It was a tough week for stocks and bonds. Several factors were at play, including higher interest rates, geopolitical risks such as the threat of trade tariffs with China, and eurozone risks including the looming issues with the Italian debt markets. On Friday, soft inflation data coupled with good bank earnings helped to ease the rise in bonds and calmed U.S. equities markets. However, the trading week was brutal as both stocks and bonds broke down and the reliable relationship that usually sees government and treasury bond yields rally when stocks experience steep declines.
As the Fed attempts to normalize interest rates after a decade of ultra-low or accommodative rates, it should come as no surprise that equity markets could be hurt by a repricing of risk based on higher interest rates. However, our hope remains that the Fed will be able to move to a neutral rate without the equity tantrums seen a few years ago. The U.S. economy remains strong with business confidence high, corporate earnings healthy, and major economic readings continuing to support more normalized interest rates. Therefore, rates are being moved higher for the right reasons at the moment.
Fears remain which could help bond yield stay attractive here in the U.S. including the aforementioned issued with Italy debt, the slowing of the Chinese economy, and near-zero interest rates in Japan and Germany. Rate experts do see the 10-year Treasury note, the benchmark for pricing everything from car loans to mortgages, settling in between 3.25% to 3.500%, which is still attractive from historical perspectives.
New home buyers can use the recent rise in interest rates to negotiate with sellers on price. Banks need to lend and are continuing to hold down shorter date ARM rates in a bid to drive business. We remain cautious and believe locking-in rates at still attractive levels is the prudent move.
What a difference a few weeks make! It was only a short while ago that we were opining on the dangers of a flattening yield curve. Those fears have all but disappeared as the bond market had a tough week in the face of quickly rising bond yields. Both the 10-year and 30-year U.S. Treasuries hit highs not seen for many years. Rising rates reiterate our belief that interest rates are going up for the right reasons: strong economic data, strong corporate earnings, low unemployment, and manageable inflation.
However, as interest rates continue to move higher, the low-interest rate environment we have all become so accustomed to is affecting both the real estate and equities markets as investors evaluate how much higher interest rates will affect valuation. Buyers may want to use this to their advantage as they negotiate purchases.
The big economic news this week was that The Monthly Jobs Report, one of the most watched economic reports in the marketplace, supported our view that the U.S. economy remains strong. The unemployment rate reached a low not seen in almost 40 years, with a reading of 3.70%. Annual wage growth came in a nudge under estimates which helped to prevent bond yields drifting higher.
This column has been vocal about locking-in interest rates for several months. This week demonstrated how floating interest rates can be so dangerous, especially when momentum is gaining for higher yields. While we believe a lot of the damage has been done with regards to higher rates near term, it would not surprise us to see rates gradually increase in the coming months. With that said, banks need loans and we are working closely with our lenders to find ways to offer highly competitive terms to for our borrowers in the face of higher interest rates.
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The big economic news this week was from the Federal Open Market Committee (FOMC) which, as expected, increased overnight lending rates by .25% point. These rates are now pegged at 2.00% – 2.25%. The increase came as no surprise to markets as it was well forecasted by the Fed.
As with each of these meetings, the real focus is on the discussion with the Fed Chairman after the committee vote. Chairman Powell calmed the bond markets with his commentary and his belief that inflation will remain tame, which was supported Friday morning by the Fed’s favorite inflation gauge, the Core PCE, which was unchanged from July to August and remains at 2%, right within the Fed’s target range. Government and mortgage bonds traded well after the meeting and the trend looks as if it will continue through the week. Further helping to keep a lid on our domestic interest rates are potential debt and political issues in Italy, a slowing European and Chinese economy, and ultra-low interest rates in Japan. For the moment, the U.S. is outshining the rest of the world as our domestic economy is booming, consumer and business confidence is high, and company earnings remain strong.
As short-term interest rates gently move higher, there are some experts contending that it is time to be more risk-averse. Remember it has been ten years since we have seen interest rates at current levels and with high equity valuations as well as home and commercial real estate prices at pre-recession levels, we agree with this sentiment. However, there appear to be no signs of a recession and due to more robust underwriting guidelines in residential lending, banks remain stringent which will protect banks during the next recession.
However, given the strong fundamentals of our economy, interest rates while off of historical lows, are still attractive. Therefore, we continue to advise our clients to lock in interest rates as the safer decision.
This week marks the 10-year anniversary of the Lehman Brothers collapse. Some reflection on this historic and painful day is in order. The collapse of Lehman Brothers was the darkest hour in the U.S. housing market crash. To summarize, it was a direct result of years of lax and very risky loan underwriting, which included loans on properties with no down payment or no verifiable income or assets, toxic pay-option ARM’s (amongst many other poorly underwritten residential and commercial loans), and the subsequent bundling of these mortgage into complex securities, which were misleading and much riskier than investors thought.
