The Consumer Price Index (CPI) was stronger for August and beat expectations by rising .2% month over month. Rising CPI indicators are inflationary and increase the likelihood of increasing bond and mortgage yields. Core CPI, which excludes the impact of food and energy, also came in above expectations.

The above inflation numbers will put additional pressure on the Federal Reserve to give strong consideration to raising short term interest rates by the end of the year.

With core CPI running at a 2.30% annualized rate and with the unemployment rate below 5%, there are calls from prominent Wall Street veterans such as Jamie Diamond of JP Morgan to increase short-term lending rates by year’s end. With this in mind, we remain mindful that the 10-year Treasury Note is still at a very attractive sub 1.750% and locking in interest rates in the face of the inflationary data is a prudent decision. However, given the poor state of the global economy, lowered interest rates would not surprise us. In summary, the world is very complicated from a macro level.

The big news this week was a surprise Fed speech by Fed Governor Lael Brainard who is wildly considered the Fed’s most dovish official. These comments Friday morning, which surprised both the bond and equities market, resulted in a heavy sell-off in U.S. equities, as well as an increase in bond yields. With the world economies addicted to extraordinarily low yields, Friday was a perfect example of how sensitive our markets are to low interest rates and how volatile the markets may become if the Fed raises interest rates near term.

From abroad, a less dovish stance by the European Central Bank put further pressure on bond yields.

Economic reports remain mixed, so there will be a lot of discussion over the coming days as to what matrices the Fed Reserve is studying in deciding future rate movements.  The Fed’s mandate is to support maximum employment and inflation. Based on these two indicators, one could argue that a rate hike is warranted.  However, with the global economies so intertwined, one could also argue there’s a need to keep rates low for longer.

Given the spike in the 10-year Treasury yield from 1.500% to a Friday close of 1.67%, we are biased toward locking in loans. The next couple of weeks could be very volatile from both political and economic standpoints.

As with each new month, all eyes were on the August Jobs Report, which came in lower than expected with 151,000 new jobs created versus expectations of 180,000 new jobs. The unemployment rate remained at 4.90% and the Labor Force Participation (the amount of people actually in the labor force as % of population) held steady at 62.80%.

This probably means no rate hike announcement at the next Fed meeting. One wonders how many more times the Fed will talk up a rate hike only to be disappointed by a lackluster economic report.

With the 10-year U.S. Treasury Bond trading a touch above 1.600%, we are biased toward floating interest rates at these levels ever so cautiously.

Have a great Labor Day Weekend!

Not much to report on this week with respect to economic news. The one headline that caught some attention was the diverging opinions within the Federal Reserve concerning the timing of a rate increase. There appears to be no clear message out of the Fed as to what will be the trigger for an increase in interest rates. The bond market had a muted response to the Fed Minutes as bonds are mildly off their lows from earlier in the week and fell range bound (1.500% to 1.600% on the 10-year U.S. Treasury note).

When it is all said and done, bond yields are all about inflation and economic data. We see little inflation at the moment (although WTI oil traded up $4 this week to barely over $48.00 per barrel) and we are keenly aware of the global economic troubles that are abound.

It sure feels like a goldilocks scenario with the market being stoked by low-to-negative interest rates, slow growth, and low inflation. That said, new highs were hit this week for the troika of the stock indexes. The U.S. 10-year Treasury closed at a touch under 1.500%.

The ongoing benefits of massive global central bank stimulus include low debt in all sectors, including mortgages. As low as interest rates are in the United States, we may see interest rates go lower especially when considering 10-year Italian Treasury bonds are trading for .500%, a full percentage point lower than U.S. government debt. Go figure.

The downside to low rates is bank margin compression. That is one reason why we continue to remain biased toward locking in interest rates at these levels.

U.S. Bonds responded as expected with yields rising modestly in response to a very healthy June jobs report. The June jobs report saw an additional 255,000 jobs created above the 185,000 expected. The closely watched U-6 number, or the total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, rose to 9.7% from 9.6%. For reference, the U6 number was 10.4% in July 2015. The Labor Force Participation Rate (LFPR) rose to 62.8 from 62.7 and is a measure of the active portion of an economy’s labor force.

Globally, the UK surprised the markets on Thursday by lowering the overnight lending interest rate plus re-starting their QE program. This is in response to the overall poor economy in the European Union and the recent Brexit vote.

With so much of the world’s government debt yielding negative interest rates, the U.S. interest rates are high relatively to those of weaker countries. Therefore, even with a strong U.S. job’s report, we are modestly biased to floating interest rates at current levels.

This week is a great example of how quickly investor sentiment can change with “risk on trading” coming at the expense of bonds.

U.S. treasury bonds and mortgage bond yields continue to move higher and are off from the best levels ever, as investors continue to shy away from the safety trade and consumer inflation starts to bubble.  The risk on trade has once again pushed stocks to record levels with the Dow closing yesterday at 18,506 and the S&P at 2,163.

Economic data showed that June Core Consumer Prices rose by 2.3% year-over-year, matching the hottest year-over-year rate since 2008. Core Consumer Prices rose 0.2% in June, which is in line with expectations.  While inflation remains in check and is by no means a threat at this time, we must pay attention to the incoming inflation numbers because an uptick in inflation will result in higher interest rates despite other bond-friendly external forces.

The 10-year U.S. Treasury note, presently at 1.57% is well off the best levels seen just a couple of weeks ago.  It would not surprise us to see the 10-year note retest and potentially make new closing yields in the not too distant future. Given the recent uptick in interest rates, we are biased toward floating interest rates at these current levels ever so cautiously.

Rates remain at historical lows, and given the negative interests globally, US government bond yields are still high relative to global bond yields in Europe and Japan. On the jobs front, the month of June saw 287K jobs created in June versus the expected 175K with total unemployment at 4.9%, a slight rise from May. Within the jobs report, the closely followed U6 number fell to 9.6% from 9.7%. The U6 number is calculated by adding up the total unemployed plus all people marginally part of the labor force, plus total employed part-time as a percentage of the total civilian labor pool. This number is closely followed by economists. The labor force participation rate edged up to 62.7% from 62.6%, but is down significantly from the last decade and remains at multi-decade lows.

Banks are feeling the pinch with the compressing of the yield curve, as well as with the extraordinary low interest rates both domestically and abroad. Near-zero and negative interest rates are also affecting pension funds and insurance companies as it’s becoming more difficult to find yields to match long-term obligations. Banks are very hesitant to lower rates further since deposit rates are so close to zero, and they can no longer maintain deposit spreads.

While it would not surprise us to see movement in the 10-year US Treasury yield either up to 1.550% or down to 1.250% from the current yield of 1.374%, we are aggressively advising clients to lock in interest rates at these levels.