You might think the big economic news this week was the .25% increase in the Federal Funds Rate to a range of 1% to 1.25%, but the real news is that the Federal Reserve raised short-term rates even though there are signs that inflation is cooling. With unemployment at 4.3%, economists have been confounded as to why wage inflation has not appeared. The Fed explained their rationale for raising rates on the basis that price inflation and wage inflation will eventually make its way into the economy and that low inflation is probably temporary. Overall, inflation remains below the 2% target rate. The jury is still out whether or not the Fed’s thesis will hold true.
Psychologically, the Fed’s rate increase telegraphs its confidence an overall improvement in the US economic picture. Surprisingly, bonds rallied lower Wednesday in anticipation of this announcement with the 10-year U.S. Treasury touching its lowest level this year. Equities also traded well. Bond traders are closely watching the 2-year-to-10-year Treasury spread which continues to flatten and may be signaling a slowdown in the economy. A flattening yield curve is never a good sign, but so far the markets have not been deterred by this pattern.
In other news, May housing starts fell 5.5% from April to an annual rate of 1.092 million units, well below the 1.227 million expected. It was the lowest rate since September 2016 and the third straight month of declines. Starts are down 2.4% from May 2016. A larger drop was seen in the multi-family home sector. A slowdown in housing starts is likely to weigh on economic growth, which is good news for bonds and the continued trend of low interest rates.
We continue to watch rates and rate spreads as we advise clients on mortgage rates and remain cautiously biased toward floating interest rates given that bond yields responded well to the Federal Reserve’s decision to raise short term rates.
Bond yields ended the week a touch higher after a wild week of political uncertainty culminating with the testimony of former FBI Director James Comey. The equity markets responded favorably as the testimony revealed a potentially inappropriate private conversation between President Trump and the former director, confirmed that the President was not under investigation, and revealed that many news outlets had been misinforming the public on the Trump-Russia connection.
Across the pond in Europe, the UK votes delivered a stunning blow to Prime Minister May and her conservative party. The vote raises the possibility of whether the Brexit negotiation should be put on hold while the British sort out their political crisis. The UK pound plummeted in response to this vote. Uncertainty typically benefits bonds and the low European rates have helped keep our rates in the U.S. low.
The idea of “buy the rumor and sell the news” held true for U.S. bonds as rates rose as fear eased this week. The next big economic event is the Federal Open Market Committee’s meeting next week. All eyes will be on what the Fed has to say about the state of the economy and on short-term interest rates.
With mortgage and treasury bonds trading close to their 200-day moving average, we remain biased toward locking in interest rates. We envision too many scenarios that could push rates higher and not enough catalysts to lower interest rates.
Surprisingly, U.S. equities traded higher Friday morning to new all-time highs in reaction to a very poor May U.S. jobs report. Bonds also benefited from the poor report with the 10-year Treasury note touching 2.140%, breaching the 200-day moving average of 2.170%. Even though the unemployment rate fell to 4.30%, the lowest reading in 16 years, the concern within the report was the drastic slowing of new hires. The expectation for new jobs in May was 184,000 versus actual new job creation of 138,000. Finally, the labor force participation rate fell to 62.90%, and has trended near the lowest level in 30 years.
The drop in unemployment supports the belief that the U.S. economy is near full employment. Ironically, wage inflation remains flat which is one reason why bonds continue to trade attractively. The soft report supports the need for tax reform and infrastructure spending to boost job growth.
It is widely believed this report did little to change the trajectory of the Federal Reserve’s short-term interest rate forecast. The odds are very much in favor of a June quarter point (.25%) rate hike for short-term interest rates.
We continue to be biased toward locking in interest rates at these lower than expected levels.
