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.
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.
Concerns about technology companies and potential trade wars set the markets on a downward surge this week. Global equities fell Thursday and continued falling on Friday. Treasury and mortgage yields fell slightly, but the bond markets’ response was muted given that the Fed raised short-term interest rates on Wednesday while global growth remains strong.
Some highlights from the Fed’s press conference were:
- Expect at least two more rate hikes this year.
- Expect inflation to finally rise due to pro-business policy and lower corporate tax rates.
- Inflation to touch 1.9% and rise above its 2% target next year.
- Government spending (infrastructure spending) will stimulate the economy.
- The GDP forecast for 2018 is 2.7%, up from previous forecast of 2.5% back in December.
With the 10-year Treasury note moving down to 2.81% from a high of 2.89% earlier this week, we are open to floating rates as the equity markets are burdened by global trade war tensions and the potential for inflation. We would become even more bullish on bond yields moving lower should we see a move below 2.800% on the 10-year Treasury note.
Purchase season is gearing up and even with rates moving up, lenders remain hungry for new business and continue to offer competitive and historically low interest rates.
Government and mortgage interest rates edged higher Friday morning after trading better for the week. Even the weaker than expected housing data reported for February did not benefit the bond market.
By all accounts, the U.S. economy remains strong as evidenced by strong consumer sentiment. While the CPI inflation readings pulled back from last month, the consensus remains intact for higher interest rates. With the two-day Fed meeting set to kick off on this coming Tuesday, traders may not want to make any big bets ahead of Wednesday’s 2:00 p.m. ET release of the monetary policy statement. It is almost 100% certain that the Fed will raise rates by .25% to 1.75%. This predicted rate increase in short term lending rates will come as no surprise to the market. Keep an eye on the policy statement as this will provide clues to where the Fed officials feel the economy and inflation is headed.
The Commerce Department reported that housing starts fell 7% in February from January due in part to a plunge in multi-dwelling units. Building permits fell 5.7% from January. Housing remains severely constrained, especially in coastal cities. Prices are high and inventory low. The lack of future incoming supply is worrisome, but to date higher home prices have not stopped buyers from entering the market.
The yield on the 10-year note fell to 2.80% yesterday, which is acting as support and has increased to 2.85% this morning. A break below 2.80% on the 10-year note would be a welcome sign, however getting there would require some new worries or unexpected bad economic news.
With the economy and consumer sentiment robust and the likelihood of higher short-term interest rates is all but a given, we remain biased toward locking-in interest rates. Lenders remain hungry for business and continue to tweak rate sheets to attract the best quality borrowers which is helping keep rates attractive by historical measures.
Economic and geopolitical news captured the headlines this week. By Friday, global equity markets rallied hard in response to the watered down Trump tariffs, as well as easing geopolitical tensions with North Korea.
The equity markets were also spurred on by a strong February jobs report (313,000 new jobs created vs. 210,000 estimated). Furthermore, December and January new jobs were revised higher by 54,000 new jobs created. While bond yields rose, yields were kept in check by wage inflation from lower than expected wage inflation data. The improvement in the Labor Force Participation Rate from 63% from 62.70% helped explain why wage inflation remains tame given that the economy is at full employment.
The European Central Bank (ECB) modified commentary regarding how it buys bonds that supports the improving economic landscape in Europe. It’s also interesting to note the delta between U.S. long-term Treasuries and the equivalent long-term German Bund. The spread on each respective 10-year government bond is now over 125 basis points. Given the positive economic news out of Europe, one may argue European bonds may rise in the near future. Back in the U.S. given the confluence of strong economic earnings, low employment, and a bullish stock market, three Fed rate hikes seem likely. All signs point to modestly higher interest rates.
While higher interest rates will make it harder for some borrowers to qualify for new home purchases and refinances, the increase in rates is attributable to positive economic forces. Housing demand remains high while housing supply is limited. Banks are eager to lend and make deals work. With little to no bad news to fall back on, we continue to see little reason to not lock in interest rates at this time, and continue to remain biased toward locking in interest rates.
It was a packed week of economic commentary beginning with newly appointed Federal Reserve chairman speaking to Congress in his first big public commentary as Fed Governor, and ending with an impromptu announcement by President Trump on steel tariffs (more on this next week).
Chairman Powell’s comments reflected his more conservative posture as he opined on the strong economy, expectations of increasing inflation, and measured rate increases this year and into 2019. He did scare some with his use of the word “overheating” and that had a negative effect on the stock and bond market midweek.
Love him or hate him, President Trump stayed true to his campaign promise to impose tariffs on the steel industry. It is too early to speculate how this protectionist policy will play out long term, but early on both the bond and equity markets traded negatively in response to his impromptu and “details to follow” announcement.
The big economic reading this week was the Fed’s favorite gauge of inflation, the personal consumption expenditure (PCE), was unchanged at 1.500%. This author was disappointed that bonds did not react favorably to this tame inflation reading, but given the “hawkish” comments from Mr. Powell earlier in the week, I was not surprised.
Even with the 10-year Treasury touching a high of 2.94% this week, banks remain ultra-competitive as loan originations on refinances have slowed. This remains a boon for new home buyers, especially those interested in portfolio jumbo products.
