Equity Weakness & Credit Support
Last week saw increased central bank support for Treasuries, Mortgage Backed securities, money market funds and municipal securities. It also saw more states imposing shutdowns to cope with the spread of the Covid-19 virus. Of the above markets, only US Treasuries showed a gain with the ten-year benchmark closing at 0.89%, down 8 bps on the week but lower by 28 bps from its weakest post before the Fed bought $275 billion bonds as part of its announced plan to buy $500 billion over the coming months. Purchases of $32 billion MBS, part of its announced plan to buy $200 billion over time, did not have as much impact as all credit product widened on the week. With such aggressive intervention it would seem those total dollar amounts can now be considered minimum amounts as Chairman Jay Powell announced there is “no monthly cap, no weekly cap, as the bank will buy at a strong rate that we think will restore market function”. Of additional help to corporations is a $1.1 trillion lending facility to unclog the Commercial Paper market where companies make short-term loans.
The Fed is not authorized to directly buy Municipal or Corporate securities but is permitted to create lending facilities that lend money with those securities as collateral and that is what they did as municipal and corporate bond funds saw heavy withdrawals last week. Like the Fed’s intent to support Treasury and MBS markets, it is likely these other facilities will be expanded to provide additional support as they have the greatest need. The average yield for investment grade corporate debt has risen from a year-to-date low of 2.26% two-weeks ago to 4.7% on Friday. For higher-risk junk companies, whose securities cannot be used for collateral, the damage is harsher as average yields have spiked as high as 10%. Even the MBS market, considered the second most liquid market after Treasuries, suffered from selling to raise cash as spreads widened to 130 bps from +44 bps a month ago.
The week’s performance for the S&P 500 index unfortunately ranks high in historical performance, down 15% for the week and now down 29% year-to-date. For a brief time on Friday it appeared the index might register its second consecutive up day for the first time in five weeks, but that failed as the market reversed and the index closed down 4%.
Demand for US$
The selling pressure in these markets reflects investor demand for cash, not even traditional safe-haven assets like Treasuries and gold, just as foreign countries seek US$ to relieve pressure on their currencies and economies. One reason why Fed intervention to buy Treasuries has been needed when rates backed up is the expected increased government funding needs to sponsor the stimulus packages. White House economic advisor Larry Kudlow was quoted as saying the money the Fed will spend to support loans and other programs will have a total impact of more than $2 trillion and daily updates indicate that will climb higher.
What is needed in addition to progress fighting the virus is a respite from the selling pressure in securities markets and less demand for product being hoarded on the consumer side.
Measures that have been established to date are significant and can be expected to be increased:
These proposals are viewed as a bridge to survive the crisis and help markets settle down. Other bridges that are more immediate can be found within SBA loan programs when lenders take the initiative to help small business borrowers, like in the WSJ article linked below.
In the absence of the stimulus plan, the Federal Reserve Bank announcement about increased bond purchases plus the TALF program has resulted in a 1,000-point reversal for equity futures and pushed Treasury rates lower.
The Weeks Ahead
The cost of these programs is significant, matching their need and that need will increase. Economic reports will have little positive impact on market performance as data in the near future will be unrecognizable.
An Historic Week
Not waiting for their scheduled meeting to act, the FOMC reduced its target for federal funds Sunday afternoon by 100 bps to a range of 0-0.25%, revisiting its mark from after the financial markets collapse. Also announced were plans to buy huge amounts of Treasuries and Mortgage Backed securities “over coming months”; $500 billion of Treasuries and $200 billion Mortgage Backed securities. This will bring the overnight financing rate for institutional investors to positive levels, giving strength to the Treasury market which wobbled last week.
The Fed also encouraged banks to use its discount window, another source of ready access to financing and said it was “encouraging banks to use their capital and liquidity buffers as they lend to households and businesses.” Eliminating bank reserve requirements is another measure to free up cash for the banks to keep lending.
As well received as these measures were upon their announcement (described by some analysts as the Fed bringing out its heavy artillery), markets themselves are the final arbiter and their response has been disappointing. The ten-year benchmark did improve to trade at 0.78%, down 20 bps from Friday’s close, but futures markets for domestic stocks indicate a decline of almost 5% at the opening. Oil is down 10% as the Saudi Arabia price war continues; energy companies, airlines, and hotels are all down similarly as they are most vulnerable to the travel bans and social distancing that is being imposed.
What began as a virus inspired supply chain disruption in China has morphed to demand constriction that is starting to show cracks in the financial markets. With travel bans, work from home initiatives, and social distancing already having an impact on consumer spending, the impact on economies is being felt and the need for fiscal stimulus in addition to monetary aid is needed. With states now closing restaurants and bars, it is clear that businesses and workers of those establishments will need financial aid and the Coronavirus Preparedness and Response Supplemental Appropriations Act recently signed by the President will provide vital economic support to small businesses. Loans up to $2 million to compensate for the temporary loss of revenue will be offered at rates of 3.75%, 2.75% if for a non-profit, and reflects how quickly the Small Business Administration can be mobilized to provide aid.
Frequent mention has been made to price action from the financial crisis in 2008 and Black Monday in 1987 as equities experienced both the biggest single day percentage decline since 1987 and the single largest one-day rally since 2008 – occurring on consecutive days late in the week when Friday’s rebound almost offset Thursday’s total decline of 10%.
Spurring Friday’s late afternoon recovery was President Trump’s declaration of a National emergency that includes waiving interest payments on student loans held by the federal government, buying oil to fill the strategic reserve, plus freeing up an additional $50 billion in aid. An agreement with Congress on a coronavirus relief package that was approved by the House after midnight Friday will be voted on by the Senate this week.
In another Sunday announcement, a trade group representing eight of the nation’s largest banks will suspend share buybacks and use such funds to provide maximum support to individuals, small businesses and the overall economy. Access to loans is key yet it does represent more debt for companies lacking a revenue stream.
Rates and the Fed
Acting off-cycle for the second time in two weeks, the Fed has already responded to price action in the Treasury market last week. The swing in benchmark Treasuries has been problematic as their performance contradicts their assumed safe-haven status during a crisis such as this with back-end rates rising on the week and the curve (2-year/10year rates) steepening by 23 bps. One indication of their swing is CT-10 finished the week at 0.98% after trading as low as 0.31% on Monday. Since the March debenture sales for the SBA 504 program were priced off a CT-10 rate of 0.94% it might look like there has been little change, but another impact in addition to its underperformance has been on credit spreads which have widened out in sympathy with higher Treasury rates.
There can be several explanations for the disappointing performance of Treasuries, ranging from basis trades (cash vs. futures contracts) and risk-parity trades (allocation of risk based on volatility) being unwound, as well as risk managers just directing traders to reduce risk and close out other relative value trades.
The Mortgage Backed Securities market, considered the second most active after US Treasuries, also underperformed as mortgage rates initially declined in sync with lower Treasury rates only to see the housing refinance market light up with demand. That devalued existing MBS product (the underlying mortgages that comprise the securities) forcing dealers to reduce price on inventory thereby raising mortgage rates greater than the rise in Treasury rates. 30-year mortgages that might have been offered as low as 3.25% one week ago are now offered close to 4%.
An indication of how aggressively the Fed put to use some of its new tools occurred Friday morning when it purchased $37 billion of Treasury debt, more than half the intended purchase amount ($60 billion) that was expected to occur out to April 13. Additionally, the Fed is providing massive liquidity support to banks by increasing the size of short-term financing with up to $1.5 trillion available out to three-months. This provides funds at appropriate rates for firms inventorying securities and reduces stress in the financing market. Complimenting both of those initiatives was Sunday’s announcement from the Fed which vowed to use its “full range of tools” to support the economy and the “smooth functioning of markets.”
Once the dominoes began to fall Wednesday night when the NBA postponed its games for at least 30-days other professional sports followed suit. Two of the most popular Spring events, the NCAA basketball tournament was cancelled, and the Masters golf tournament was postponed, probably until October. Any hope that sports might provide some emotional relief from this pandemic is gone.
The Week(s) Ahead
A light week for economic reports and Treasury issuance, and with the Fed having already announced its rate cut, attention will focus on additional comments from their Tuesday-Wednesday policy meeting. Authorities have cautioned things will get worse before getting better so we can expect continued volatility as we all deal with managing this crisis.
Wednesday – FOMC meeting concludes with a policy announcement, followed at 2:30 with a press conference with the Chairman, Jay Powell.
*** A Monday morning update to the commentary shows a dramatic drop in oil prices engineered by Saudi Arabia that sent global equity markets sharply lower, along with Treasury yields, as the entire curve is sub 1%. Domestic equity markets are bumping up against 5% down limits, oil is lower as much as 30%, and the ten-year benchmark Note is 0.42%, 52 bps lower than when the 504 program priced its March debentures last Thursday.
As Steve mentioned last week, we can expect more interest rate cuts, volatility, wider spreads and demand for US Treasuries. Ordinarily, low interest rates and cheap oil are a boon for economies, but it is rare to see a demand collapse coincide with a supply surge. Until this coronavirus is brought under control, markets will remain disrupted.
Led by price action that compelled the Federal Reserve Bank to reduce its interest rate target by 50 bps ahead of its planned March 17-18 meeting, benchmark Treasuries closed the week at their lowest rates in history. Much of the entire curve is sub 1% with the benchmark ten-year Note at 0.76%. That level represents a 48 bps decline on the week and a 116 bps decline year-to-date. Of most importance to the SBA 504 program was its pricing of March debentures, also at historic low rates. This chart shows the 20-year maturity pricing of 1.49%, shattering the previous low rate of 1.93% set back in December 2012. Additionally, at $379,573,000 the total March sale was $45 million above the previous 12-month average.
In last week’s commentary Steve Van Order identified the probability of:
All three happened quickly before he priced Thursday’s debenture sale and his reference to banks being short duration added fuel to the rate decline as they needed to hedge their liabilities and will continue to chase Treasuries should rates decline further. As unconventional as the Fed’s aggressive inter-meeting rate reduction was, the market expects another 25 bps move by the end of next week’s scheduled meeting.
Benefit of Fixed Rate Financing
As important as the low debenture rates are, the ongoing effective rate cost to small business borrowers is even more impressive in this low interest rate environment.
Just like bank demand for duration to offset refinanced mortgages is linked to their demand for Treasury debt, so too is China’s import/export relationship linked with the global economy. For the January-February period their exports declined 17.2%, leaving them with a trade deficit of $7.1 billion for the period. The decline in imports was just 4%, meaning there is a supply shock from the lunar new year holiday coupled with the coronavirus impact. The shutdown of factories, ports and cities is spreading globally as Italy announced a planned lockdown of Lombardy, its northern industrial region responsible for 50% of the country’s GDP and home to 16 million people. The widening impact of the spreading virus has already resulted in the IMF lowering its global economic forecast to 1% from 2.6%. Adding to global concerns is a rift in the Opec+ Alliance that developed when Russia refused Saudi Arabia’s initiative to cut production in order to maintain price stability.
A 48 bps weekly decline in Treasury rates is stunning and equity markets had their share of volatility too. Market records have been falling like dominoes as the Dow Jones industrial average had both its biggest single day decline of 1,191 on February 27 and gain of 1,294 on March 2. Bank, energy, hotel and airline stocks have suffered the most as companies encourage employees to work from home or alternate sites and events are being postponed or cancelled outright. Such restrictions on business activity and social gatherings is restrictive and linked to consumer spending which is a significant part of our economy.
The sharp 12% equity decline from their February 19 highs is what triggered demand for safe-haven assets like Treasuries and gold, so containment of the virus is crucial in order for global economies to return to normal. How long that takes will determine how much pressure stocks face and what that impact will be on rates and central bank policy decisions.
Jobs and the Economy
Friday’s jobs report exceeded expectations but was dismissed as data predating the impact of the coronavirus. 273,000 jobs were added with 85,000 added to previous totals, the unemployment rate dropped to 3.5%, and earnings increased 0.3%. Average monthly gains for the last six months were 231,000 vs. 171,000 for the preceding six months, reflecting a solid if not expanding economy.
The Week Ahead
A blackout period for Fed speak ahead of their March 17-18 meeting, a light economic report calendar and the quarterly refunding Treasury supply.
Monday – Treasury auctions 13 and 26-week Bills
Tuesday – 3-year Note auction
Wednesday – CPI and 10-year Note auction
Thursday – PPI and 30-year Bond auction
The Virus Spreads Further, the Risk Markets Totally Crack
Last Monday, Eagle’s Frank Keane commented “On balance, it is impressive that equity markets have not suffered more than they have, but with reports of more contagion and increasing deaths it is likely its full impact has not been felt.” All we can say this week in response to Frank’s timely comment is “and how.”
Last week the equity markets completed the fastest correction of at least 10% in many years. Commodity prices again fell sharply. Gold, haven currencies, and government bonds rallied. After touching 1.11%, the 10-year Treasury note yield settled the week at a record low of 1.14%. Since the last SBA 504 debenture deal pricing on February 6, that yield has fallen over half a percentage point. The monthly range chart of the 10-year note yield since 2001, seen below, shows a sharp and stunning drop to the bottom of the rolling 20-month volatility band. The sharp move coming off an already low yield forced short covering and mortgage hedgers to buy duration, accelerating the move lower. Banks appear to still be short a massive amount of duration per a recent J.P. Morgan survey. This should cushion any yield rebound.
We will not get into a detailed discussion of the headline equity markets because investment managers and the news media covered it in quite some detail. What we look at this week are some aspects of the credit markets that are helpful in describing the new market environment we find ourselves in as we enter the March debenture offering.
Much higher probability of Fed rate cuts. Fed Chairman Powell’s brief statement Friday, in light of the sharp sell-off in financial and commodity markets and expected shock to global industrial production, resulted in markets pricing in certainty of a ¼ point, and a nearly 3-in-4 chance of a ½ point rate cut at the March 17-18 meeting. The other major central banks have indicated that easing is clearly on the table. Central banks are concerned about a demand shock arising out of 1) virus fears dampening the “animal spirits” and 2) supply shock-driven disruption to output, corporate earnings and hours worked. The market-implied Fed funds rate for the end of this year was 0.83% on Friday, which compared with the current policy target rate range of 1.50% to 1.75%. Not too long ago, the Fed communicated that it would be on the sidelines for the foreseeable future.
Higher expected interest rate volatility. We can see in the chart below, expected interest rate volatility in the Treasury market increased sharply (the MOVE index for Treasuries is similar to the VIX index for equities). As well, the term structure of interest rate volatility inverted, signaling that the market expects higher volatility in the shorter run before settling down to higher levels than experienced in the low volatility cycle that just ended.
More U-shaped yield curve. As we can see in the chart below (using Thursday’s close), yields collapsed in the belly of the yield curve, which is the area of the curve most sensitive to the change in Fed policy expectations. Short-term Treasury bills remain stuck more to the current Fed funds rate. Longer term maturities fell quite a bit, but not as much as in the belly of the curve.
Wider spreads to Treasuries. As is to be expected in times of market turmoil, credit spreads have widened, approximately 20 basis points for investment grade corporate credit and 75 basis points for high yield bonds since the last SBA debenture pricing on February 6. Spreads on government-guaranteed securities with embedded prepayment options, such as nominal coupon MBS and SBA 504 debenture pools, have widened as lower interest rates lower the threshold for prepayment. In addition, at times like this, spreads widen on all bond market securities, to varying degrees, because of the liquidity preference for Treasuries during a flight to safety.
As we bring the March SBA debenture offering to market this week, while the recent moves in the markets have been sharp, and in some cases nearly unprecedented over such a short time frame, and conditions sloppy, feedback we've received from underwriters is that the markets remain orderly. Full faith and credit securities, such as SBA 504 pools, typically perform relatively better in these environments. Given how fluid the situation is with the spread of the virus and fragile risk market psychology, amid what will be updated projections on the impact all this could have on the global economy, the clearest thing to expect for this week is the potential for more interest rate volatility
The Week Ahead – Main Releases and Events
Monday – ISM manufacturing for Feb. Treasury auctions bills
Tuesday – SBA 504 debenture offering announcement
Wednesday – ADP employment report, Fed Beige book
Thursday – SBA 504 prices. Productivity, ULC for Q4, factory orders for Jan. Treasury auctions bills
Friday – Employment Situation for Feb
The Virus Spreads
Stocks and interest rates dropped as more signs of the coronavirus affecting economic growth surfaced.
***And go lower they did as the ten-year benchmark is trading at 1.38% this morning as global equity markets have sold off sharply after Italy joined South Korea in locking down cities due to the spreading virus.
Surprisingly, with this virus entering its second month domestic stock indices suffered their first weekly loss of the year as all three were lower by more than 1% with the tech heavy Nasdaq Composite down 1.8%.
A Financial Times article reports that signs of complacency abound, citing a Bank of America global survey of fund managers that reports cash comprises just 4% of portfolios, the smallest amount since March 2013. When investors are worried, they usually hold more cash, instead they have been putting it into global equities that recently hit record highs. Even with last week’s selloff domestic markets are still +3% ytd.
Even though volatility has remained low, the benchmark 10-year Treasury rate has declined 45 bps this year, closing the week at 1.475% (as shown in the WSJ chart below), 22 bps lower than when the SBA 504 program priced this month’s debentures on February 6th.
Last year’s decline in rates was driven by Fed rate cuts and recessionary fears over US-China trade tension while this year’s performance has been accelerated by fear of the virus’ economic impact, leading analysts to expect at least one rate cut this year. Whether or not such action is taken, Fed Governor Lael Brainard noted “now is the time for lawmakers to undertake a review of tools and strategies to ensure they are ready and effective.” That echoes the call of others seeking fiscal policy initiatives that would complement monetary policy which is limited by how low rates are already.
On balance, it is impressive that equity markets have not suffered more than they have, but with reports of more contagion and increasing deaths it is likely its full impact has not been felt.
The Week in Review
Economic news last week was fairly dismal:
The Week Ahead
Treasury to sell $241 billion, some Fed speak, a light economic calendar but with the Fed’s preferred inflation gauge.
Monday – Treasury to sell $84 billion 13 and 26- week Bills
Tuesday – Treasury sells $26 billion 52-week Bills and $40 billion 2-year Notes
Wednesday – Treasury sells $18 billion 23-month Floating Rate Notes and $41 billion 5-year Notes
Thursday – Treasury sells $32 billion 7-year Notes; second estimate 4Q19GDP expected to be 2.1%; Durable Goods expected to be -0.9%
Friday – Personal Income & Outlays; Personal Income expected to be +0.3%, core Personal Expenditures +0.2% with a range of +1.6-1.8% y/y
Even as the number of people affected by the coronavirus rises, so do domestic stock indices, up 1% on the week and setting record highs amid concern over the potential impact on global trade. With more than 67,000 cases reported in China alone, and a death toll of more than 1,700, the first death in Europe has been recorded. While the safe-haven Treasury trade paused with the ten-year benchmark flat on the week at 1.59%, the Treasury did sell $19 billion of 30-year debt at a record low yield of 2.06%. Fixed income mutual funds and exchange traded funds took in $23.6 billion last week with US funds accounting for $15.4 billion of that total.
Economy in Quarantine
In China the epidemic is hitting a growing list of companies, disrupting supply chains and reducing consumer demand as many analysts ask – how much of an effect will it have on global economies and equity markets? With an economy that is four times larger than it was during the SARS outbreak eighteen years ago, any continued shutdown in China will weaken its growth, lower Chinese tourist spending and lower Chinese goods imports. To stem the previous week’s equity decline, China has announced substantial fiscal stimulus that offset last week’s slump. In his Congressional testimony Jay Powell noted the US is “closely monitoring the emergence of the coronavirus which could lead to disruptions in China that spillover to the rest of the global economy.”
An indication of what that impact might be is indicated below in this Financial Times chart and supports market beliefs the Fed may resume cutting interest rates this year.
In other events last week, Retail Sales (+0.3%) and CPI (+0.2%) came in as expected and the President proposed an increased tariff on plane imports from the European Union.
The Week Ahead
Treasury sells $132 billion in debt, Fed speak, some housing data and economic reports.
Tuesday – Treasury auctions $40 billion 21-day Cash Management Bills and $84 billion in 13 and 26-week Bills
Wednesday – PPI expected to be +0.1%
Thursday – Leading Indicators forecast to be +0.3%; Treasury sells $8 billion 30-year TIPS
Friday – PMI Composite Flash expected to be flat
Stocks Show Immunity
In a week that saw the coronavirus death count exceed 800, stock indexes had their best week since June as the safe-haven trade lost momentum though it recovered a bit on Friday with weak manufacturing data from Europe. China’s central bank pumped cash into its market helping to calm worries and then the government announced it would halve tariffs on some US imports, both events helping investors think containment is possible even as more countries try to isolate themselves from Chinese interaction. Leading the equity surge was Tesla, up 20% on Tuesday alone as its market value reached $130 billion, more than that of GM, Ford and Fiat Chrysler combined. This performance continues to catch many investors offsides as it is speculated that short sellers have lost $11 billion betting against the company.
As impressive as overall equity performance has been during this crisis, it is important that it not escalate further so that businesses can reopen shortly to resume economic activity.
One sector that is not seeing much love is commodities, as energy stocks are down 20% since last April and Brent crude is down 12% this year alone. Consumer demand and rising wages are driving our economy, but the retail trade still seeks its footing. Macy’s announced it is cutting 2,000 management jobs and closing 125 stores as mall traffic continues to decline.
Equity weakness on Friday seemingly ignored that morning’s jobs gain of 225,000, well above consensus and the 175,000 monthly average for all of last year. While the Unemployment rate ticked up to 3.6%, the amount of job seekers increased and the average hourly earnings rate of 3.1% also showed a y/y increase.
This report should give the FOMC comfort that its wait and see approach to monetary policy is justified even as the market seems to expect at least one rate cut this year.
On Thursday the SBA 504 program saw its 20 and 25-year debenture rates decline 25 bps from January levels, benefitting from the recent flight to quality. Continued demand for high quality assets helped tighten their financing spreads by 4 bps with both issues strongly over-subscribed. At debenture rates of 2.07% and 2.20% these debentures provide small business borrowers with ongoing cost of funds of 3.39% and 3.46% respectively. Both levels are significantly lower than Prime Rate and offer attractive alternatives to adjustable rate loans which use that marker for a base rate.
Treasury confirmed it would reintroduce a 20-year maturity later this year, using a quarterly schedule of sales along with Treasury Inflation Protected Securities. Initial size would be $10-$13 billion with subsequent sales slightly smaller. This structure was discontinued in 1986 when its financing cost exceeded that of both the 10 and 30-year issues.
In another move to separate funding from LIBOR (London Interbank Offered Rate) Treasury announced interest in offering a Floating Rate Note based on its preferred alternative, SOFR (Secured Overnight Financing Rate), a system using pledged Treasury collateral.
The Week Ahead
Treasury to sell $198 billion in debt, Jay Powell provides semi-annual testimony before Congress, and some inflation and consumer data.
Monday – Treasury auctions $84 billion 13 and 26-weeek Bills; Pitchers and Catchers report
Tuesday – Treasury sells $30 billion 56-week Cash Management Bills and $38 billion 3-year Notes; Jay Powell speaks before Congress
Wednesday – SBA 504 program funds its February debenture sales; Treasury sells $27 billion 10-year Notes; Jay Powell speaks before Congress
Thursday – CPI ex food & energy expected to be +0.2% and +2.2% y/y; Treasury sells $19 billion 30-year Bonds
Friday – Industrial Production expected to be flat to -0.3%; Retail Sales expected to continue its recent history of 0.3% gains
The Infection Worsens
Add the negative impact of the coronavirus to existing tariff induced trade tensions as a reason for global growth concerns. With the Chinese death count rising, expansion of the isolation zone around Wuhan, and many businesses closing their doors the impact on the Chinese economy is being felt. And, by extension, its impact on the global economy as worldwide supply chains have been disrupted causing commodity prices to drop sharply.
This WSJ chart shows investors’ flight to quality as the benchmark ten-year Treasury continued its rally, now down 41 bps in rate since the start of the year.
Since sharp rate declines don’t coincide with equity strength, this virus outbreak has seen global stock markets surrender their previously robust gains, with domestic indices down more than 3% from the January 17 record highs. With Chinese stock markets closed since January 23, their reopening Monday could reinforce safe-haven trading as related markets like Hong Kong’s Chinese stocks have already declined 6.7% last week, their worst performance in two-years. In advance of the domestic stock markets re-opening, the government has pledged $22 billion in financial market support, something that might pump the brakes on markets that have remained open but can only help to limit some pressure on Chinese markets whose Shanghai Composite did fall 8.4% today.
What Else Happened?
Not to be overlooked were two significant events that occurred within one hour of each other on Friday evening – the failure of a Senate proposal to call more witnesses in President Trump’s impeachment, virtually assuring his acquittal, and the formal departure of the United Kingdom from the European Union. The former will become a contentious issue in the presidential campaign while the latter simply sets the stage for terms that need to be finalized by December 31st as Britain is pleased to regain its individual identity while it may remain subject to EU trade terms even though it no longer has a place at the table.
