloff.
The Week Ahead - contains just one-day of Fed speak but the Bank of England will have a Thursday announcement regarding its monetary policy, which is expected to be unchanged.
Retails Sales - is Thursday and growth is expected to continue June and July’s slow pace.
Industrial Production - follows solid gains in June and July but is expected to be in the 0-+0.4% range
CPI - is Friday and while its year-over-year rate (ex food & energy) is +2.2%, August is expected to be flat to +0.2%.
reads the headline of a NY Times article, and it captures the status quo element of Friday’s jobs report. With a gain of 151,000 and an unchanged Unemployment rate of 4.9%, the report came in below forecast and dampened confidence of a rate hike at the FOMC’s September 20-21 meeting. Details of the report are:
The report does not rule out a policy change as the year-to-date monthly average is 182,000, below that of previous years but strong enough to keep hiring near the FOMC’s goal. Market reaction was muted with both stocks and bonds relatively unchanged on the week.
Productivity has also shown the biggest one-year decline since 2013, down to a seasonally adjusted annual rate of 0.6%. Performance like this, as well as low inflation, contribute to the Fed’s hesitance to raise rates.
As a result of this low output, the cost of producing goods and services has risen for many companies and cut into profits despite rising sales. Unit-labor costs jumped a revised 4.3% in the second quarter vs. an initial 2% reading.
Global demand for assets – remains strong as Blue Chip Corporate issuance has surpassed $1 trillion year-to-date and the sector has rewarded investors with a 9.5% gain, vs. a loss of 0.9% last year. Asian demand for an initial $15 billion offering by Saudi Arabia is so strong the kingdom will schedule additional sales to follow. Formal announcement will not be until later this month for sale in October.
The reaction was muted, and not immediate, but rates did rise Friday after Chairwoman Yellen made a stronger case for an interest rate rise in her speech at Jackson Hole.
As usual, her comments were hedged, making any decision dependent on continued improvement in jobs reports (like this Friday’s) and no setbacks in inflation and economic growth. The Committee appears committed to a rate hike but is sensitive to timing as it will meet three more times this year and the Financial Times has increased its probability of a 2016 rate hike to 80%, from 70% before Friday’s speech.
Last week – again saw mixed reports.
The week ahead – includes more Fed speak, plus:
On Your Mark?
In keeping with the Olympic spirit, this Market Watch photo illustration has Chairwoman Yellen poised to signal a restart to the Bank’s rate increases, and identifies this Friday’s speech at Jackson Hole as a possible venue for that intent. Hiring, inflation and growth are the metrics for any rate hike, and though inflation and growth remain below target, more analysts are expecting a rate hike this year. Probably in December, but possibly in September if job growth remains robust. It is highly unlikely the Fed would move in November ahead of the election.
There was some pressure on rates last week, mostly from Fed speak, with two Bank Presidents indicating the Committee is “getting closer to the time it would be appropriate to raise interest rates.” Adding to this hawkish talk was a Sunday report in the Financial Times quoting Stanley Fischer, Vice Chairman of the Federal Reserve Bank’s Board of Governors, saying “We are close to our targets. Not only that, the behavior of employment has been remarkably resilient.”
The minutes from the July FOMC meeting showed mixed support for a rate hike, and followed the Consumer Price Index release. CPI headline number was zero, but that was dragged down by a 1.6% decline in energy prices. Ex food & energy the index was +0.1% and the Y/Y rate was +2.2%.
The week ahead - has Treasury selling $175 billion in short-term Bills and intermediate-term Notes.
July’s NFP report of +288,000 caused a spike in rates, but even with that rise 2016-20H priced at the same debenture rate as July’s 2.04%, below the program’s 12-month average of 2.59%.
Rates are being held down by:
And then on Friday, Retail Sales were reported to be flat in July, and just +2.3% Y/Y. Department store sales declined 0.5%, while e commerce sales rose 1.3%. An indication of this disparity is Macy’s, the nation’s largest retailer, announcing the closure of 100 of its 728 stores. Following this release, Producer Prices came in at -0.4%, -0.2% from a year ago. This report will influence Tuesday’s Consumer Price Index report that is now expected to be flat.
The week ahead – will focus on Wednesday’s release of the minutes from the July 27 FOMC meeting.
Is a rate hike back in play?
Perhaps in December if employment gains continue, and global economies improve, yet the probability of a September change has increased to 40%.
The WSJ chart below identifies the projected domestic inflation rate as implied by the yield on ten-year TIPS – Treasury Inflation Protected Securities. These securities have semi-annual inflation adjustments that are determined by the CPI, and paid out at maturity. With this projection it is obvious the Fed is unlikely to see inflation hit its target anytime soon.
You would have to dig deep to find anything negative about Friday’s NFP report that sent domestic stock indexes to record highs, but wage growth is probably the weak link. At 2.6% annually it is showing strength but remains well below its 2009 level. Additionally, job expansion is running about 1.7% annually, similar to projected GDP growth and that indicates productivity is not growing. The previous week’s report of +1.2% 2Q16 GDP identified the third consecutive quarter of declining capital investment and is a contributing factor to reduced productivity.
One question a skeptic might ask is – how is the financial services category adding jobs when banks and insurance companies (like Met Life taking a $2 billion charge to its variable annuity business) are cutting jobs to reduce costs due to this low rate environment?
The week ahead
Last week’s spike in rates was headlined by the jobs report but there had been earlier pressure when weak demand for Japan’s ten-year note auction moved its rate from -0.27% to -.07%, starting a global selloff in sovereign debt. That is a reminder that even with central bank buying of these bonds investors are not fully committed to negative yields. Rate locking on new corporate issuance also helped to move rates higher.
Friday’s closing rate of 1.59% on CT-10 is 17 bps higher than when 2016-20J was priced.
GDP Disappoints – and rates decline
Expected to be more than double 1Q16’s report, not only did the 2Q report show just a 1.2% gain but 1Q was revised down to 0.8% from 1.1%. For the week, ten-year rates declined 12 bps to 1.45%, equities softened (though S&P 500 index gained 3.4% on the month), and $US also sold off, especially after the GDP release.
This WSJ chart shows the declining trend in our country’s output since 2Q15. A gain of 2.5% was the optimistic forecast, so the 1.2% gain leaves the first six months with an average gain of 1.0% compared to that period’s average gain of 2.0% since the recovery began in 2009.
The weakness was led by capital investment, down for the third consecutive quarter with a decline of 9.7%, as seen in the Financial Times chart below. Companies continue to cut back on structural spending like oil wells, equipment, and inventory. With regard to oil wells, oil prices have declined 20% since their June 8 peak, contributing to some of the world’s largest oil companies to report a quarterly profit at its lowest level since 1999 (Exxon Mobil), or its biggest quarterly loss since 2001 (Chevron).
Friday’s GDP report followed Wednesday’s release of minutes from the FOMC’s recent meeting, where the Committee again emphasized a gradual path for rate hikes but added “near-term risks for the economic outlook have diminished.” Modest wage gains and an increase in reports like the Employment Cost Index (+2.3% Y/Y) offer some encouragement to policy makers that a higher rate policy can buck the global trend, but the market remains skeptical. Though the probability of a December rate hike stood at 50% on Tuesday, it ended the week at 37%.
Brexit & Exit
European equity funds continue to see money leave, heightened by the uncertainty caused by the Brexit vote. YTD these funds have seen $76 billion withdrawn with the emerging Italian banking crisis contributing to the trend, as well as British consumer sentiment dropping the sharpest since 1990. The market that is benefitting from this is Emerging Markets, whose funds have attracted $14 billion in just the last four-weeks, and have rewarded investors with an 11% return for the year.
The week ahead
Monday – Institute of Supply Management report is expected to reflect moderate growth
Tuesday – the Fed’s preferred inflation indicator, Personal Consumption Expenditures, is forecast to show a gain of just 0.1%, while Personal Income is expected to be stronger
Friday – we play “guess your best “again with Non- Farm Payroll expected to show a gain of 185,000 after June’s +287,000 and May’s disappointing +38,000. The Unemployment Rate is expected to be unchanged at 4.9%
A quiet week in stocks and bonds amid ongoing global turmoil.
Ten-year Treasury yields rose slightly as did prices on most stock indexes. The week saw some interesting releases:
The week ahead
Overall, the market continues to battle with conflicted issues of moderate domestic growth and global concerns; negative sovereign debt yields in particular. The Treasury will auction $172 billion of debt this week, consisting of $69 billion in T-Bills and $103 billion of term debt.