The U.S. government’s response to this financial catastrophe was a massive federal bailout to backstop our entire financial system in order to jump-start the economy and restore business confidence. The massive failure of our financial system led to years of strict underwriting and a new era of regulations on residential home loans. Fast forward ten years and bank underwriting remains intelligent and rigid, although we are seeing some more creative products return to the market to serve the self-employed. Borrowers in the markets we serve appear to be doing well (U.S. unemployment is under 4.00%) and home values have returned to their pre-recession levels or higher, in most major markets.
With interest rates on the rise, the Fed is now attempting to normalize interest rates in order to stave off the next potential bubble. As interest rates move higher, what happens next is anyone’s guess, but I believe we will see a slowdown in home appreciation as well as more volatility in both the stock and the commercial real estate markets. Inflation remains muted but is definitely beginning to show signs of reviving. Business confidence is high and while the flattening of the yield curve is of some concern, most economic strategists don’t foresee a recession in the cards anytime soon. To summarize the sentiment of most of our clients, “business is good.”
With all of that said, we continue to remain cautious with respect to interest rates as the 10-year Treasury note sits a tick under 3.00%. With the economy doing well and the Federal Reserve committed to moving short-term interest rates higher, there are many more reasons for rates to move higher rather than lower at the moment and locking in rates remains the right decision.
U.S. interest rates continue to trade in a tight range in response to emerging markets’ struggles with dollar-denominated debt and Europe’s slowing economy as government interest rates in other major economies remain at or near zero.
Also helping to keep rates low is slow and gradual inflation data. This week, the Fed’s preferred measure of inflation, the personal consumption expenditure (PCE), ticked up but was in line with forecasts. Inflation is not necessarily a bad thing if kept in check, and the most recent report confirms a healthy level of inflation.
Even with housing data suggesting a slowdown in home sales, consumer confidence remains strong, as are corporate earnings and domestic economic growth.
The so-called flattening yield curve causes some concern. Short-term and long-term Treasury spreads are right around 20 basis points. There are many theories as to why, but we advise to watch this closely, because should the yield curve invert, this inversion may be signaling an oncoming recession. For the moment, there is no real data suggesting a recession is around the corner.
We continue to remain cautious and believe locking-in interest rates to be the prudent choice. While we don’t see interest rates dramatically moving higher short-term, we would not be surprised to see the 10-year Treasury note trading above 3% in the near future.
Have a great and safe Labor Day!
Rates are set to close flat for the week as we near the end of summer and many traders are out of the office. The U.S. stock market reached a milestone as the longest bull run on record. All signs domestically point to the “Goldilocks” environment continuing for stocks and bonds as the economy is very healthy, consumers are spending, unemployment is low, and inflation is in check. Fed Chairman Powell echoed our comments in his remarks at Jackson Hole and his comments confirmed that a 1/4 point increase in the overnight lending rate is a given at the September FOMC meeting and that continued gradual increases in short-term lending rates are appropriate given the current positive economic environment.
With Europe’s economy slowing, Japan’s interest rates at or below 0% and China beginning to stimulate again due to a weakening economy, U.S. interest rates appear to be capped by these exogenous circumstances, even as we reiterate that our domestic economy is the best we have seen in many years. Also capping interest rates are the factors of ongoing trade tensions with China, a decline in emerging stock markets, and subdued inflation.
In housing news, Toll Brothers reported better than expected earnings as luxury home buyers continue to be active even with the increased rates and home prices juxtaposed with middle income and lower income borrowers being priced out as new home sales continue to fall even with more inventory coming on the market.
With the 10-year Treasury note trading at ~2.83%, interest rates are still low and accommodative. While we don’t have a crystal ball, we continue to maintain a locking-in bias for new loans as we see more reasons for interest rates to move up rather than down.
U.S. stocks were lifted in the later part of the week after a rough mid-week trading session. Factors that helped include strong quarterly sales from retailers and news of resumed talks with China on tariff negotiations. Consumer spending is up, encouraged by a strong domestic economy, rising wages, and improved employment opportunities. Business confidence remains high and the U.S. economy continues to remain unaffected by the respective slowdowns in the Chinese and European economies.
However, even in the face of a robust U.S. economy and powerful stock market rally, bond yields remain attractive with the 10-year Treasury note trading at 2.86% late day Friday. Treasury yields have been held down by the fear of a global slowdown due to trade tensions, the potential recessionary “flashing yellow light” of the flattening yield curve, the drop in copper and other commodities prices, and a poor sentiment reading from the manufacturers’ survey. Bonds were also helped further by the flight to safety in response to political and economic turmoil out of Turkey which spurred fears of contagion throughout developing economies.
Even with the many problems in the world today which could push bond yields lower, we continue to remain cautious on interest rates going lower and are biased toward locking in interest rates given the current state of our domestic economy and the likely prospects of continued short-term interest rates hikes anticipated by the Fed in the coming months.
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.