In other market related events, the Fed announced no change in policy while noting that household spending is viewed as moderate rather than previously described as strong in its December release. Affirming that description was Friday’s release of Personal Consumption & Expenditures showing a 4% gain in household spending, its smallest since 2016. Part of that report showed Personal Income at +0.2% and the Fed’s preferred inflation gauge holding at 1.6%, stubbornly below its 2% target.
Real Interest rates are defined as Nominal Interest Rate less Inflation, making the Treasury curve out to ten-years already negative. With the base rate for Federal Funds currently at 1.50%, the Fed has little room to be accommodative if economic conditions should soften more.
Intensifying this move lower in rate are two other items to be considered:
Both could contribute to increased demand for government guaranteed debt even as Treasury increases supply by funding the government’s growing budget deficit.
Revisiting the GDP report, non-residential fixed investment fell for the third consecutive quarter, the first time since the financial market collapse. This WSJ chart shows that trend which many analysts ascribe to concerns about ongoing trade tensions, something this virus outbreak could enhance.
What all of this means is we have increasing amounts of cash seeking assets for investment in a risk-off environment that has increasing concerns for global growth.
The Week Ahead
A light Treasury calendar, the SBA 504 program prices its February debentures, and Fed speak resumes.
Monday – Treasury auctions $94 billion 13 and 26-week Bills; ISM Manufacturing Index
Tuesday – Factory Orders expected to be +1.2%
Wednesday – ISM Non-Manufacturing Index
Thursday – 504 program prices its February 20 and 25-year debentures
Friday – Non-Farm Payroll expected to be +153,000 vs. 145,000 last month
A Virus Hits the Markets
Stocks tried to rally but eventually succumbed to global concern over the coronavirus outbreak in China which damaged those domestic markets much more severely. For the week, S&P 500 Index was down 0.9% for its poorest weekly performance since August after a second case in the US was reported. But Asian markets were off as much as 4% before closing Friday to celebrate the lunar new year holiday.
The impact on China’s economy is yet undetermined but with central China under a near-lockdown and many new year festivities cancelled there is concern over the extent of possible damage. Stock sectors that were most affected by travel restrictions resulting from the virus were airline stocks like American and United, down almost 4% and Wynn Resorts, whose revenue at its Macau casino is heavily dependent on air travel, was down 3%. A SARS outbreak 17-years ago was estimated to cost China’s economy $50 billion in losses and there remains concern that the country is not acting fast enough to contain this event.
While equities sagged, safe-haven trades were back in vogue as Treasuries broke out of their recent range with the benchmark ten-year Note closing the week at 1.69%, better by 13 bps on the week and 20 bps from when the 504 program priced its January debentures two-weeks ago. Both trends are likely to continue as authorities struggle to contain the outbreak.
In a week devoid of Fed speak and light in Treasury issuance, one economic report that showed encouragement was existing home sales that were stronger than consensus at +3.8%, bringing total sales for the year to 5.54 million. Additionally, data company IHIS Markit reported its purchasing managers index for January climbed to its highest level in ten-months. This overall increase was concentrated in the service sector, with manufacturing showing a decline.
The Week Ahead
The FOMC meeting is most prominent but with no change, Treasury sells $243 billion in debt, and economic reports reflecting GDP and the Fed’s preferred inflation gauge that is expected to remain below target.
Monday – Treasury auctions $84 billion 13 and 26-week Bills, $40 billion 2-year Notes, and $41 billion 5-year Notes
Tuesday – Treasury auctions $26 billion 52-week Bills, $20 billion 2-year Floating Rate Notes, and $32 billion 7-year Notes. FOMC meeting begins; Durable Goods orders expected to recover to +0.5% from the previous level of -2.1%
Wednesday – Fed announcement at 2:00 with Jay Powell press conference at 2:30
Thursday – 4Q GDP estimate is +2.1%
Friday – Personal Income & Outlays forecast to show Personal Income at +0.3%, with core inflation at +0.1% and y/y unchanged at +1.6%
Is it More Than FOMO?
In a week that saw the first phase of the US-China trade pact signed, China removed from the list of currency manipulators (but still being monitored) and Impeachment proceedings having begun, the Treasury market stood still while stock indexes continued to set new highs.
As this WSJ chart indicates, all three major indexes improved at least 1.25% on the week with the technology sector of the S&P 500 index up 3%. Indicative of that sector’s strength Alphabet, parent company of Google, became the 4th US firm to reach the $1 trillion mark in market value, joining Apple, Amazon and Microsoft, though Amazon has not sustained that level. This record growth is not without concern as this sector is trading at elevated earnings per share levels, an indication of how pricey that may be.
In addition to this cautionary truce in the trade war, another contributing factor that helps discount the Fear of Missing Out concept for this sustained equity strength was Friday’s report from China that December industrial production rose 6.9%, better than forecast and putting GDP at 6.1%. That final number is low compared to past performance but eases some fears about the world’s second largest economy while apprehension remains about an overall soft outlook for global trade as cyber security and Chinese subsidies are yet to be negotiated. With the Fed on hold as it evaluates data to determine any future moves, equity markets continue to gain as banks report strong earnings amidst robust consumer demand. All good for now, let’s see how long it continues.
A Big Hurdle
Wednesday’s trade agreement identified four sectors where China will increase its purchases of US products by $200 billion over the next two-years – agriculture, energy, manufacturing and services. Since the government is involved in much of the country’ s business this is achievable, but possibly at the expense of its other global trade partners.
Domestic reports came in below consensus: CPI core at +0.2%; PPI core at +0.1% and y/y lower at +1.1%; while Retail Sales disappointed at +0.3% but with November revised up by 0.1%. While European bond sales saw strong over-subscriptions, US Treasury rates softened late in the week after Treasury announced resumption of 20-year Bond sales to take place later in the year. Expectations are for increased funding needs as the deficit hits $1 trillion and shifting some of that financing to longer maturities is prudent in this low rate environment. This is a reintroduction of a security last sold in 1986 when long-term rates were above 8%.
The Week Ahead
A light week for Treasury auctions and economic reports, with no Fed speak in this blackout period ahead of the January 28-29 FOMC meeting.
Monday – Martin Luther King holiday
Tuesday – Impeachment trial resumes and Treasury auctions $78 billion 13 and 26-week Bills
Wednesday – Existing Home Sales
Thursday – Jobless claims
Friday – PMI Composite Flash
Slow and Steady
In a week where geo-political issues replaced trade tension for headlines, the 504 program priced its January debentures and the jobs report came in below estimates but held unemployment at 3.5%. Additionally, women held 50.04% of jobs for the first time in a decade and the positive number completed a year that represented 10 consecutive years of job growth. 2.1 million jobs were created in 2019, placing it 8th overall in the decade as the economy reflects the diminishing impact of the tax cuts that took effect in 2018. There was a total of 14,000 in reductions to previous reports and wage gains shrunk to 2.9% as markets seem resigned to steady but slower economic growth.
The admitted missile attack by Iran on the Ukrainian jet impacted markets in a more subtle way than might have been expected as it drove traders into safe-haven Treasuries for a day before that fear trade faded. It did take three days for Iran to claim a junior officer made a mistake in firing the missile though Western authorities suspected Iranian involvement almost immediately. The admission resulted in global outrage and protests on the streets of Teheran as Canada and Ukraine demand retribution.
Markets were still uncertain when the 504 program priced its January debentures, but the sales were met with strong demand and were priced at improved spreads to benchmark Treasuries as investors continue to seek high quality assets.
This chart reflects the ongoing Effective Rates for the 20 and 25-year debentures (more than 100 bps below Prime) which were priced at 2.32% and 2.45% respectively.
For the week, the benchmark ten-year Note traded in a fear on/fear off range of 10 bps, ending the week higher by just 3 bps at 1.82%.
The Week Ahead
A light Treasury calendar, heavy Fed speak, some economic reports and impeachment papers are expected to be submitted to the Senate.
Monday – Treasury sells $78 billion 13 and 26-week Bills
Tuesday – CPI expected to be +0.2% core and +2.3% y/y
Wednesday – PPI expected to be +0.2% core and +1.4% y/y; SBA 504 January debenture sales fund
Thursday – Retail Sales forecast to be +0.3%
Friday – Industrial Production expected to decline, -0.3%
A week that initially saw robust strength in equities evolved into a risk-off safe haven trade for oil and US Treasuries. After trading aIn a week where geo-political issues replaced trade tension for headlines, the 504 program priced its January debentures and the jobs report came in below estimates but held unemployment at 3.5%. Additionally, women held 50.04% of jobs for the first time in a decade and the positive number completed a year that represented 10 consecutive years of job growth. 2.1 million jobs were created in 2019, placing it 8th overall in the decade as the economy reflects the diminishing impact of the tax cuts that took effect in 2018. There was a total of 14,000 in reductions to previous reports and wage gains shrunk to 2.9% as markets seem resigned to steady but slower economic growth.s high as 1.93% on the first trading day of the new year the benchmark ten-year Note rallied to close the week at 1.79%.
The primary cause was Mideast tension resulting from a drone attack that killed an Iraqi General, supplemented by a weak manufacturing report that continued a five-month string of unimpressive numbers that continue to fall below consensus. In equities, the major indexes had set new record highs before Friday’s selloff where they were able to claw back a bit from an early 1.1% selloff.
The flight to quality was more subtle than on previous occasions and reversed the recent trend higher in rate that resulted from recent Fed comments about not taking rates lower. That stance was confirmed by Friday’s release of minutes from the Committee’s mid-December meeting that indicated they are comfortable with holding rates steady and are more concerned with economic activity than with a below target inflation rate of 1.6%. Supporting the premise of stronger economic activity is a yield curve that has steepened to +26 bps from -0.7 bps in August.
Any escalation of the Midbeat tension would continue a rally in rates as the 504 program prepares for its January debenture sales. At 1.79% the benchmark Treasury is 2 bps lower than in December when the 20-year debenture was priced at 2.26% and the 25-year at 2.38%.
This chart shows the dramatic rate drop in funding cost for the program as the 20-year rate dropped from its recent high of 3.87% in November 2018 to its low rate of 1.98% in September 2019. It was at that time when the Fed’s neutral stance was pronounced, and rates have gradually risen, but still remain low.
A Brief Review
Looking back at 2019 there was central bank volatility, some advancement on Brexit, some resolution of trade tensions, and successful intervention by the Fed in stabilizing the Repurchase Agreement market. Fear of a rate spike over year-end did not happen and it is hoped their participation can be reduced.
Looking ahead it is expected that the Fed will retain its neutral stance, Britain needs to finalize its departure terms from the EU, and more advances with China are needed. Hopefully, the most volatile development will be the rhetoric contained in the presidential election campaign.
The Week Ahead
Fed speak, Treasury to auction $156 billion in debt, the 504 program prices its January debentures, and the December jobs report.
Monday – Treasury auctions $78 billion 13 and 26-week Bills
Tuesday – Treasury auctions $38 billion 30-year Notes; ISM non-Manufacturing index
Wednesday – Treasury auctions $24 billion 10-year Notes
Thursday – SBA 504 program prices its January 10, 20 and 25-year debentures; Treasury auctions $16 billion 30-year Bonds
Friday – Non-Farm Payroll report for December expected to be +150,000
Equities and Rates Rise
With trade tension temporarily reduced, a bi-partisan trade pact with Mexico and Canada on track, and an impeachment process possibly delayed until 2020 stocks again closed at record highs. The three major indexes closed higher on the week by as little as 1.1% for the DJIA and as much as 2.2% for the tech heavy NASDAQ. Support was also received from economic reports like:
What is interesting about the closing level of 1.92% for the benchmark ten-year Treasury is that it now matches the 75 bps in rate cuts orchestrated by the Fed this year. At one point in September the market had driven its rate as low as 1.46% in expectation of additional rate cuts which the Fed has since indicated are unlikely to happen. That stance, along with strong consumer spending has bolstered domestic equity markets while vacating the safe-haven trade in Treasuries. Another indication of the market’s interpretation of Fed policy is the 2/10 Treasury curve is now at +28.6 bps, its widest spread since November 2018 and far removed from its brief and slight inversion.
Globally, the amount of negative yielding sovereign debt has been reduced from its high of $17 trillion to just above $11 trillion.
With passage of a $1.4 trillion spending bill through September 2020, Congress has removed the risk of a government shutdown while also removing parts of the Affordable Care Act.
A WSJ survey of 57 economists cites a healthy labor market contributing to the US expansion that is now in its 11th year. Growth is expected to slow to 1.8% by 4Q20 from 2019’s estimated level of 2.2%. Job growth in the first half is expected to average 157,000, declining to 104,000 in the second half of the year. With the economy well balanced between employment and inflation, plus strong consumer demand, the economists see no need for the Fed to act in the 2020 election year, leaving us in a range bound market for interest rates.
The Week AheadTreasury to auction $191 billion, no Fed speak, and few economic reports.
Monday – Treasury auctions $78 billion 13 and 26-week Bills and $40 billion 2-yer Notes; Durable Goods expected to remain strong at +0.9%; New Home Sales forecast to show continued strength
Tuesday – Treasury sells $41 billion 5-year Notes
Thursday – Treasury sells $32 billion 7-year Notes
Both the Federal Reserve Bank and the European Central Bank announced their satisfaction with economic developments with no plans to tighten monetary policy while leaving the door open to cut rates further. The three rate cuts so far this year from the Fed have been the most aggressive moves since the financial crisis, leaving the benchmark ten-year Treasury rate lower by 87 bps YTD (unchanged on the week at 1.82%) while the S&P 500 index has gained 25.5%.
And it was the equity market that responded most favorably to the limited Phase One trade agreement announced Thursday as new highs were reached once again. Chinese negotiators were pleased with the rollback of many tariffs while agreeing to an undisclosed reduction to its demands for sharing intellectual property and will provide access to domestic financial markets. Their agreement to purchase $32 billion of agricultural products yearly, with the intent to increase that amount, will be welcomed by American farmers.
This agreement was one of three recently concluded by the President’s chief negotiator, Robert Lighthizer, who added the USMCA agreement with Mexico and Canada, plus elimination of the appellate process at the World Trade Organization. The second agreement is the successor to NAFTA while the WTO action blocks the overreach that recent Administrations have accused the organization of doing.
Not part of the Phase One agreement though, was China’s recent decision requiring government offices to cease using foreign equipment and software by 2022.
Thursday’s general election has provided Boris Johnson a Conservative majority in Parliament which should make it easier for him to facilitate Britain’s exit from the European Union. Terms of that move are to be determined as Mr. Johnson has not defined his plan for the exit, especially Northern Ireland’s border, nor its cost. While that will be negotiated with EU leaders in Brussels, he will also have to deal with renewed demands for Scottish independence as that country has voted its preference for remaining in the bloc.
Repo Market Blame
As we approach year-end and its usual financing pressure over the turn, blame for the distorted rate pressure in October for Repurchase Agreements (Repo’s) has been directed to Hedge Funds, in addition to the Treasury for issuing more debt and banks for increasing their reserves above the required levels. The rationale for this is their Basis trading, a representation of Relative Value Trading - which deals with the difference in price between two assets that are nearly identical – like buying Treasuries and selling Interest Rate Futures contracts. These products are similar but not identical and their price difference is small, so the trades need to be large to be profitable. Hedge Funds will buy the Treasuries and finance them in the Repo market to raise more cash to put on more of the trade, a process that has recently strained that market. While these Funds may be criticized for their impact on financing rates, it should be appreciated that they are buying the increased amounts of Treasury debt being sold to fund the government’s deficit, something that helps lower its funding costs.
Reports last week had CPI above forecast at +0.3%, PPI below consensus at 0.0%, and Retail Sales a bit disappointing at +0.2%.
The Week Ahead
Treasury will sell $111 billion of debt, Fed speak resumes, and we get the Fed’s preferred inflation gauge on Friday.
Monday – Treasury sells $78 billion 13 and 26-week Bills
Tuesday – Industrial Production forecast at +0.8% after two very weak reports
Wednesday – Treasury sells $18 billion 2-year Floating Rate Notes
Thursday – Treasury sells $15 billion 5-year TIPS
Friday – 3Q2019 GDP forecast as 2.1%; Personal Income & Outlays includes Personal Consumption Expenditures forecast as +0.2%, 1.6% Y/Y
Stronger than Expected
After reacting to daily, contradictory messages on trade, Friday’s Non-Farm Payroll report sent equities and Treasury rates higher. Coming in stronger than consensus at 266,000 with unemployment lower at 3.5%, the report especially helped equities recover from additional tariffs announced earlier in the week. The tariffs included steel from Brazil and Argentina plus a 100% tariff on French goods and accompanied comments from President’s Trump that there was “no deadline” for a China deal. This combined to send stocks lower by 1.2% on Tuesday, only to recover 0.7% on Wednesday when the President said talks were going “very well.”
In addition to the stronger than expect jobs report, Y/Y wage growth came in at 3.1% and was accompanied by a comment from Labor Secretary Scalia that 6.6 million jobs had been created since January 2017.
With the Fed having already indicated it would be cautious about additional rate cuts, it is unlikely Wednesday’s announcement will result in any action as this report represents the “incoming information” that the Fed has stated it will assess for its decisions.
One Weak Sector
The global auto industry continues to shrink faster in 2019 than at the height of the financial crisis. VW and Daimler announced job cuts totaling 20,000 recently and the Association of the Auto Industry projects 4 million fewer cars will be sold in 2019 than last year.
This month’s jobs report did show a gain of 41,000 auto workers but this is misleading as they were returning from an extended strike at General Motors.
Continued Low Rates and Higher Volume
Last week’s debenture sale for the SBA 504 program was well received and continues to produce ongoing effective rates at attractive levels. With the Prime Rate having been reduced by 75 bps this year the differential is not as great as it had been, but the reduced government borrowing fee for FY20 was realized by loans this month for the first time.
At 2.26% the 20-year debenture rate was 28 bps lower than the 12-month average and total pool size of $342,753,000 for the two debentures was $13,393,000 more than the 12-month average.
Fed Continues Support
The Fed continues to add liquidity to the financial markets to ensure stable financing terms through year-end when cash can be scarce. The bank continues to buy T-Bills and will do so through next summer as it hopes that activity will reduce the need for continued support in the short-term Repurchase Agreement market.
The Week Ahead
A light economic and Treasury calendar, and no Fed speak until Wednesday’s announcement.
Monday – Treasury sells $78 billion 13 and 26-week Bills, and $38 billion 3-year Notes
Tuesday – FOMC meeting begins, Treasury sells $24 billion 10-year Notes
Wednesday – SBA 504 program funds its December debenture sales, CPI forecast to be +0.2%, Treasury sells $16 billion 30-year Bonds; FOMC announcement and economic forecast @ 2:00 followed by Jay Powell press conference
Thursday – PPI expected to be +0.2%; Britain holds a General Election which will influence its Brexit negotiations
Like the movie sequel from Disney, markets seem trapped with Treasury rates yo-yoing within a tight range while equities continue to grind higher as alternate days bring reports of progress and dissension on trade talks. Adding to that tension was President Trump’s signature on legislation supporting the Hong Kong protesters, a gesture that so far has produced a muted response.
The benchmark ten-year Treasury was basically unchanged at 1.78% while equities gained 1% on the week, closing November with their best monthly performance since June. At 1.78%, UST-10 is 12 bps lower than when the SBA 504 program priced its November debentures.
Below is a Financial Times chart displaying a long-range forecast of JP Morgan Asset Management that reduces its expectation for the performance of long-dated US Treasuries. The bank’s opinion reflects the impact of central bank interest rate cuts and investors are advised to abandon safe-haven trades because “they can no longer provide the combination of portfolio protection and positive income that they have in the past.”
The head of multi-asset strategy at JPMAM, John Bilton, cautioned investors that monetary policy will probably remain “extremely accommodative” throughout this business cycle and into the next due to global economic weakness and low inflation. Lending support to those observations is a recent quote from Chairman Powell -“we would need to see a really significant move-up in inflation that’s persistent before we would consider raising rates,” and by virtue of the recent rate cuts the Committee is affirming that the economy is showing less strength than it expected.
And speaking of low inflation, the Fed’s preferred gauge, Personal Consumption Expenditures, declined to 1.6% y/y, trending further away from its 2% target. Consumer spending did increase, but much of that gain was attributed to higher outlays for electricity and gas, which are excluded from the core calculations. In other economic reports last week:
The Week Ahead
No Fed speak ahead of their December 10-11 meeting, Treasury sells Bills only, and the SBA 540 program prices its December debentures.
Monday – Treasury sells $78 billion 13 and 26-week Bills; ISM Manufacturing Index
Tuesday – Treasury sells $26 billion 52-week Bills
Wednesday – ISM Non-Manufacturing Index
Thursday – SBA 504 program prices its December 20 and 25-year debentures
Friday – Non-Farm Payroll expected to be 180,000
Still Waiting on Phase One
But while we wait there was some positive news on the economy as illustrated in this WSJ chart showing an October increase in the recent Purchasing Managers Index. The release from data company HIS Markit shows an increase to 51.9, partially reversing the year to date drop from its February high of 55.5. A reading above 50 reflects economic growth while a reading below 50 indicates a retraction, as shown for the Eurozone, Japan, and the Brexit in waiting UK.
The report included a comment from HIS Markit’s economist, Chris Thompson, that “the worst of the economy’s recent soft patch may be behind us,” though it is clear that is not applicable globally. Trade tensions continue to promote uncertainty which is compounded by the impeachment inquiry and a UK election next month that will influence Brexit negotiations. For the week, safety was again sought in Treasury debt with the benchmark ten-year Note improving 6-bps while equities marked time be setting back from the previous week’s record highs. UST-10 settled at 1.77%, improved by 6 bps on the week and 13 bps from when the SBA 504 program priced its November debentures.
The Week in Review
Release of the minutes from the October 31 FOMC meeting were as expected with the Fed indicating it was moving to the sidelines and will review economic activity before making any “material reassessment” of its policy.
Reflecting the cautious state of investors, year-to-date inflows into Corporate bond funds reached $180 billion, making it the third most active year for that product. But risk in fixed rate debt is still being embraced if the potential reward is high enough. Angola, a country whose debt almost matches its GDP, attracted $8 billion in orders for $3 billion 10 and 30-year securities. The respective rates of 8% and 9.25% proved to be very attractive for yield starved investors.
Discount Window Lending vs. Repurchase Agreement Support
The Discount Window is a facility the Fed manages to support member banks needing to meet reserve requirements on any given day. Much is not currently needed as banks are holding cash positions well above what regulators require; like JP Morgan Chase holding $120 billion vs. the required $60 billion. The reason given by bank officials is to provide a big buffer should any crisis arise, but the effect of that approach is to reduce liquidity in the Repo market where securities firms finance their overnight positions. To reduce that strain, the Fed continues to add billions of dollars daily to maintain financing rates in line with their Fed Funds range of 1.50%-1.75%, resulting in a stable Repo market but an increased balance sheet for the bank.
The Week Ahead
Light Fed speak and economic reports in a holiday shortened week, and Treasury to sell $215 billion in Bills and Notes.
Monday – Treasury sells $84 billion 13 and 26-week Bills and $40 billion 2-year Notes; Jay Powell speaks in Providence, Rhode Island
Tuesday – Treasury sells $41 billion 5-year Notes and $18 billion 2-year Floating Rate Notes
Wednesday – Treasury sells $32 billion 7-year Notes
Risk On, and Off
In a week where preliminary reports of a trade accord were challenged, both the US Treasury safe-haven trade and the risk-on equity trade prospered. The benchmark ten-year Note recovered almost 11 bps and the DJIA improved by 1.4%, crossing 28000 for the first time.
While Treasuries steadily improved, positive Jay Powell comments on the economy helped equities gain ground later in the week. A strong earnings report from Walmart (+27% ytd) and then a stronger than expected +0.3% gain for Retail Sales helped retailers like JC Penney show a 6.5% spike on the week. If nothing else, investors seem to have identified value in both market sectors while still exhibiting caution.
As positive as Chairman Powell was regarding economic stability, he, and other Fed speakers referenced the “low for long” interest rate environment as possibly resulting in “financial vulnerabilities” as investors reach for yield and more debt is assumed. And nowhere is this felt more than in underfunded pensions, where life expectancy has increased, and funds are scrambling for yield. With $11.5 trillion of global debt trading at negative yields, any spike in rates will compound this dilemma for fund managers.
This teeter-totter approach to monetary policy will continue as the Committee balances President Trump’s yearning for lower, even negative interest rates with the reality of full employment and reasonable, though not dynamic economic stability. Further insight on the Committee’s thinking should be available when the minutes of their October meeting are released this Wednesday.
CPI and PPI both came in as expected and will do little to change Fed policy.