The ten-year Treasury yield increased 19 bps last week for the largest one-week rise in thirteen months. Market uncertainty that had been prevalent was displaced by factors like:
Even in weakness, demand for the U.S. Treasury product remains strong, especially from foreign investors. Wednesday’s $12 billion auction of thirty-year debt at 2.17% was its lowest auction rate ever, attracting an oversubscription of 2.5X, with 68.5% of the total going to foreign buyers. With a majority of stocks offering a higher yield than Treasuries, it is clear how overpriced the market is, and how dependent the product is on demand from global investors whose debt is even more expensive.
Aided by the Brexit vote and the ongoing QE purchases by the BoJ and ECB, $13 billion of global debt now trades at negative yields, making US debt even more attractive when its yields increase.
The week ahead – is fairly light on economic data but we do get Housing Starts and Home Sales, plus a consumer sentiment reading in the EU.
By the numbers -
Last week ended with stocks rising towards a new record high and government bond yields closing at new, low yields. Though these two markets usually move in opposite directions ongoing central bank policies are supporting fixed income product while data points to more strength in the economy.
Last Week -
This Week -
Most stock markets rallied sharply late last week, with US markets up more than 3% for the biggest weekly gain of the year.
Ordinarily, that would mean bond prices would weaken but Central banks affirmed their intent to support easy money policies and while the “safe haven” trade lost some its momentum U.S. Treasuries remained well bid, ending the week at 1.44% after trading at an historic low of 1.38%. In early morning trading today we are revisiting 1.38% (a 37 bps improvement since the 6/23 Brexit vote) and stocks are wobbling.
British regret – Brits representing the Remain bloc marched on Saturday to show their support for remaining in the European Union but potential candidates to succeed David Cameron have stated there will be no second referendum and that they see no urgency to file Article 50, the trigger mechanism for leaving the EU. That assures markets of continued uncertainty, leaving the pound sterling under pressure and strengthening $US. The Bank of England has indicated it may cut rates this summer and the amount of global, sovereign debt trading at negative yields now totals $11.7 trillion. Part of that mix shows Japan selling new, ten-year debt at -0.25% and Switzerland’s 50-year bond is now at a negative yield. With the central banks in England and Japan committed to Quantitative Easing this amount will increase, leaving $US denominated debt as an attractive alternative for global investors.
Last week – saw Puerto Rico default on almost $1 billion of constitutionally guaranteed debt, Standard & Poors downgrade the UK’s credit rating to AA, and Italy is preparing to offer aid to a failing bank, Economic reports continue to be mostly positive:
The week ahead – includes pricing for the program’s 2016 10-D and 20-G debentures on Thursday, for funding on Wednesday July 13. Important government releases are:
Against all odds – going into Thursday’s Brexit vote, Ladbrokes, the English bookmaker, placed a 90% probability on Britain remaining in the European Union. Though less costly than their 5000/1 odds against Leicester City winning the Premier League, this result will have significant influence on financial markets and global economies.
After rising earlier in the week global stock markets buckled on Friday as traders reacted to Britain’s decision to leave the European Union.
The vote was 52%-48% with 72% of eligible voters participating. A clear demographic was generational: 57% of voters ≥55 voted to Leave, while 57% of voters aged 18-34 supported Remain. Analysts identify this split as younger Britons having grown up in a period of European integration and liking it, while the older group seeks to reclaim their nationalist identity.
Issues to be settled
Trade – England would prefer to retain access to the EU’s single market but probably will have to negotiate bilateral trade deals, which could be costly and time consuming to negotiate
Immigration – perhaps the most compelling argument to Leave and one that might parallel sentiment in the U.S. presidential campaign. Existing EU nationals in the UK could remain but new entrants would no longer have the automatic right to work and live there.
Economy – the consensus opinion is that Brexit will hurt UK growth, at least short-term
UK composition - two years ago Scotland voted to remain but there is speculation they, and perhaps Northern Ireland, will seek membership in the EU themselves. Such a decision could further weaken Britain’s economy.
Lower, for a lot longer
The Treasury market had weakened leading up to Thursday and then had the sharpest one-day rate drop in five and one-half years. The chart below shows how the ten-year rate had traded as low as 1.57% in the week of June 20, then eased back going into last Friday. Treasuries will continue to be a “safe haven” investment while the impact of this vote and timing of the withdrawal continues to be evaluated. Likewise, the British pound will continue to weaken until there is more clarity or it simply becomes oversold.
Maybe, maybe not – the referendum took place because David Cameron promised it during his reelection campaign to appease the Brexit contingent of his party. While not legally binding, it will be interesting to see how long it will take for the necessary paperwork to be submitted. An Article 50 needs to be initiated by the UK and sent to Brussels in order to formally begin the process. While Mr. Cameron had previously said he would submit it the day after the vote, he decided not to submit it, offered his resignation, and will leave that task to his successor, who will probably not take office until October. It is that person who will be handed, in the words of one British writer, the “poisoned chalice.” Cameron has deftly identified the reluctance of any politician to be the architect of Britain’s departure from the Union. If that assessment is correct and Britain delays the paperwork (which triggers a two-year deadline once it is submitted) markets will face more uncertainty and remain unsettled. Such a delay could be offset by the insistence of some EU leaders who want Britain to act quickly, something even the Brexit leaders do not advocate as they prefer informal talks in order to negotiate the best terms.
The week ahead – should help to sort out some issues, like:
Lower for Longer
Last Wednesday’s FOMC announcement was a unanimous vote to not change policy, reflecting acknowledgment of slow economic growth. The Committee’s expectations for GDP growth were revised downward for the second time, to 2%, with little change expected in 2017 yet it still expects to raise rates twice this year while acknowledging stronger, sustained gains are needed.
The above chart is from a WSJ article that asks if the US is headed for a Japan like environment that has existed for decades because its working age population growth peaked in 1995, and its productivity growth slowed. Since then growth has averaged less than 1% and low, now negative, interest rates have done little to spur investment. Reasons for this extended malaise are:
“A slower-growing work force needs less equipment and slow growth in productivity also leads to slower growth in wages and profits, which discourage households from borrowing (since they will have less future income with which to pay the money back) and firms from investing. In this way, sluggish growth can become self-reinforcing.”
Japan’s policies, like raising taxes then deferring them, and raising, then lowering, interest rates have added to the problem and that is one reason why the Fed is cautious about a higher interest rate policy – they do not want to raise rates only to reverse field when growth does not follow.
This is another reminder that central bank monetary policy can influence economic growth but fiscal stimulus is needed to encourage capital investment. With a presidential campaign imminent, Congressional cooperation a memory, and regulatory bank oversight increasing, prospects for a cohesive policy are slight.
The week ahead
Janet Yellen has two scheduled speeches and the UK vote on Brexit is scheduled for Thursday. This vote will have an impact, both on the unity of the EU which will be compromised, and the UK economy which could face trade barriers with its former members.
Bonds rallied, stocks softened, and 2016-20F was priced at the lowest rate since May 2013.
In addition to its recent cycle low debenture rate, the June sale represented the largest issue since September 2014 - $349,640,000.
The market trends mentioned above were more pronounced globally as Japanese, German and UK bonds hit record low yields; with 10-year German bunds ending the week at 0.01%, compared to U.S. Treasuries at 1.64%. This yield differential is the reason why as much as 73% of last week’s ten and thirty-year Treasury auctions went to foreign investors as they seek value and liquidity.
With the ECB and BoJ continuing their Quantitative Easing policies (sending sovereign debt to even greater negative yields), and the Fed checkmated by May’s extremely weak jobs report, we can expect these trends to continue.
Regarding those negative yields, Bill Gross of Janus Capital tweeted this warning: “Gross: Global yields lowest in 500 years of recorded history. $10 trillion of neg. rate bonds. This is a supernova that will explode one day.” Hopefully, a gradual, global approach to policy change, like the one advocated by Janet Yellen, can control any fireworks.
The week ahead – focus will be on the FOMC meeting that concludes Wednesday, though drama has been reduced and attention will be on other reports of significance.
Friday’s Non-Farm Payroll report disappointed even the most cautious analysts; reflecting a gain of just 38,000 jobs with a downward revision of 59,000 for March and April.
Key points of the report were:
The slight chance of a June rate hike is now off the table and a July increase becomes less likely. The June NFP report will reflect a gain of 31,500 striking Verizon workers who returned to work last Wednesday, but the recent trend will remain below last year’s gains.
The report sent ten-year Treasury yields down to 1.70%, lower by 14 bps on the week and 9 bps below where we priced 2016-20E. As historically low as that rate is, it represents a very attractive level compared to Germany’s bunds whose yield declined to 0.07%. With $10.1 trillion of global, sovereign debt now trading at negative yields, Treasuries and other $US denominated bonds will continue to be in demand.
