Market Commentary 6/22/18

U.S. bonds traded nearly unchanged for the week as interest rates rate remain capped by a combination of geopolitical and macroeconomic events. Key events this week that kept rates low included increased tariff tensions between the U.S. and China, a choppier stock market with a couple of ugly trading days both here and abroad, and commentary from the European and Japanese central banks about ongoing stimulative interest rate policies. Keep in mind that the world is addicted to low-interest rates and any news from our domestic or foreign central bankers about keeping rates “low for longer” is usually met with a positive response.

We are paying particular attention to the 2-year versus 10-year spread on U.S. Treasuries which compressed to near 40 basis points(bps). Economists consider a flattening yield an ominous signal of a slowing economy and it’s also a key recessionary indicator.

With what we believe to be a few tough weeks of negotiations ahead on tariffs, we are slightly biased toward floating interest rates as we can see the case for rates to go lower. However, if the geopolitical tensions around tariffs ease, we believe rates will rise quickly.

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Market Commentary 6/15/18

Bonds traded impressively in the face of several important events this week. The most important economic event was the announcement by the Federal Reserve to increase short-term interest rates by a ¼% in response to a strong economy. They also stated an intention to pick up the pace of future increases. In his press conference, the current Fed chair, Jerome H. Powell, discussed the need to continue to raise rates in response to a strong economy, which is at nearly full employment, and signs of rising inflation. The Fed raises short-term rates as a defense against overheating the economy and to help protect against asset bubbles, but this comes at a cost to consumers and businesses who will experience higher borrowing costs.

Two other important global events, the U.S. and North Korean summit and the European Central Bank meeting, were also potentially hazardous to bond yields. The US-N.Korea summit was a success which lessened geopolitical tensions and the ECB announced that it will begin winding down its stimulus program, known as quantitative easing, later in the year, but did not expect to raise interest rates until well into 2019.

To make things worse for bonds, the European economy is showing signs of slowing and there’s an emerging threat of a trade war with China, both of which would certainly cap the rise in U.S. bond yields.

We continue to remain cautious with respect to interest rates and are biased toward locking-in rates, especially with the 10-year Treasury note trading near 2.90%.

Market Commentary 6/8/18

U.S. government bond yields dipped and traded favorably this week in response to mounting concerns about emerging market economies, increased tensions over global tariffs between the US and our major trading partners, and the likely prospect of a Fed Rate hike next week. However, the aforementioned events must be weighed against positive factors including the U.S.’s strong economic growth, the low rate of unemployment, and the corporate and personal tax cuts, all of which have increased business and consumer confidence and which continue to support the argument of higher interest rates.

We remain watchful of the 10-year Treasury trading pattern to see if the all-important 3% yield level is breached. We believe rates above 3% is what may make a dent in the value of stocks, bonds, and other hard-asset valuations. We also fear that if the yield pushes above 3%, rates may move higher quickly and volatility will surely follow as well.

With several important meetings next week including the U.S. and North Korea Summit, the Federal Reserve Meeting, and the European Central Bank meeting, we are heavily biased toward locking-in interest rates to protect still historically attractive rates and terms.

Market Commentary 6/1/18

In the past week, we witnessed a global inflow into the safe haven U.S. bond market as yields fell precipitously in response to the turmoil in Italian politics. Italy, as much of Southern Europe, has witnessed anemic growth for almost a decade, still has high unemployment rates, not to mention displaced workers and migrants, all of which has spurred a rise in populism. Thankfully, the fears of a new anti-Euro Italian government were quickly squashed but not before denting the stock market and catching some bond managers off-guard who had placed bets on higher interest rates globally. This week’s issues in Europe support the argument as to why our own interest rates in the U.S. may be capped as we are reminded of the flawed nature of the European Union (think Brexit) and the global implications of even the thought of dismantling the European Union would have on the world economies.

Back in the U.S., jobs are strong and the economy is robust. At least that is how the May Jobs report played out with unemployment touching an 18-year low at 3.8%.

There were 223,000 new jobs created above the 190,000 expected. May hourly payroll increased .3% in line with expectations, and for the time being, is not flashing any real wage inflation signals. Labor Force Participation fell a tick to 62.70%. Bonds responded as expected given the strong jobs report with the 10-year Treasury note closing at 2.900% up from the low of the week of 2.818%.