We remain cautious and biased towards locking in interest rates as we believe the chances of higher interest rates outweigh any argument for lower interest rates.
U.S. bonds and equities traded positively today as bonds attempted to recover from touching the highest yield seen within the last four and a half years. Equities continue to recover from the violent sell-off witnessed a couple of weeks ago.
The 10-year Treasury note, which is a barometer for all types of credit from consumer loans to corporate debt, reached 2.960% mid-week, but closed out the week a touch lower at 2.886%. We expect the 10-year to reach 3.000% near-term and we’re delighted to see some retrenchment in interest rates after what has been a rough couple of weeks for bonds. With little economic news out this week, the market experts are all awaiting some key reports due out next week, notably data on housing, GDP, and the closely watched Core PCE (personal consumption expenditures), which is the Fed’s favorite gauge of inflation. If the PCE reading is hotter than expected, global government bond yields will move higher quickly.
As to why interest rates are moving higher, we believe the reasons are mostly positive and may be attributed to ongoing signs of robust global growth, business optimism, strong earnings forecasts, the unwinding of QE (quantitative easing) and rising consumer and wage inflation. Whether or not the move up in interest rates becomes an impediment to the economy is yet to be determined. Our belief is that should the long bond 10-year Treasury yield hit above 3.250%, we will see increased volatility in equity and hard asset pricing.
We remain biased toward locking in interest rates as we are still locating attractive home loan programs by historical standards, but at the same time, we are witnessing much greater volatility in the daily pricing sheets from our lending relationships.
The yield on the benchmark 10-year Treasury note, which affects yields on all types of financing, rose to a four-year high this week. The rise in yields was stoked by ongoing inflation concerns which were further supported by higher inflation data at both the consumer level and wholesale level. Stronger inflation may cause the Fed to raise short-term interest rates more than forecasted this coming year which would not be friendly to bonds. However, after two weeks of selling in both the stock market and bond market, equities shined higher this week, even with the 10-year Treasury note touching 2.95%. At what point Treasury yields “take the shine out of equities” is anyone’s guess, but this author’s feeling is that rates moving above 3.000% will put pressure on equities and hard assets.
The big question that remains is whether inflation will continue to rise and eventually meet or exceed Fed inflation target rates. A faster pick-up inflation could result in another vicious bond and equity sell-off.
While interest rates are higher, rates are still attractive from a historical perspective. It also should be noted that rising inflation is not “all bad” as recent increases in both wage and consumer inflation are being supported by a strong global economic expansion and a high level of business confidence in the U.S. The low level of housing inventory, will continue to keep home demand high with lenders increasing loan product offerings in the face of rising prices and an ultra-competitive purchase market.
With the big move in rates, we remain cautiously biased toward floating interest rates due to the quick move higher in all yields the past couple of weeks. We reiterate this position with extreme caution as the bond market has not been friendly to those borrowers floating interest rates as of late.
After several months of tranquility, volatility has definitely returned to both the bond and equity markets. All major U.S. indices traded down near or above 2% on Friday after a choppy week of trading. The 10 Year U.S. Treasury broke through key technical indicators and closed above 2.84%. Some of the factors propelling Friday’s negative market include fears of inflation, mixed earning from big tech companies this past week, as well as rumors about global central bankers looking to reduce quantitative easing, and an unease with the rapidity of the market’s rise over the last few months.
In economic news, the January jobs report was solid with 200,000 jobs created. Unemployment remained at 4.100%. The big news (of which we have been warning our readers) is that there was an uptick in wage inflation. Bonds responded as expected and traded higher in response to the threat of increased inflation. Why is higher wage inflation scary, when one would think higher incomes are good for the economy? The answer is that for a long time, assets have been priced against ultra-low or negative interest rates. Rising inflation also affects bondholders as rising rates hurts bond portfolios. With the government debt yields moving higher, risky assets may become less appealing. All of this was at work this week.
In defense of interest rates, rates are still low from a historical perspective. However, we must keep in perspective that the reason interest rates are rising is that the economy is doing well. With the 10 Year Treasury hitting 2.85%, we remain cautious and biased toward locking-in interest rates unless you have the stomach to weather continued volatility.
Stocks rose and bond yields worsened Friday despite slower than expected U.S. economic output. The miss in 4th Quarter GDP, which rose 2.600% below the 2.900% expected, was largely a result of U.S trade imbalances. However, within the report, consumer spending grew at the fastest clip in two years. Business spending also surged and December Durable Orders grew by 2.9%, well above the 0.9% expected.
The rise in the stock market Friday has more to do with Mr. Market looking ahead at 1st quarter GDP readings and how the added business tax cuts from this past year’s tax reform will affect future growth. Bonds also appear to be adjusting higher in anticipation of consumer and wage inflation. Inflation is the archenemy of low interest rates. With the 10 Year Treasury Note breaking through the 2.62% ceiling of resistance, this now becomes our new support level and it will take significant negative news to push yields below 2.62%
With the rip-roaring equity rally that we are witnessing, we are biased toward higher interest rates and continue to advise clients to lock in interest rates. It is important to note that lenders are still offering adjustable rate mortgages (ARM’s) in the low to mid 3 percent range and 30-year mortgages are still in the low 4 percent range. By historical standards, interest rates remain very attractive and the move higher in rates should not adversely affect home buying decisions.