The week ahead - is relatively light on economic releases.
Monday – Janet Yellen speaks in Philadelphia on the economy. Probably the last official Fed comment before the FOMC meeting June 14-15
Tuesday – Department of Labor report on productivity & labor costs
Wednesday - JOLTS report on job openings and labor turnover
***Thursday – pricing of DCPC 2016-20F, for settlement on June 15th
Friday – University of Michigan consumer sentiment survey
Following up on the release of the minutes from the Fed’s April meeting, Janet Yellen last Friday affirmed the Committee may be ready for a rate increase this summer. While still historically low, ten-year rates have pushed above their 50-day Moving Average as the market prepares for a June, or possibly July move. Probability of a June increase has risen to 34% while a July move is estimated to be at 62%.
All comments regarding a rate increase are hedged by emphasizing continued strong, domestic economic data and improving global conditions. The domestic releases start this week with Tuesday’s Personal Consumption Expenditure report that is expected to show a strong increase, though a smaller one of about 0.2% in the Fed’s preferred core calculation. That is followed by Friday’s Non-Farm Payroll report that is expected to repeat April’s disappointing number of 160,00 but may reflect a reduced rate of unemployment, to 4.9%.
Analysis of these reports might be provided by Chairwoman Yellen in a June 6 speech in Philadelphia and that will affect Treasury prices and our June debenture sale, scheduled for June 9. The next FOMC meeting is June 14-15, with a policy statement released at its conclusion.
Is a June rate hike now in play?
The rates market was softening before Wednesday’s release of the minutes from the April FOMC meeting that indicated a June rate increase was possible “if incoming data showed an improving economy.” A pretty modest quote but the minutes also indicated less concern for the global economy and more Governors than expected are in support of a rate increase.
Ten-year notes had the biggest weekly rise in rate in six-months, improving slightly on Friday to close the week at 1.84%, + 14 bps on the week, but only 5 bps higher than when we priced 2016-20E.
In addition to the overall softer tone the market showed a flattening of the yield curve, indicating pressure on short-term rates that are most affected by Fed policy. The closing spread Tuesday, pre Fed minutes, was + .936%, the tightest spread since December 2007; predating the financial crisis and the Fed’s zero interest rate policy. By Friday this spread widened somewhat to +95 bps.
The two smaller charts above reflect investors’ extension into longer-maturity Treasury notes and the continued net buying of Treasuries by foreign investors. While foreign central banks might be selling Treasuries to raise cash to support their currencies, foreign private investors are buying them to replace sovereign debt being sold to the ECB and BoJ.
The FOMC next meets June 14-15 with a policy statement at the conclusion of the meeting. Last week’s minutes from the April meeting served as a caution to the market and, in normal times, might have resulted in a stronger setback. With $9 trillion of global sovereign debt trading at negative yields there is nothing normal about this market and the attractive yield difference for $US debt will deflect any recurrence of the “taper tantrum” on its three-year anniversary.
The trend for weaker bond prices started last Monday but accelerated Tuesday with two stronger than expected releases:
The weeks ahead – contain some of the key indicators that the Committee uses to gauge economic activity and will influence their decision:
In addition to pricing the twenty-fourth consecutive 20-year debenture ≤ 3.0%, 2016-20E was priced 42 bps below the series’ 12-month average rate as the market continues to defy prospects of a tighter monetary policy. Most importantly, the issue’s ongoing effective rate to small business borrowers was 4.32%.
After marking time around the 1.76% rate on ten-year Treasuries, positive economic releases on Friday were expected to move rates higher, but they didn’t. Instead, that rate dropped 6 bps to close at its lowest level in a month, close to its February low. The reports were a Retail Sales release that grew at its fastest pace in a year and a positive reading on consumer sentiment. So, rates continue to defy positive news and the market puts the likelihood of a June rate hike by the Fed at just 6%.
An interesting analysis of last Tuesday’s Small Business Optimism Report by Bloomberg News:
“The most important paragraph of the latest NFIB Small Business Optimism report is about labor markets and the first two sentences say: "53 percent reported hiring or trying to hire (up five points), but 46 percent reported few or no qualified applicants for the positions they were trying to fill. Hiring activity increased substantially, but apparently the 'failure rate' also rose as more owners found it hard to identify qualified applicants." In other words, nearly half of businesses can't get good applicants for their open jobs, hiring activity is increasing substantially, and more and more positions are simply going unfilled. Ultimately, a tightening labor market is the mother's milk of higher wages, and though the headline average hourly earnings number from the monthly Non-Farm Payrolls report hasn't yet broken out, evidence continues to build that the economy is shifting more in favor of labor. Today's NFIB report is the latest evidence (the report also says 24 percent of owners are raising worker compensation, which is up 2 points from the previous month). Meanwhile, at 10:00 AM E.T. today, we'll get the latest JOLTS report, which will have figures on total job openings and quits, among other things. We'll see if this confirms the story of ongoing labor market tightness.”
***JOLTS (Job Openings & Labor Turnover Survey) confirmed the trend analysis as openings increased 0.1% and hiring declined 0.1%. The quit rate was unchanged (indicating workers are less inclined to shift jobs) and the layoff rate declined 0.1%, confirming the labor market is the strongest part of the economy; yet, this job growth remains centered in retail and health care positions, with manufacturing jobs in decline due to the dollar’s strength and sluggish global demand for goods.
The Week Ahead – contains several housing reports, plus:
The trends continue – benchmark interest rates remain low, supported by weak economic data; and the 504 program continues to fund 20-year debentures at sub 3.0% levels. Last week’s sale was the twelfth consecutive pricing below 3.0% and the second lowest coupon since May 2013. The summer of 2013 was the “taper tantrum” when rates soared in anticipation of a possible rate hike. That increase did not occur for two and one half years, yet we are at lower rates now due to global concerns and subdued domestic inflation.
Job growth disappointed Friday with a report of just 160,000 in gains for April. It was another good news, bad news report as it was the weakest gain since September but average hourly earnings showed a 3% gain. Other categories in the report were:
The pace of hiring and the pace of economic growth have been out of step. At the end of 1Q16, 2.8 million more jobs existed than a year earlier but GDP growth was just 1.9%. Their historical relationship would have associated growth of 3.4% with that pace of job creation, a rate that would have prompted more than one rate increase from the Fed.
Less pressure on rates – could come from increased corporate issuance in Europe to take advantage of pending ECB purchases of Corporate bonds, perhaps as much as €5 billion per month. The bonds must be issued by a Euro zone entity though the parent company can be located elsewhere, and last year such firms issued 22% of that market’s debt. Increased EZ sales would result in less domestic US issuance thereby reducing domestic supply and rate pressure. As things now stand, there is little expectation the Fed will increase short-term rates at its June 14-15 meeting.
This week's reports
Tuesday – a report on small business sentiment which hit a 2-year low in March
Friday – reports on Retail Sales, that have been down or flat all year; and PPI which had declined in March.
Treasury rates ended the week higher but improved from their weakest levels prior to the 1Q16 GDP report, and a reminder from the FOMC that it will pursue a gradual approach to higher rates. The post meeting announcement offered no hint of a June increase and that helped rates decline and, coupled with weak corporate earnings, sent equities lower.
Wednesday’s GDP report renewed signs of caution from businesses and consumers. It is the weakest quarterly report since 1Q14 and a sharp reduction from 4Q15’s report of -1.4%.
A NY Times article addressed productivity. More than 151 million Americans count themselves employed, a number that has risen sharply in the last few years. The question is this: What are they doing all day?
Three explanations were offered: 1. While improved technology and outsourcing have already been discounted, the impact of a slowdown in capital spending is not helping efficiency; 2. Perhaps economists are not counting things properly, a measurement error; and 3. The increase in payrolls is viewed as an investment for the future, and once these workers are fully trained, productivity will improve.
Last week – saw Unilever take advantage of the ECB’s corporate bond purchase program by issuing debt as long as 12 years with a 0% coupon. The notes were offered at a slight discount so their yield was 0.06%.
Durable Goods orders increased a lower than expected 0.8%, with February revised downward by 0.3% to -3.1%.
Personal Consumption Expenditures – showed a gain of just 0.1%, leaving it at 0.8% y/y, and the core rate at 1.6%, both below the Fed target of 2.0%.
The week ahead - we prepare for the May debenture sales with the program’s Treasury benchmark rate of 1.83%, 12 bps higher than when we priced in April, but FOMC sentiment has stabilized rates. Pricing is Thursday with settlement on Wednesday, May 11th.
Non-Farm Payroll is reported on Friday and expected to be +200,000, with the Unemployment Rate declining to 4.9% because of the increased Labor Force Participation Rate.