Housing supply also remains tight due to strong demand and a lack of inventory. At the moment, the U.S. economy is in a Goldilocks environment with a strong business sentiment, low-interest rates, and many jobs and employment opportunities available. Even tough talk from U.S. policymakers on global tariffs did little to unhinge the bond and equity markets. As we have opined previously, the only real threats to the markets currently are geopolitical, which were on display briefly mid-week, but were quickly dispatched.

We remain biased toward locking in interest rates at current levels. Should interest rates rise above 3.25% on the 10-year Treasury, we would see reasons to float interest rates, but given the strength of the U.S. economy and where interest rates are trading currently, we feel locking-in is the right move.

Market Commentary 5/18/18

Higher interest rates were all the rage this week with the 10-year Treasury bond rising to a high close of 3.12% before retreating on Friday. We pay close attention to the 10-year Treasury because it underpins the pricing of various financial instruments from mortgages to corporate debt.

This upward trend in the 10-year Treasury pierced the psychologically important 3.00% threshold which may suggest higher interest rates in the future. The reason for the rise in rates is always complicated, but you can chalk higher rates up to strong earnings and a high level of confidence about the economy, the continued normalization of interest rate policy by the Fed, our huge deficits, and anticipation of QE ending in Europe come later this year. For the week, stocks and bonds shrugged off geopolitical tensions involving disarming North Korea, trade tariffs with China, and tensions in Italy.

With the housing market in full bloom, purchases remain strong and lenders continue to find more creative ways to finance home purchases. With interest rates still in the upper 3% to low 4% range, rates are still attractive historically. Given the above, we are biased toward higher interest rates in the coming months and believe locking-in rates is advisable.

Market Commentary 5/11/18

Bonds traded in a tight range this week while stocks ascended in response to muted inflation data, a decline in volatility, and ongoing strong corporate earnings. Even the U.S. pulling out of the Iran nuclear deal and the resulting Israeli-Syrian conflict could not deter the stock market rally.

Small business optimism remains high, which is a good sign for home purchases, especially in states such as California which have a high number of business owners. Oil traded above $70/per barrel supporting a strong economy spurred on by low rates and reduced regulation amongst other geopolitical factors.

While many economists believe wage and consumer inflation will become more of a factor in the not too distant future, key inflation readings came in lighter than expected. Wholesale and consumer inflation readings were tame and included the widely watched CPI readings. All of this helped keep the 10-year Treasury note at or below 3%, even with central bankers continuing to reiterate the need to move short-term rates higher. We will see how long the “so-called Goldilocks” environment can last given that the U.S. is at or near full employment and the economy is running at high capacity levels, both of which should produce meaningful inflation at some point.

It is hard to argue the lower interest rate narrative for the moment absent a black swan event. Therefore, we remain biased toward locking-in interest rates given the potential for higher interest rates globally.

Market Commentary 5/4/18

Each new month brings a new jobs report which is one of the most heavily watched economic reports on Wall Street. April’s Job Report was no exception with the headline unemployment reading dipping below 3.90%. However, it is what is inside the report that moves the bond and equities markets, and not necessarily the headline reading.

The April jobs report was a bit of a disappointment with 164,000 jobs created versus 190,000 expected. The report did include some positives and negatives within the numbers.

Within the report, the hourly earnings grew less than expected with the annualized pace of wage growth coming in at 2.600%, down from the 2018 January pace of 2.900%. The U6 number, or the total unemployed, fell to 7.8% and the Labor Force Participation Rate ticked down to 62.8% from 62.9%

Earlier in the week, another important inflation reading was published, the Core PCE, which is the Federal Reserve’s favorite inflation gauge. Per this report, inflation grew at 1.90% over the previous 12 months and is now approaching the Fed’s target rate of inflation which is 2.00%. In the Fed’s eyes, a 2% yearly gain in inflation is a sign of a healthy economy and will enable the Fed to continue to raise short-term interest rates. If inflation were to get out of hand (which is not currently the case), the Fed could decide to raise interest rates more quickly to slow down the economy and prevent asset prices from becoming too bubbly.

At the moment, we remain in a “Goldilocks environment” with no sign of a recession. Interest rates, while higher by a bit, are still below 3% on the 10-year Treasury note, corporate earnings continue to beat estimates, central banks around the world continue to be accommodating, and finally, global tensions such as the threat of tariffs with China and the threat of war with North Korea have been subdued.