For the first time in quite some time, U.S. bond and equity markets showed increased volatility on the heels of President Trump’s firing of FBI Director Comey. In tandem with that, there was increased turbulence in the White House surrounding allegations of possible Trump-Russia collusion, though no hard evidence has surfaced as of yet. Investors seem less concerned with the potential conflicts with Syria and North Korea. There is a lack of certainty over the Trump administration’s ability to pass promised pro-growth tax reform. Trump’s unorthodox style came to a head on Wednesday, which saw a massive rally in bond yields and also a violent sell-off in stocks due to the aforementioned concerns. The markets traded better on Friday as this market has proven to have a short memory.
Overall, U.S. earnings were strong for the first quarter, and ultimately the stock market trades on earnings and earnings growth. The one question on everyone’s mind is how the stock market will react to the Trump administration’s actions on policies on tax cuts, deregulation, and infrastructure spending. The success or failure of tax reform will have big consequences later in the year with respect to interest rates.
With the 10-year Treasury note closing below 2.25%, we remain biased toward floating rates. We are closely watching support (2.16%) and resistance (2.61%) on the 10-year note. Breaking below or above these levels could mean much lower or much higher interest rates. For the moment, we are delighted for the positive week and better pricing for our borrowers with the drop in interest rates.
U.S. government bonds and mortgage rates have been strengthening since yesterday afternoon and throughout today as demand for safe haven assets increased. U.S. equities closed the week out with their worst trading week in about a month.
One reason for the rally in bond yields today was the soft reporting out of the Consumer Price Index (CPI), which is a closely watched inflation indicator and measure of what consumers pay for most finished goods. The CPI index was up 0.2% in April and in line with estimates. Core CPI, which strips out food and energy data, saw a just 0.1% gain in April, a touch below the 0.2% expected. The year-over-year CPI reading slipped to 1.9% from the plus 2% that has been the norm over the past 12 months. This low trajectory of consumer inflation is good news for bonds and as evidenced by the 10-year Treasury yield closing the week out at 2.32%.
On a separate note, first-time home buyers are on the increase. The Census Bureau shows that 854,000 new-owner households were formed during the first quarter of 2017 versus the 365,000 new rental households. It’s the first time in 10 years that there were more new buyers than new renters, according to Trulia.com. Seeing such a shift from buying a home rather than renting is a very good sign of ongoing confidence by young people in our economy. We are delighted to see that the younger generations are participating in the American dream of owning a home.
Given the strong rally today in bonds, we are biased toward floating rates as we can see rates dropping further in the short term. In the long term, the old notion of “don’t fight the Fed” must not be forgotten. The Central Bank continues to call for higher interest rates, and we feel one must be pay close attention to their commentary.
The April jobs report confirmed continued improvement in the labor force with 211,000 new jobs created in April, above the 180,000 expected. That was well above the anemic 79,000 jobs created in March, which had been revised lower from the 98,000 originally reported.
The report’s key data findings were as follows:
* The total unemployment or the U-6 number, fell to 8.6% from 8.9%, which is the lowest rate of unemployment since November 2011.
* The unemployment rate fell to 4.4%, the lowest level in 10 years.
* Average hourly earnings rose 2.5% year-over-year as of April, compared to the recent high of 2.9% in December.
* The Labor Force Participation Rate (LFPR) edged lower to 62.9%, still at decade lows.
Overall, the report was positive given that this is the 93rd consecutive month of the economic expansion. However, wage growth rates have been anemic even as more jobs are being created and this is one reason why bonds did not sell off in response to the report. Economists continue to be perplexed by the low rate of wage growth and the general lack of inflation considering the massive amount of liquidity that has flooded the global marketplace over the course of this economic recovery.
Interest rates remained basically unchanged from last week. It is unclear where the economy is headed from here, with various indicators conflicting. On one hand, strong corporate earnings and consumer sentiment reports suggest a surging economy. On the other hand, published soft economic data suggest things are anemic at best.