U.S. Treasury bonds had the biggest weekly selloff of the year, 14 bps, as investors migrated to riskier assets.
Contributing factors to that move were:
An interesting WSJ article illustrated the impact of low global rates. An investor would have to wait 30-years to earn $100 in interest on $1,000 invested in Japan’s 40-year bond, now trading at 0.26% yield. This lack of investment income is one of the criticisms German finance ministers cite when criticizing ECB policy.
The week ahead
Economic releases of interest are: Durable Goods, which is expected to rebound with a report of +1.6%, and Friday’s Personal Income and Outlays report which tracks the Fed’s preferred measure of inflation, Personal Consumption Expenditures. It is expected to show an increase of 0.1% which would put the y/y rate at 1.5%, short of the Committee’s 2.0% goal. On Wednesday, the Fed will conclude its two-day meeting with an interest rate announcement at 2:00. While no change in policy is expected, the announcement can impact bond prices as investors search for clues concerning improved sentiment about economic conditions.
Treasury rates were on the rise last week until oil prices declined after reports from a meeting in Qatar indicated significant production cuts from oil producing countries were unlikely, and Treasury rate declines have recently matched declining oil prices. That trend is linked because weaker demand for oil reflects weaker economic activity which supports easy monetary policies and lower bond yields.
The week in review – was marked by weak economic data:
The week ahead has Treasury auctioning short-term debt and Treasury Inflation Protected Securities. Economic reports mostly concern housing data and the weekly report on jobless claims.
Global economic concerns are now a part of FOMC consideration for rate increases, along with 5% Unemployment and 2% inflation. At last week’s G-20 meeting, the world’s top financial chiefs acknowledged improvement from the recent commodity influenced equity weakness but cautioned “growth remains modest and uneven, and downside risks and uncertainties to the global outlook persist.” The ministers acknowledge monetary policy alone cannot provide a return to balanced growth and encourage reforms to boost employment and productivity, low interest rates, and less austerity in countries that can afford it. Also, the IMF cut its global growth forecast to 3.2%.
More than easy monetary policy and massive debt purchases are needed for sustained growth and global weakness is why no more than two, if that many, rate increases are expected by the Fed this year.
Politics and bonds – Congress is considering a bill that would hold Saudi Arabia to be held responsible in American courts for any role in the 9/11/2001 attacks. The Saudi response is they may be forced to sell up to $750 billion U.S. Treasury bonds held by the Saudi Arabia Monetary Authority. Reality dictates it would be difficult to sell that amount of bonds without disrupting both the global bond market, for which the Saudis would be blamed, and the Saudi economy since such action could destabilize the American dollar, to which the Saudi riyal is pegged. President Obama visits the kingdom this week and this could be a topic of conversation as the Administration does not support the legislation, arguing it would put Americans at legal risk overseas.
The rates market continues to improve, with CT-10 ending the week at 1.72%, 5 bps lower on the week in which the 504 program priced its twenty-year debenture at 2.26%, its lowest monthly rate since May 2013 (2.07%).
There is always confusion about the actual inflation rate, since many reports exclude food and energy costs due to their volatility. Unfortunately, we all pay for food and energy, so taking that into account it is clear why the FOMC links inflation to its policy decisions. The WSJ chart below identifies the impact of negative sovereign debt yields resulting from the aggressive bond purchase programs in Europe and Japan. Using Friday’s close of 1.72%, and matching it with the most recent core consumer price index rate of 2.3%, the real U.S. ten-year yield is -0.58%.
Helping the rates market was last Wednesday’s release of the minutes from the March FOMC meeting. Only two of the seventeen participants advocated for a rate hike due to job growth and firming inflation data. A gradual approach to rate increases was the consensus and probably will be so again at the April 27 meeting. What this means is that market direction will be dictated by other central bank initiatives and investors’ appetite for risk.
The week ahead - contains three economic releases of interest.
Eventually, Treasury rates will rise again; perhaps after some more encouraging news like Friday’s jobs report; they just won’t increase right away. The gain of 215,000 displayed some wage growth, barely budged interest rates, and helped stocks recover from an uneven week.
So, jobs are increasing at a steady clip, wages are showing an annual growth rate of 2.3%, and while the Fed is not expected to raise rates at the end of its April 27th meeting, prospects seem to be gaining for a June increase if jobs and wages continue to increase.
Ten-year Treasury rates are now 50 bps lower than when the year started, and approaching levels that existed before the “taper tantrum” in May 2013.Yes, we’ve been this low for that long, not far away from the historic low yield of 1.39% in July, 2012.
Contributing factors for this remain: aggressive global easy money policies; negative interest rates on $6 trillion + of sovereign debt (making $US denominated debt look cheap); negative inflation readings in the Euro zone; an Unemployment Rate of 10.3% in the same zone; and an enhanced Quantitative Easing policy from the ECB that will now purchase European, non-financial, Corporate debt in addition to the already negative yielding sovereign bonds.
The week ahead
In addition to pricing 2016-20D on Thursday, the market will see:
In a holiday shortened trading week the rates market moved sideways and equities reentered negative territory for the year. The most positive news was the most recent revision for 4Q15 GDP which was increased to 1.4%, up from last month’s estimate of 1.0% and the original report of 0.7%.
Focus will now turn to this Friday’s jobs data which has shown a three-month average gain of 228,000 and a current unemployment rate of 4.9%. Below is a WSJ chart that displays two other employment categories that display a more grudging, but steady, improvement.
Earlier in the week will be a Personal Income and Outlays report that is expected to show a 0.2% gain in the Fed’s favorite inflation indicator – Personal Consumption Expenditures. Such a gain would push the Y/Y rate to 1.7%, moving it closer to the Committee’s 2.0% target. Even with that increase it is unlikely the Fed will raise rates at its April 26-27 meeting, especially after projecting just two increases for 2016.
The WSJ chart below shows how the Treasury rates market reversed course after Wednesday’s FOMC announcement that reduced its expectation for the number of rate hikes this year. Though the market has been skeptical of the previously announced four hikes, confirmation from Janet Yellen that global concerns have encouraged the Committee to plan on just two rate hikes enabled stocks and bonds to rally. The ten-year benchmark rate declined for the first time in five-weeks and the highly sensitive two-year note declined the most since October.
And while Treasuries rallied for the first time in five-weeks, stocks notched their fifth consecutive week of gains, putting them in positive territory year-to-date.
Of interest during this rates rally is the increased positioning of Treasury debt by the market’s 22 Primary Dealers, as they reported holding as much as $121 billion in position last month, the most since October 2013. This increased inventory is probably the result of central bank selling to raise cash in support of their currencies.
Additional policy support for the Fed is coming from other central banks:
This Financial Times chart displays the Committee’s expectation for interest rates, progressing from the current 0.25-0.50% range to a mid-point range of 3% in 2018.
Then and now - comparing the Committee’s December 2015 forecast to last week’s estimates.
|Projected mid-point||December 2015 Forecast||March 2016 forecast|
Such an announcement highlights the perceived “lower for longer” market sentiment. Even as many domestic indicators reflect growth, the Fed has affirmed its concern for the global economy and will maintain a cautious approach.
The week ahead
Housing data for existing and new home sales with more significant releases at week end: Durable Goods orders and the third estimate for 4Q15 GDP, previously reported as 1.0% with a Y/Y rate of 2.0%.
ECB stimulus revives “risk-on” trades - was the big story last week.
Below is a NY Times chart showing the extent of the European Central Banks’ rate cuts, with its deposit rate now at -.40%, while the Federal Reserve Bank’s rate is +0.50%.
In addition to charging member banks more for their deposits, the bank will also effectively pay banks to borrow money from central bank funds to make loans to consumers and businesses. This unique measure will cover loans made, at no cost to the borrowing bank, for up to four years, and the central bank will compensate the bank as much as 0.40% if it lends more than what it has borrowed from it. An increase in monthly bond purchases to €80 billion from €60 billion will also include Corporate debt for the first time, since the existing pool of eligible securities presently trades at negative yields. These newly eligible securities will represent non-financial institutions only.
The ECB’s announcement helped stocks close higher for the fourth consecutive week and that is what encouraged investors to increase their risk appetite which ended (temporarily?) the “safe haven” trade for Treasuries.
The benchmark Treasury used for pricing March’s twenty-year debentures rose 30 bps from the February sale date, and then another 7 bps into the week end. That move widened the yield difference between U.S. Treasuries and European sovereign debt which had rallied after Wednesday’s ECB announcement.
The week ahead – has a lot of economic data but attention will be focused on the FOMC meeting that begins Tuesday and ends with Wednesday afternoon’s policy announcement. Even with recent job growth it is not expected that a rate increase will be announced.
