As the end of the year quickly approaches, market volatility has spiked and fear over a slowing economy, global trade tensions, and a government shutdown have taken most major global stock indexes into bear market territory. Long-dated bonds have traded (as expected) higher as the flight to quality has pushed 10-year Treasury yield to under 2.80%. Parsing out the negative news stories that continue to be the focus of concern lately, it is important to remember that our economy remains strong, employment remains at historical lows, and inflation is contained. However, for the moment, the markets are focused on negative headlines, and stocks are getting beaten down.
In economic news this week, the most anticipated Fed meeting in years ended as we predicted. The Fed raised overnight lending rates by .25%, and while the Fed comments were dovish with respect to anticipated future Fed hikes, the market wanted more. The lack of the so-called “Powell putt” to soothe the markets increased selling throughout the week. However, if the Fed focuses on the data, we don’t foresee 3 or 4 rate hikes next year.
The Fed’s favorite gauge of inflation, the Personal Consumption Expenditure (PCE), came in as expected on Friday, yet another reason to support not raising rates any time soon.
In housing, buyers and sellers are working well together to make a deal and lenders remain committed to closing loans, a major source of revenue for most non-money center banks.
Global equity markets continue their wild ride as major daily swings with a bias to the downside have become the norm. Long-dated bonds have benefited from this volatility as the 10-year Treasury yield has dipped to 2.90% from a high just a short while ago above 3.24%. There are several reasons for the drop in interest rates, but the main negative themes continue to be U.S.-China trade and tariff tensions, a partial inversion of the yield curve, fears of a slowing global economy, the end of QE in Europe, ongoing QT in the U.S., and European political issues including Brexit as well as French protests over rising fuel costs.
Economic data was light this week with only one big headline report, the consumer price index (CPI), which showed that inflation is currently contained, which is positive for bond yields.
However, with both a slowing housing market across the U.S. and what seems to be a general slowdown of global economy, relatively low rates are needed to continue to spur the economy. With that in mind, we will be carefully reading Fed comments next week. We do expect a .25% increase in the overnight banking rates to be accompanied by very dovish commentary. Hopefully, The Fed’s comments will provide a much-needed tonic for the current market negativity.
Lenders continue to price aggressively as the need for business outweighs the need for yield. We continue to see attractive rates across the lending spectrum which is a good thing for new home buyers. With rates near 2.90%, we are agnostic as to the next direction in interest rates and are very curious to read the comments from the Fed next week.
The markets were strained again this week by a confluence of factors including a slowing economy, European geopolitical issues, inconsistent messaging from the White House on the trade talks with China, and finally, an inverting of the 5 minus 2 U.S. Treasury yields. All of this meant it was a terrible week for equities.
The Jobs Report came in under expectations, which may ultimately be viewed as a good sign from the standpoint of placing a hold on raising short-term interest rates. Some Fed officials commented Friday mid-morning that a pause may be in order given the recent market turbulence. Personally, I believe the Fed will increase short-term borrowing rates by .25% in December, but temper the effect of the rate increase with dovish commentary and a lowering of expected rate increases within the 2019 and beyond forecast.
The actual November Jobs Report came in lower than expected with 155,000 new jobs created against estimates of 189,000. The unemployment rate remains unchanged and one of the lowest on record at 3.70%. The Labor Force Participation Rate remained steady at 62.90%. Wage growth did not rise above the October reading (a benefit for bonds) as wage inflation appears to be growing at a manageable pace.
Those borrowers and businesses relying on debt were happy to see the 10-year Treasury note, the benchmark for financing costs from auto-loans, corporate debt, and real estate purchase, fall to around 2.85%.
With the major downward drift in interest rates, we are heavily biased toward locking-in interest rates at these lower levels. While we don’t foresee interest rates rising rapidly, we do not foresee long-dated interest rates falling much further from these levels. We must remember that overall the U.S. economy remains strong and job creation remains positive.
Dovish commentary this past Wednesday from Federal Chairman Jerome Powell was just what the doctor ordered for both the equity and bond markets. Backing off of comments made a couple of months ago, the Fed Chair stated that Fed policy was closer to the neutral rate, in which Fed policy is neither too accommodative or too restrictive. While we still believe the Fed will raise in December, this gave markets some relief on the prospect of future rate hikes by the Fed, which has been a source of concern for many market participants who have felt the U.S. economy was still fragile and could be derailed by an aggressive Fed rate policy.
We liked the comments from the Fed and their reiteration that they will remain data dependent. The U.S. economy is in good shape for the moment with historically low unemployment levels, no threat of runaway inflation, the fear of a slowing global economy, a looming potential trade war, quantitative tightening, and a mild correction in housing. All these factors support keeping interest rates low for longer.
With the 10-year Treasury trading right above 3%, we are biased toward locking-in interest rates given the move lower. President Trump and President Xi will meet this weekend at the G-20 to hopefully resolve the trade tensions. Should the meeting surprise to the upside, rates could quickly move up on any positive news.
Signs of a slowing global economy, trade tensions with China, geopolitical concerns over Brexit, and Italian debt levels have all played a role in the very volatile stock market swings the last several weeks. Compounding these concerns is the rate trajectory set by the Federal Reserve which is also weighing heavily on the overall market. While business sentiment remains high, if there is not a resolution on at least some of these very important matters, confidence will erode quickly and negatively impact business and consumer spending. We are already witnessing a slowdown in high-priced real estate markets, and the unsettling seesawing in the equities markets has investors on high alert.
