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.
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%.