Consumer Price Index, Producer Price Index, Retail Sales, Housing starts and Industrial Production are all on the calendar.
The headline release last week was Friday’s Non-Farm Payroll report, showing a February gain of 242,000 and upward revisions of another 30,000 to previous reports. The Unemployment rate remains at 4.9% and the only disappointment was wage growth of just 0.1%, and a reduction in hours worked. The below chart from the WSJ shows the dramatic improvement in all measurements since 2009.
The answer is – not very. The report’s impact reflects a reduction of fear in the financial markets as the benchmark ten-year Treasury yield rose to 1.88% (27 bps above where the February debenture was priced) and equites rallied for the third consecutive month. The DJIA closed above 17,000 for the first time since January 5th.
Items of note in the flow of funds –
Even with the selloff in Treasuries, the benchmark ten-year yield at 1.88% is 39 bps below where it began the year, as well as since the Fed raised rates in December. The reasons for this contrary move continue to be:
The week ahead
Reports on Consumer Credit and Household Net Worth can offer support for economic bulls but the rates market will be most affected by $56 billion of Treasury debt to be auctioned. In particular, $20 billion of the benchmark ten-year will be sold the day before we price March’s debentures. Expectations of a rate hike at the March 15-16 FOMC meeting are slight.
Modest, but Positive Growth
In a week that saw negligible change in rates, the market saw some signs of life with economic releases that exceeded forecasts:
The benchmark ten-year Treasury remains anchored near the 1.75% level, virtually unchanged on the week. Spread product has improved and the market awaits the next FOMC meeting in two-weeks (March15-16).
“Fed speak” – Fed Governor Lael Brainard cited the strength of $US and the weak start for stocks as a form of financial tightening that has already taken place and “is a factor to lower expectations that the U.S. would be able to diverge, or grow strongly, compared with the rest of the world.”
This week – is relatively light on economic releases but Non-Farm Payroll is reported on Friday. Expectations are for a +190,000 report with the Unemployment rate holding at 4.9%.
Last week’s Treasury performance ended three weeks of gains as trading was driven by erratic gains in oil and stocks, plus the release of the minutes from the Fed’s January meeting.
The Fed has frequently stated its goals of 5% unemployment and a 2% reading for Personal Consumption Expenditures as two items, now plus global growth concerns, that would influence their decisions on rate increases. One hike took place in December and the proposed four additional increases in 2016 have been discounted by the market, with March unlikely and June possibly being in play.
At 4.9% the unemployment rate has already reached its desired level but inflation has been held in check by declining commodity prices, particularly oil. Last Friday’s release of the Consumer Price Index (CPI) showed a monthly gain of 0.3%, which beat forecasts and raised the year-on-year rate to 2.2%. When including energy however, and food, total prices were unchanged in January but the yearly rate did rise to 1.4%. New vehicle sales and airfares showed strong gains but energy costs declined 2.8%, weighing down the overall rate.
Personal Consumption Expenditure
More important to the Committee though is this measure of inflation which uses a chain index, that takes consumers' changing consumption due to prices into account (the CPI uses a fixed basket of goods with weightings that do not change over time). Trailing the conventional CPI reading for sure, but gaining ground, the PCE now registers a 1.4% rate. Continued growth will be needed, as will stabilized commodity and global equity performance, before the Fed can add to its December policy change.
This week ahead -
has several releases on home sales and Friday’s second estimate for 4Q15 GDP growth, expected to be +0.4%. With Treasury rates at levels dramatically below their pre-rate- hike levels, the market will absorb $88 billion of new Treasury debt this week, so additional price gains might depend on headline news.
Could it be One and Done?
The recent push for “safe-haven” assets has strengthened the speculation about additional rate hikes by the Fed. In fact, in a report last Thursday BNP Paribas stated they “do not expect any rate increases for the Fed in 2016, and possibly not in 2017.” Such speculation will support demand for Treasury debt even as employment and wage growth remain decent. Global concerns, like Japan reporting a negative 1.4% growth rate in 4Q15, isolate the Fed as the only central bank having adopted a tighter monetary policy. Japan will be expected to expand its stimulus as domestic demand has declined and a stronger yen has hurt its exports.
It was a volatile week for all markets as they reacted to headline news about European banks, Janet Yellen’s congressional testimony, and renewed fears of recessionary pressure. The most difficult time for stocks was Thursday (as seen below) as global indices were under pressure that created another flight to “safe haven” securities like U.S. Treasuries.
That move pushed ten-year yields as low as 1.61% when the SBA 504 program priced 2016-20B at 2.27%, the lowest twenty-year debenture rate since May 2013.
Stability in overseas markets held stock prices firm at Friday’s opening and then a strong Retail Sales report (+0.2%, with a correction of +0.2% for December) sent the DJIA up 2% on the day. Treasuries then lost their bid and weakened to close the week at 1.75%.
Credit Default Swaps make a return
Prior to Friday and yesterday’s recovery in stocks, it was concern for the health of European banks that negatively impacted global equities (and enhanced safe-haven demand) and Deutsche Bank was at the forefront. This Wall Street Journal chart shows how the cost of insuring against a default on $10 million worth of DB debt for five-years has risen to $268,000 per year; compared with a cost of $96,000 at the start of the year.
The cost for other banks, like Goldman Sachs and Credit Suisse has also risen, but Goldman Sach’s cost is $159,000, by comparison. Driving this fear is sluggish economic growth, with particular attention paid to bank’s energy loans that are impacted by weak oil and other commodity prices.
The week ahead
As we wonder when a tighter Fed policy will register with the rates market, there has been a noticeable change in bank lending standards. Below are details, and a graph, that were included in a Credit Suisse piece that analyzed the Fed’s “Senior Loan Officer Opinion Survey on Bank Lending Practices.”
The survey was made available to Fed officials for their January 26-27 FOMC meeting; it was reported that banks, on balance, tightened their standards on commercial and industrial (C&I) and commercial real estate (CRE) loans in the fourth quarter of 2015. The 73 domestic, and 24 U.S. branches of foreign banks, also indicated they expected standards on C&I and CRE loans to tighten over 2016.
The timing of the 504 program’s initial Debt Refinance program in 2010 ironically coincided with an easier lending policy by banks, and still resulted in $2+ billions of loans being funded by the program. Perhaps the program’s reintroduction this year is arriving at a more fortuitous time for small business borrowers.
An offset to that recent Fed survey is in a February 4 article in the American Banker, where reference is made to: “Federal banking regulators issued a joint statement in December that warned of a "substantial" rise in exposure to loans backed by commercial real estate that often included loosened underwriting standards. Total CRE loans, meanwhile, increased 6% in the third quarter from a year earlier, to $1.2 trillion, according to the most recent data from the Federal Deposit Insurance Corp.”
Below is a chart from that article showing that increase in lending, and also showing the improved delinquency rate from its peak in 2010. For the 504 program, the annualized default rate is 0.87%, as of February 1st.
Back to the markets
Friday’s Non-Farm Payroll report came in at 151,000, with a downward revision to January’s report. Disappointing for stocks that trended lower, but positive for Treasury rates. Key elements of the report are:
When the Fed announced its 25 bps rate hike in December, the accompanying announcement suggested as many as four more rate hikes in 2016, with March being the likely first one. Market sentiment appears to be taking that off the table, a view that is reinforced by an observation from Fed Governor Leal Brainard: “market volatility and weak emerging market growth reinforce the case for watchful waiting.”
Adding to the attractiveness of Treasuries is a February 3rd announcement that Treasury will reduce the issuance amount of maturities with five-years or longer terms by $18 billion over the next quarter. This reflects smaller deficits but will also enhance the scarcity value for existing Treasuries, which are very cheap when compared to European and Asian sovereign debt.
The value of U.S. Treasuries supports the value for $US denominated credit product, though investors continue to seek additional spread premium because of elevated price levels on the benchmark Treasuries.
That was interesting! – even with an almost 400-point gain Friday, the DJIA ended the month down 5.5%. Items of interest during the week were:
The effect of these releases, Friday’s in particular, was to see stocks, commodities, and Treasury prices rally; leaving our benchmark ten-year note at 1.94%, 35 bps lower than on the day the FOMC raised its lending rate by 25 bps – an unintended consequence.
Why? – the initial answers for the ten-year notes performance were weakness in Chinese stocks and its currency; declining commodity prices (especially oil), and their combined impact on emerging market economies that depend on Chinese demand for their resources. The U.S. does not export much to China so its slowdown does not have a direct impact, but it will be a cautionary item for the Fed to consider.