As of late, the retreat of the 10-year Treasury bond yield may be an early warning sign that the narrative about our own U.S. economy is changing, as well as the global growth narrative. Rates have broken lower from around 3.25% to now under 3.07%. The move lower on the 10-year Treasury bond has also further flattened the yield curve, which is being closely watched as it moves closer to inversion. An inverted yield curve is one of the key recessionary signals monitored by market watchers.
This was a dramatic week for the markets: oil fell, possibly triggering a bond rally, bond yields fell (even with inflation moving up and reaching the Fed’s 2% target). Core inflation readings may cool in the near future should oil remain lower. Copper, known for its economic forecasting ability, also has traded poorly, yet another sign that the global economy is slowing. Housing fell off this week, further helping interest rates. This makes one wonder how much higher, if, at all, interest rates can go, and I wonder if this is the peak. Keep an eye on the U.S. dollar, which has been on a tear. U.S. dollar fluctuations will also impact interest rates.
With this in mind, we are biased toward floating interest rates to see what happens over the coming weeks. Our feeling remains that interest rates may move higher, but the markets seem to like ~3 10-year Treasury yields, and we think we may see rates touch down to these levels. With housing and commercial real estate cooling off and a very volatile stock market, rates may be pushed lower in the coming weeks.
The two most impactful market events this week were the mid-term elections and the Federal Reserve meeting, both of which yielded predictable outcomes. The market seemed to like the House election results, given the massive equity rally Wednesday. Thursday, the Fed kept rates flat and offered an upbeat assessment of the economy. All signs point to another rate hike in December, unless something fundamentally changes from now, which is unlikely.
In other news, the 10-year Treasury yield hit a 7-year high of 3.232% before settling back down. This is relevant since the 10-year Treasury is the benchmark for both consumers and companies who borrow money. There is ample support that higher rates are here to stay. Factors behind this include a strong U.S. economy, high consumer sentiment, rising inflation readings, and large-scale public government debt auctions in public markets.
Lenders remain aggressive with price in a bid to win over well-qualified borrowers. This has helped offset higher yields, but only for the most qualified borrowers. While we believe interest rates will rise over time, our sense is that longer-dated interest rates will be range-bound and we are slightly biased towards floating rates.
U.S. Treasury bonds sold-off heavily Friday afternoon in response to a strong October Jobs Report and hints from President Trump that the U.S. and China are discussing a potential resolution on tariff and trade negotiations which would be welcomed news for the global markets.
In economic news, the 250,000 new jobs created in October were well above estimates. However, the troubling part of the report for bonds was the year-over-year wage growth which rose 3.10%, the highest rise since September 2009. The rate of unemployment remained at a 49-year low of 3.7% and the Labor Force Participation Rate rose 62.9 from 62.7. All we can say is this was a very good report and that the U.S. jobs market is on strong footing. Business confidence is sky high.
Should we see a pattern of higher wage inflation in future reports, we would think the Fed would continue to carefully raise short-term interest rates given that the economy is very near full unemployment and that inflation has returned to the targeted 2% range and possibly moving higher.
The equity market acted better this week as volatility subsided. Bond yields trended higher with the ever important 10-year Treasury bond closing out the week at 3.22%. We usually don’t speak about politics but next weeks mid-term elections have been the most passionate we have seen in years. Bonds could react differently depending on how the voting shakes out.
Given that bonds were not able to break lower during the last couple of weeks, even in a brutal trading environment, we remain cautious on interest rates and continue to advise clients to lock-in what are still favorable interest rates.
October has been a rough month for stocks. Government bond yields, known as the safe-haven trade, have remained elevated even in the face of major volatility in the global equities markets.
Generally speaking, volatility has increased due to a myriad of factors which have slowed momentum trading in equities. Markets have been pressured by a combination of Fed rate normalization, as well as the Fed buying fewer bonds in the open market, trade tensions with China, debt issues in Italy and geopolitical tensions with Saudi Arabia. With market participants knowing that the Federal Reserve is taking its foot off the gas with respect to low-interest rates, the result has been a much more volatile and unpredictable bond and stock markets. Many are questioning if this week’s sell-off is the start of something bigger or simply another wash-out until a move higher in equities. Riskier-priced assets are already in correction territory (corrections are considered to be sell-offs of 10%). The usual relationship of interest rates dropping in the face of volatility has not happened as one would have expected in previous market sell-offs since the Great Recession. This is forcing the market to deal with a more normal market price on all asset valuations, from real estate to technology stocks.
In economic news, the economy remains strong with the first reading on 3rd Quarter GDP in at 3.50%, though down from the 4.2% seen in the 2nd quarter. Inflation remains tame. All eyes will be on the Fed’s favorite gauge of inflation, the Core PCE, which will be out on Monday and could sway the Fed regarding the direction of short-term rates in the coming months.
However, the global growth story that consumed the markets earlier in the year has slowed and there remain concerns that additional Fed tightening may lead to a recession. Given the fear we witnessed this week in the market, we are cautiously optimistic that rates may fall further should we witness another tough week in equities. Combining that with the need for banks to lend may result in better pricing for borrowers even in a rising rate environment.
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.