One weaker than expected event was Friday’s -0.8% update on Industrial Production, which was double consensus. Though a decline was expected due to the impact on vehicle production resulting from the UAW strike, production of business equipment continues its downward trend.
Fed Balance Sheet
As this WSJ chart indicates, the Fed has reversed its Quantitative Tightening by providing liquidity to the short-term financing market. The graph identifies the bank has reversed 40% of balance sheet reduction in the last two months as it has moved to normalize the market’s financing terms. That rate has settled slightly below the 1.625% mid-point of the bank’s Fed Funds range.
The Week Ahead
There is a light calendar for reports (some housing data), Fed speak and Treasury supply.
Monday – Treasury to sell $87 billion 13 and 26-week Bills
Wednesday – Minutes of the last FOMC meeting are released
Friday – PMI Composite Flash report on manufacturing and services
A Change in Market Sentiment
In a week that saw rumors of reduced tariffs only to be squashed by President Trump saying he has not agreed to that, we saw equities reach new highs again while bond rates rose in response to the unconfirmed agreements.
The market had become hopeful on tariff resolution for stocks and cautious on rates following the most recent FOMC rate cut. Rates began the week by drifting higher into the Treasury’s quarterly refunding of debt and on Thursday the benchmark ten-year Note increased 9 bps ahead of the SBA 504 program pricing its November debentures. That trend has paused the safe-haven trade in Treasuries and gold for now, leaving UST-10 at 1.94% to close the week and looking for its next level of support. This move in rates has steepened the 2/10’s Treasury curve to +27 bps negating talk of a pending recession when it was inverted at -1 bps back on August 30th. Since that date, the Fed has reduced its base rate by 50 bps and the benchmark ten-year Treasury has risen 44 bps, and even UST-2 is higher by 18 bps, a disconnect from traditional performance.
Here is a snapshot of how the November debenture rates changed this month, but more importantly, how much lower they are y/y than the 75 bps rate reduction that has taken place since July. Part of the explanation is change in sentiment, as rates were increasing last November in anticipation that the Fed was about to raise rates again in December, but after that rate hike the market front-ran the Fed in response to weaker economic reports and trade tensions. Global sovereign rates declined, and a changed central bank posture soon followed with the most recent announcement indicating they will be on hold pending future reports.
What stands out in the comparison is how the 25-year debenture tightened in pricing spread by 2 bps m/m (and by 6 bps over the 12-month average) as investor demand for the maturity has matched small business borrowers increasing preference for it.
As seen in this chart, even with the 75 bps reduction in Prime Rate and increased debenture rates, the 504 program is still delivering attractive ongoing Effective Rates for term loans with 2019-20K at 3.74% and 2019-25K at 3.80%.
Other Items Last Week
The Week Ahead
A light Treasury calendar, more Fed speak including Chairman Powell, and some economic reports on inflation and consumer demand.
Tuesday – Treasury auctions $87 billion 13 and 26-week Bills
Wednesday – SBA 504 program funds its November debenture sales; core CPI expected at 0.2%/2.4% y/y; Chairman Powell speaks before the Congressional Joint Economic Committee
Thursday – Core PPI expected to be 0.2%/2.0% y/y
Friday – Retail Sales forecast to be 0.2%; Industrial Production expected to be 0.4%
The Week in Review - Third Rate Cut, as Expected
The FOMC announcement on Wednesday was as expected, but with the Fed pumping the brakes on additional cuts. The language in their announcement changed from “act as appropriate” to assist the economy to - the Committee will “monitor the implications of incoming information, as it assesses the appropriate path” of rates; whatever that means. Markets were quiet immediately afterwards but then Thursday delivered a sense of Chinese pessimism for a long-term trade deal whose first phase was expected to be signed at a now cancelled meeting of world leaders in Chile. That cancellation was nominally a result of riots caused by a $.04 transit fare increase but are largely associated with global recognition of income inequality and the economic prosperity gap between the wealthy and the masses.
Treasuries rallied on the week with the benchmark ten-year Note closing at 1.72%, 8-bps higher than when the SBA 504 program priced its October debentures. Equities were hurt by the Chinese assessment but recovered on Friday after the jobs report.
Slower, but Stable
Helped by a 1.9% reading for 3Q19 GDP and then a larger than expected gain of 128,000 jobs in October, stocks ended the week on a strong note even as the market battles a lack of consumer confidence. That deficiency is perplexing since the GDP report was bolstered by a 2.9% increase in consumer spending, a significant component of economic growth. To show how the market perception has changed recently, this Financial Times chart shows the negative reaction to the previous two rate cuts, but the Fed’s comments supporting economic stability resulted in a more positive reception with the three domestic indexes closing at or near record highs. October’s report reduces the year’s monthly average gain to 167,000 but also represents the 109th consecutive month of gains, the longest stretch in the report’s history.
PM Boris Johnson successfully maneuvered for a general election on December 12 after agreeing with opposition demands for a “flextention” to leave the EU by January 31. This qualification will permit an earlier departure should an agreement be reached after the election and allow the UK to leave at that time without waiting until the new end date.
How Attractive is the Residential Real Estate Market?
For sellers, the answer is very attractive, for others not so much. While the Pending Index of Home Sales report came in with its strongest reading in two years last week, the strength is not felt by all participants. Using local data, in September the average home sale price in Charlotte was up nearly 10 percent over last year. Meanwhile, the number of houses on the local market is down 40 percent from five years ago. Few people feel that squeeze more than real estate agents who, to make things even more competitive, have seen the number of licensed agents nearly double since 2014. Additionally, a report from Redfin, a real estate brokerage, shows homeowners staying in their homes an average of thirteen years, five years longer than they did in 2010. Adjusted for population growth the inventory level is the lowest in 37-years, contributing to reduced supply and increased valuations. Click here to view full Redfin report.
The Week Ahead
SBA 504 program prices its November sale of 10, 20 and 25-year debentures; heavy Treasury supply and Fed speak, and a light economic calendar.
Monday – Treasury sells $87 billion 13 and 26-week Bills
Tuesday – November debenture sale is announced; Treasury sells $38 billion 3-year Notes and $28 billion 52-week Bills
Wednesday – Treasury sells $27 billion 10-year Notes
Thursday – November debentures are priced; Treasury sells $19 billion 30-year Bonds
Friday – University of Michigan Consumer Sentiment survey is released
Trade Optimism Boosts Stocks, Softens Bonds
The first phase of a trade agreement with China still waits to be finalized but positive comments were enough to push the S&P 500 Index close to its record high, gaining 1.2% on the week, as seen in this WSJ chart.
Reports and Rates
Not even a weaker than expected Durable Goods number and a mixed bag of earnings reports could dampen the enthusiasm for stocks as the rates market dealt with a heavy Treasury calendar and then news of an increased budget deficit that grew by 26% in the latest year, approaching $1 trillion. Durable Goods came in even weaker than its negative forecast at -1.1% and did nothing to deter either market from the paths they were on, especially Treasuries which usually rally on weak economic news.
The ten-year Treasury benchmark yield rose 5 bps (1.796%) on the week putting it 16 bps above where the SBA 504 program’s October debentures were priced. A greater deficit translates to increased funding needs for Treasury at a time when the market expects further rate cuts that should lower Treasury rates, at least in the front-end. From levels in January (and even higher last year) the market front-ran the Fed by pushing that ten-year yield lower by 67 bps to 2.01% even before the first rate cut on July 31st; but now, with expectations of a third rate cut at Wednesday’s announcement the market is more cautious.
Like most countries, Japan is experiencing reduced manufacturing activity with a September decline that was the most in five-years. It was affected not only by global weakness but a recently increased consumption tax and a deadly typhoon. Like the Fed, this week their public policy Board meets to discuss monetary policy with an announcement scheduled for Thursday.
With regard to Treasury supply, the Fed increased its intervention in the overnight Repurchase Agreement market to $120 billion and to $45 billion in the term market. Like its monthly purchases of $60 billion of Treasury Bills, these moves are directed to reduce market volatility, especially as firms approach year-end when they generally reduce their Balance Sheet exposure. In other news, Brexit continues to stumble along with continued debate on seeking an extension of the October 31 deadline and for how long. Negotiations are complicated by a government preference for a general election which the opposition resists because they currently lag in the polls.
The Week Ahead – It’s Fed Time
No Fed speak until Wednesday, a light Treasury calendar, and some significant economic reports.
Monday – Treasury auctions $87 billion of 13- and 26-week Bills
Tuesday – Federal Open Market Committee meets
Wednesday – 3Q2019 GDP expected to decline to 1.7% from 2% in Q2; Fed announcement at 2:00 followed by Chairman Powell press conference at 2:30
Thursday – The Fed’s preferred inflation gauge is part of the Personal Income & Outlays release, expected to show a 0.1% gain with the core rate at +1.7% y/y
Friday – Non-Farm Payroll expected to decline to 95,000 from a 136,000 gain in September. Average hourly earnings forecast to be +0.2%, +3% y/y
Deal or no Deal
That header qualifies for a few negotiations:
On Brexit, the leaders of both entities have an agreement, though final terms and ratification are pending. In the case of the UK, their sticking point is that dreaded border issue on the island of Ireland and Mr. Johnson’s proposal is not fully endorsed by his coalition’s partner, the Democratic Union Party of Northern Ireland. A desired vote on Saturday was postponed forcing the PM to request a Brexit extension, something he has said he would prefer “being dead in a ditch” to doing. As for the EU, their flexibility on negotiations seemed to indicate a “leave already” attitude as they want to finalize this departure.
If anyone knows where the US-China negotiations stand, they have not come forward with a clear explanation. Confirmation of a tentative, first phase agreement two weeks ago lent support to equities while softening Treasuries, and Thursday’s release of 6% 3Q2019 growth for China confirms the impact that tariffs are having on the world’s second largest economy. While that rate of growth seems to be sizeable, this was the weakest quarterly performance in three decades. In the US, factory output slumped 0.5% in September as a strike at General Motors caused a steep decline in auto production.
That leaves the UAW-General Motors deal as the firmest of the negotiations, but even that requires a final vote from union members. The deal resulted in increased wages, benefit gains and a signing bonus for workers while agreeing to permanently close three plants and not relocate any production from Mexico.
The situation in Syria has little impact on financial markets for now but has embroiled the President in a dispute with his own party members as he negotiated a cease fire to permit Kurd fighters to evacuate the country over a five-day period.
Three for Three?
The FOMC meets again on October 29-30 and it is expected they may reduce rates for the third consecutive meeting, lowering the Fed Funds target to 1.50-1.75%. Investors in interest rate futures assign a 90% probability for such a cut while Fed Governors caution future policy will be decided on a meeting to meeting basis.
Regarding the $15 trillion of global debt trading at negative yields, the International Monetary Fund cautioned that bond funds who hold $1.7 trillion of bonds could be facing a bond bubble if volatility increases and they face sudden withdrawals.
Adding to the weak manufacturing report, Retail Sales came in at the expected number of 0.3%, but it was -0.3%. A partial offset was an upward revision of 0.2% to the August report. Additionally, Leading Indicators were -0.1% with August being revised down 0.2%.
This WSJ chart identifies the concern analysts have for the health of the US economy as Industrial Production continues to trend lower from its most recent peak in 2018.
Here is the US industrial production on a year-over-year basis.
The benchmark ten-year Treasury remains in a vacuum, closing the week 7 bps higher than when the SBA 504 program priced its debenture sales on October 10th. At 1.75%, this benchmark is down 89 bps ytd with just 50 bps in rate cuts by the Fed, while domestic equity indexes hold their double-digit gains.
The Week Ahead
Fed speak, Treasury sells $220 billion of debt, some housing numbers and a Durable Goods report.
Monday – Treasury auctions $87 billion 13 and 26-week Treasury Bills
Tuesday – Existing Home sales; $40 billion 2-year Note auction
Wednesday – Treasury sells $20 billion 2-year Floating Rate Notes and $41 billion 5-year Notes
Thursday – Treasury sells $32 billion 7-year Notes; Durable Goods expected to be -0.7%
Friday – University of Michigan report on Consumer Sentiment
Well, maybe temporarily. Auctioning long-term debt at its lowest levels in three-years drew below average demand from investors, forcing dealers to position the securities and raising yields going into Thursday’s pricing of the SBA 504 program’s October debentures. Then Friday’s session was impacted by news of a first-phase agreement between the US and China that will pause some tariff increases which will be met with increased Chinese purchases of agricultural products. The impact on markets was somewhat unexpected since much of the agreement had previously been settled. Nevertheless, safe-haven trades were abandoned, and equities strengthened, gaining almost 1.5% on the week to levels that are within 2% of their recent highs.
Of benefit to small business borrowers was Thursday’s debenture sales that showed increased demand for the 25-year term issue, which was larger than the traditional 20-year issue for the third consecutive month. The chart below shows the slight uptick in rate for the benchmark Treasury and the recent 504 debentures while the Prime Rate has seen a 50-bps decline since July. At 2.08% and 2.22% respectively the ongoing effective rates for the debentures are -154 and -146 bps to Prime.
Stimulus or Not?
Other developments that had a positive market impact last week included two actions by the Federal Reserve Bank:
The Week Ahead
As Ohio prepares to host the next Democratic presidential debate it is interesting to note how the state’s economy has changed. Unemployment is down yet median hourly wages are below where they were in 1979 and that reflects the changing nature of its employment, from manufacturing to services. A generation ago General Motors, currently in the fourth week of a strike, was the largest employer; now it ranks 72nd, just ahead of Starbucks.
The holiday shortened week has a lot of Fed speak, light Treasury calendar, and few economic reports.
Tuesday – Treasury auctions $87 billion 13 and 26-week Bills
Wednesday – Retail Sales forecast to be +0.3%; SBA 504 program funds its October debenture sales
Thursday – Treasury auctions $17 billion 5-year TIPS
A run of weaker-than-expected US economic data led to lower Treasury yields as the week wore on. Treasury yields declined across the board led by a 22 bps drop w/w in the two-year note to 1.41%. The ten-year note yield declined 14 bps w/w to 1.53%. Below is a chart of the daily trading range in the ten-year yield over the past three months. Bordered by green lines is the trading range since the start of September of 1.4% to 1.9%. Last week’s rally in Treasuries brought the yield into the lower half of the trading range (circled in red in the chart).
Weaker Economic Data. The weaker US economic data can be captured in the downturn in the Citigroup economic surprise index. This index is nicely positively correlated with the rolling 13-week average yield on the ten-year note. A lower Citi index correlates with lower Treasury yields. After a run of positive surprises, the surprise index turned south last week. The weaker manufacturing, services and payrolls data released were the culprits.
Bond Market Priced in More Fed Cuts. The bond market took this turn south in the US data seriously. Despite Fed Chair Powell’s comments about a single “mid-cycle adjustment” the other month, the market quite disagrees. Why?
Measuring Market Expectation for Fed Easing. The bond market has now priced in a material easing cycle. How can we measure this expectation? The OIS market provides a good measure of expected future Fed funds rates. It now prices in a high probability (80% or more) of quarter-point cuts in the target Fed funds range at the October and December FOMC meetings. If so, that would leave the year-end target Fed funds rate range at 1.25% to 1.50% versus a cycle starting range of 2.25% to 2.5% (the Fed has made two ¼-point cuts off that target so far). Further out the market prices in a 1% Fed funds target by the end of 2020. One hundred to 150 bps in rate cuts on such a low starting target base would be a material easing cycle indeed.
The yield curve is another measure of the expectations for a minor Fed easing cycle. The two-year Treasury note yield was 4 bps above the ten-year yield on August 27. It now is 12 bps lower than the ten-year note, a swing of 16 bps in five weeks. That relatively stronger move lower in shorter-maturity yields is a hallmark of market expectation for more Fed easing.
Risk Appetite Held In. While the Treasury market priced in a weaker outlook, US stocks closed not much lower on the week, and other measures of risk appetite were steady. In currencies, expectations of more Fed easing helped emerging market currencies. For example, the Brazil Real strengthened 2.6% and the Mexican peso was up 1%. Emerging market currencies typically sell off on higher US interest rates and rally on lower US rates.
In US credit, the CDX HY US high yield (HY) index spread to Treasuries was a bit wider. In higher-grade credit sectors spreads were a few basis points wider. In the government-guaranteed agency CMBS market spreads were 3-4 bps wider as Treasury yields fell amid heavy housing agency new issuance. Yet, continuously heavy flows into US bond funds has meant that portfolio managers have lots of cash on hand and have vigorously bought any bump higher in market yields, which helps contain any material spread widening.
Managers also face a chunk of the global government bond market at negative yields, with the US bond market the most liquid spot in the world to capture positive yields. Cheaper USD currency hedging costs help global investors to support the US bond market. As well, the Fed is expected to increase shorter-maturity Treasury purchases, not for easing purposes, but to get the level of banking system reserves to a higher level as a more permanent way to smooth over recent liquidity disruptions in the money market. For fixed income portfolio managers that would be an unplanned-for source of Treasury demand that would help soak up massive Treasury issuance, helping to keep bond market yields lower.
Calendar. This week the calendar is highlighted by the setting of the 20- and 25-year SBA 504 debenture interest rates on Thursday morning. In economic data we will see inflation data for producer (Tuesday) and consumer (Thursday) prices. On Wednesday the FOMC will release minutes from the latest meeting.
Whistleblowers Ruled the Week
Using a whistleblower complaint that the White House used a classified security system to cover up President Trump’s conversation with his Ukrainian counterpart in which it is alleged that he threatened to withhold financial aid, House Democrats launched an Impeachment inquiry into the affair; and NFL referees showed that they still cannot identify pass interference.
The implications of the presidential conversation are extensive as the President has rolled former Vice-President Biden into the affair as he claims that Mr. Biden had intervened with Ukrainian officials while in office on behalf of his son, who served as a board member for a Ukrainian energy company.
It seems that impeachment has been a topic of conversation since President Trump took office and the opposition finally settled on an issue thought to be appropriate. While the House of Representatives is authorized to bring the resolution of impeachment and officially charge the President, it is the Republican controlled Senate that must adjudicate the charge, needing a two-thirds vote to convict. With strong party support it may be difficult to find a sufficient number of Republican Senators to be swayed, but the process will be partisan and extended, even though House Democratic Committee chairs look to accelerate the timetable for the probe.
Developments related to the release of this Presidential transcript include:
The impact of this inquiry on financial markets, along with a new threat to limit Chinese access to US markets, can be substantial. Stocks are somewhat paralyzed, down about 0.5% and it appears investors are shunning companies that lose money, evidenced by WeWork pulling its IPO and Peloton opening at a loss. Most surprising might be the subdued flight to quality as the ten-year Treasury ended the week at 1.68%, down just 4 bps on the week, yet 10 bps above the level when the September debentures for the SBA 504 program were priced.
The Federal Reserve Bank of NY, the branch of the central bank that manages daily oversight of the Treasury market, was active once again in supplying cash for Repurchase Agreement activity. On Friday alone it added $71.7 billion, much of it on a term-basis to alleviate any quarter-end pressures to finance investor positions.
Last week marked the one-year anniversary of the Fed’s next to last rate increase on 9/28/2018 that left the above-mentioned ten-year Treasury at 3.06%. We have since seen one additional increase, and two rate cuts this quarter alone, as the Fed reluctantly reversed course amidst conflicted economic reports and heightened trade tensions.
As previously mentioned, the Fed’s preferred inflation gauge, Personal Consumption Expenditures, increased y/y to 1.8%, but the report also showed household spending increasing by just 0.1% as consumers may be suffering some fatigue, even with increased wage growth. If consumer spending remains soft, it will complicate matters for the Fed which signaled no more rate cuts this year even with market analysts predicting a further decline in rate. A probable cause for that expectation is a defensive posture by investors who are uncertain about trade resolution, geo-political issues in Britain and Hong Kong, and now an Impeachment inquiry.
Other reports showed New Home Sales above consensus with an upward revision to July, Durable Goods was +0.2% vs. a forecast of -1.2%, and 2Q19 GDP was unchanged at 2%.
The Week Ahead
Fed speak, a light Treasury calendar, and Friday’s jobs report tops the economic calendar.
Monday – Treasury auctions $87 billion 13 and 26-week Bills
Tuesday – ISM Manufacturing report (a mid- September UAW strike could be a drag on this number)
Thursday – Factory Orders, plus ISM Non-Manufacturing report. Treasury to sell an undetermined amount of 4 and 8-week Bills
Friday – Non-Farm Payroll expected to rebound from last month’s 130,000 report
Regarding Wednesday’s Fed action the vote was 7-3, the first time there has been as many as three dissents since September 2016. An indication of that dissent is captured in this recap from the WSJ: “A summary of projections by Fed officials released Wednesday showed five of 17 policy makers see the benchmark federal-funds rate remaining in its current range between 1.75% and 2% through the end of the year. Seven officials see another quarter-point cut, to a range of 1.5% to 1.75%, while five officials expect rates to finish the year where they were before this week, between 2% and 2.25%.” That means all three options are almost equally represented with two more meetings scheduled this year, so we can expect recently strong economic reports to compete with trade negotiations and drone attacks to direct the path for interest rates.
The Week in Review
Economic reports were consistently strong.
Industrial Production was above consensus at +0.6%, with manufacturing surprisingly strong at +0.5%
Housing Starts & Permits were stronger than expected, both in single and multi-family units, with an upward revision to July
Existing Home Sales showed additional strength. The median home price is now $278,200 with a 4.7% gain y/y
The Week Ahead
Fed speak resumes, Treasury to auction $200 billion, and we’ll see if the Fed’s preferred inflation indicator affirms previous week’s gains in CPI and PPI
Monday – Treasury auctions $87 billion in 13 and 26-week Bills; Purchasing Managers Index flash indicator
Tuesday – Treasury sells $40 billion 2-year Notes
Wednesday – New Housing Starts and Treasury sells $41 billion 5-year Notes
Thursday – Third estimate of 2Q2019 GDP expected to be unchanged at 2%; Treasury auctions $32 billion 7-year Notes
Friday – Durable Goods orders expected to be -12% after two strong monthly increases; Personal Income & Outlays expected to show Personal Income +0.4% and core Personal Consumption Expenditures forecast to increase 0.2% and 1.8% y/y
An overbought market that began the week with a rise in rate saw that move accelerate with stronger than expected inflation data, more Quantitative Easing from the ECB, and enhanced by reciprocal moves by the US and China to ease tariff increases. Defensive trades were off and value investing took hold, allowing domestic stock indices to record a 1% gain for the week and finish with its first three-week winning streak since June while Treasuries had their worst week in three years.
The mood for this activity was captured by a Financial Times columnist, Mike Mackenzie, who wrote on Tuesday, before the move accelerated, about Sovereign bond fatigue: “This (change) cuts to the heart of the debate rippling across markets. Sovereign bonds are currently poised for a cycle-busting recession, whereas the tone of data and central bank easing this year signals only slowing growth and possibly a near-term bottom.”
This captures the dilemma for central bankers and investors concerning markets that are over-extended and economies that need fiscal stimulus and trade resolution. Fiscal stimulus, in particular, was mentioned by ECB President Mario Draghi when he announced a rate cut and a restart to a €2.6 trillion Quantitative Easing program, measures that were not unanimously agreed to by the 25-member council.
Next up for central bankers is this week’s FOMC meeting that markets expect will end with a 25 bps rate cut on Wednesday, but the Fed’s dilemma is deciding if growth will only weaken slightly over the next few years without contracting, and that distinction is critical. A Bloomberg survey of economists shows a median estimate for 2019 GDP to be 2.3%, dropping to 1.8% in 2020. That weakness does not necessarily support recessionary fears and Chairman Powell said last week that “the most likely outlook for our economy remains a favorable one with moderate growth,” and “our main expectation is not at all that there will be a recession.” Such sentiment reflects a cautious approach to rate cuts which the administration endorses as it seeks more monetary stimulus to spur the economy. Adding to that mandate is the drone attack on Saudi oil fields that has halved that country’s production. The President called for more stimulus in its wake while Russia and OPEC recognize an opportunity when they see one and announced no increase in production. The result has been a large spike in the price for Brent crude, but only a modest reentry into safe-haven Treasuries. “Act as appropriate” can be expected to be included in Wednesday’s Fed announcement regardless of how big, if any rate cut is announced.
At 1.899% the benchmark ten-year Treasury ended the week 47 bps higher than where it was on September 2, before it was disclosed that trade talks would be scheduled for next month. That began the reversal, but not before the SBA 504 program was able to price its September debentures at the lowest ongoing effective rates in the program’s history. A snapshot of what has changed since that sale on September 5 shows the difference between that day’s debenture pricing and what a pricing last Friday would have looked like.