The issue’s performance since mid-December now is attributed to the market’s perception that additional rate hikes this year will be much fewer than the four increases advertised in the December announcement. Added to that view are the ongoing Quantitative Easing policies of the Bank of Japan and European Central Bank that are draining hundreds of billions of sovereign debt from their respective markets, making $US denominated debt attractive by comparison.
The week ahead
We get some “Fed speak” from Stanley Fischer on Monday, along with a manufacturing report (ISM) that is expected to show continued underperformance. On Friday, the employment report for January will be released and is expected to be decent, around 200,000, but far below December’s 292,000 release.
Concerning other Central Banks, the Bank of England announces its policy statement on Thursday and is expected its leave its benchmark rate unchanged at 0.50%.
Last week oil found some traction, and so did stocks as they had their first positive week of the year. That reduced the demand for “safe-haven” assets so Treasuries marked time until it was revealed that capital outflows in China last year may have reached $1 trillion, more than seven times the amount for 2014.
The result this morning was a 7% decline in the Shanghai index, U.S. Treasuries flirting with the 2.0% rate on the ten-year note, but U.S. stocks are holding firm, possibly uncoupling from the trend in China.
We are so far below the 50 and 200-day Moving Averages for the ten-year note that they are simply reference points, almost meaningless with regard to how overpriced it is.
This week contains ample central bank activity with –
After briefly trading below 2% on Friday the ten-year Treasury closed the week at 2.04%, 8 bps lower on the week in response to continued weakness in China and disappointing US economic releases, such as producer prices at -.02%, retail sales at -.01%, and the Empire State Manufacturing Survey dropping to its lowest level since April 2009.
Could this be true?
The below chart is from a Financial Times story that identifies why the Fed may pause its planned rate increases for 2016:
Those withdrawals, and new cash deposits, found their way into Money Market funds (+$24 billion) and Government debt (+$19 billion). These investments are offsetting the recent Treasury sales by China.
This chart reflects Fed Funds futures contracts that indicate probably just one rate hike this year in September, and a 25% chance the Fed does not raise rates at all in 2016. It is important to note that these contracts reflect current sentiment and that is always subject to change, especially if China and oil prices stabilize soon.
One thing is almost certain though - the Fed will not be raising rates at its January meeting and a change at the March meeting, even if job growth maintains its 4th quarter pace, is unlikely. Downward pressure on inflation, weak equity markets, and global concerns will offset continued job gains, which are not being accompanied by significant wage growth.
The week ahead – will give us much data on housing and Wednesday’s report on Consumer Prices, expected to be mild as weak oil prices continue to have an impact; keeping CPI ex-food & energy at 0.5%.
This was the week that was-
The driving force in last week’s market activity focused on China, with stock trading halted two separate days by triggers that were activated by intraday declines of 7%. By the end of the week regulators abandoned the triggers but you can see the impact its equity weakness had on global equity exchanges and commodities. Gold resumed its identity as a “safe-haven” investment (until Friday), oil prices declined to 2003 lows, and Treasuries saw increased demand as investors continued to seek safety.
Domestically, the DJIA is off to its worst ever 5-day start to its trading year. The above chart is from Thursday’s close so when you add Friday’s decline of 1% the index was down 6.2% for the week.
Factors that are driving this trend domestically are: underwhelming fourth-quarter earnings reports, a commodities bust, Mideast turmoil, and overall concern about Chinese and U.S. economies.
What rate hike?
On December 16th after the Federal Reserve raised its benchmark rate 25 bps the ten-year Treasury yield closed the day at 2.29% and expectations were for it to inch higher as the market was preparing for as many as four more increases in 2016. Friday’s close at 2.12% reinforces the global demand for “safe-haven” assets and continues to assist the 504 program in delivering effective rates to borrowers, like the 4.83% rate on last Thursday’s 20-year debenture.
As good as this movement is for small business borrowers, the underlying conditions are troubling as global concerns will contribute to a modification of domestic GDP growth and heighten the Fed’s awareness of slowing global growth.
Minutes of the Fed’s December meeting were released last Wednesday and revealed Committee members’ concerns about lingering low inflation, a strong dollar, and their effect on trade. That said, some officials continued to talk about four possible rate hikes this year, something the markets are less inclined to believe.
Non-Farm Payroll increases 292,000 in December
Not even this greater-than-expected report helped equities, nor hampered Treasuries, after its Friday release. Key elements of it were:
This week will see the Treasury auction $58 billion in intermediate and long-term securities and that should pause immediate price gains for the market. On a positive note, Chinese stocks were down another 5% in Monday trading yet global equities opened with gains and Treasuries are marking time.
How far have we traveled?
In terms of the ten-year Treasury yield, not very far. We ended 2014 with CT-10 at 2.17%. Last Thursday’s close was 2.27%, and that is after a 25 bps rate hike by the Federal Reserve. This chart identifies a 2015 range of 85 bps for the issue but also shows how we have maintained its current rate level the last two months. What has changed the most is short-term yields, like the two-year note that went from 0.64% a year ago to close Thursday at 1.06%.
The December 16 policy change was the only one by the Fed, though they had been expected to raise rates three times in 2015. Now, attention turns to its plans for 2016, and just as the Fed’s tighter monetary policy has diverged from other central banks, so too is its “dot-plan” at odds with market indicators.
The Fed Funds futures market projects a much lower rate than the Fed. The above chart also displays how the central bank’s 2015 forecast has changed from December 2014. If the futures market is correct, the pace of rate increases will be slower than expected.
What affects possible Fed policy decisions: China, inflation, strength of the $US, success of the European Central Bank’s bond purchase program, and stabilization of commodity prices. All of these items will be central to future Fed moves and illustrate why there is skepticism about the pace of future tightening.
It’s hard to imagine a country with 6.5% GDP having a negative impact on global economies but that is the state of affairs in China. Its weakening demand for commodities is putting/keeping emerging market countries in recession and a 7% decline today in its CSI 300 Index has pushed the DJIA down 2.6%.
The week ahead-
2016-10A and 20A will be priced this Thursday, a day after the minutes from the Fed’s December meeting are released and also after much “Fed speak”. Wednesday will also provide data on the U.S. trade gap, and Friday will have a release of the December jobs report. Monthly averages for 2015 were a solid 210,000 but paled vs. 2014’s average gain of 260,000.
On the day of our December funding, the Fed’s Open Market Committee fulfilled its ambition and raised its range for Federal Funds to 0.25-0.50%. Initial market reaction was for stocks to improve and interest rates to rise, but both moves reversed themselves by weekend with stocks down 1% on the week and ten-year Treasuries 1 bps lower from when we priced 2015-20L on December 10th.
Now that the rate hike is out of the way, it appears the market is less optimistic about things than the Fed. In its announcement, the central bank provided its “dot-plot” to chart interest rate hikes in 2016 and its number is four, or as much as another 100 bps while the market is expecting just two, bringing the Fed Funds rate to 0.875%, not 1.375%. Forward contracts for two-year Treasuries, the notes most sensitive to policy changes project a December 2016 yield of 1.65% vs. Friday’s close of 0.95%, also reflecting just two rate hikes. Last year at this time, Fed officials were projecting they would have made three rate increases by December 2015, not just this one; so perhaps the Committee is again overenthusiastic about the economy.
An indication of how effectively the Fed has managed its planned rate hikes is that the pricing day average rate for ten-year Treasuries in 2015 was 2.145%. Such stability is in marked contrast to the taper tantrum in 2013 when we priced the September debenture off a 2.96% rate in Treasuries with the same Fed policy in effect as for this month’s debenture sale. At that time, there was less concern about China’s softening economy, its impact on demand for commodities, and how that has affected so many of its suppliers in emerging markets.
Another factor contributing to low rates is the European Central Banks’s continuing purchases of sovereign debt that has pushed the yield differential between European and Treasury yields to levels that make domestic debt very attractive. A comparison with German debt is below.
So long as the ECB continues its bond purchases, domestic debt will attract global buyers and soften the potential of a tighter monetary policy. Of additional benefit is the Committee’s decision to continue reinvesting proceeds from its own Quantitative Easing purchases.
"The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities, and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”
It had been expected the Fed would discontinue these reinvestments once it raised rates, so this continuing reinvestment can be taken as a measure of how sensitive the bank is to withdrawing support from the markets too abruptly.
As we await Wednesday afternoon’s announcement from the Fed, markets refuse to cooperate with the central bank. The S&P 500 declined 3.8% last week (with energy shares down 6.5%); oil slumped 11%, to below $36 per barrel (hitting a 7-year low); a $789 million junk-bond fund barred investors from withdrawing funds while its managers liquidate the fund; and Fed officials conceded they are ill-equipped to quell dangerous asset bubbles.
