Market Commentary 5/11/18

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.

Market Commentary 5/4/18

Each new month brings a new jobs report which is one of the most heavily watched economic reports on Wall Street. April’s Job Report was no exception with the headline unemployment reading dipping below 3.90%. However, it is what is inside the report that moves the bond and equities markets, and not necessarily the headline reading.

The April jobs report was a bit of a disappointment with 164,000 jobs created versus 190,000 expected. The report did include some positives and negatives within the numbers.

Within the report, the hourly earnings grew less than expected with the annualized pace of wage growth coming in at 2.600%, down from the 2018 January pace of 2.900%. The U6 number, or the total unemployed, fell to 7.8% and the Labor Force Participation Rate ticked down to 62.8% from 62.9%

Earlier in the week, another important inflation reading was published, the Core PCE, which is the Federal Reserve’s favorite inflation gauge. Per this report, inflation grew at 1.90% over the previous 12 months and is now approaching the Fed’s target rate of inflation which is 2.00%. In the Fed’s eyes, a 2% yearly gain in inflation is a sign of a healthy economy and will enable the Fed to continue to raise short-term interest rates. If inflation were to get out of hand (which is not currently the case), the Fed could decide to raise interest rates more quickly to slow down the economy and prevent asset prices from becoming too bubbly.

At the moment, we remain in a “Goldilocks environment” with no sign of a recession. Interest rates, while higher by a bit, are still below 3% on the 10-year Treasury note, corporate earnings continue to beat estimates, central banks around the world continue to be accommodating, and finally, global tensions such as the threat of tariffs with China and the threat of war with North Korea have been subdued.

With all of this in mind, we remain biased toward locking in interest rates given the overall positive economic environment that we are experiencing and expectation of higher short-term interest rates over the coming months which should move the entire yield curve higher.

Market Commentary 4/27/18

Long-term Treasury yields rose in response to ongoing confidence in the U.S. economy. The 10-year Treasury note breached the 3.00% mark this week for the first time in more than four years. The significance of the 10-year rising above 3.00% is that it supports a strong economy and suggests the U.S. is healing and now prospering after the worst financial crisis since the Great Depression, even as some economists believe that the U.S. economy is in the late stages of expansion.

The rise in rates across the yield curve is a response to both the current forecasts by the Federal Reserve of at least three more Fed Funds increases (which would bring short-term rates) from 1.75% up to 2.25% to 2.500% and the sense that wage and consumer inflation may be on the horizon. Further supporting higher interest rates are talks in Europe about the pullback in bond purchases by the ECB, known as QE (“quantitative easing”).

In economic news, the first read on Q1 2018 GDP came in at 2.30% versus the 2.10% expected and down from 2.90% in the final quarter of 2017. Within the report, it showed that consumer spending rose just 1.1% from the lofty 4% gain the in the fourth quarter. Inflation data within the numbers were a bit hotter than expected. If today’s 2.3% GDP reading remains as intact as the final reading, the forecast for 2018 GDP growth is near 3.00%. This is good news for the economy and bad news for bond yields.

With the 10-year Treasury note near 3.00%, we are biased toward locking-in interest rates, but can also make the argument for a small dip in rates given the psychological significance of the 10-year Treasury breaking and closing above 3.00% this week.

Market Commentary 4/20/18

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.

Market Commentary 4/6/18

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.

Market Commentary 3/24/18

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.

Market Commentary 3/16/18

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.

Market Commentary 3/9/18

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.

Market Commentary 3/2/18

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.