Economic reports that lent support to equity strength were:
Retail Sales above consensus at +0.4%, helped by strong auto sales
CPI +0.3% ex food & energy and +2.4% y/y; both above consensus
PPI +0.3% ex food & energy and +2.3% y/y; both above consensus
The Week Ahead
No Fed speak until Chairman Powell’s press conference Wednesday afternoon, just $99 billion in Treasury auctions, some housing data and Industrial Production
Monday – Treasury auctions $87 billion 13 and 26-week Bills
Tuesday – FOMC meeting begins; Industrial Production expected to be +0.1%
Wednesday – Fed announcement, Chairman Powell press conference and the Committee’s forecast
Thursday – Leading Indicators forecast to be +0.1%; Treasury auctions $12 billion 10-year TIPS
A Tale of
Two Economies – with a Manufacturing Index coming in below expectations because of weak export orders. and its counterpart, the Non-Manufacturing Index, coming in above expectations due to strength in the service and business sectors. The weak export orders are a direct result of trade tensions and that situation is having a global impact.
Two Fed Presidents – as the Federal Open Market Committee prepares for its September 18 announcement, where at least a 25 bps cut is expected, different Fed Presidents offered conflicting views on policy. Eric Rosengren, FRB Boston, believes developments in the US Treasury market are tied to economic weakness abroad, which is of less concern to the Fed. The partial inversion of the curve, usually a precursor to recession, is different this time because it is not the result of the Fed raising short-term rates but because of demand for Treasury assets. On the other hand, there is Robert Kaplan, FRB Dallas, who is focused on weakening domestic growth and its need for lower rates now before it is too late. Plus, he is joined by James Ballard, FRB St. Louis, who believes that the Fed should be more aggressive and cut by 50 bps this month.
Back to the economy, we have a weak but still steady jobs report that had a little something for every point of view. Pessimists point to slowing economic growth with manufacturing in a recession, while optimists point to historic job growth and strong consumer spending. This Washington Post chart shows how employment gains in 2019 have slowed as the economy is in the tenth year of its expansion and slower job growth is not an unusual development.
The 130,000 jobs gain for August was below consensus and the more encouraging gain of 195,000 that was in the private sector ADP report on Thursday, but positive items in Friday’s report were:
A Busy Week
As the market was headed to lower rates a surprise announcement to resume trade talks next month gave it pause, sending rates higher and boosting equities which allowed the three major indexes to close higher by at least 1.5% on the week.
Taking advantage of global demand for quality assets the global, investment grade Corporate market saw what was described as a month’s worth of issuance in just three days - $140 billion, with $74 billion of that in the US. This was accomplished without any mega deals as the US activity represented 45 issuers who are utilizing this low rate environment to raise cash to prepay outstanding debt and extend their maturities, much the same as homeowners who are refinancing their mortgages.
And demand for quality assets benefitted the SBA 504 program, which sold $385,364,000 term debentures with very strong subscription levels that permitted pricing at spreads far tighter than comparable Agency CMBS. Below is a chart that shows the 20-year debenture being priced at 1.98%, second lowest in history, while the 25-year debenture was priced at 2.14%. Of particular note is the growth in the 25-year series which last week was 22% larger than the 20-year issue. Both issues provided historically low, ongoing effective rates for small business borrowers of 3.36% and 3.46%, respectively.
Signaling the start of the blackout period for Fed speak ahead of the September 17-18 meeting was Fed Chairman Jay Powell’s speech on Friday in Zurich. He emphasized his comments were personal and did not reflect FOMC opinion, but they did contain references to previous announcements. When asked about future rate increases, he adhered to the standard response that the Committee will “act as appropriate,” and not be influenced by political or trade issues which are not in their domain. He did mention though that trade policy is weighing on the economy as the US deals with low inflation, low growth, and low investment.
The Week Ahead
No Fed speak, $193 billion in Treasury auctions, closing date for September SBA 504 debentures, some inflation data, and then the consumer is heard from again.
Monday – Treasury sells $87 billion 13 and 26- week Bills
Tuesday – Treasury sells $28 billion 52-week Bills and $38 billion three-year Notes
Wednesday – Treasury sells $24 billion ten-year Notes, the 504 debentures fund, and PPI expected to be 0.2% and 2.2% y/y ex food & energy
Thursday – Treasury sells $16 billion thirty-year Bonds, and the ECB addresses monetary policy
Friday – Retail Sales expected to remain strong at 0.3% after a 0.7% gain in July
Au Revoir August!
Markets breathed a sigh relief that August ended quietly after an escalation of trade war rhetoric roiled markets for much of the month. For the week, Treasury rates were stable, and equities eked out a positive weekly close after China extended an olive branch regarding retaliatory tariffs. President Trump has frequently mentioned the Chinese want to talk, but this official statement was the first from them in advance of tariffs being implemented on Sunday by both sides, but trade talks remain unscheduled.
That soothed global stock markets, allowing them to stabilize and end the week with modest gains. Some consumer companies did stand out, like Target jumping 24%, Lowe’s 11% and Neville Brands, the maker of Sharpies, up 17%. For the month though, stock indexes were down almost 2%.
Demand for safe-haven assets continues, with sovereign debt trading at negative yields now totaling $17 trillion, and Japan accounts for almost half that figure and is responsible for the phrase Japanification, something that is more troubling to economies than a mere recession that inverted yield curves traditionally foreshadow. Analysts fear other economies could mimic Japan’s 30-year battle with slow growth, low inflation, and persistently low bond rates, so it is hoped that the remaining countries with positive yields maintain that status.
The two-year/ten-year Treasury curve has flirted with inversion in recent weeks but has now moved clearly negative, ending the week at -1.1 bps.
Speaking of changes, this WSJ chart shows the 114 bps decline this year in the ten-year Treasury rate, and 18 bps in August alone, as the SBA 504 program prepares to price its September debentures on Thursday. An indication of how much the market has anticipated future rate cuts is that 114 bps move occurred with one 25 bps reduction and has moved the 30-year bond below 2%, closing the week at 1.96%. What this means is the entire Treasury curve offers investors income that is below the 1.98% dividend yield on shares in the S&P 500 index.
Driving some of that demand for longer-term Treasuries could be increased prepayments in mortgage backed securities resulting from homeowners refinancing their mortgages that pay off those securities faster, forcing their holders to replace that income as quickly as possible.
In international news, Argentina announced it will look to restructure $101 billion of debt after “technically” defaulting on $7 billion of short-term securities, and a Chinese bank citing loan losses will skip a year’s worth of interest payments to international bond holders. It also reported that its non-performing loan ratio has reached 6.88%.
Last Week’s Reports
Durable Goods showed a strong +2.1% reading thanks to transportation orders, aircraft in particular.
2Q19 GDP showed a slight decline to 2.0% but with strong consumer spending keeping the number at consensus.
Personal Income was +0.1% and the Fed’s preferred, core inflation gauge was flat at +0.2% and 1.6% y/y.
Consumer sentiment report on Friday showed a dramatic drop from 92.1 to 89.8, its lowest reading in three years and a troubling indicator for an economy so dependent on consumer spending.
The Week Ahead
A light Treasury calendar; heavy Fed speak; some manufacturing reports; the SBA 504 program prices its 10, 20, and 25-year debentures; and the all-important jobs report.
Monday – Treasury auctions $87 billion of 13 and 26-week Bills
Thursday – Factory Orders expected to be up 1%; the SBA 504 program prices its September debentures
Friday – Non-Farm Payroll forecast to be slightly lower at 158,000; Fed Chairman Jay Powell speaks in Zurich on Economic Opportunity and Monetary Policy
One Crazy Day of Tariff Tirades
As much as Chairman Powell’s Friday speech was anticipated, and had pretty much frozen the markets in the run up to it, his comments that the Fed will continue to provide stimulus but warning that trade policy uncertainty is creating challenges, signaled that the market should not expect the deep interest rate cuts as requested by the President. Reaction was muted until President Trump took to Twitter to challenge the “weak Fed”, sending Treasury rates down, inverting the curve further, and plunging stock indexes which fell for the fourth consecutive week.
The President then directed American companies to start looking for alternatives to trading with China, prompting a US Chamber of Commerce executive to remind everyone the answer isn’t for American companies to ignore a country with 1.4 billion customers. In a retaliatory effort, President Xi announced a new 5% tariff on American oil imports after having started the day with an imposition of tariffs on $75 billion of American goods.
For good measure, after the markets closed, the President tweeted that he was escalating the trade war further, applying a 15% tariff on $300 billion worth of Chinese goods starting October 1 and raising the rate on $250 billion of imports to 30% from 25%.
The disconnect between reserved central bankers and foreign trade policy is global in nature, as Bank of England governor Mark Carney, another attendee at Jackson Hole, described the limited ability to use monetary policy to offset the damage expected from Britain’s possibly messy exit from the European Union.
So, we have the benchmark ten-year Treasury trading at its lowest end of day rate (1.52%) in three years and an escalating trade war that may not be as serious as the 2008 financial crisis, but is different in that central bank tools were better suited to address that crisis while there is little they can do in a trade war. One analyst noted that interest rate cuts to address trade policy issues is like giving pain relievers to someone with a broken bone - “better to have than not, but unable to solve the underlying problem.”
Earlier in the week the release of minutes from the July 31 FOMC meeting identified that rate cut as a “recalibration”, not the onset of an easing cycle so the market seemed prepared for Chairman Powell’s speech, but not for the President’s comments, and they will continue to be the driving force going forward.
The Week Ahead
Fed speak resumes, some housing data, the Fed’s preferred inflation gauge on Friday, and Treasury auctions $227 billion of debt.
Monday – Durable Goods expected to be 1.1%; Treasury sells $87 billion 13 and 26-week Bills
Tuesday – $40 billion two-year Treasury note sale
Wednesday – Treasury sells $18 billion two-year Floating Rate Notes and $41 billion five-year Notes
Thursday – Release of second estimate of 2Q19 GDP expected to be 2%, and $41 billion seven-year Notes are auctioned
Friday – Personal Income & Outlays core price index expected to be 0.2%, 1.5% y/y
The markets are expressing impatience for central bank policy as you can see in this Financial Times chart that shows the difference between where the Fed’s main rate of 2.10% is now after last month’s rate cut, and where traders expect it to be next year.
Now, the market anticipates multiple rate cuts going forward as we have seen equity prices lower for three straight weeks and the benchmark ten-year Treasury yield lower by 46 bps this month alone. The result has been an inversion in some sections of the yield curve, a negative real yield on the ten-year benchmark (1.56% less current inflation rate), and renewed fears that the inversion portends a recession sometime next year.
Two small caveats to that implication are: the emphasis that Treasury has placed on funding more debt in the front-end of the curve, creating more supply in short-term securities and less in the longer maturities that have been in demand; and, it seems longer ago, but in September 2012 DCPC 2012 20I was priced off the ten-year benchmark rate of 1.55% and it seemed rates were headed lower. The following Spring a “taper tantrum” led a U-turn in rates and in September 2013 that benchmark rate was 140 bps higher. That is not to suggest we near such a move now, only a reminder that the rates market appears ahead of itself and any improvement in trade negotiations could be a game changer.
Recent market performance illustrates the limits of central bank policy as low, even negative interest rates for a prolonged time have failed to strengthen the global economy, so they alone are not the answer. Resolution of trade disputes, expansive fiscal policies, and increased corporate investment are needed to reverse recent trends
The Week in Review
In a world where low inflation is a puzzle and $15 trillion of sovereign debt trades at negative yields, this may be the most confusing item to ponder – a Danish bank this week launched the world’s first negative rate mortgage, where a home buyer can pay back less than what they pay for their house.
The Week Ahead
A light calendar for Treasury and Fed speak, though Chairman Powell has a significant speech Friday at the Jackson Hole Economic Symposium. His timely topic is “Challenges for Monetary Policy.”
Monday – Treasury sells $87 billion 13 and 26-week Bills
Wednesday – Release of the FOMC minutes from the July 31 meeting
Thursday – Treasury auctions $7 billion of 30-year TIPS
Friday – Jay Powell speaks in Wyoming
A Sigh of Relief – For Now
Markets exhaled on Friday as stocks closed the week marginally down after some tumultuous sessions resulting from the heightened US-China trade tensions. This WSJ chart shows the dramatic drops before sustaining a recovery on Thursday when China’s central bank stabilized its currency by fixing its mid-point at a less aggressive level than had been expected. That diffused criticism that the country was manipulating its currency in retaliation to the recently expanded tariffs.
As stocks were being punished, Treasury securities rallied with the ten-year benchmark Note trading as low as 1.61% before the currency stabilization gave support to stocks and temporarily curtailed the safe-haven trade. Settling back to 1.726% on Thursday, the SBA 504 program was able to price its two debentures at 2.15% (20-years) and 2.31% (25-years) respectively. That is the lowest 20-year rate since September 2016 and produced an ongoing effective rate for small business borrowers of 3.53%, 172 bps lower than Prime Rate, while the 25-year effective rate was 3.63%, a difference of 162 bps. Both represent significant savings, even after the recent 25-bps rate cut and are dramatically cheaper than just one year ago when their effective rates were 30 and 35-bps above the Prime Rate, as shown in the chart below.
With regard to the August debenture rates, it should be noted that in a week of heightened turmoil and wider credit spreads, both issues were priced essentially at unchanged spreads from the previous month
Other developments last week were:
The Week Ahead
Some Fed speak with a light calendar for economic reports and Treasury debt.
Monday – Treasury auctions $84 billion thirteen- and twenty-six-week Bills
Tuesday – Treasury sells $28 billion fifty-two-week Bills; CPI ex food & energy expected to be 0.2%, 2.1% y/y
Wednesday – the SBA 504 program funds $310,591,000 from its August debenture sales
Thursday – Retail Sales expected to be 0.3% and Industrial Production forecast as 0.1%
Tariffs Trump Fed
Things were peaceful after the expected and first rate cut in eleven-years, with Treasury rates slightly improved and equities encouraged by the prospect of another cut later this year. And then they weren’t. On Thursday President Trump announced a 10% tariff on an additional $300 billion of Chinese goods, pushing investors back into government guaranteed debt as a safe-haven trade. The benchmark ten-year Treasury closed the week near its lowest level since 2016 and even the thirty-year German bund dipped into negative yield, with Germany joining Denmark and Switzerland as countries whose entire yield curve is negative, meaning if investors hold their debt to maturity, they will never receive their original investment in return. At 1.846%, this benchmark note is 23 bps lower than when the SBA 504 program priced its July debentures.
These proposed tariffs add to the existing 25% tariffs on $250 billion of Chinese imports and further dampen any hope for resolving trade tensions in the near future. Talks don’t resume until September and the President has already stated he believes the Chinese may wait until after next year’s election before resolving the issues.
Have the tariffs had an impact yet?
Add heightened concerns about a no-deal Brexit and weak growth in Europe as contributing factors to equities suffering their worst week this year. Major domestic exchanges in the US suffered declines ranging from 2.6% to 3.9% and will remain unsettled for a while. Ironically, in his comments after Wednesday’s announcement Chairman Powell identified “trade policy uncertainty being more elevated than we expected” as part of the reason for the Fed’s action. Additional reference to this cut not being the start of an easing cycle, perhaps a mini cycle, disappointed some analysts who hoped for a more assertive reference to future moves.
Lending support to the FOMC decision to cut rates was the Personal Income & Outlays inflation gauge showing a 0.2% gain in its core reading, and just 1.6% y/y, further below the Committee’s 2% target than before. Lost in Friday’s price action was a solid jobs report of 164,000 with the unemployment rate holding steady at 3.7% and with private sector average hourly wages rising to 3.2% y/y. This current US expansion became the longest on record in July but as 2Q19 GDP indicated, it is slowing down. Manufacturing output and business spending are in decline and those indicators, not so much the President’s criticism, possibly cautioned the Committee to make what some analysts call an “insurance cut.”
Small Business Job Growth
Though this Paychex Small Business Employment Watch chart reflects a tight labor market, showing a continued decline in its index, it reported increases in hourly earnings and weekly hours worked. The data is taken from 350,000 small business clients and reflects a 2.76% increase in hourly earnings.
The Week Ahead
Fed speak resumes, Treasury to auction $162 billion in debt, the SBA 504 program prices its 20 and 25-year debentures, and some economic data.
Monday – Treasury to sell $78 billion 13 and 26-week Bills; ISM non-manufacturing report expected to be stable
Tuesday – Treasury sells $38 billion three-year Notes
Wednesday – Treasury sells $27 billion ten-year Notes
Thursday – Treasury sells $19 billion thirty-year Bonds and the 504 program prices 2019 20H and 2019 25-H
Friday – PPI expected to be 0.2% and 2.4% y/y
Waiting for the Fed
Interest rates moved sideways in advance of Wednesday’s expected 25 bps rate cut by the Fed, for which the market assigns an 81% probability; and both the S&P 500 index and NASDAQ hit record highs with strong earnings reports.
At 2.07%, the ten-year benchmark Treasury is within 2 bps of where the last two debenture sales were priced, and analysts expect the effect of the cut is already priced into the market so language from the announcement and Chairman Powell’s press conference will be important. Rates had been lower earlier in the week but the ECB policy announcement disappointed, containing nothing meaningful, but with language that strongly suggested future moves could be taken.
With no Fed speak, headlines did the talking last week:
This category of non-residential fixed investment reflects spending on software, research and development, equipment and structures, and it is feared the decline represents the uncertainty crested by the trade tension with China. That tension may be extended as President Trump announced that China may wait until after next year’s election to finalize a deal. The President also challenged the World Trade Organization to compel certain countries – China, Mexico, Turkey, and Qatar to name a few, to drop their designation of “developing countries,” a description that permits them export subsidies and procedural advantages for WTO disputes.
Economic reports other than GDP showed Durable Goods rising 2.0%, but with May’s number revised down an additional 0.8% to -2.3%.
The Week Ahead
All eyes on Wednesday’s FOMC announcement, light Treasury issuance, and key inflation and jobs reports.
Monday – Treasury auctions $72 billion of 13 and 26-week Bills
Tuesday – Personal Income and Outlays contains the Fed’s preferred core inflation gauge, expected to be +0.2%, +1.7% y/y
Wednesday – FOMC announcement, followed by Chairman Powell’s press conference
Friday – Non-Farm Payroll expected to be 156,000
Marking Time Until FOMC Meeting
Equities ended the week lower, as were Treasury yields (CT-10 @ 2.06%), as every indication points to just a 25 bps rate cut from the Fed on July 31. Though up more than 1% for July, the three major domestic exchanges are torn between mixed corporate earnings reports and uncertainty over central bank policy.
And US markets are not alone, as the ECB meets shortly to shape its policy that is expected to result in a further reduction of its deposit rate to -0.50%. That rate compares to the US rate (Interest on Excess Reserves) of 2.35%.
Regarding that IOER rate, it is lower than what mutual funds charge to lend money overnight to bond brokers (2.47%) who use Treasury securities as collateral. This condition results from the increased supply of bonds in the overnight market, a reflection of increased Treasury funding needs.
The Week in Review
China did report 2Q19 GDP as 6.2%, its lowest rate in almost 30 years. A deeper slowdown was avoided by increased domestic consumption, something the government has promoted to offset decreased emphasis on its exports trade.
Sub-zero sovereign debt enabled Greece to sell 7-year bonds at 1.90%, more than 100 bps tighter in spread to German benchmarks than during a March sale. Such was the demand for it that $13 billion in orders were received for the $2.5 billion issue.
Retail Sales came in stronger at 0.4% than its 0.1% forecast.
Industrial Production was flat vs. a 0.1% consensus.
The Week Ahead
No Fed speak as part of its 2-week blackout ahead of the July 30-31 FOMC meeting, $205 billion in Treasury auctions, some housing data, and the first estimate of 2Q19 GDP. There will be meetings to reach an agreement on US government borrowing and spending limits.
Monday – Treasury auctions $72 billion 13 and 26-week Bills
Tuesday – Treasury auctions $40 billion 2-year Notes
Wednesday – Treasury auctions $20 Billion 2-year Floating Rate Notes and $41 billion 5-year Notes
Thursday – Durable Goods expected to recover to +0.7% from -1.3% last month; Treasury sells $32 billion 7-year Notes
Friday – 2Q19 GDP expected to be 1.9%, a decline reflecting reduced net exports
Chairman Powell Signals Rate Cut
In testimony before Congress, Jay Powell reiterated the Fed’s intention to “act as appropriate to sustain the expansion.” That confirmed market expectations for at least a 25 bps cut with the impact felt by shorter dated securities, steepening the 2/10 Treasury curve by 10 bps. It seems market sentiment now fully embraces the thought that it no longer is if the Fed will cut rates, but when and by how much.
The current range of Fed Funds rates is 2.25% - 2.50% (2.375% mid-point) and this Financial Times chart shows that financial futures contracts have already assumed a mid-point for future policy to be around 1.75% by January, meaning 50 bps in cuts is expected over time, and possibly more.
The best performers on the week were short-term Treasuries (which benefit most from a rate cut) and equities where the S&P 500 Index closed above 3,000 for the first time and the DJIA above 27,000, also for the first time. Major indexes are up 2.4% in July, adding to large gains in June, even as worries about the global economy remain.
July’s debenture rates for the SBA 504 program continue to reflect the change in Fed policy, producing impressive ongoing, effective cost of funds to small business borrowers.
Should you Fight the Fed?
Because falling rates are good for stocks it is easy to see why investors are bullish. Of concern is softening economic data, projections for lower GDP, unresolved trade disputes, and Brexit. If economic growth is slowing faster than Fed estimates, investors may want to reconsider which side of the fight to be on between the Fed and a possible recession.
The Week in Review
Both core CPI and PPI came in 0.1% higher than expected at 2.1% and 2.3% respectively, y/y. Globally, Singapore’s trade dependent economy contracted 3.4% in Q2 and China’s exports declined 1.3% in June, indicating the trade war is starting to have an impact. Additionally, imports fell 7.3%.
The Week Ahead
Fed speak, some economic data, and Treasury to sell $112 billion of debt
Monday – Treasury auctions $72 billion 13 and 26-week Bills; China announces 2Q19 GDP, expected to decline to 6.2%
Tuesday – Treasury sells $26 billion 52-week Bills
Wednesday – Retail Sales and Industrial Production are both projected to be 0.1%; 504 debenture sales fund
Thursday – Treasury sells $14 billion ten-year TIPS
On Course, Maybe a Bit Slower
A holiday shortened week saw robust trade activity change course after Friday’s stronger than expected jobs report. A gain of 224,000 with increased labor force participation was not forecast and pushed the benchmark ten-year Treasury yield back above 2% to close the week at 2.04%. The 9 bps move was the largest one-day increase in rate since January 4, and while the reason for it lessens optimism about Fed policy a dramatic further increase is unlikely unless the Fed reverses course again.
This Financial Times chart shows expectations of a 50 bps cut this month have now declined to a 11% probability while the chances of a smaller 25 bps cut have increased to 89% from 70%. Even with Friday’s selloff, the benchmark ten-year Note remains 6 bps lower than it was for last month’s 504 debenture sales.
Stocks maintained their parallel performance with bonds by slipping on Friday but registering weekly gains from 1.2% for the Dow to as much as 1.9% for NASDAQ.
Friday’s jobs report was strong throughout: +224,000 jobs, Participation Rate up 0.1% to 62.9%, and average hourly earnings +0.2%, +3.2% y/y. Through the first six-months average monthly gains are 172,000 vs. 223,000 for the previous year and it is that slowdown that the Fed is closely monitoring. The only other report of note last week was Institute of Supply Management showing at 51.7, slightly lower than the previous month but not as weak as forecast.
The Week Ahead
The SBA 504 program prices its 10, 20 and 25-year debentures, a lot of Fed speak with Minutes from the last meeting, some inflation data, and Treasury’s quarterly refunding.
Monday – Treasury auctions $72 billion 13 and 26-week Bills
Tuesday – Treasury sells $38 billion three-year Notes
Wednesday – Minutes of the June 19 FOMC meeting are released; Treasury sells $24 billion ten-year Notes
Thursday – CPI core expected to be 0.2%, 2% y/y; Treasury sells $16 billion thirty-year Bonds
Friday – PPI core expected to be 0.2%, 2.2% y/y
Trade Tension Reduced, a little
Last week saw the S&P 500 Index close its best first half year performance in 22-years and US stocks had their best June since 1955. After a meeting with President Xi of China, President Trump halted any increase on Chinese tariffs and relaxed the ban on American companies doing business with Huawei while China agreed to increase its purchase of farm products. A positive step for sure, but a final agreement is what markets seek.
It is not only stocks that have been robust:
So, the stage is set for the Fed at its meeting that ends the last day of this month, and the above YTD Stockcharts.com chart shows just how much this policy change is already in place.
Greater Fool Theory
According to Investopedia, “The greater fool theory states that it is possible to make money by buying securities, whether or not they are overvalued, by selling them for a profit at a later date. This is because there will always be someone (i.e. a bigger or greater fool) who is willing to pay a higher price.” Austria just sold €1 billion of 100-year bonds at a yield of 1.2%, so at least the yield is positive, even if not fully realized in an investor’s lifetime. Presently, there is $12.5 trillion of sovereign debt trading at negative yields, and as a Financial Times columnist points out “if you hold to maturity, there are no number of lifetimes in which you recoup your initial capital. You just lose less than you might elsewhere, which, conceivably is a kind of gain, depending on what happens to everyone else.”