So, what happens when turmoil like this presents itself? Treasuries become a safe-haven and that helped our benchmark Treasury close the week 15 bps lower, and 10 bps lower than when we priced 2015-20L on Thursday.
Such price movement is an indication of volatility and there is an index that measures it; and as you would expect, it rose last week. This gauge, also known as the” fear index,” is at highest level in months as Treasuries experienced their largest one-day drop in yield since July.
What to expect?
The Week in Review
Good News -
Bad News -
The Week - in addition to 2015-20L being priced Thursday there are two releases of interest that contribute to the Fed’s interpretation of economic health. PPI on Friday is expected to be within 1 bps of zero, and Retail Sales is forecast to be in a range of -0.2% - +0.5%. Showing the uneven performance of this statistic is the chart below.
Trends - remain in place.
On Friday, the Bureau of Labor Statistics will release its employment numbers for November, its final report before the Federal Open Market Committee meets on December 15-16. October’s report of +271,000, with a reduced unemployment rate of 5.0%, has influenced the market to expect its first rate hike in seven years at the conclusion of this meeting. As certain as that increase appears to be there is more speculation about market reaction and the subsequent path of rate increases. Markets, both stocks and bonds, have seemed stress free in response to events like the Paris terrorist attacks and the Turkish downing of a Russian fighter jet, and most analysts expect a muted reaction on December 16 since short-term rates have mostly built in the higher cost of funds.
It’s not just the relatively uneven U.S. recovery that concerns our central bankers but such a changed money policy will be divergent from most global economies still battling low commodity prices that have weakened their currencies and consumer demand. Consideration for these conditions is why the Committee has repeatedly said they expect rate increases to be gradual and that sentiment has been accepted by the markets.
On Your Mark, ...
This chart of the two-year Treasury note does not directly factor into any of our debenture pricings but does immediately anticipate/reflect change in Federal Reserve Bank monetary policy; and on Friday, this note reached its highest yield level in five years. Additionally, with ten-year yields lower on the week at 2.26%, this spread relationship (2/10’s) is at its tightest in seven months. Such a tightening (+134 bps, its tightest spread since April) is called a flattening of the yield curve, and since Federal Reserve Bank monetary policy most affects short-term debt, this move tells us the market is prepared for its first rate hike in seven years.
December 16, the date of our December funding, is also the second day of the next FOMC meeting and it will include an announcement on any decision made by the Committee. Market opinion is near unanimous that there will be a rate hike and this price action reflects the market’s preparation for it. Enhancing that sentiment was a Federal Reserve Bank comment last Wednesday that “it could well be time to raise rates at the December meeting.”
Rates are going higher, right?
Eventually, yes. With a near unanimous opinion of forecasters that the Fed will raise rates at its December meeting the ten-year benchmark Treasury note declined 6 bps on the week, as oil had its worst performance in months and stocks followed. It is important to note that only Treasury rates are declining, credit spreads are widening as their relationship to benchmarks is being turned upside down.
Additionally, China’s markets have stabilized, reducing their need to sell Treasuries and on Friday, the U.S. government said that wholesale inflation saw a record decline over the past year, while sales at U.S. retailers barely rose in October.
Details for those reports are:
At Odds with the World - As the Fed prepares to raise interest rates it is at odds with its global counterparts who maintain their own Quantitative Easing policies, buying their domestic debt which holds down their bond yields. Hold down actually is quite an understatement - $26 trillion global government bonds are trading under 1% with $6 trillion trading at negative yields. To date, central banks have purchased $12 trillion of sovereign debt and economies in Europe and Asia continue to struggle.
Relative Value – as shown in the chart above, Treasury debt at 2.27% yields 182 bps more than German bunds and that differential will support foreign buying of Treasuries so long as the European Central Bank and Bank of Japan continue their QE policies. Affirmation of that was evident in last week’s Treasury auction of $24 billion ten-year notes where 60.5% went to foreign buyers.
Not if, but What Pace?
Friday’s Non-Farm Payroll report marked a turning point in the debate over the Federal Reserve Bank’s plans to start raising interest rates. The following are some of the positive notes from the report:
If there is one negative to the report it is the static Labor Force Participation Rate, languishing at 62.4%, the lowest level since 1977, and reflects discouraged workers who have discontinued their job search.
Market reaction was as expected, though muted. The ten-year Treasury benchmark rose 9 bps from our Thursday pricing level to close the week at 2.33% while the two-year maturity, an area most impacted by rate change, rose to its highest level since 2010, 0.89%. That the first rate increase since 2006 will happen next month has been virtually assured by recent comments from Chairwoman Yellen, so the focus will now turn to the pace of rate increases and that is why the market’s performance was muted. There are two things to keep in mind:
Slight Reversal - After hovering near 2.0% early in the week our ten-year Treasury benchmark gave ground on Thursday and ended the week at 2.15%, for its poorest performing week since June. Weak economic releases kept the issue around 2.04% until a Federal Reserve announcement on Wednesday indicating December is still in play to raise rates; in fact that omission is almost a concession to a rate hike and will leave the markets more cautious than usual.
All it took was the removal of an explicit mention of global concerns from its post-meeting announcement Wednesday afternoon. At its previous meeting the Fed added global concerns to its focus on unemployment and inflation, the two criteria that have been targeted for normalization of monetary policy to resume. The Unemployment Rate is acceptable at 5.1% but Personal Consumption Expenditures (the Fed’s preferred view of inflation) was released on Friday and shows just a 0.2% rise Y/Y, far below its 2.0% target.
The ease with which the ten-year yield rose is a result of a thin, illiquid market that has been poised for a rate hike since its “taper tantrum” in May 2013. Since it is acknowledged our recovery has been erratic and the global concerns expressed earlier are still in play even this initial rate increase could be a singular event for the near-term.
Comparative Rates - At 2.15%, Treasuries yield 162 bps more than German bunds and even 69 bps more than Italian bonds, a country that was almost barred from the market six-years ago. To show how things have changed, on Friday Italy sold €1.75 billion two-year notes at -0.023%. That’s right, investors are paying Italy to hold their money for two-years.
As a result, even if the Fed hikes rates there will be strong global demand for $US assets in any selloff.
Last Week - All economic releases were negative:
This Week - We price our November debenture sales on Thursday, one day ahead of a Non-Farm Payroll report that should show some recovery from the recent weak reports. Estimates are for a gain of 180,000 but it is weakness like in previous reports, combined with low inflation and high global unemployment that have given, and will continue to give the Fed, a reason to be patient and gradual when they change policy.
There was little change in rates but equities surged at the prospect of continued low interest rates. The DJIA is + 12.6% since its low point in the summer.
The housing market is one sector that has experienced price gains and last week’s report on existing home sales was + 4.7% in September, the second largest gain in eight-years.
The Treasury Department decided to postpone a planned auction of two-year notes as it approaches a debt ceiling deadline on November 3. This was preemptive as other auctions will be held this week. And, this is only an appetizer as the budget crisis deadline of December 11 awaits.
This week we get some economic indicators and a FOMC meeting:
This chart shows the daily closing yield of the ten-year Treasury note, which is the benchmark for our monthly twenty-year debenture pricing. Its high yield in the last six-months was in June (2.50%) as the market expected a Fed rate hike to occur. Disappointing global reports and low inflation (disinflation in some countries) have led the Federal Reserve Bank to be more cautious, resulting in a changed market sentiment that has reduced the note’s yield to 2.04% on Friday.
The two lines in the chart simply reflect moving averages for the note; 50-day and 200-day periods, and they clearly reflect the trend that has taken place – a risk-off trade for investors seeking full faith & credit Treasury debt that offers great liquidity.
The need for liquidity is for the exit trade, as many investors do not hold to maturity, but instead will look to sell once the trend reverses and rates rise. That time may be farther off than once thought and barring a sudden spike in inflation, we may remain in this low rate environment through year-end.
Last week’s events – most economic reports were weak
This week – is fairly light on economic releases; mostly Housing Starts and Home Sales with some manufacturing data late in the week.
As much as rate hikes continue to be deferred, and inflation remains low amid global economic concerns, the ten-year Treasury seeks out this 2.12%-2.16% range of rates and for now, we should find 2.12% to be support in the near-term.
Last week saw a 12 bps spike in rate as equity and commodity markets gained strength. An earlier move higher in rate was in September, in anticipation of a normalization of policy and the benchmark then moved down to 2.0% when the markets realized a change in policy was not imminent. Minutes of the September meeting that were released last Thursday confirmed the dovish tone of September’s meeting and have influenced market participants to disregard Fed speak about potential rate hikes; though that talk will continue.