With all of this in mind, we remain biased toward locking in interest rates given the overall positive economic environment that we are experiencing and expectation of higher short-term interest rates over the coming months which should move the entire yield curve higher.

Market Commentary 4/27/18

Long-term Treasury yields rose in response to ongoing confidence in the U.S. economy. The 10-year Treasury note breached the 3.00% mark this week for the first time in more than four years. The significance of the 10-year rising above 3.00% is that it supports a strong economy and suggests the U.S. is healing and now prospering after the worst financial crisis since the Great Depression, even as some economists believe that the U.S. economy is in the late stages of expansion.

The rise in rates across the yield curve is a response to both the current forecasts by the Federal Reserve of at least three more Fed Funds increases (which would bring short-term rates) from 1.75% up to 2.25% to 2.500% and the sense that wage and consumer inflation may be on the horizon. Further supporting higher interest rates are talks in Europe about the pullback in bond purchases by the ECB, known as QE (“quantitative easing”).

In economic news, the first read on Q1 2018 GDP came in at 2.30% versus the 2.10% expected and down from 2.90% in the final quarter of 2017. Within the report, it showed that consumer spending rose just 1.1% from the lofty 4% gain the in the fourth quarter. Inflation data within the numbers were a bit hotter than expected. If today’s 2.3% GDP reading remains as intact as the final reading, the forecast for 2018 GDP growth is near 3.00%. This is good news for the economy and bad news for bond yields.

With the 10-year Treasury note near 3.00%, we are biased toward locking-in interest rates, but can also make the argument for a small dip in rates given the psychological significance of the 10-year Treasury breaking and closing above 3.00% this week.

Market Commentary 4/20/18

The focus this week was on what is known by investment professionals as the 2-10 spread, which is the gap between short and long-term Treasuries. The gap between these two Treasuries is the narrowest it has been in almost ten years. What we know is that the odds of 3-4 rate hikes on short-term rates, known as the Fed Funds Rate, has increased and that this expected tightening of the money supply may be the cause of a flattening yield curve. The reason that a flattening yield curve needs to be monitored is that while a flattening of the yield curve is not that concerning, should the yield curve invert that inversion would be an ominous sign that a recession may be on the way. A flattening yield curve also hurts the economy as banks make money borrowing short-term and lending long-term. The margin they earn is a result of the spread between short-term and long-term rates.

Late in the week, the 10-year Treasury note moved higher which increased the 2-10 spread. Currently, the 10-year Treasury is yielding 2.94%, a big move from the start of the week which saw this note down to 2.82%. Give credit to the rise in rates to ongoing positive discussions with North Korea, the decreased threat of a trade war with the Chinese, and an overall strong economy.

On the housing front, home inventory remains scarce. We are seeing our lending partners continue to offer more nuanced programs for the self-employed and foreign buyer with attractive rates to accommodate the changing dynamics of the marketplace.

We remain cautious on rates as the line in the sand of 3.00% on the 10-year Treasury note is a concern for us. Given the decreased global risk and positive economic growth globally, we warn of the potential for higher interest rates in the absence of an unforeseen global or domestic shock.

Market Commentary 4/6/18

Bonds were in rally mode this week with the 10-year US Treasury closing at 2.77%, down from a high of 2.95% just a few weeks ago. For now, a 3.00% 10-year Treasury is not a threat. Bonds rallied after another volatile week of trading for various reasons, including: (1) more discussions on tariffs with China and the threat of a trade war, (2) ongoing scrutiny by the public and equity analysts on privacy issues with big technology firms, (3) and a disappointing March jobs report.

The March Jobs Report was a miss, with 103,000 jobs created versus 175,000 expected. However, within the report there were some positives. The two most important factors in the report were a decrease in U6 unemployment from 8.2% to 8%, and the increase in hourly earnings. Keep in mind what we’ve said before: inflation is the archenemy of bonds and wage inflation was a major concern not too long ago.

With the economy at full employment, it is logical to assume that at some point wages will need to increase. The lack of wage inflation has perplexed economists for some time. However, real wage pressure has yet to be confirmed and bonds benefited today from the aforementioned events plus the lack of meaningful increase in wages.

The dip in rates has helped banks price mortgages better late this week. We are cautiously biased toward floating interest rates given the ongoing volatile environment. We are carefully monitoring the 10-year Treasury note and view 2.92% as the line in the sand for higher rates.