Bank of England President Mark Carney identified what can happen to everyone else when he identified funds that “have pushed into a host of risky investments that are built on a lie,” and possess scant liquidity. In previous statements Mr. Carney estimated $30 trillion is at risk in this “Wall of Worry,” the result of investors seeking yield in a low interest rate environment.
Economic reports were again mixed; New Home Sales came in far below consensus with median price down 8.1% to $308,000 and the third estimate of 1Q19 GDP was unchanged at 3.1%, with retail consumer spending below forecast.
The Week Ahead
The holiday shortened week is light on Fed speak, Treasury and ACMBS supply, and reports.
Monday – Treasury to auction $72 billion in 13 and 26-week Bills; Institute of Supply Management expected to be down slightly
Thursday – Happy Independence Day!
Friday – Non-Farm Payroll forecast to be 165,000, recovering from the May report of 75,000. Unemployment to be unchanged at 3.6% and Average Hourly Gains to remain 3.2% y/y
Last week some new records were set in the global bond market. The primary catalyst was the formal shift to dovish stance by the US and European central banks. With few exceptions most global central banks are easing or leaning that way. The European Central Bank kicked things off with the indication on Tuesday that it was leaning towards easing. That was followed by the same message from the Fed on Wednesday. On Thursday, the benchmark 10-year Treasury yield broke below 2% before retracing a little bit. Yet equity markets rallied, presumably because with sharply lower global interest rates money will have to flow back towards equities in an effort to generate acceptable returns.
This week let’s take a look at non-US government bond yields since that’s where very interesting action has been in the global bond market. To start, the chart below shows selected 10-year government bond yields that are all trading below zero. As well, last week, for the first time French and Swedish 10-your benchmark yields fell below zero. In the German yield curve, everything is below zero from 19 years inward, and the benchmark 10-year Bund traded at a record-low yield of minus 33 bps. In the Japanese yield curve we have negative yields from 15 years inward.
The Italy 10-year government yield is only about 10 basis points above the US 10-year yield. Italy is in its usual political chaos, having (again) threatened to break its budget agreement with the EU. Italy’s deficit is 132% of GDP, highest next to Greece in the EU. Political chaos seems to be the normal situation for most major Western countries right now. That also helps push yields so low that investors in many major government bond markets, like Germany and Japan, are willing to accept a loss on their money in the interest of maintaining liquidity.
The next chart shows that last week a new record $12 .5 trillion of global bond yields were below zero, 22% of the entire global bond market (including investment- and below-investment-grade debt). The $57 trillion Barclays Multiverse index yield, which includes all of those negative-yielding government bonds, is just 1.7%, 30 basis points above the record low set in 2016.
If as a result of this you ask yourself how equities can be rallying in the face of negative yields, with central banks leaning towards easing because of weaker economic data on a global basis, then you are with the many other investors with a fundamental bent, and probably on the sidelines. But the impact of central banks in the post-crisis era on market liquidity is difficult to overstate, and when the yields on more liquid assets fall sufficiently, investors react by moving into riskier asset classes. And that could fuel the risk-on rally for a while. A surprisingly strong US employment report for June, though, could calm the party, at least for a while. But we will have to wait a few weeks for that possibility.
This week markets will remain focused on the fluid situation with Iran, any news on upcoming trade talks, and whether the various market rallies will stall out or resume. The economic data is not top tier. On Tuesday the Case/Shiller housing indices, residential home sales and consumer confidence will be released. Durable goods and the EIA petroleum reports will come out Wednesday and the last revision of Q1 GDP will hit screens on Thursday.
Add Iran and India to China Dialogue
Stocks managed to end the week with marginal gains after weathering a mid-week slump due to rising tensions in the Middle East. As a result, US Treasuries reversed course and the ten-year benchmark closed unchanged on the week, benefitting from a risk-off mindset for investors
Treasuries seemed headed to seek their next level of support ahead of this week’s FOMC meeting before that safe-haven trade asserted itself. It is unlikely that a rate cut could result from this meeting and strong economic reports on Friday may guide the Committee to exercise more patience while carefully phrasing their statement and rate forecasts. It seems that right now the markets are more in need of a rate cut than is the economy.
Inflation poses little threat with both CPI and PPI coming in as expected; Core PPI was 0.2% (2.3% y/y) and core CPI was 0.1% (2% y/y). The Fed’s preferred gauge, PCS, is at 1.6%, far below its 2% target.
Iran was identified by the Administration as being responsible for the attack on two oil tankers in the Strait of Hormuz, escalating an already tense relationship while increasing fear in the region along with insurance costs. Ironically, the price of oil showed only a small gain after an initial surge and its recent weakness reflects the lack of demand resulting from the US-China trade dispute.
India now has joined the trade wars by retaliating for its loss of preferential trade status with the US by hiking tariffs on its goods
Other news items reflect the good news/bad news that seems to be so perplexing to market analysts:
The Week Ahead
Some housing data, $113 billion in Treasury debt, and no Fed speak until Wednesday’s FOMC announcement, with their forecasts and a Jay Powell press conference
Monday – ECB begins a three-day forum; Treasury auctions $72 billion 13- and 26-week Bills
Tuesday – Treasury sells $26 billion 52-week Bills
Wednesday – FOMC announcement with forecast, and a press conference
Thursday – Treasury auctions $15 billion 5-year TIPS
Weak Jobs Report Caps a Strong Week for Equities and Bonds
In a week that saw domestic equities find buyers and the DJIA rally 4.7%, Treasury debt also rallied as both markets benefited from comments by Jay Powell that the Fed is considering cutting rates. Such a sentiment was reinforced by ECB President Mario Draghi who said the bank expects to keep rates on hold until mid-2020, which means a refinance rate of Zero and a deposit rate of -0.40%. Additionally, the ECB is even more challenged with inflation than the Fed, as the Eurozone rate rests at 1.2%.
The possibility of a rate cut at the FOMC’s June 19 meeting is about 20% and a 70% chance of at least one cut by the meeting after that, on July 30-31. The effect of this on bonds was felt most sharply in the front end of the curve, as seen in Friday’s steep decline in Treasury’s two-year Note.
For the week, the 2/10 Treasury yield curve steepened from +15.7 bps to +23.4 bps but still helped the SBA 504 program price its monthly debentures at rates significantly lower than in May. At 2.60%, 2019-20F is 28 bps lower than last month and 100 bps lower than in June 2018. 2019-25F is 30 bps lower m/m and 91 bps lower than the inaugural 25 year offering in July 2018.
This chart displays the dramatic performance in the rates market and the emphatic value of 504 loans as measured by the ongoing Effective Rate to small business borrowers.
This cheapness to Prime Rate will change with any rate cut but even with that, 2019-25F’s ongoing effective rate of 4.09% (Prime -141 bps) will remain quite cheap by comparison.
Late on Friday President Trump “indefinitely suspended” the planned tariffs on Mexican goods that were to take effect this week. Enhanced security concerning immigrants and Mexican care of asylum seekers are part of the agreement which both parties hope to finalize within the next 90 days. As such, market reaction will determine if it is viewed as a temporary settlement or more permanent, though some op-ed columnists believe this simply affirms prior agreements.
The Week Ahead
No Fed speak during the blackout period ahead of the June 18-19 FOMC meeting; Treasury to auction $150 billion in debt, and some economic reports.
Monday – Treasury auctions $72 billion 13- and 26-week Bills
Tuesday – Producer Price Index expected to be +0.2%; and Treasury sells $38 billion three-year Notes
Wednesday – Consumer Price Index consensus is +0.2%; and Treasury sells $24 billion ten-year Notes
Thursday – Treasury sells $16 billion thirty-year Bonds
Friday – Retail Sales expected to rebound to +0.7% from -0.5% in April; and Industrial Production also expected to rebound to +0.2% from -0.5% in April
Increased Tariffs Batter Stocks and Rally Treasuries
Trade tension between the US and China continues, as do recent trends in the markets. Investors seek safety and that has propelled the benchmark US Treasury ten-year Note to end the week at a 20-month low of 2.13%. As the SBA 504 program prepares to price its June debentures this week, the benchmark is 29 bps lower than it was for the May sale and 16 bps lower than it was before the Fed raised short-term rate 225 bps beginning in December 2015.
So, the thought of additional rate hikes is gone, and the market is now anticipating at least one rate cut by the Fed before year-end. The January Fed Funds contract implies a rate around 1.92%, and with Fed Funds currently at 2.38% a reduction of 50 bps seems built into expectations. That prospect has again inverted the 3 month/10-year Treasury curve -21 bps, and while such a condition is identified as a predictor of recession, it is a long-range indicator and with lower yields now expected a lower cost of borrowing could help equities. Then again, there could be a recession as soon as nine months, according to Morgan Stanley’s Chetan Ahya, if another $300 billion of Chinese goods see a 25% tariff and China retaliates in kind. Friday’s move in Treasuries also reduced the rate on US two and five-year Notes below 2% and saw German ten-year Bunds trade at -0.21%.
“Sell in May and go away” is an old saw for stocks and it held true as the S&P 500 index had its worst month in seven years and second worst since the 1960’s. For the month it was down 6.6% and dip buyers are not to be found, yet.
Adding to the anguish in stock markets was the President’s Thursday night announcement of a tariff on Mexican imports, starting at 5% this month and increasing to as high as 25% in October if action is not taken to relieve the border crisis. This adds another level of complexity to the use of tariffs and creates concern over future measures. The announcement’s impact was a continuance of the sharp drop in Treasury yields as seen in the above chart, and another down day for stocks in a month that has had many of them. Major indexes declined 1% on the day and all were down 6.5% or more for the month.
The question might be asked – at what point do the increased costs resulting from tariffs get passed on to consumers, and increase inflation? Producer prices have consistently outpaced consumer prices as producers have opted to absorb much of that expense, but that cannot last forever.
Economic reports came in as forecast and offered some stability until Thursday night:
The Week Ahead
Fed speak, light Treasury issuance, the jobs report, and the 504 program’s sale of 20 and 25-year debentures in an Agency CMBS market that will see heavy supply from Fannie Mae and Freddie Mac.
Monday – Treasury sells $72 billion 13 and 26-week Bills; President Trump begins a five-day visit to the UK
Tuesday – Factory Orders expected to be +1.5%
Thursday – SBA 504 program prices its June debenture sales, and the 75th anniversary of the D-Day invasion
Friday – Non-Farm Payroll expected to be +180,000 after an April increase of 263,000
More of the Same
Trade tension continues to send both interest rates and stocks lower. On Thursday, after more headlines on trade tariffs and a weak European purchasing managers’ report, the benchmark ten-year note traded at its lowest level (2.29%) since October 2017, before easing back at the end of the week. At 2.33% this benchmark is just 4 bps higher than it was the day before the Fed began its recent cycle of interest rate increases in December 2015. Nine rate hikes totaling 225 bps have been erased as minutes from the Committee’s May 1 meeting stated they may leave rates unchanged for the rest of the year. Weak export reports from Asia and a reduced growth forecast in Europe find the ten-year German bund back in negative territory at -0.12%.
There is reduced confidence that a US-China trade agreement can be reached and falling expectations for inflation have helped spur this Risk Off trade that is hurting equities. The one economic report of significance last week, Durable Goods, showed an as expected decline of 2.1% as manufacturing continues to slump, leading the DJIA to fall for the fifth consecutive week. That is its longest streak since 2011, leaving it at -3.5% for the month. Its counterpart in China, the Shanghai composite Index, is now down 17% for the month.
Contributing to equity weakness was the US Purchasing Managers Index that continued its downward trend, coming in far below consensus forecast. This WSJ chart shows it at a 9-year low due to trade war worries, further strengthening the safe-haven Treasury rally and forcing Agency CMBS slightly wider.
The Brexit vote that Theresa May did not support but whose mandate she tried to implement is finally forcing her out as Prime Minister. Three years after its vote the event almost seems inconsequential, but she will be succeeded by a hard-liner whose advocacy for Britain could be disruptive for the European Union, Ireland in particular.
The Week Ahead
$203 billion in Treasury auctions, light Fed speak, and PCE, the Fed’s preferred inflation indicator on Friday.
Tuesday – $72 billion in 13 and 26-week Bills, $40 billion in 2-year Notes, and $41 billion in 5-year Note
Wednesday – $18 billion in 2-year Floating Rate Notes, and $32 billion 7-year Notes
Thursday – Second estimate of 1Q19 GDP expected to drop to 3.0%
Friday – Personal Income & Outlays: Personal Income expected to be 0.3%, and Core Personal Consumption Expenditures expected to 1.6% y/y, remaining below the Fed’s 2.0% target
Investors continue to pile into US Treasuries because of trade tension fears that may lead to an economic slowdown. The ten-year benchmark yield ended the week at its lowest weekly close in two-months while analysts now assign a 77% probability of a rate cut this year. Additionally, Fed officials expressed concern over low inflation, and one, Philadelphia bank President Patrick Harker, stated he did not see the need for any rush to raise rates, reversing previous comments he had made. This market strength continues even with China having been a net seller of $20 billion of US Treasury debt in March. Usually that type of trade is done to support its currency (sell US$, buy Renminbi), but the Renminbi has been static, not in need of support, and ten-year Treasuries have declined 31 bps since the beginning of March.
A cautionary article in the Financial Times identified the concern of some people that China might use its significant US Treasury holdings as a tool in trade negotiations. While that $1.1 trillion amount is substantial its utility as a bargaining tool was discounted as any large scale sale of that debt would create global financial instability in an already uncertain environment.
Equities performed well mid-week, but soft economic data and trade concerns drove some indexes to their fourth consecutive weekly loss, and China announced reciprocal tariffs on $60 billion of US good in response to President Trump raising the tariff on $200 billion of Chinese goods to 25%. For now, the impact of these tariffs is affecting Chinese investors more severely – since April 19th the Shanghai Composite Index has declined 12.4% vs. a 1.6% decline in the S&P 500 Index.
Additional items that contributed to the weakness in stocks were:
The Week Ahead
Heavy Fed speak with a light economic calendar and just $109 billion of Treasury auctions.
Monday – Treasury auctions $72 billion of 13 and 26 week Bills
Tuesday – Treasury sells $26 billion of 52 week Bills
Wednesday – Minutes of the FOMC meeting ended May 1 are released
Thursday – Treasury sells $411 billion of ten-year TIPS (Treasury Inflation Protected Securities)
Friday – Durable Goods report expected to be -2.0%
President Trump shook up the financial markets last week with first the threat of, and then the imposition of, a new round of trade tariffs on China, at a time when the Chinese trade delegation traveled to Washington DC to finalize a trade agreement. Of course, the talks stalled. While stocks fell over 2% on the week, one might consider this a mild response compared to the way the markets reacted earlier in Trump’s term to similar situations. Treasury yields fell, the benchmark 10-year note yield declined eight basis points on the week to 2.45%. Credit spreads held through the middle of the week but started to widen as equity volatility levels remained elevated and prices down into the weekend.
Way Sub-Prime. Sub-Prime is not a bad word when used in the context of the SBA 504 program. Last Wednesday interest rates were set on the monthly SBA 504 debenture offering. The resulting effective rate for the 20-year maturity was 4.27%, the lowest since October 2016. That effective rate was 123 basis points below the Bank Prime Rate. A chart showing these interest rates since 2004 is below. The last time the 504 effective rate was this far sub-Prime was in September 2007, well over a decade ago.
We are now six months into this new cycle of sub-Prime SBA 504 effective rates. With the Fed expected to be on the sidelines for quite some time, the wide gap between the effective rate and the Prime rate should persist. The prior cycle lasted 32 months (we are not predicting that the current cycle will last that long). With the Fed on the sidelines, inflation expectations low, and the economy doing reasonably well, it is a great time for 504 fixed-rate funding.
The Week Ahead – Mainly second-tier economic data, a lot of Fed speak.
Monday – Three Fed speakers – Kashkari, Clarida, Rosengren
Tuesday – Three Fed speakers – Williams, George, Daly plus NFIB small business survey, import prices
Wednesday – Retail sales, industrial production, inventories, NAHB builders indices, SBA 504 funds
Thursday – Housing starts, Philly Fed index, two Fed speakers – Kashkari and Brainard
Friday – Consumer sentiment, leading indicators
Lowest Rate in Nearly Half a Century
With a jobs gain of 263,000 the report was positive for the 103rd consecutive month and the Unemployment Rate declined to 3.6%, matching a number last seen five months after Apollo 11’s moon landing. Additionally, the previous two months’ reports were revised upward, and average hourly earnings rose 3.2% from a year earlier. Since the US has more job openings than unemployed people it is considered to be at “full employment,” yet this strong economic data seems to have little impact on inflation, something that was alluded to in Chairman Powell’s comments after the FOMC meeting concluded on Wednesday with no change in policy.
In addition to leaving the Fed’s target rate for Federal funds at 2.25-2.50%, the Committee reduced its rate for IOER (Interest on Excess Reserves) from 2.40% to 2.35%. This does not change their monetary policy but does seem to reflect their previously discussed patient approach to increasing interest rates by lowering its rate on bank deposits.
Move the Goalpost?
It is perplexing for the Committee, as well as all economists, why such strong economic data is having little impact on inflation, persistently tracking below the Fed’s 2% target rate. In his comments Mr. Powell noted the Fed does not see a strong case to move rates higher or lower and that its forecasts on inflation generally miss on the downside, creating a risk that “over time inflation expectations could be pulled down.” This WSJ chart offers some alternative measures to the 1.6% core rate for the Fed’s preferred gauge of Personal Consumption Expenditures should the Fed either lower its target or change the measure that it follows. Last Monday’s release for this report included a 0.9% increase in consumer spending, well above consensus and another perplexing element to why inflation is so tame.
At week’s end equities were strong and Treasuries a bit soft, but all that changed when President Trump tweeted that he was dissatisfied with Chinese trade talks and intended to impose a 25% tariff this Friday. Ahead of today’s open equities are off sharply and the benchmark ten-year note has returned to where it was when the April debentures were priced – 2.48%. Headline news will dominate activity this week.
The Week Ahead
Light on economic data, a lot of Fed speak, some Treasury and ACMBS supply, plus the SBA 504 program prices its 10, 20 and 25-year May debentures.
Monday – Treasury sells $75 billion 13 and 26-week Bills
Tuesday – Treasury sells $38 billion three-year Notes
Wednesday – Treasury sells $27 billion ten-year Notes
Thursday – the SBA 504 program prices its May debentures and Treasury sells $19 billion thirty-year Bonds
1Q2019 growth came in at an annualized rate of 3.2%, far above expectations and overcoming fears that the 35-day government shutdown would have caused a slump. Ironically, the report had a reverse effect on markets as equities were basically unchanged and US Treasuries rallied. The reason for that was identified as the core price index report of 1.3% being weaker than the consensus forecast. That type of weak inflationary data substantiates the recent reversal in Fed policy that has helped the S&P 500 index gain 17% YTD and hold at its record high.
Since there is always a caveat to an economic report, the GDP cautionary note was its growth resulted from trade and increased inventories, two categories that are expected to reverse in future quarters. Trade improved because exports exceeded imports and it is felt that occurred because firms boosted imports in 2018 in anticipation of an increase in trade tariffs that did not occur. Also, consumer spending which makes up two thirds of the economy rose just 1.2% in the first quarter, down from 2.5% in the fourth quarter.
Other economic reports showed Existing Home sales declined, New Home Sales rose, and Durable Goods came in far above forecast at 2.7%.
Things You Don’t Hear About Anymore
The first two items are unlikely to get much air time anytime soon and while number three may return, its brief appearance a few weeks ago was temporary and its reliability as a recessionary forecaster may be in doubt. Benchmark Treasury rates are range bound, in sync with a patient Fed and with a market that assigns a 66% probability of a rate cut this year, it’s possible short-term rates could decline faster. Helped by Friday’s weak inflation data the ten-year Treasury benchmark yield moved lower on the week, closing just 4 bps higher than when the 504 program priced its April debentures.
The Week Ahead
A light Treasury calendar, some Agency CMBS issuance, and an FOMC meeting and announcement.
Monday – Treasury sells $75 billion 13 and 26 week Bills; Personal Income & Outlays, including the Fed’s preferred PCE inflation gauge, expected to remain below target
Tuesday – FOMC meeting begins
Wednesday – The meeting concludes with an announcement that likely will keep policy unchanged, and a press conference
Friday – Non-Farm Payroll is expected to be 180,000 with average hourly earnings increasing .01% to 3.3% Y/Y
Unchanged, in Light Trading
Markets ended the holiday shortened week where they started. Stock indexes were flat, and the ten-year Treasury benchmark remained at 2.56%, up 7 bps from when the SBA 504 program priced its April debentures two weeks ago.
Recent reports of unified central bank policy supporting economic growth amidst downward revisions to forecasts indicate interest rates may remain in current ranges for an extended period. It has been noted recently that foreign buyers have accounted for fewer purchases of US Treasury debt even though ten-year Treasuries are 253 bps cheaper than comparable German debt, the European benchmark. One reason for this lack of demand is currency risk should the buyers not hedge their investment. Leaving the purchase unhedged against currency fluctuations would reap that additional yield but if $US should weaken vs. the Euro or Yen, then that additional income is lost.
This Financial Times chart shows how the currency hedging cost of buying US ten-year debt results in that 2.56% yield turning to -0.50% for European investors, and for Japanese buyers it is only slightly improved at -0.30%. The FT article does identify firms who are willing to take the risk, noting that Nippon Life has made recent purchases unhedged and expects to add even more in the coming year.
The risk of this is not confined only to the investor as a weakening $US could spur unhedged investors to sell, further weakening the $ and possibly promoting more selling in a vulnerable bond market.
The Week in Review
Reports last week were again mixed, with Industrial Production at -0.1% vs. a forecast of 0.3%; and Retail Sales was 1.6%, exceeding even an optimistic 0.8% forecast; Housing Starts and Permits were both weaker than forecast.
One other report was that the Administration might withdraw the names of two recent nominees to the Federal Reserve Bank’s Board of Governors. Criticism of their selection was very strong as even Republicans believed their focus was too strongly political.
The Week Ahead
$237 billion of Treasury debt, a light economic calendar with housing data, and no Fed speak in advance of the April 30 FOMC meeting.
Monday – Treasury auctions $78 billion 13 and 26 week Bills
Tuesday – Treasury auctions $26 billion 52 week Bills, and $40 billion 2 year Notes
Wednesday – Treasury auctions $20 billion 2 year Floating Rate Notes and $41 billion 5 year Notes
Thursday – Treasury auctions $32 billion 7 year Notes
Friday – 1st estimate of 1Q19 GDP expected to be 2.0% vs. 2.2% in 4Q18
SBA 504 Loan Performance
In a week that saw continued strength in equities and a late spike in Treasury rates, it is important to note how the 504 loan program is delivering fixed rate funding for small business borrowers at rates significantly below the Prime Rate.
On Thursday the 504 program priced its 20 and 25 year debentures at rates that continue to decline and more importantly, at ongoing effective rates that are dramatically lower than banks’ base lending rate. Of particular interest is that 46% of the $360,347,000 total that was funded was in the program’s relatively new 25-year maturity. The growth in demand for this maturity has steadily risen since its introduction in July 2018, and now totals 940 loans for $786,957,000
The week in Review
Economic reports were weaker than forecast with core CPI coming in at 0.1%, and Factory Orders at -0.5%, with a slight downward revision to January. Core PPI was about as expected at 0.3% but was 0.6% when including energy prices, its biggest increase since October.
This WSJ chart shows that late spike in benchmark rates which fortunately came the day after the 504 program priced its debenture sales, when CT-10 was trading at 2.493%. A reason given for the selloff was a large March increase in Chinese loan activity that can be interpreted as expanding their economy; a simpler reason might be the market was overbought.
The Week Ahead
A light calendar for Treasury debt, Fed speak, and economic reports.
Monday – Treasury auctions $78 billion 13 and 26-week Bills
Tuesday – Industrial Production expected to be 0.1%
Wednesday – SBAP 2019-20D and 25D are funded
Thursday – Retail Sales forecast to be -0.2%; Treasury auctions $15 billion 5-year TIPS (Treasury Inflation Protected Securities)
Friday – Housing Starts expected to be 1.16M
In a week that saw the S&P 500 index rise for the seventh straight day (+3.1%), Treasury yields rose 10 bps from the ten-year Note’s overbought level, but still sits 16 bps lower (2.49%) than when the 504 program priced its March debentures. Trading volumes in both markets are reduced as investors continue to be concerned about the usual suspects – trade tension with China, Britain’s unresolved exit from the European Union, and inconsistent global strength. It is that last item that is captured in the chart below, a tracking index created by the Brookings Institute and the Financial Times. This tracking index compares indicators of real activity, financial markets and investor confidence with their historical averages for the global economy and individual countries.