Throughout the three phases of Quantitative Easing it was stated that an Unemployment Rate of 5.1%, and Personal Consumption Expenditure Rate of 2.0% would be triggers for the FOMC to raise rates. Last month global economic concerns were introduced for consideration and China’s slowing economy has had a truly global impact, especially for emerging markets. Those markets would be particularly hurt by a Fed hike because dollars would be diverted to the US and its higher rates, possibly resulting in inflationary pressures in those countries. Yet, at the just concluded International Monetary Fund meeting in Peru central bankers urged the Fed to get on with it and end the uncertainty. Ironically, the redirection of dollars may turn out to be insignificant because it’s been emphasized that rate increases will be gradual so there may be little change in rate, just policy.
Y/Y rate of inflation is hanging around 1.2% and Friday’s report for Import and Export prices will do little to move the needle. Import prices were -0.1% and export prices paid were -0.7%, a reflection of the impact of a strong $US and its effect on agriculture.
For policy, the trend will be to mark time waiting for stronger economic reports and that should translate into a continued low rate environment with a delicate balance between trading liquidity and pressure on new-issue spreads.
Yes, the market continues to defy predictions; most recently Friday’s expected gains for Non-Farm Payroll. Unfortunately, the consensus proved incorrect and the report of just 142,000 job gains was disappointing and compounded by a downward revision of 59,000 to the July and August reports. Both the equity and bond markets reversed course after the opening – DJIA went from -240 to close at +200, and ten-year Treasuries traded as low as 1.95% only to ease back to 1.99% at the close. That puts it 11 bps lower on the week and 22 bps lower than when 2015-20I was priced on September 10th.
Factories and energy companies were dominant in the weak employment number as they have been most affected by a strong US$, depressed commodity prices, and weakness in China.
Fed speak will continue to mention the probability of a rate hike this year but the October meeting is pretty much out of the question, so the Committee would have to see strong gains in inflation, renewed employment strength, and global economic strength to fulfill that objective at their December meeting. In fact, sentiment is growing, evidenced by trading in Federal Funds futures contracts, that the first rate hike may not occur until March 2016. So, ‘lower for longer” may be with us for a while and the capital markets are feeling its impact. The High-Grade bond market has seen a 15% increase in issuance this year, but just last Monday, several issuers cancelled or reduced their issue size due to market turbulence. Issues that came to market were forced to price at wider credit spreads to accommodate investor caution and that condition will prevail going forward.
No sooner did we survive the threatened government shutdown last Thursday than two other deadlines were presented:
This week is fairly light on economic releases, though Thursday will see the release of minutes from the last FOMC meeting on September 17th. Since that meeting resulted in a vote of 9-1 to not raise rates, the actual minutes may not offer much.
On Tuesday, we will announce terms for the October debenture sale, which will consist of just the twenty-year debenture. The twelve-month averages for this series are:
|# of loans||Issue size||Debenture rate||Spread to Treasuries|
The actual numbers for October may vary dramatically from these averages and 2015-20J will be priced Thursday, October 8 and fund on Wednesday, October 14.
The gap between the 50-day and 200-day Moving Average continues to shrink as the on-again, off-again shift in Fed policy keeps the market offsides. At the conclusion of the FOMC’s meeting on September 17, the near unanimous vote of 9-1 to not change policy spurred a risk-off move for Treasury yields to decline, only to reverse course late last week after Chairwoman Yellen spoke in Amherst and stated that she fully expects a rate hike this year. Reference was made to a recovering US economy, whose 2Q GDP was revised up to 3.9%, improved from a 1Q reading of 0.6%. Capturing our uneven recovery was a WSJ article headlined: Slow down, Surge forth, Grow steadily, Repeat.
Weakening global growth was included in the recent FOMC announcement with China prominently mentioned. Emphasis for that concern was last week’s China Purchasing Manager’s Index reading that was its lowest since the financial crisis.
It remains to be seen what impact Volkswagen’s emission control violation will have on the company, but heavy fines and customer pushback certainly will follow. A car maker with 600,000 employees, and countless thousands more for its suppliers, will not fare as badly as America’s car makers did in 2008 but VW will experience a slowdown. Just this morning, Switzerland announced it is contemplating a ban on VW diesel cars.
State Administration for Foreign Exchange (SAFE) is China’s investment manager and they have withdrawn tens of billions of dollars from global funds in support of their weakening economy, and now Saudi Arabia Monetary Authority (SAMA) has also been identified as having withdrawn up to $70 billion in reserves since the onset of declining oil prices. Its purpose, too, is to support a weakening economy. These withdrawals can partly explain why rates have not sustained a stronger push lower, but these sales are being met with demand from other buyers which is what is keeping us in this range.
Yes, keeping your assets in cash, earning nothing, has outperformed most other global choices so far this year, and if you trade FX in your personal account, you were the big winner.
All eyes on Congress to see if government business goes on after Wednesday at midnight. As for economic data, the big event, as usual, is Friday’s Non-Farm Payroll report that is expected to match the twelve-month average of 212,000, with the Unemployment Rate unchanged at 5.1%.
The defensive trades in front of last week’s FOMC meeting proved unnecessary as global concerns outdid the modestly improved domestic indicators, leaving interest rate policy unchanged. The CT-10 weekly chart shows its rate moving higher into Thursday’s announcement only to rally at week’s end, closing 7.5 bps lower than when we last priced on September 10th.
The wording of the announcement identified global concerns, read China and its impact on emerging markets, as a consideration for not changing policy. The Fed has focused on full employment as the engine to drive higher interest rates but has now introduced an international perspective for its consideration and that further clouds the transparency for Fed policy. Chairwoman Yellen was candid about emerging market weakness and cautioned about the risk of an abrupt slowdown in China. Abrupt slowdown or just gradual weakening of Chinese GDP the impact is widely felt since they are the biggest trading partner for emerging market economies. Its reduced demand for raw materials impacts commodity prices and foreign exchange rates resulting in weaker global growth.
Speaking of lower community prices, they are impacting domestic Gas and Oil businesses which are filing for bankruptcy at a rate of 4.8%, the sector’s highest level since 1999 and double the rate of businesses in general. The volume of defaulted bonds YTD stands at $10.4 billion and yields in this sector of the junk bond market are as high as 11%.
CT-10’s closing rate of 2.135% is its 200-day Moving Average and represents a rate the market has frequently settled at in weakness and strength going back four-months. Indications are that we will remain with this low rate sentiment as the Fed exercises increased patience before normalizing monetary policy.
Even their modest projections seem inflated as officials still maintain a 2015 rate hike is probable. Here is the schedule of projected federal funds rates:
The .375% projection for 2015 assumes a 25 bps increase in the next three months and then little else if the Fed is to maintain the gradual path they have advertised.
If we are going to see this 2.135% Treasury rate serve as a magnet until the Fed is confident of the global market’s tolerance for higher rates we might see our debenture rate hold near its two most rent levels of 2.82%, compared to our twelve-month average rate of 2.73%. The challenge will be to maintain historical pricing spreads because that is where investors will demand more for their participation. - at +60 to Swaps 2015-20I was 15 bps wide to its twelve-month average.
The market gyrated slightly last week as it anticipates a possible rate hike this Thursday afternoon.
CT-10 ended the week off 7 bps but slightly improved from when we priced 20-I on Thursday and equities regained strength as Chinese markets stabilized.
Last week saw a robust funding calendar as not only did Treasury conduct its quarterly funding of 3, 10, and 30 year maturities ($64 billion) but on Wednesday alone the market digested $28 billion of Treasury and High Grade new issuance. Helping to distribute the credit debt was wider pricing spreads as High Grade investors seek more yield in a market that has generated negative (-0.63%) returns YTD.
Reports were pretty light but encouraging. Though Producer Prices came in flat that number was dragged down by lower gas prices. 2QGDP was revised upward for a second time to +3.7%, a reading that shows a nice recovery from a sluggish first quarter.
Thursday afternoon at 2:00 the FOMC will provide a Summary of Economic Projections to be followed by a press conference with Janet Yellen. There is potential for market movement leading up to this event but shy of dramatic change in China the rates market can be expected to mark time.
It’s questionable what impact a rate hike will have since the Committee’s approach to the first increase since 2006 is expected to be a singular event for 2016, and the subsequent path of increases has been advertised to be gradual. The front end of the curve has already adjusted and Treasury debt remains cheap to other sovereign issuers as displayed in this chart:
So, even with China having been a seller of Treasury debt to raise $US with which to support its currency in FX trading, bond funds continue to see demand and other central banks also continue to invest in US debt. And yes, investors continue to pay the Swiss to hold their money for ten-years.