Domestically, the big news this week was the first reading on Q1 2017 Gross Domestic Product (GDP). GDP fell to 0.7% in the first quarter, below the 1.1% expected and below the 2.1% recorded in Q4 2016. In addition, consumer spending plunged to 0.3% from 3.5% last quarter, the weakest showing since Q4 2009. The weak consumer spending was blamed partly on the mild winter, which translates to less spending on utility bills. However, there were some inflationary readings that were bad for bond yields. Personal consumption rose 2.4%, the highest since Q2 2011. The inflation reading for the Employment Cost Index, which measures wages and benefits paid to workers, rose 0.8% in Q1 2017, the fastest pace in seven years. All in all, this mixed bag of GDP data did little to move bond yields off of current levels.
Overseas, Japan and Europe remain committed to keeping interest rates low as each country tries to stimulate economic growth. This has benefited U.S. bonds by providing a ceiling on spreads between foreign and U.S. government interest rates, and between mortgage and corporate yields, especially if one believes the economy is improving.
With the 10-year note yield once again hovering at 2.30%, we continue to remain biased toward locking in interest rates at what we know to be still near historically low interest rates.
Interest rates have moved lower. Combined with geopolitical anxiety and a persistently weak economic expansion, these factors have juiced the U.S. bond market this week. Treasury Secretary Yellen has recently remarked that a sweeping tax overhaul plan is nearly ready and the U.S. equity markets rallied on this news. Her statements have reassured the markets this week. Government and mortgage bonds remain attractive with the U.S. 10-year Treasury trading under 2.25%.
Bonds have benefitted from recent geopolitical trends. Fears of a possible Marine Le Pen election and potential “Frexit” have been spooking the market. There is a lack of certainty over how this will impact the Euro. This extreme move would have major global economic and geopolitical repercussions and may be one reason U.S. yields have dipped. Thankfully, the U.S. has engaged China to help calm down the situation in North Korea, and news out of Syria and Afghanistan has been quiet since the U.S bombings a couple of weeks ago.
From a technical standpoint, interest rates have not been able to break through lower resistance bands. Therefore, we remain biased toward locking in loans at these lower rates, especially given that most economists and even the Federal Reserve continue to discuss the justification for higher interest rates given the current state of the U.S. economy.
Government bond yields fell this week as investors are reconsidering whether or not Trump’s economic policies will deliver a welcomed boost to job growth, inflation, and interest rates. With many investors wondering how all this will play out, interest rates benefited by heading lower. Other factors further pushed yields down, including geopolitical events in Syria, North Korea, and France (where two of the four leading presidential candidates are European Union skeptics). The 10-year U.S. Treasury closed this shortened Easter holiday week down at 2.237%, its lowest level since November.
We can make the argument either way for both higher or lower interest rates and so we remain cautious with a bias toward locking.
Bond yields were muted this morning despite airstrikes in Syria yesterday and an underwhelming Jobs Report. One would think bond yields would fall given this combination of circumstances.
We will start with the jobs report.
The most recent Jobs Report notes that only 98,000 new workers were added in March, well below the 180,000 expected, while January and February readings were revised lower by a total of 38,000 jobs. The Unemployment Rate declined to 4.5% from 4.7% and below the 4.7% expected with Average Hourly Earnings rising only 0.2% versus the 0.3% expected. The Labor Force Participation Rate (which is a broader measure of employment) remained at 63%, a multi-decade low.
The significance of March’s punk Jobs Report is how it will affect the Fed’s interest rate forecast. The March jobs data does not support additional rate hikes and may give pause to the recent suggestions by the Federal Open Market Committee that 3 to 4 rate hikes are in order. Furthermore, the poor data within the jobs report supports the need for tax reform along with infrastructure spending in order to boost the economy.
Now on to Syria.
The U.S. launched a missile strike on Syria last night. U.S. officials described this as a one-off attack that would not lead to wider escalation. Typically, we would see bond yields drop in the face of such action, but we live in unusual times at the moment.
In closing, the U.S. bond market remains focused on President Trump’s economic policy reform which is unfriendly news for bond yields, and one big reason why U.S. bond yields are not trading as expected. Therefore, we continue to be cautious. This week, we are biased toward locking in interest rates at current trading levels. Should we see the 10-year Treasury break below 2.300%, we may see interest rates move lower.