The report identifies a “synchronized slowdown” and states that although sentiment remains high in advanced economies it is plummeting in emerging markets, led by fears that a slowdown in China will lead to more weakness. Other points of concern are:
The topic of Quantitative Easing has become part of President Trump’s critique of Federal Reserve Bank policy, including more QE with his repeated request for the bank to lower interest rates. To further such policy, he signaled an intention to appoint two supporters, Stephen Moore and Herman Cain, to the Board of Governors.
The Week in Review
The Week Ahead
A lot of Fed speak, especially Chairman Powell speaking at a Democratic caucus over three days late in the week; Treasury to sell $156 billion of debt, some inflation numbers, and the SBA 504 program sells 20 and 25-year debentures.
Monday – Treasury sells $78 billion in 13 and 26-week Bills; Factory Orders expected to be -0.5%
Tuesday – Treasury auctions $38 billion 3-year Notes
Wednesday – Core CPI expected to be 0.2%, 2.2% y/y; Treasury sells $24 billion 10-year Notes; minutes of the March 30 FOMC meeting are released
Thursday – Core PPI forecast to be 0.2%, 2.5% y/y; Treasury sells $16 billion 30-year Bonds; SBA 504 program prices its April 20 and 25-year debentures
Friday – Chairman Powell concludes his comments
Lower for LongerSovereign debt continues to rally as central banks capitulate to the reality of softer than expected global growth, the ongoing concerns over trade tariffs, and the uncertainty surrounding Britain’s exit from the European Union.
Patient Fed, and Then Anxiety!
Any thought that Wednesday’s FOMC annuncements would be the focal point of the week was erased by a much weaker than expected German Purchasing Managers report on Friday that caused the biggest one-day drop in US equities since January. It also rallied the ten-year Treasury to close at 2.44%, virtually unchanged from its January 2018 level. What is significant about that timeline is that the Fed had raised interest rates by 100 bps since then, yet now this benchmark rate is unchanged. Additionally, this has resulted in a yield curve inversion, where long-term rates fall below short-term rates; an event that has signalled every recession over the last 60 years. This NY Times chart shows the trend of this inversion whose development caused equities to turn negative for the week, with the NASDAQ index off as much as 2.5% on Friday alone. Such concern is global, only heightened by ongoing trade tensions, low inflation, and uniformly weak economic reports. Whether or not long-term rates continue to decline and enhance the inversion will determine the likelihood of a recession and its obvious impact on Fed policy. A pause may occur this week as Treasury auctions $244 billion in dedt and there could be a pullback.
Earlier in the week the FOMC announcement spurred a relief rally in both stocks and bonds as the Fed update focused on the word no, as in:
The patient approach to further rate increases has given way to a more dovish stance as possible rate hikes in 2019 were removed from the Committee’s forecast, and just one is expected for 2020, though some analysts now predict a possible rate cut. The cap on reinvestments of interest payments and matured debt in their portfolio will be lifted in stages, with no cap on reinvestments as of September. The Committee does intend to allow its holdings of Mortgage Backed Securities to decline with the objective of holding primarily US Treasuries in the longer run. This statement drove the initial improvement in Treasury prices this week and Friday’s weak reports from Europe extended their gains in anticipation of large buyer reentering the market.
Specific forecasts from the Fed reflect their concern about the health of the economy, with economic growth and the cost of money being lowered, while Unemployment is expected to rise.
The only category that remains unchanged is the stubborn inflation gauge that has yet to reach its 2.0% objective, and that report is due this week.
The Week Ahead
Fed speak resumes, Treasury to auction $244 billion in debt, a light economic calendar, and Brexit continues to unravel, endangering Theresa May’s leadership as support grows for a second referendum.
Monday – Treasury auctions $87 billion 13 and 16-week Bills
Tuesday – Housing Starts expected to be flat; Treasury auctions $26 billion 52-week Bills and $40 billion two-year Notes
Wednesday – Treasury auctions $41 billion five-year Notes and $18 billion two-year FRN’s
Thursday – 4Q2018 GDP expected to be revised down to 2.2% from 2.6%; Treasury auctions $32 billion seven-year Notes
Friday – Personal Consumption Expenditure expected to maintain a core rate of 0.2%, 1.9% y/y; Personal Income forecast to be 0.3% after a -0.1% report last month
Weak Data = US Treasury Strength
After processing lower than consensus inflation numbers earlier in the week, the safe-haven trade gained momentum on Friday when Industrial Production came in at 0.1%, far below the expected 0.4% increase. That pushed the ten-year benchmark yield through its 2.61% resistance level, allowing it to close at its lowest yield since January 3, and significantly lower than its 3.25% rate last November.
The usual suspects of weakening global growth, low inflation, and trade tensions continue to drive market performance, and expectations for any rate increases this year continue to wane. Helping this performance in US Treasuries was good demand for its recent debt sales.
Ironically, the economic weakness that is identified as creating demand for Treasury debt did not affect demand for domestic equities as the tech heavy NASDAQ gained 3.8% on the week. This performance seems to reflect confidence that the Federal Reserve Bank will be more than patient and actually look to support growth by cutting rates. On Thursday, analysts at JP Morgan announced they expect no increases this year, and Fed Funds futures contracts now assign a 26% probability of a rate cut.
As always, market participants will be paying close attention to the FOMC announcements on Wednesday, especially their forecasts and Chairman Powell’s press conference.
The Long Goodbye
The anticipated March 29 deadline for final terms of the UK’s exit from the European Union has been delayed; revised date to be determined. Parliament has voted twice to reject Theresa May’s negotiated terms and now they will wait for her to get EU approval for a new date.
The Week Ahead
FOMC announcement on Wednesday is the primary Fed speak, Treasury calendar is light, as are economic reports.
Monday – Treasury auctions $87 billion in 13 and 26-week Bills, and $11 billion in ten-year Treasury Inflation Protected Securities (TIPS)
Tuesday – FOMC meeting begins
Wednesday – FOMC announcement, forecasts, and press conference
Thursday – Leading Indicators expected to be 0.1%
Friday – Both Purchasing Managers Index and Existing Home Sales forecast to show slight declines
Odd Jobs Report
A gain of just 20,000 jobs in February added to earlier reports that contributed to equity weakness and lower interest rates in capital markets. Friday’s jobs report was the weakest since September 2017 and reflects possible fallout form the 35-day government shutdown. There were positive signs however, with the Unemployment Rate falling to 3.8% and average hourly earnings increasing 0.4%, 3.4% y/y, for its best performance since 2009.
In comments later in the day, Fed Chairman Powell removed any lingering uncertainty about how patient the bank intended to be. He cited the usual suspects – restrained price pressure, a strong labor market and slower global growth – as reasons for why there is no need to change its paused interest rate policy now.
Friday’s negative performance for equities extended their poor week as domestic indexes declined 2.5% and global indexes like the Shanghai Composite dropped as much as 4.4% on Friday alone. That weakness was triggered by a report that Chinese exports dropped 20.7% in February, while imports fell 5.2%, also a bigger decline than forecast.
Earlier in the week the shutdown delayed report from the Commerce Department identified 2018 to be the largest ever merchandise trade deficit at $891.2 billion, with $419 billion of that representing trade with China alone. The failure to resolve trade negotiations continues to erode investor confidence while continuing to promote safe-haven trades.
The white towel seen wafting over the European Union was the European Central Bank’s surrender, admitting that it would keep its deposit rate at -0.40%, as it will continue to reinvest proceeds from its QE portfolio and resume auctions of collateral at low interest rates to promote growth. This U-turn, coupled with its downward revision for growth to 1.1%, will make it very difficult to end its dovish policy by year-end, as it had hoped.
Benefitting from this vacuum that Treasury rates have been locked in, the SBA 504 program continues to fund fixed-rate, long-term small business loans cheap to the Prime Rate. 2019-20C and 2019-25C in particular, represent 20 and 25-year loans that are funding more than 75bps below Prime.
The Week Ahead
No Fed speak as we enter the blackout period ahead of the March 19-20 FOMC meeting, Treasury to auction $165 billion in debt, and some inflation and manufacturing reports.
Monday – Treasury sells $87 billion 13 and 26-week Bills and $38 billion 3-year Notes
Tuesday – CPI expected to be 0.2%, 2.2% y/y, Treasury sells $24 billion 10-year Notes
Wednesday – Durable Goods forecast to be -0.8% after a 1.2% gain in December; PPI consensus is 0.2%; Treasury sells $16 billion 10-year Notes
Friday – Industrial Production expected to be 0.4%
Slower, but Not Slow
The economy slowed in 4Q2018 to 2.6% from a robust 3.4% the previous quarter, but still finished the year with growth at 2.9%.
The decline can be attributed to the mid-year surge resulting from the 2017 tax cuts and increased government spending. With the positive effects of those measures fading, the Federal Reserve Bank forecasts 2019 growth to be even lower, at 2.3%. Such a forecast, coupled with overall global concerns, reflects the patient approach to interest rate hikes that Jerome Powell reinforced during his Congressional testimony last week.
The new year has started with reports of slowing growth as measured by declines in both the Purchasing Managers Index and the Institute of Supply Management Manufacturing Index. Personal Income declined 0.1% and the core Personal Consumption Expenditure inflation gauge was 0.2%, 1.9% y/y.
Market performance ranged from equities being flat on the week while the rates market saw a 9 bps increase in the ten-year benchmark, as seen in this 5-day WSJ chart. At 2.75% the benchmark is at its highest level in five-weeks and 8bps above where the 504 program priced its February debentures.
The Week Ahead
At $22 trillion the government has reached the limit that it can spend to fund operations. An increase in the debt ceiling is needed as Treasury employs extraordinary measures to conserve cash and make payments to bond holders, federal benefit recipients and others. Scheduled issuance for the week is limited to $87 billion 13 and 26-week Bills; the SBA 504 program will sell 10, 20 and 25 year debentures, some Fed speak, and the February jobs report.
Monday – Treasury sells 13 and 26-week Bills
Tuesday – New Home Sales
Thursday – 504 program prices its March debentures
Friday – Housing Starts, and Non-Farm Payroll expected to be 178,000, with average hourly earnings +0.3%
The Week in Review
Deal or No Deal?
As of now, there is no deal on US-China trade negotiations, but persistent reports of progress continue to provide hope to the equity markets, even after being rocked by a $15 billion impairment announced last week by Kraft Heinz Co., driving down its stock price by 27%. Indicative of overall investor confidence is the YTD performance of the S&P 500 index, which is +11%.
All three US indexes gained at least 0.5% on the week, helped not only by a less aggressive monetary policy from the Fed, but also in anticipation that trade negotiators can achieve an agreement to avoid increased trade tariffs. A March 1 date for implementation of the tariffs has been extended, and while that is helpful, a final agreement would best serve all parties. The effect on Treasury rates has been minimal as the benchmark ten-year Note was unchanged on the week, closing at 2.66%, virtually unchanged from when the SBA 504 program priced this month’s debentures on February 7, and down 8 bps from the January debenture sales.
The European Central Bank’s deposit facility rate of -0.40% is intended to discourage borrowers and consumers from keeping money in a bank or other financial institution, yet there it sits. Failing to promote increased consumption, markets now have 23% of outstanding global, sovereign debt at negative yields.
Insurance companies, mutual funds, banks and other institutional investors are compelled to match liabilities or an index, so a monetary policy intended to discourage this type of investment supports it instead.
Wednesday’s release of minutes from the January 30 FOMC meeting confirmed that the Committee looks for its balance sheet contraction to end later this year. A portfolio that stood at $900 million before the financial crisis grew to $4.3 billion in 2014, and now sits at $3.8 billion. This is another reason why Treasury rates are sitting in a vacuum as the Fed will remain engaged with some reinvestments of cash payments. The minutes also identified there are “few risks” that might result from pausing planned rate hikes as inflation remains stubbornly lower than its projected models. Low unemployment and rising wage growth have not lifted the Fed’s preferred inflation gauge, which will be updated this Friday. Economic reports were conflicted as above consensus Durable Goods at+1.2% was in contrast to Existing Home Sales that remain weak at -1.2%.
The Week Ahead
Treasury to auction $226 billion in debt, Fed speak is focused on Jerome Powell’s Congressional testimony, and major economic reports are 4Q18 GDP and Personal Consumption Expenditure.
Monday – Treasury sells $87 billion 13 and 26-week Bills, $40 billion two-year Notes, and $41 billion five-year Notes.
Tuesday – Jerome Powell testifies before the Senate, and Treasury sells $26 billion 52-week Bills and $32 billion seven-year Notes. President Trump meets with Kim Jong Un in Hanoi .
Wednesday – Jerome Powell testifies before the House, and Factory Orders are forecast to be 0.6%.
Thursday – initial 4Q18 GDP expected to be 2.4%vs. 3Q18 report of 3.4%.
Friday – Personal Income forecast to be 0.2%, Core Personal Consumption Expenditure to be 0.2%, and 1.9% y/y, and Institute of Supply Management expected to hold its steady gains.
The Week Ahead
A lot of Fed speak is scheduled, Treasury to sell $110 billion in debt, and a light economic calendar.
Monday – Treasury to sell $84 billion in 13 and 25-week Bills
Wednesday – Treasury auctions $18 billion in 23-month Floating Rate Notes; Minutes from the 1/30/2019 FOMC meeting are released
Thursday – Treasury auctions $8 billion 30-year Treasury Inflation Protected Securities; Purchasing Managers Index composite flash expected to hold steady
No Pause in Rate Rally
Capital markets continue to embrace the Fed’s patient approach to rate hikes, with the ten-year benchmark ending the week 9 bps lower than its December 19 close, the same day the central bank raised rates for the eighth time in this cycle.
What it means for the 504 program is continued low funding costs for small business borrowers, with both February issues’ effective rates dramatically below the Prime Rate.
Part of the reason for these low rates is the caution that has followed recent downward revisions for global economic growth, reversing projections that have been proved to be too optimistic. This Financial Times chart displays the decline in American imports, especially from China, that is driving a slowdown in trade and compelling other central banks to reverse previously planned rate increases. There is a March 1 expiration date for the tariff truce and negotiations are as shaky as the budget negotiations.
Following Chairman Powell’s announcement to pause rate hikes, and amplified by Trump administration comments, the Reserve Bank of India cut short-term rates by 25 bps, and the Bank of England revised its near-term growth lower to 1.2% and is stepping back from its plans for a tighter monetary policy. The contentious Brexit talks are also a cause for this revision.
Caution on Treasury Debt
The private sector Treasury Bond Advisory Group commented on reduced holdings of Treasury debt by non-American entities as being at 36%, down from 45% in 2009, and identifying $12 trillion of debt that will need to be funded over the next ten years. For now, domestic accounts, helped by household savers, have filled the gap.
The Week Ahead
Hopes for a budget agreement to avoid another government shutdown will dominate the next five days since weekend negotiations were unproductive. Treasury financing is light at $84 billion of short-term Bills, Fed speak is relevant, and there are some economic reports.
Monday – Treasury sells $84 billion of 13 and 26 week Bills
Wednesday – CPI expected to be 0.1%; Pitchers & Catchers report
Thursday – PPI expected to be 0.2%; Retail Sales forecast is 0.1%
Friday – Industrial Production expected to be 0.2%
As described in a Financial Times article, the Fed seems to have pivoted on its monetary policy and is prepared to embrace a more accommodative stance in response to weaker global indicators. Chairman Powell’s affirmation on Wednesday that the Committee will pursue a patient approach provided the expected comfort to the equity market as all three domestic indexes gained at least 1.3% for the week. In announcing that the Fed is standing pat, he emphasized three items that drive policy:
Speaking of the bank’s balance sheet, its reduction also will be slowed, a contributing factor to the benchmark ten-year Note improving 7 bps on the week, and even more before a strong Institute of Supply Management report on Friday scaled back some of its gains.
That effect of that report was enhanced by a much stronger than expected jobs gain of 304,000, the 100th straight month of increased employment as the private sector shrugged off the government shutdown. The report did contain some ambiguous items, like December’s report being revised down by 90,000 and the Unemployment Rate increasing to 4.0%, while the Labor Force Participation Rate increased to 63.2%. The modest average hourly wage gain of 0.1% (3.6% y/y) does support the belief that inflation is subdued, remaining just below the Fed’s target of 2%.
Possessing the largest economy in the world, as well as its reserve currency, the Fed’s actions have a profound effect on global economies, and its announced pause reflects that. Some recent, and other ongoing issues they consider are:
The Week Ahead
Treasury conducts its quarterly refunding as part of $218 billion in sales, the SBA 504 program prices its February 20 and 25-year debentures, much Fed speak, and possibly some economic reports delayed by the shutdown.
Monday – Treasury auctions $84 billion 13 and 26-week Bills; Factory Orders forecast to be 0.4%
Tuesday – Treasury auctions $38 billion three-year Notes
Wednesday – Treasury auctions $50 billion 18-day cash management Bills and $27 billion ten-year Notes
Thursday – the 504 program prices its 20 and 25-year debentures, Treasury auctions $19 billion thirty-year Bonds, and the Fed’s Balance Sheet is released
It’s Over (for now)!
Friday’s announcement that the partial government shutdown would end helped equity markets recover from losses earlier in the week, proving their resilience in the wake of shaky data from China. This WSJ chart shows how Friday’s recovery helped equities close flat on the week as encouraging domestic corporate results were offset by reports like the International Monetary Fund, stating that global activity is weakening at a faster than expected pace. Trade tensions remain high with contradictory statements adding to confusion about negotiations.
Concerns over economic growth have been evidenced by recent Fed official comments hinting at a pause in planned rate hikes, joined by comments now about the bank holding a larger portfolio of securities, a topic that may command more attention at this week’s meeting. The drawdown in their balance sheet holdings has been referred to as Quantitative Tightening, as the bank’s holdings have declined from $4.3 trillion to about $3.9 trillion, reducing reserves and making credit spreads and equities less attractive. Besides debating the size of its portfolio, consideration will be given to the maturities it holds, currently weighted with longer dated debt.
The impact on the Treasury market has been to stabilize rates, with the benchmark ten-year note closing Friday at 2.76%, just 5 bps higher than when the 504 program priced this month’s debentures on January 10.
These will take place in two locales over the next few weeks – domestically and the UK. The three week reprieve for the government shutdown hopefully will result in a conclusive agreement re: immigration; a border wall to be restrictive and a permanent solution for immigrants already here as part of the DACA program, plus related issues. Funding through FY2019 should be the goal of these negotiations.
In the UK, Parliament will vote again on Theresa May’s updated Brexit plan, which is almost identical to the initial proposal. That vote is Tuesday, and the country’s March 29 deadline to leave the European Union does not allow much time for an alternative solution.
The Week Ahead
A very active week with Treasury to auction $240 billion in debt, the FOMC to meet, the Committee will get its preferred inflation gauge on Thursday, and then the December jobs report ends the week.Monday – Treasury to sell $81 billion in 13 and 26-week Bills; $40 billion two-year Notes; and $41 billion five-year Notes
Trade Tensions Reduced
Hopes that the US would scale back some of the tariffs imposed on Chinese imports and China rumored to be committing to additional purchases of US goods were aided by strong quarterly earnings to boost equities last week. The S&P 500 index gained 2.9% w/w, with its Financials Index even stronger with a 6.1% gain, its best weekly performance since November 2011.
With increased confidence in equities, US Treasuries lost ground with the benchmark ten-year Note closing at 2.79%, its highest yield since just before Christmas, but just 16 bps higher than on this date one-year ago. That performance speaks to the building market sentiment for the Fed to pause its tighter monetary policy by reducing or eliminating previously planned rate increases for this year. A stronger than forecast Industrial Production report of 0.3% helped investors increase their risk appetite, helping to offset a dramatically lower reading for Consumer Sentiment earlier in the week. That reading was 90.7, down from 98.3 in December and the lowest reading since October 2016. An additional cautionary note is China’s report of a third consecutive quarterly decline in GDP, stirring an ongoing concern that such continued weakness could damage global econimic growth.
Deal, or No Deal?
The Brexit debate lingers after Theresa May’s proposed plan to leave the EU was rejected by Parliament, though her government did survive a vote of no-confidence; barely. An adjusted Brexit deal is scheduled for debate in the House of Commons on January 29, just two-months before the departure is to take effect, while fears of a no-deal Brexit are increasing.
Definitely No Deal
An offer to extend protections for DACA immigrants in exchange for the $5.7 billion wall construction was summarily rejected by Democrats, calling the offer a “non-starter.” Included in the offer were proposals for additional humanitarian assistance, drug detection measures, and increased staffing for border patrols and immigration judges. Presidential advisors described the offer as the most aggressive one the President could consider, so it appears ending the shutdown first is the only way Democratic leaders will resume negotiations.
The Week Ahead
A holiday shortened week has a light Treasury calendar, no Fed speak ahead of the 1/29-30 FOMC meeting, and the one economic report of note, Durable Goods, may be affected by the government shutdown.
Tuesday – Treasury to auction $81 billion 13 and 26-week Bills
Thursday – TBD amounts of 4 and 8 week Bills to be auctioned
Friday – Durable goods orders forecast to be 1.8%
If the Fed Pauses, Which Pause Will It Be?
This Financial Times chart shows two recent tightening cycles, in 2006 and 2016. In the first, the pause led to rate cuts necessitated by the financial markets turmoil. In the second, after the first rate hike in December 2015, the Fed paused for a year in response to market conditions, then followed with seven additional rate hikes. In both instances, equity markets rallied and that may explain why those markets have been up 10% since their December low, while the ten-year Treasury benchmark has stabilized more than 55 bps lower than its 4Q18 high yield. Now, it seems the markets have settled in expecting a reduced number, if any, rate increases this year as expectations are for a slowing economy and the central bank has expressed how it intends to be patient with its tightening policy.
Adding to this sentiment was additional commentary from Chairman Powell re: the damage a continued government shutdown could have on the economy, and then reports from Macy’s and Apple concerning their lackluster performance, plus China reporting sharp declines in both imports and exports for December.
Speaking of that 55 bps move in Treasury rates, here is a WSJ chart tracking the 3-month performance of the ten-year benchmark; a period that includes the eighth, and most recent increase on December 19th. Helping rates rally late last week was a weaker than expected Consumer Price Index report of -0.1%, its first decline in nine-months.
With the drop in rates, credit market spreads have been pressured, but are now stabilizing as market participants seem to be heeding Chairman Powell’s mantra of patience. Amidst the market turmoil and the inability of High Yield issuers to come to market, the SBA 504 program priced its January debentures at lower rates m/m. Most dramatic is the decline in the ten-year series from its November 8 sale date which pre-dated the most recent rate hike. As a result of this tightening cycle that has had the most impact on short-term rates, all three January debentures represent an ongoing effective rate to small business borrowers well below the Prime Rate of 5.50%.
The New Record
At midnight Saturday, this government shutdown ended its 22nd day, making it the longest one in American history, and in need of a sudden shift in sentiment for things to change. Across the Atlantic, Britain continues its struggle to amicably exit the European Union as the Prime Minister’s proposal for its European Union agreement is likely to be defeated in Parliament. That vote could set the stage for a no-deal Brexit, whose prospect is already pressuring British financial markets.
The Week Ahead
Some economic reports, a light Treasury calendar, and a Parliament vote on Brexit.
Monday – Treasury auctions $75 billion 13 and 26-week Bills
Tuesday – PPI expected to be 0.1%, and the Brexit vote
Wednesday – Retail Sales forecast is 0.1%
Thursday – Treasury sells $13 billion ten-year TIPS, and a TBD amount of 4 and 8 week Bills
Friday – Industrial Production expected to be 0.3%
A noun: the capacity, habit, or fact of being patient, and a word used by Fed Chairman Powell on Friday after the release of December’s much stronger than expected jobs report. “US data seem to be on track to sustain good momentum into the new year,” adding the Fed would take a “patient” approach to monetary policy tightening, further stating the bank is “prepared to adjust policy quickly and flexibly if necessary.” That last comment expands past possible rate hikes to include a possible adjustment to its balance sheet policy. It was only three weeks ago that he stated that policy was on auto-pilot, meaning the bank would continue to shrink its portfolio by running off maturing securities and not reinvest proceeds in Treasury and mortgage backed debt. At the time, that comment resulted in another equity decline in excess of 2%, like last Thursday’s decline of almost 3% after Apple reduced its guidance for the current quarter. Adding to that pressure was a soft Institute of Supply Management report that was the weakest in two-years. This WSJ chart shows how Friday’s employment report and Mr. Powell’s comments helped reverse that move, with the DJIA gaining almost 750 points.
Key features for the December report were:
The effect on capital markets was an increase in Treasury rates with the benchmark ten-year Note increasing 11 bps to 2.66%. Even with that move, Treasuries retain a safe-haven characteristic for investors as that rate is 18 bps lower than when the 504 program priced its December debentures, and prior to the most recent Fed rate hike on December 19.
