Bonds breathed a sigh of relief after an intense week of economic reporting. The Federal Open Market Committee left short-term interest rates intact, but a .25% point increase in the overnight lending rate is all but a given after the Fed’s next policy meeting in September. Friday morning’s July unemployment report was strong with unemployment dipping below 4%. Total unemployment dropped to 7.5% and the May and June employment numbers were revised higher by 59,000 jobs. Wage inflation remains in check, which definitely gave bonds some breathing room from surging higher after the report was released.
Further pressuring bonds is the desire by central bankers to start dialing back the ultra-accommodative monetary policies we have all become so accustomed to. The U.K., the Czech Republic, and India all raised short-term lending rates as the fear of quickening inflation becomes more of a concern ten years out of the 2008 financial crisis.
Domestically, our own 10-year Treasury note touched over 3.00% mid-week for the first time in several weeks. While trade frictions remain a real potential threat to ongoing global growth for the time being, the markets have shrugged off these fears and focused on U.S. growth, strong corporate earnings, and business confidence, which all support higher interest rates.
While much lower interest rates in Japan and Europe are providing a cap for now on how high our domestic rates may rise, we still are of the opinion that interest rates remain very low by historical standards and therefore we continue to advise locking-in interest rates.
Bonds breathed a sigh of relief as the highly anticipated first reading of 2nd quarter GDP registered at 4.1%, a strong reading, but in line with expectations. However, the report confirms that the US economy is running on all cylinders and business confidence remains high.
The trend with interest rates has been up the last couple of weeks as trade tensions have decreased for the moment and the US and global central banks are slowly removing accommodation from the bond market in their desire to begin to normalize interest rates. This tightening has resulted in a flattening yield curve which has pushed up short-term interest rates and has made borrowing more expensive for business and consumers.
Housing has been a big beneficiary of low interest rates the last decade and with interest rates moving up a touch, we are starting to see how interest rates can work as a restraint in evaluating the purchase of a home. Although rates are just one factor in buying a home, the rise in interest rates is making it a little tougher on buyers.
Next week will be an active report week with several key economic reports slated to be released. With that in mind, we remain biased toward locking-in interest rates at what is still considered a low rate environment.
The yield on the benchmark 10-year Treasury note closed up as President Trump reiterated his desire to keep interest rates low. The President’s remarks helped to steepen the yield curve on Friday in an otherwise light trading environment with no market-moving economic headlines. An inverted yield curve is widely considered an ominous sign and is a respected indicator of a potential slowdown of the economy.
The concern over the President’s comments is that with the economy growing at what many believe is near 4% along with a decades low unemployment rate, on-going low interest rates have the potential to overheat the economy and create a surge in inflation. Alternatively, the argument for on-going accommodating interest rate policy by the White House is the belief that low interest rates and a very strong U.S. economy will give the White House the wiggle room needed to navigate tough talks on trade with our primary trading partners. Given that the German 10 Year Bond is nearly 256 basis points lower than our own 10-year Treasury note — one must wonder what will give – lower interest rates in the U.S. or higher interest rates abroad. Also, given the massive debt on our balance sheet, at what point higher interest rates will become a thorn in the side within our economy is also of much interest to economists. All of this makes forecasting where interest rates will settle a tough task.
U.S. long-dated bonds remain stuck as yields are being weighed down by ongoing uncertainties which include slowing global growth, trade tensions, ballooning debt in China, and Italian political turmoil. Furthermore, uncertainty as it relates to Trump tariff policies and other important trade agreements such as the World Trade Organization has benefited the bond market with respect to lower interest rates. Juxtaposed to the aforementioned, interest rate probably won’t go much lower as inflation is nearing the Fed’s target rate, U.S. corporations are doing well overall, unemployment is at generational lows, and general business sentiment is upbeat. Core PCE, the Fed’s favorite gauge of inflation, touched 2%, a healthy number by Fed’s measurement, and is a sign that the economy is in a sweet spot.
Separately, the yield curve continues to flatten which is a concern and may be forecasting slower growth or some other type of economic/geopolitical issue. Banks dislike a flattening yield curve as it compresses interest rates margin and reduces their income. Borrowers dislike a flattening yield curve because it reduces optionality on loan programs.
With the 10-year Treasury note near 2.84%, we think it’s wise to lock in interest rates as there are many reasons for rates to go higher and far fewer reasons that would move interest rates lower.
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.
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%.
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.
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.
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.
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.