The shutdown drags on into its third week with 800,000 federal workers on leave without pay, but it will not interfere with the 504 program’s ability to fund on schedule this month. The program will price 10, 20 and 25-year debentures on Thursday, to close on January 16.
Additionally, SBA has been pro-active in getting ahead of the curve regarding the February sale and anticipates that will pricing occur as scheduled on February 7, for closing on February 13. SBA has provided staffing at key sectors and extended deadlines for several of its funding participants.
Significant dates are:
Friday, January 11, which represents the day that federal workers miss checks and the federal court system runs out of money, forcing curtailment or postponement of some cases. Saturday, January 12, makes this the longest federal shutdown.
The Week Ahead
Treasury will sell $153 billion during its quarterly refunding and there are a couple of economic reports.
Monday – Treasury to auction $75 billion in 13 and 26-week Bills; Factory Orders expected to be 0.4% vs. last month’s -2.1%
Tuesday – Treasury will auction $38 billion three-year Notes
Wednesday – Treasury auctions $24 billion ten-year Notes, and FOMC minutes of the December meeting are released
Thursday – SBA 504 program to price its January debenture sales; Treasury to auction $16 billion thirty-year Bonds and Chairman Powell speaks at an economic forum
Friday – CPI expected to be 0.2%
Riding Out the Storm
This WSJ chart shows the one-month move in the benchmark ten-year Treasury note that has declined 35 bps in rate while the S&P 500 index has lost 10% in value. This shift was accomplished even as the FOMC raised interest rates on December 19 for the eighth time in this cycle, and the fourth time in 2018 alone.
This leaves the benchmark at a level not seen since January 2018 and it almost seems like the market is betting against the Fed raising rates this year, or, at least, less frequently.
Trade tensions, expectations for a global economic slowdown in 2019, and Fed Chairman Powell’s comment that Balance Sheet reduction would continue have been the main reasons for concern, but they were joined by upheaval in the President’s cabinet and then a government shutdown that is stretching into the new year.
In an attempt to calm the equity markets, Treasury Secretary Mnuchin tried to solve a problem that wasn’t a problem, when he announced that he had spoken to the leaders of the country’s six largest banks to confirm their liquidity. Bank liquidity is not a problem, investor confidence is frayed, resulting in most asset classes closing in the red for 2018 while the safe-haven trade into Treasuries has asserted itself. The Fed raised rates a total of 100 bps in 2018, yet the ten-year benchmark is higher by just 22 bps, and now short-tern Treasury Bills offer a guaranteed yield (2.40%) equal to the dividend yield of the S&P 500 index, which declined 6.2% for the year.
Prospects are grim as the President’s demand for $5 billion for a border wall is being stonewalled by the Democrats, who are about to take control of the House. Hundreds of thousands of federal workers are on leave while thousands more are working with no pay. Additionally, it must be noted that $5 billion is probably just a deposit on what such a wall will cost. Labor, land acquisition, and electronic surveillance systems will certainly swell that figure, leading to future Congressional conflicts over its funding. House Democrats have proposed a Thursday vote to end the shutdown, but it contains only a fraction of the demanded $5 billion.
The shutdown imposed a sense of immediacy for the 504 program to process loans for the January debenture sales, and the system has managed it very well. The January pricing will take place next Thursday, with funding on the following Wednesday, January 16.
The Week Ahead
What lies ahead is uncertainty, for sure. Treasury auctions took place on Monday, and economic reports are few, though the jobs report is always important.
Monday – Treasury auctioned $101 billion in 13, 26, and 52 week T-Bills
Thursday – Institute of Supply Management report and the House vote to end the shutdown
Friday – Non-Farm Payroll expected to be 185,000 with an unemployment rate of 3.6%
Nowhere to Hide
This NY Times chart shows how five major investment classes have dropped in unison this year, something that rarely happens, as the impact of rising rates, trade tensions, and weakening economic reports have taken their toll.
The article states that if this persists it can create a dangerous feedback loop with doubts about the economy hurting the markets, and trouble in the markets hurting growth. As recently as September 20th the NASDAQ was +15% and WTI crude oil was +20% for the year; those gains are gone and Thursday’s report that Chinese Industrial Production was just +5.4% for November was identified as a catalyst for Friday’s 2% decline in equity markets. This was its smallest gain in nine-years.
While a gain of 5.4% might sound positive, this WSJ chart shows the declining trend for the world’s second largest economy, a driving force for much of global trade. By comparison, the US gain for November was 0.6%, an improvement on the forecast of 0.3%.
Adding to the week’s events was further confusion about Brexit, a downward revision for European Union growth to 1.9%, and confirmation from the European Central Bank that it would end its bond purchases this month, concluding its QE program that bought €2.6 trillion bonds. The bank did keep its overnight lending rate at -0.40%. Ending QE had been previously broadcast, and its termination was softened by the bank’s pledge to hold the purchased securities “for an extended period of time” until after its first rate hike, expected to occur in late 2019. Domestic Treasury rates maintained their safe-haven status, though the ten-year benchmark increased slightly in rate to 2.89%, just 5 bps above where the 504 program priced its December debenture sales. Suffering more than other credit products is High Yield, where rates have increased 100 bps since the September high in equities, and where for the first December since 2008 not one issue has been brought to market.
According to the National Federation of Independent Business, small business optimism continues its strong two-year trend, even with a modest decline in November. An increasing number of owners reported capital outlays and higher sales, with job creation rising to a net addition of 0.19 workers per firm. As positive at that is, most owners are cautious about the economy’s ability to improve.
The Week Ahead
All eyes will be on the Fed, widely expected to make its eighth rate hike, raising rates to a range of 2.25%-2.50%, a possible government shutdown is tentatively scheduled for a vote on Wednesday night, and Treasury to auction $72 billion T-Bills and $14 billion TIPS.
Monday – Treasury sells $39 billion 13-week and $36 billion 26-week Bills
Wednesday – 2:00 FOMC Announcement, followed by the Committee’s forecasts and a Jay Powell press conference
Thursday -Treasury to auction $14 billion 52-month Treasury Inflation Protected Securities
Friday – Durable Goods expected to be 1.5% after a 4.5% decline in October; third estimate of 3Q18 GDP expected to be unchanged at 3.5%; and the Fed’s preferred inflation gauge, Personal Consumption Expenditures, is forecast to be a 0.2% core rate, 1.9% y/y
Back into the Red
After early gains resulting from the temporary halt to increased tariffs, the stock market reversed course on Tuesday and accelerated its decline into the end of the week. Administration comments that it would take a tough stand, or increase tariffs, during the 90-day trade negotiations with China were identified as causes of the slump. The weekly selloff was the largest since March and the early December performance is the month’s worst in ten-years, pushing the major indexes into the red for the year. This WSJ chart shows the DJIA down 4.5% for the week and NASDAQ down 4.9%.
Analysts have identified at least three reasons for this seemingly sudden realization that economic growth may be waning:
With 2018 GDP surpassing forecasts and now expected to remain above 3%, the previous pessimistic forecasts for 2019 and 2020 may result in a bigger drop-off than predicted. Even Friday’s report of steady wage growth and low unemployment were overshadowed by a jobs gain of 155,000, below forecast but representative of the 98th consecutive monthly gain.
One market’s weakness leads to another market’s strength and that saw the SBA 504 program benefit from the safe-haven trade into Treasuries, pricing its December 20 and 25 year debentures 33 bps lower than in November. The 5 bps wider pricing spread reflects the widening of credit spreads in response to the safe-haven trade and continued flattening of the 2/10 Treasury curve. What is most impressive about these sales is that both have ongoing effective rates below 5% for any loans that were processed since October 1st.
The Week Ahead
There is no Fed speak as we are in the blackout period leading up to the 12/18-19 FOMC meeting, some secondary inflation data, and the Treasury’s quarterly refunding.
Monday – Treasury auctions $75 billion 13 and 26-week Bills
Tuesday – Core PPI expected to be 0.2%, 2.8% y/y; Treasury auctions $38 billion 3-year Notes, and President Trump meets with Democratic Senate leaders to discuss budget plans ahead of a potential government shutdown
Wednesday – Core CPI forecast to be 0.2%, 2.2% y/y and Treasury sells $24 billion ten-year Notes
Thursday – Treasury auctions $16 billion 30-year Bonds
Friday – Retail Sales forecast to be 0.1% after a 0.8% gain in October; Industrial Production expected to be 0.3%
Quote of the Week – “just below” Neutral Rate
With those words Fed Chairman Jay Powell deftly gave support to those who hope to see the Fed pause their rate hikes while simply confirming that the Committee is on track to achieve a neutral rate. The S&P 500 index surged 2.3% on the day, its strongest performance since March, with the benchmark ten-year Treasury held firm, eventually declining to 3.01% to close the week. This neutral rate is a point where economists believe policy is neither helping nor hurting the economy and has always been the Fed’s objective, previously stated as being between 2.5% and 3.5%. With Fed Funds currently at 2.0%-2.25% a December increase would bring us to 2.25%-2.5%, technically reaching the lower end of their targeted range; so, Chairman Powell confirmed that we are approaching that level without saying the Fed might slow down. Wednesday’s comment does modify his October quote that we were “a long way away from neutral rate” which had been identified as a partial catalyst for equity market weakness, reinforcing the impact that “Fed speak” can have on markets.
Even Thursday’s release of the minutes of the November 7-8 FOMC meeting suggesting near unanimity for continued rate hikes had little negative impact on stocks or bonds. This StockCharts.com chart for the ten-year Treasury shows its rate decline over the last four weeks, threatening to break through 3.0% again, even as the market expects the Fed to increase rates at its December 18-19 meeting. A Bloomberg poll of analysts expects the Note to gently resume a sell-off, ending December near 3.21%, and serving as a reminder of how conflicted the markets are. The potential “Fed pause” trade is a 2019 possibility, so unless there is some additional headline news the benchmark note’s rally may have run its course.
President Trump’s decision to delay increasing the 10% tariff on $200 billion of Chinese imports to 25% in January averts increasing trade tensions but does not resolve the issue. It is hoped that progress can be made so that some normalization can resume, though investors are wary. Economic reports came in below forecast, with New Home Sales continuing to slump and the Fed’s preferred inflation gauge was below forecast at 0.1%, with the core y/y rate declining to 1.8%.
Open or Closed?
U.S. financial markets will be closed on Wednesday in respect for former President George H.W. Bush. After discussions with the underwriters and SBA, we anticipate that the bond market closure, in particular, will not adversely impact the offering of 504 debentures this month. The marketing will commence on Tuesday, and debenture interest rates will be set on Thursday, as scheduled.
The looming government shutdown, however, will be affected by President Bush’s funeral. The current continuing resolution to fully fund the government will expire after this Friday and President Trump has threatened to partially shut down the government. The president has used the threat of shutdown to try and get $5 billion in funding for his Mexico wall but to no avail, even with his party controlling both chambers of Congress. He has backed off the threat to not sign spending legislation, which would have partially shut down the government. In light of President Bush’s funeral, however, the president is open to an up to two week continuing resolution past the Friday deadline. This probably will be agreed to early this week. Be ready for fireworks when the Democrats take over the House in January, as that will give the president even more reason to threaten (or follow through with) a shutdown.
The Week Ahead
Financial markets will close Wednesday to honor President George H.W. Bush; more Fed speak, including Jay Powell speaking before the Joint Economic Committee in Congress; Freddie Mac is active in the Agency CMBS market; the SBA 504 program prices its December 20 and 25 year debentures; and Treasury auctions are limited to short-term Bills plus the jobs report.
Monday – Construction Spending expected to show a modest bounce; Treasury auctions $75 billion in thirteen and twenty six week Bills
Tuesday – four and eight week Bill auction size will be determined, and $26 billion fifty two week Bills will be sold
Wednesday – Institute of Supply management report expected to decline after three strong months and Jay Powell speaks before Congress; markets closed
Thursday – Factory Orders expected to decline 2%
Friday – Non Farm Payroll expected to show an increase of 190,000 and Consumer Sentiment forecast to hold steady
In a holiday shortened week that saw continued pressure on stock prices, Treasuries remained in demand and oil continued its slide. Down 30% since the beginning of October, oil continued its drop as President Trump wields political influence on Saudi Arabia to keep prices low even though it would prefer to cut production. Increased US supplies and a global economic slowdown are also contributing to this price decline. This Financial Times chart shows the sharp drop for last week alone, putting it at its lowest price since October 2017.
This WSJ chart shows the impact that trade tensions and weaker oil have had on equity markets over the last month, with the tech heavy NASDAQ suffering the most, down 4.3% last week alone.
While equities and commodities have suffered, US Treasuries have been revisited by the standby safe haven trade, illustrated by the ten-year benchmark closing Friday at 3.04%, down from its intraday high of 3.24% in October, and lower by 14 bps since SBA 504 debentures were priced two weeks ago. Knowing there is a strong probability of rate hike next month, the back end of the Treasury curve has outperformed with the 2/10 spread declining from +29 bps to +23 bps over that time. This flight to quality was mentioned in a Financial Times article that identified the global financial system as being dollar centric and mentioning a “Fed pause trade” that could occur in 2019. Whether or not traders are getting a jump on that concept, such a move would benefit major asset classes that are now in negative territory for 2018.
Economic reports last week did nothing to support growth with Durable Goods being -4.4% and September revised down to -0.1% from +0.8%. Also, the Purchasing Managers index reported slowing growth in November.
Though passage in Parliament is not assured, the European Union and Britain have agreed in principle for the UK withdrawal from the Union. This is important not just for providing structure and guidance for the UK, but also for the EU to discourage additional defections.
The Week Ahead
There is Fed speak (most importantly Jay Powell speaking on Wednesday), Treasury to sell $204 billion in debt while the Agency MBS market picks up, and the Fed’s preferred inflation gauge on Thursday.
Monday – Treasury auctions $75 billion in 13 and 26 week Bills, and $39 billion two-year Notes
Tuesday – Treasury auctions $40 billion five-year Notes
Wednesday – Treasury auctions $18 billion two-year FRN’s and $32 billion seven-year Notes; second report of 3Q18 GDP expected to remain at 3.5%. Jay Powell speaks to the Economic Club of NY
Thursday – FOMC minutes of the November 8 meeting are released, Personal Income & Outlays report contains the core PCE gauge, expected to be 0.2% with the y/y rate possibly declining to 1.9%
Friday – G-20 Summit in Buenos Aires where President Trump is expected to meet with President Xi
Safe Haven Return
Stocks weakened in volatile trading as earnings and economic reports disappointed investors, sending them to Treasuries like the ten-year benchmark that improved almost 12 bps on the week. This was achieved even as it was reported that China, the largest holder of US Treasury debt at $1.13 trillion, has reduced its holdings for the fourth consecutive month. Theirs is not a one off event as all foreign investors in Treasury debt now hold 40% of outstanding balance, down from 50% just three years ago. During this period the Fed has raised interest rates eight times (200 bps), with the benchmark ten year Note rising just 80 bps as the rate curve flattened. This WSJ chart shows how the Treasury market strengthened into the weekend.
Headlines that gave equity and credit investors pause were:
US growth at 3.5% is not the only robust economy, but close to it as trade tensions are taking a toll on global economies, with Italy beseeching citizens to buy its debt as investors back away, and the UK coming closer to the possible catastrophe of a “no deal” Brexit. Rome is fighting with Brussels over its proposed spending plans and selling pressure has pushed its ten year debt higher by 167 bps this year while its German benchmark yield has risen just 4 bps. In London, Mrs. May has achieved cabinet approval for her proposed plan but Eurosceptics in Parliament are dissatisfied and threaten her governing coalition’s ability to achieve acceptance. On Friday, British bank stocks dropped more than 10% and other business sectors were hit hard, fearing no deal on Brexit and an uncertain future. Overall, the FTSE 100 index was down 1.7% on the week, close to the S&P 500 indexes decline of 1.6%.
The Week Ahead
Our second consecutive holiday shortened week has much Fed speak, more Treasury Bill auctions and a light calendar of economic reports.
Monday – Treasury auctions $78 billion in thirteen and twenty six week Bills, and announces size of Tuesday’s four and eight week Bill auctions
Tuesday – four and eight week Bill auctions
Wednesday – Durable Goods orders expected to be 0.8%, and Leading Indicators is forecast to be 0.5%. Treasury auctions $11 billion ten year TIPS (Treasury Inflation Protected Securities)
While stocks and oil continue to express concern over trade tariffs and economic strength, it is the election results that will set up clashes over a potential repeal of tax cuts, proposed infrastructure spending, and health care, a topic which voters identified to be a primary concern. All of these items require increased spending, meaning increased debt and that is of concern. The US pays $1.3 billion each day to service its public debt, benefitting somewhat from today’s relatively low interest rates. The annual cost, per the Congressional Budget Office, is expected to be nearly $1 trillion by 2028, assuming the long term average for rates like the ten-year Note are around 3.70%. Should rates be higher that cost will increase, and with Treasury continuing to focus on shortening its average maturity (currently six years) its need to refinance will be more frequent, incurring even greater expense at higher rates.
The Fed held short term interest rates steady, offering an upbeat assessment of the economy with no reference made to October’s price volatility. Comment was made about reduced business investment as corporate America continues to use tax cut related profits to repurchase stock. Such activity adds support to equity prices but does little to sustain economic growth. Gradual rate increases are still in the Committee’s plans, with the December meeting likely to produce the next change.
This Morgan Stanley chart that was posted in the WSJ shows the recent decline in business investment and is enhanced by regional Federal Reserve Bank surveys that project continued declines.
Red or Black?
Those are colors that are usually identified with roulette, but also identify how domestic stock markets flirted with being in the red this year, before rallying midweek to reflect marginal ytd gains. After a tumultuous October, the S&P 500 index showed a 2.4% gain for the week, but negative 7% for the month. US Treasury yields might be expected to prosper from such a performance but Friday’s jobs report, and its healthy average hourly earnings increase, lend support to the Fed’s commitment to gradually raise rates and almost assures another 25 bps increase in December. That report of +250,000 was well above consensus and the 0.2% wage increase brought that category to +3.1% y/y, the highest rate since 2009 as seen in this Financial Times chart, and well above the Fed’s Personal Consumption Expenditures inflation rate of 2%.
Health care, manufacturing and construction were the strongest categories of jobs growth, with the unemployment rate holding at 3.7%, and the labor force participation rate increasing to 62.9%, perhaps lending credence to the belief that more discouraged workers are actively seeking jobs. Another report that supported rising costs was the Employment Cost Index that gained 0.8% last quarter, its fastest pace in a decade.
Other reports of interest were the previously mentioned PCE figure of 2.0%, reflecting a monthly increase of 0.2%, and a weak reading from Institute of Supply Management, reflecting slow growth as a result of recently imposed tariffs amidst conflicting reports of a thaw in US-China trade war rhetoric.
These tariffs, coupled with Treasury’s recently announced plans to increase the size of its funding schedule, concern about highly leveraged Corporate debt, and the Fed’s reduction of balance sheet are all negatively impacting capital markets, raising rates and pushing funding spreads wider. Here is the WSJ chart reflecting the weekly move in the benchmark ten-year Treasury note.
Janet Yellen, no longer restricted by the blackout period in advance of FOMC meetings, spoke last week about her concern regarding a “huge deterioration” of lending standards on corporate debt. Over the last thirty years this lending has shifted from banks to the bond market, where one half of Investment Grade debt is now rated BBB, the lowest level before junk and if downgrades took place it could force holders of that debt to sell because of rating limits. Such additional supply would not be a welcome addition in a defensive, rising rate environment.
The Week Ahead
Ordinarily, the FOMC meeting and its policy announcement, which is expected to signal no change, would be the foremost event but Tuesday’s midterm elections will garner the most attention. Treasury will sell $193 billion in debt, the Agency CMBS market will be active, including the SBA 504 program pricing its November debentures on Thursday. Economic report activity is light.
Monday – Treasury auctions $84 billion in 13 and 26 week Bills, and $37 billion in three year Notes
Tuesday – Treasury auctions $26 billion in 52 week Bills and $27 billion ten-year Notes
Wednesday – FOMC meeting begins and Treasury auctions $19 billion thirty year Bonds
Thursday – SBA 504 program prices ten, twenty, and twenty-five year DCPC’s; FOMC announcement is scheduled for 2:00 PM Eastern
Friday – Producer Price Index expected to be 0.2%
Market Movers: The October Bear Is Everywhere
October has earned its reputation as a difficult month for the financial markets as this year the bear continues to roll through global fixed income and equity markets. It seems troubled most everywhere at the moment, not just in markets but in politics and society. The backdrop for this is the major central banks’ withdrawing of liquidity from the global system. Coordinated easing from the major central banks over a number of years covered up any number of potential problems in the markets. It was a record large injection and maintenance of global liquidity that has run its course.
Historically, withdrawal of liquidity has meant problems for emerging markets as the supply of dollars tightened up, and indeed this has been the case in 2018. But investor concerns have steadily moved up the investment food chain as the world became a more uncertain and less friendly place. Investing in the post-war era has been an increasingly global exercise no matter where you live. When the global outlook dims investment returns broadly take a hit. Late economic-cycle fiscal stimulus allowed the U.S. to delay participating in the global market correction this year, but that reprieve seems over.
Since surfing the liquidity wave is out as a sport, investors now must look even more to the fundamentals. In the U.S. fundamentals are less bullish but not bearish, but the post-crisis expansion has gone on long enough that macro-economic speculation now centers on how soon it will be to the next recession. The Goldman Sachs Financial Stress index is back to March 2017 highs. Europe has not even had much of an expansion and is already facing head winds. China lately appears to be unable to fight its way out of a paper bag thanks to internal imbalances and the tariff war. And Great Britain, well, we know what’s happening there.
Fixed income, typically the place where investors hide when worried, is not really safe during Fed hike cycles and posts a negative return (U.S. Aggregate index -1.7% ytd). This was followed last week by the tech-heavy S&P 500 which is now down 0.7% on the year. Junk bonds (per iShares HY) are hanging onto a small and diminishing positive return. Not only disappointing earnings from tech companies, but earnings warnings from core industrial companies such as Caterpillar last week reminded investors that the U.S. market is not immune from a bear attack.
But it has been worse offshore, the Global Dow is down 7.9% in dollar terms. The yen has beaten the dollar in the recent haven trade (yup, Japan is considered a safe haven in the post-GFC world), but the dollar index is up 5% this year. Correlations between global financial markets are broadly and highly positive, meaning that they have been more likely to trend in the same direction, which of late has tended to be down.
Last week, Treasuries did benefit from the fear trade. The chart below shows the benchmark ten-year T-note yield fell steadily during the broad risk-off trade, from 3.20% to 3.08%. Market-implied odds of a Fed rate hike in December fell from 4 in 5 to 2 in 3.
Closer to home, in the agency CMBS market heavy new issue supply, and an overall widening of credit spreads, pushed spreads in that sector out 7-9 bps, including for SBA 504 debenture pools.
Economic reports were mixed:
The Week Ahead
Looking ahead, there appear to be no deep and potentially destabilizing new problems set to surface soon in the financial markets. Declines in the markets, while broad, have been orderly and fairly predictable based on less rosy fundamentals, uncertainty about economic policies and politics in China, Europe, and the U.S., and deteriorating technicals. Bearish sentiment is getting high enough that some stabilization and retrenchment would not be surprising in the risk markets. A Goldilocks-like U.S. Employment Report would be a good step.
Monday – Personal Income and Consumption
Tuesday – Consumer Confidence, Case/Shiller Indices
Wednesday – ADP employment data, ISM indices
Thursday – Jobless Claims
Friday – Employment Report for October
Of course true major financial crises typically come from areas that are overlooked by market analysts. As Rumsfeld would’ve said, they are the “unknown knowns.”
In the US it was the release of the minutes of the July 26 meeting which confirmed the vote to raise rates an eighth time was unanimous, leaving the markets with a sense the Committee is becoming more hawkish about the strong economy. The benchmark Treasury closed just 4 bps higher on the week but the move to higher rates was enhanced by comments from Fed officials like Randal Quarles, who said economic reports suggest “the economy will stay strong for a significant period into the future.” The vote from the last meeting, coupled with hawkish comments, reaffirm the Fed’s intent to maintain its gradual path of rate hikes, as advertised. Equities reversed a three week decline, eking out a small gain.
This WSJ chart shows how the benchmark ten-year Note yield increased after the FOMC minutes, only to decline somewhat heading into the weekend.
Globally, aside from concerns about the involvement of Saudi Arabia in the death of Jamal Khashoggi, it is Italy and China that are center stage. Italy is pursuing a progressive track that will require financing at a time its funding spread is +312 bps to the benchmark German Bund. That spread was +100 bps three years ago and this increased cost of funding could spread to other EU members like Spain and Portugal. For China, it is not debt but weakness in its currency and equity markets that was reinforced by a decline in its 3Q2018 growth. Hard to imagine a rate of 6.5% is considered weak, but that is testament to the global impact of its economy. Its currency weakness has prompted criticism of government policy, but Treasury has not charged them with manipulation and China is challenged by what sector it can support – currency or equities, which are down 29% year-to-date.
Economic reports were mostly weak:
The Week Ahead
A lot of Fed speak, Treasury to sell $211 billion of debt, an active Agency CMBS market, and some more economic reports.
Monday – Treasury auctions $84 billion 13 and 26 week Bills
Tuesday – Treasury sells $38 billion two-year Notes
Wednesday – Treasury sells $19 billion two-year Floating Rate Notes and $39 billion five-year Notes; New Home Sales expected to hold steady, with price discounting offsetting higher mortgage rates
Thursday – Treasury sells $31 billion seven year Notes; Durable Goods expected to decline 1.4% after a 4.4% increase in August
Friday – first estimate of 3Q2018 GDP expected to be 3.3% vs. 4.2% in 2Q2018
Higher rates roil stocks
The previous week’s increase in rates reversed itself, only after sending US stock markets down 4.1% for the week, and that is after a Friday rally of 1.4%. This Financial Times chart shows the sectors that were hardest hit by ongoing concerns about rates, oil prices being up 30% ytd, and trade tensions, especially with China.
Some other items:
In 4Q2017 the yield on the two-year Treasury broke above the dividend yield on the S&P 500 index. At 2.86% it now stands 100 bps above it, and though not mentioned by the President in his critique of Fed policy, it does provide an attractive risk free alternative to stocks, especially in this volatile period and with its yield expected to rise.
In addition to the successful DCPC sales, last week’s supply of debt saw good demand with as much as 65% of Treasury’s 10 and 30 year issues going to indirect/foreign bidders. The CPI and PPI reports were weaker than expected with PPI 2.5% y/y ex food & energy, and CPI at 2.2% y/y ex food & energy.
The Week Ahead
Fed speak continues, Treasury sells $89 billion of debt, and we get the FOMC minutes from the 9/26 meeting.
Monday – Treasury auctions $84 billion thirteen and twenty six week Bills. Retail Sales expected to be 0.2%
Tuesday – Industrial Production forecast to be 0.2%. European Union expected to post update on Brexit negotiations
Wednesday – Release of the FOMC minutes from the 9/26 meeting that raised rates an eighth time
Thursday – Treasury auctions $5 billion of 30 year TIPS (Treasury Inflation Protected Securities)
As the Financial Times reported, “the quiet, low intensity 2018 bond selloff exited stealth mode this week.” The rates market had been complacent about the tighter Fed policy and was fairly benign until Wednesday’s Institute of Supply Management report registered its strongest reading since the index was created in 2008. The selloff was enhanced by comments from Fed Chairman Powell who said the US economy is in an “extraordinary period” and the Committee is “a long way” from raising rates to neutral (meaning more rate hikes).
The benchmark ten-year Treasury ended the week 17 bps higher, and 34 bps higher than when the 504 program priced 2018 20I in September, as seen in this one month WSJ chart. It seemed as if people suddenly realized:
Even Friday’s weaker than expected jobs report, with the 3.7% Unemployment Rate at its lowest level since 1969, failed to inspire confidence. The report of 134,000 was below consensus, partly attributed to Hurricane Florence, but had upward revisions to July and August of 87,000 and represents a record 96th straight month of gains. The usually consistent leisure and hospitality category was identified as being 37,000 below average and that also helped keep it below its forecast.
The Week Ahead
Fed speak, $230 billion of Treasury supply, $1 billion of Agency CMBS, plus the SBA 504 program sells 20 and 25 year debentures on Thursday. Economic reports focus on inflation data that the Fed does not prioritize.
Monday – Columbus Day holiday
Tuesday – Treasury auctions $156 billion in 4, 13, 26 and 52 week T Bills
Wednesday – PPI, ex food & energy, expected to be 0.2%, 2.9% y/y; Treasury sells $36 billion three year Notes and $23 billion ten year Notes
Thursday – CPI, ex food & energy, expected to be 0.2%, 2.3% y/y; the 504 program sells 20 and 25 year debentures; Treasury sells $15 billion 30 year Bonds
As forecast, another 25 bps rate increase
There was no surprise that the FOMC raised short-term rates on Wednesday to a band of 2.0%-2.25%, its eighth increase since December 2015. In a release of the Committee’s policy statement their forecast calls for an additional rate increase this year, and three more in 2019. Below is a WSJ chart that identifies the changes in their median estimates that support their pursuit of gradual change. As real GDP is expected to decline, unemployment will remain low in a benign inflationary environment. Friday’s core PCE report of 0.0%, 2.0% y/y was as forecast with little expectation of rising.
The move had minimal impact on the rates market as Treasuries were unchanged on the week, more confirmation of the Fed’s success in communicating their policyplans. Other reports reflected positively on the economy:
In other central bank news, the ECB reported that inflation in countries using the Euro has risen to 2.1% and that it does plan on ending its accommodative band buying this Fall. Within this European Union, concern about Italy is increasing as concerns about Greece abate. Italy, whose ten-year debt trades just 0.01% above US Treasuries, just passed a budget that will sustain its debt load at 130% of GDP, a level more than double what the ECB mandates. Its populist coalition government unexpectedly passed a budget which will increase spending and reduce taxes, though it will require final approval by the European Commission.
The Week Ahead
Fed speak resumes with a light economic calendar, save for the September jobs report. Treasury supply is light, but the Agency CMBS calendar is active.
Monday – Treasury auctions $98 billion in 13 and 26 week Bills
Wednesday – Institute of Supply Management report is expected to hold steady, a reflection of an expanding economy
Friday – Non Farm Payroll is forecast to be 180,000 with unemployment at 3.9% and earnings growth at 0.3%, 2.9% y/y
No Worry about Tariffs, Yet
Stock markets continue to surge, as this WSJ chart shows the DJIA closing Friday at its all time high of January 2018. Amid skepticism about the market’s ability to withstand pressure of increased trade tariffs, the exclusion of Canada from a renegotiated NAFTA agreement, and the UK’s uncertain Brexit, the equity market continuing its resilient performance is confusing analysts. There are some traditional concepts that are being challenged:
What may be most impressive is how investors are accepting of higher interest rates as the Fed is poised to raise its short-term target for overnight funds to the 2.0-2.25% range on Wednesday. Dating to December 2015, when the range was 0-0.25%, this WSJ chart shows how the two-year Treasury note, which is most sensitive to Fed policy, has matched the 175 bps increase in the Funds rate. The benchmark ten year Treasury note closed Friday’s session at 3.06%, up 7 bps on the week and just 77 bps since December 2015, a move that has benefitted small business borrowers who are active in the 504 loan program.
With no Fed speak, and minor economic reports last week, the rates market absorbed heavy issuance in the Corporate and ACMBS market as Treasury rates trended higher ahead of the Fed meeting and an active calendar this week.
The Week Ahead
Focus will be on Wednesday’s FOMC announcement, plus Treasury auctions totaling $213 billion, and some major economic releases that include the Fed’s favored inflation gauge, PCE, on Friday.
Monday – Treasury auctions $98 billion 13 and 26 week Bills and $37 billion three year Notes
Tuesday – Treasury auctions $17 billion two year Floating Rate Notes and $38 billion five year Notes
Wednesday – FOMC announcement, followed by Fed Chairman press conference and forecasts
Thursday – Treasury auctions $31 billion seven year Notes; Durable Goods report expected to rebound from July’s -1.7% report with a 2% gain; third revision of 2Q18 GDP expected to be 4.3%
Friday – Personal Income & Outlays forecast to show Income as 0.4% with the core Personal Consumption Expenditure report expected to be 0.1%, 2.0% y/y
The Week in Review
Benchmark Treasury rates approached 3% in advance of the expected rate increase on July 26, and a stronger than expected Industrial Production report on Friday. The 0.4% gain was as forecast, but the July report was revised up .03% to a similar 0.4% gain. Adding to economic confidence was a revision to 0.9% for July’s Retail Sales release.
Other reports that focused on inflation were muted, with headline PPI coming in at -0.1%, and core CPI being just 0.1%, 2.2% y/y. Other items of interest were:
An interesting take on median income is that it is at an all-time high of $61,372, sort of. The Census Bureau cautioned, as reported in a NY Times article, that a technical adjustment made in 2013 data meant the 2017 numbers are statistically the same as median household income from 1997 and 2007.
The stock market has fully recovered from its financial crisis level, worth about 60% more than its 2007 valuation. Unfortunately, those assets are held by wealthier households with median households, who are more dependent on their home values, showing a 20% decline. The article identifies this as a “lost decade” for the American middle class.
The Week Ahead
No Fed speak as we enter the blackout leading up to the July 25-26 meeting, light Treasury issuance, and some housing data will leave markets subject to headline news.
Monday – Treasury auctions $90 billion 13 and 26 week Bills
Thursday – Treasury auctions $11 billion ten year Treasury Inflation Protected Securities
The Week in Review
There was talk of increased tariffs on Chinese goods, no progress on NAFTA talks with Canada, a strong employment report that reflected solid wage growth, and the SBA 504 loan program had successful sales totaling $351,675,000.
The tech heavy NASDAQ market suffered the most from the tariff talk, dropping 2.6% on the week as it would be more affected by China supply issues. The above WSJ chart shows how the benchmark ten-year Treasury weakened on Friday after the jobs report showed:
It was the wage growth component that best supports the Fed’s objective of gradual rate increases as increased wages in a tight labor market are believed to be a precursor to inflation, pushing yields higher on the week. With that in mind, the market assigns a 99% probability of a 25 bps rate increase on September 26, and a 74% probability of another hike after the December 19 meeting.
The September debenture sales for the 504 program included its third, and largest 25 year debenture ($58,273,000), priced at a rate of 3.65% and an ongoing Effective Rate to small business borrowers of 5.29%, just 29 bps above Prime Rate. Below is the historical chart for the 20 year debenture series, whose 3.53% debenture rate represented an ongoing Effective Rate of 5.25%.
The Week Ahead
There is light Fed speak, some inflation data, $189 billion in Treasury issuance, and an expected increase in Corporate debt issuance.
Monday – Treasury auctions $90 billion in 13 and 26 week Bills
Tuesday – Treasury sells $26 billion of 52 week Bills and $35 billion three-year Notes
Wednesday – Treasury sells $23 billion ten year Notes; Core PPI expected to be 0.2%, 2.8% y/y
Thursday – Treasury sells $15 billion thirty year Bonds; Core CPI expected to be 0.2%, 2.3% y/y
A quiet week that saw the US and Mexico modify its existing NAFTA agreement, 2Q18 GDP estimate increase to 4.1%, and the market absorb $217 billion of Treasury debt, the FOMC’s target of 2% core inflation in Personal Consumption Expenditures was also achieved. In fact, due to revisions, the target was hit earlier this year.
As seen in this WSJ chart, core inflation has remained below this level for six-years even with declining unemployment in a lengthy economic expansion. Subdued wage growth has been identified as one reason for this, and increased consumer spending and confidence is not expected to move this indicator much higher.
What it does do is affirm the Fed’s intent to continue gradually increasing short-term rates, perhaps as often as twice more this year, with one move expected later this month.
In addition to the partial NAFTA revision, the European Union announced its willingness to eliminate all car tariffs, if done reciprocally. Along with President Trump’s additional tariffs on Chinese goods the impact of this week’s headlines was:
The Week Ahead
Fed speak resumes with just $145 in Treasury Bills to be issued, the SBA 504 program prices its September debenture sales, and Friday is August’s jobs report.
Tuesday – Treasury sells 4 week, 13 week and 26 week T Bills
Thursday – SBA 504 program prices its ten, twenty, and twenty-five year debentures
Friday – consensus for Non-Farm Payroll is 198,000 with the unemployment rate expected to decline to 3.8%, and y/y wage growth forecast to be 2.7%
Fed data dominated a week that saw minimal movement in benchmark Treasury rates, but a continued flattening in the spread between two-year and ten-year Treasury maturities. Monetary policy has seen seven rate increases since December 2015 (175 bps) with the benchmark ten-year Treasury rate rising from 2.29% to just 2.82% on Friday. This YCharts.com display shows how the spread was +260 bps on January 3, 2014, eleven months before the Fed began tightening policy with a series of seven, 25 bps rate hikes.
Even the most recent increase on June 13 affected short-term rates only; the ten-year Note rate is lower by 15 bps since then. This march to a possibly inverted yield curve is viewed by analysts as a precursor to a recession which would compel the Fed to resume an easier monetary policy. Such is the balancing act that awaits Fed Chairman Powell.
Release of the minutes from the Federal Open Market Committee’s August 1 meeting pretty much affirmed their intent to raise rates again on September 26; a 92% probability according to a financial market gauge. Points of interest in the release are:
Additional Fed commentary was provided by Chairman Powell on Friday when he identified “risk factors abroad and at home,” alluding to the recent turmoil in emerging markets. Those comments were followed by an economics research piece from the Fed warning about the potential effects of very low unemployment on inflation. Since we are at full employment, coupled with moderate inflation, it is of some concern that wage growth is static, but the Committee is not going to wait for inflation to rise before continuing its gradual tightening policy.
Economic reports showed housing data was weak, with existing home sales declining for the fourth consecutive month, and Durable Goods orders were lower than consensus.
The Week Ahead
There is $217 billion of Treasury issuance, little Fed speak scheduled, and the Fed’s favorite inflation indicator is released Thursday.
Monday - $96 billion in 13 and 26-week T Bills, plus $36 billion two-year Notes
Tuesday - $37 billion five-year Notes
Wednesday - $17 billion two-year Floating Rate Notes and $31 billion seven-year Notes; plus, the second estimate for 2Q18 GDP, expected to be lower at 4.0%
Thursday – Personal Income & Outlays forecast to be 0.4% for Personal Income, and the core Personal Consumption Expenditure is expected to be 0.2%, 2.0% y/y
The Good, the Bad, and the Ugly
The SBA 504 loan program priced its second 25-year debenture at a rate of 3.71%, representing a 5.35% ongoing effective rate for small business borrowers. This debenture was part of a $373,572,000 sale consisting of:
Walmart reported its strongest sales growth in a decade, sending its share price up 10% even though the company reported a $4.5 billion loss due to its sale of Walmart Brazil.
Treasury rates remain stable, still maintaining a safe-haven identity amidst trade tensions and sanctions.
Retail Sales came in at 0.5% but with June revised down by 0.3%.
Tencent, the Chinese internet giant, reported its first profit decline in a decade due to increased Chinese government involvement in the company’s video game business, which saw a 19% drop in income.
The benchmark CSI 300 index is down 15% since the tariff tirade, reflecting investor nervousness about the longer-term impact of a trade war.
Housing starts came in at 0.9%, but significantly weaker than its 8.3% forecast, due in part to the raging fires in California.
An indication that not all is well in the retail space, JC Penney lost one-quarter of its stock market value, admitting it has had to discount merchandise to compete.
The recent collapse of Turkey’s lira recovered somewhat, but the currency surrendered much of its gains late in the week as it continues to impact the emerging markets space.
Pricing Power, or Lack Thereof
This National Federation of Independent Business chart shows no acceleration in selling prices, indicating there is limited exposure to increased inflation. The maintenance of full employment with an approximate 2% rate of inflation should keep the Federal Reserve Bank on target for its next rate increase, probably next month.
The federation’s Small Business Optimism Index marked its second highest level at 107.9. Also contained in the July report were new records in terms of owners reporting job creation plans and those with job openings.
The story of pricing power is somewhat different for companies in the S&P 500 index, as identified in a Financial Times article. The second quarter of 2018 was the best earnings season since 2010 as profit margins for these companies are on track to increase 24.6% from the same period last year. One executive was quoted “I think, overall, there is very little pushback on price increases,” since the increases stemming from rising raw material costs and tariffs are “well understood.”
The Week Ahead
Light issuance, some housing data, FOMC minutes release, and the Jackson Hole meeting.
Monday – Treasury auctions $96 billion 13 and 26-week Bills
Wednesday – release of the FOMC minutes from the August 1 meeting. Next scheduled meeting is September 26
Thursday – Fed speak will center on the Kansas City Fed’s Jackson Hole Economic Symposium; Treasury auctions $14billion five-year Treasury Inflation Protected Securities
Friday – Durable goods expected to be up 1%; Chairman Powell speaks at the Symposium re: monetary policy in a changing economy
Last week was quiet in the financial markets until Friday when the Turkish lira fell 13%. The currency is now down 40% for the year. As the lira fell, President Trump inflamed the crisis via his Twitter account when he threatened Turkey with tariffs. This boosted fear a bit in the broad financial markets and U.S. Treasuries benefited from a flight to quality. The benchmark 10-year note yield fell 8 bps on the day and 10 bps on the week, to end at 2.85%. Earlier in the week, Treasury completed its quarterly refunding of $78 billion in notes and bonds.
On Thursday the August debenture sale was priced. Please visit the Eagle Compliance LLC website to find details on the results of the sale.
The core CPI rate was of note. In other news, the CPI data for July showed a 2.9% y/y increase in the headline measure, and 2.4% y/y for the core. That core reading edged out highs from 2012 and 2016, now the highest since September 2008, the same month and year Lehman Brothers failed. That’s how long it’s been.
Banks continued to broadly loosen lending standards. Also of interest, and a topic of focus in this note, the Federal Reserve released the latest quarterly survey of bank senior loan officers. There’s useful data in this survey with regard to broad lending conditions. It gives us a sense of where we are in the credit cycle. Chart 1, below, shows the net percentage of domestic banks tightening credit standards for commercial and industrial loans. When the readings are below zero banks are, on net, loosening credit conditions. The most recent reading is minus 16. Over the prior three economic cycles, a reading of about -19 to -24 in this data series indicated the broadest loosening of credit standards.
What this chart does not tell us, comparing one cycle to the next, is if credit standards are absolutely tighter or looser. But we know from our own experience that, relative to today, credit standards were much looser in the cycle prior to the financial crisis last decade.
Chart 1: Trend in Bank Lending Standards
Since the Great Recession, we can see in the chart that there’ve been a few cases where there was widespread loosening of credit conditions only to have banks retreat toward tightening. The first instance of such a retreat to tightening, in 2011, occurred during an intensification of the long Euro crisis. The intensified crisis revealed real Grexit fears, with associated concerns about banking system stability and the European Central Bank’s slow response to contain the crisis. Even U.S. banks turned back toward tightening credit. When the Euro crisis calmed down, banks started relaxing standards again.
Banks then reversed looser standards starting with the 2013 taper tantrum. The Fed signaled the end of quantitative easing and long-term interest rates rose sharply. Quantitative easing did end and the Fed turned to signaling interest rate hikes. Over that multi-year timeframe banks continued to snug lending standards, and even moved to net tightening of standards in the first half of 2016. Lenders, however, eventually became comfortable with a stable and growing economy and a Fed committed to telegraphing a very slow pace of rate hikes and loosened standards again.
As a result, over the last few years an increasing number of banks loosened standards. The latest reading, -16, suggests there is still some room to go in the broad loosening of lending standards but the trend has run much of its course. Lending standards, however, can remain relatively relaxed for a long period of time. Announcements of looser bank regulation may help that.
The Week in Review
The core PCE report kicked off the week with a below forecast y/y rate of 1.9%, with Personal Income increasing by 0.4% in June. This PCE level hovers at the Fed’s target of 2% and while the FOMC meeting produced no change in policy as expected, its announcement did hail the strong economy, with language changed from previous descriptions of it as being solid. The Committee does plan to stay on course for two more rate increases this year, and possibly three more in 2019. In other central bank news, the Bank of Japan expanded its zero-interest rate target to as high as 0.20% for its ten-year JGB debt (trading 0.11% on Friday), and the Bank of England raised its short-term lending rate to 0.75%, its highest level in a decade.
In response to President Trump’s threat to impose tariffs on all $505 billion of imports from China, the Chinese government threatened retaliatory tariffs on another $60 billion of American imports, bring that total to $110 billion, or 85% of last year’s trade figure. The below forecast jobs report of 157,000 for July included upward revisions of 59,000 for May and June, and was very solid. Though wage growth of 2.7% remains below the 4% rate for when Unemployment was 3.9% in 2000, it does remain above inflation and a tight labor market bodes well for wage gains.
As we approach the August debenture sales for the 504 program, we have seen some backup in benchmark rates as the market prepares to absorb the Treasury’s August refunding. CT-10 is up 12 bps since the July debentures were priced, with credit spreads improved and the slope of the Treasury curve unchanged. In the chart below you can see where the benchmark issue tested 3% mid-week and rallied Friday after China’s threat of increased tariffs.
The Week Ahead
Fed speak resumes with some inflation reports late in week. In addition to Treasury sales of $174 billion, Freddie Mac will sell $2 billion in floating and fixed-rate debt, plus the 504 program will sell 20 and 25-year debentures.
Monday – Treasury auctions $96 billion in 13 and 26-week maturities
Tuesday – Treasury sells $34 billion three-year Notes
Wednesday – Treasury sells $26 billion ten-year Notes
Thursday – Treasury sells $18 billion thirty-year Bonds and the 504 program prices 20 and 25-year debentures. PPI is expected to be 0.2% ex food & energy, 2.7% y/y
Friday – CPI forecast to be 0.2% ex food & energy, 2.3% y/y
Best Quarter in Four-Years
Rising from the 2.2% rate of 1Q18, Friday’s first estimate of 2Q18 growth gives evidence the second-longest expansion on record is not expiring. It also identifies why the President is concerned about FOMC plans to continue gradually raising short-term rates. Of course, the offset to his concern is that the report’s strength lends credence to why the Fed is pursuing a tighter monetary policy - keep inflation in check. Even though the Committee concentrates on other inflation indicators (Personal Consumption Expenditures), recent reports for both Consumer Price Index and Producer Price index are well above 2%. Plus, the GDP price index rose a very hot 3%, signaling demand for goods is increasing.
Trade contributed 1.06% as exports rose strongly, but analysts expressed concern that it was the result of customers in several countries getting ahead of the curve before new tariffs take effect. For an economy where consumer spending accounts for 70% of economic activity, real consumer spending rose 4% in the quarter. Taken together, it is clear the Fed will resist criticism and maintain its plan to have as many as two-more rate increases this year.
Other events of interest:
The Week Ahead
Has no Fed speak during the blackout period ahead of the FOMC 7/31-8/1 meeting; Treasury sells just $96 billion short-term Bills, and we get some important economic reports.
Monday – Treasury sells 13 and 26-week T Bills
Tuesday – Personal Income & Outlays report include the Fed’s key inflation indicator, Personal Consumption Expenditures, expected to be 0.2%, 2.0% y/y. Fed begins its two-day meeting with no change in policy expected. Bank of Japan may modify its zero-interest rate policy
Wednesday – FOMC announcement
Thursday – Factory Orders forecast to 0.8%, aided by strong aircraft orders
Friday – Non-Farm Payroll expected to be 188,000, with the unemployment rate possibly declining to 3.9%
After previously criticizing China and the European Union, President Trump on Thursday added the Federal Reserve Bank to the mix by that charging their plan to increase rates “hurts all that we have done.” Traditionally, Presidents and their administrations do not comment on Fed policy, but this administration is not traditional, and the President was echoing comments already made by his economic advisor, Larry Kudlow. The result was to push ten-year benchmark rates higher for the week and steepen the 2/10 Treasury curve. For the week, CT-10 is +6 bps and resting on its 40-week average; the curve is steeper by 5 bps. The market also reacted to speculation that Bank of Japan might abandon its zero-interest rate policy at its July 30 meeting. That policy has kept its ten-year JGB trading at 0.03%.
President Trump does not abide by norms but there is little upside to criticizing the FOMC and its chairman. Central bank independence permits it to make unpopular decisions, like they are doing now, and the President’s displeasure is obvious because higher interest rates strengthen the US$, making exports more expensive. Add this to Friday’s tweet about China and the EU manipulating currencies, plus a comment about possible tariffs on almost all $505 billion of China’s exports to the US, and the impact was as expected – higher rates, weaker US$, and more uncertainty.
Earlier in the week economic reports were positive and Fed Chairman Powell’s Congressional testimony was as expected:
The Week Ahead
The week is light on economic reports (mostly housing data) until GDP late in the week; has $215 billion in Treasury supply, and no Fed speak as we enter the blackout period leading up to the July 31 - August 1 meeting.
Monday – Treasury auctions $96 billion short-term Bills
Tuesday – Treasury auctions $35 billion two-year Notes
Wednesday – Treasury auctions $18 billion two-year Floating Rate Notes + $36 billion five-year Notes
Thursday – Treasury auctions $30 billion seven-year Notes
Friday – First estimate of 2Q18 GDP expected to be +4.2% vs. 2.0% for Q1. Consumer spending expected to be 2.9% vs. Q1 level of +0.9%
“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.