Stocks dipped and bond yields fell in a light economic news week, but nonetheless, it was a week filled with plenty of market-moving events. The fears of a new coronavirus out of China moved money from riskier assets into the safe haven of government bonds. Also, soft global PMI data helped to lower bond yields, which remained flat but may have bottomed.
Back here in the U.S., on the one hand, the consumer remains bullish as equity and real estate asset prices are at historical levels supported by a dovish Federal Reserve interest rate policy. While on the other hand, business leaders are skeptical and large scale purchases are soft.
With the U.S. economy expected to grow between 2.00% and 2.50%, the consensus is that it will continue to hum along and equity indexes will continue to reluctantly move higher. Some recent positives supporting that narrative include the Phase 1 U.S. – China trade deal and the expected signing of the USMCA agreement.
The strong consumer should bode well for a strong spring homebuying season so long as sellers don’t push prices back up in response to a very accommodative interest rate environment and strong demand. Interest rates are also spurring refinances as refinances lower monthly debt service payments and or cash-out refinances tap home equity to pay down more expensive debts.
With the 10-year Treasury bond set to close below 1.700%, our continued view is to take advantage of these near historically low rates. However, a “Black Swan” event such as this new virus that broke out in China could temporarily push U.S. bond yields much lower if government health officials cannot contain the spread of the virus. For perspective, very few people to date have been infected with this new virus, and the fears of widespread contagion are remote, as of this writing.
Bond yields flattened after a very tense week filled with heightened geopolitical tensions, as well as significant economic news. Rates dropped Wednesday after it was reported that Iran fired missiles at U.S.-occupied air bases in Iraq. Thankfully, no U.S. casualties were reported. The flight to safety was short-lived as the stock market rallied the day after the attack. Both the U.S. and Iran suggested that further escalations would be halted. Oil prices took a wild ride up and then quickly came back down as oversupply halted a surge in oil prices based on disruption fears surrounding the conflict.
On the economic front, weak manufacturing data was discounted due to the Phase One U.S. China trade deal being inked on January 15th. The all-important December jobs report was a bit lighter than expected, but overall not a terrible report. Unemployment remains at 3.5% and at a multi-decade low, and the U-6, or total employed, fell to 6.7%. The U.S. economy remains on solid footing and appears to be in what is often referred to as a “goldilocks” trend as the combination of low-interest rates, low unemployment, and low but stable economic growth increases our overall prosperity.
A surging stock market and low-interest rates should bode well for the coming spring home-buying season as potential homeowners feel flush. Inventory remains tight, but home builders are optimistic. With this in mind, we continue to advocate locking-in interest rates at these attractive levels. Many economic forecasts are factoring in higher inflation in the coming year, which would propel bond yields higher. Also, the overall global economy seems to be doing better and for now, any sign of a potential recession in 2020 has faded.
Treasury yields dropped this week to a 21-month low. Multiple Fed officials spoke of the possibility of lowering short-term interest rates as ongoing trade tensions with China begin to wear on the U.S. economy. Further causes of concern include slowing manufacturing data both in the U.S. and abroad, negative interest rates in Europe and Japan, and the European Central Bank opining on the high probability of rate cuts in the Eurozone to combat its sluggish economy.
At the moment, there are several conflicting economic signals: consumer and business confidence is strong, but other key economic data are showing signs of a potential recession on the horizon. Of greatest concern is the 3-month to 10-year Treasury curve, which has inverted. A prolonged inversion supports the notion that the markets believe rates are too high, and more importantly, it is a key recession indicator.
Further pushing bond yields lower Friday was the release of the May Jobs report which came in much cooler than expected (75,000 actual versus 185,000 estimated). Some of the weakness in hires last month could be blamed on worker shortages in certain sectors such as construction. It will be interesting to see how the June jobs report plays out. A tepid June jobs report will all but guarantee a Fed rate cut. Due to the Fed Funds Rate already at a very low level relative to the length of the economic recovery which dates back almost 10 years now, the Fed has very little room to lower short-term rates and it will act sooner than later once it believes economic growth is stalling.
Speaking of rate cuts, corporate and individuals are enjoying lower borrowing costs and lenders are aggressively pricing home and commercial loans in the search for new business. With so many experts expecting lower rates to come, we continue to advise clients to be cautious as any unexpected good news (think trade deal with China) could catch markets off guard. For the moment, we are biased toward floating rates at these levels with the understanding the market is severely overbought.
Declining mortgage rates have spurred refinance activity, as well as increased the probability of a strong spring home buying season. With inflation in check and the Fed on pause, interest rates should remain attractive for the foreseeable future. However be on the alert as rates may have bottomed and hit resistance in moving lower after rallying greatly since the beginning of the year.
Fears of global economic activity slowing continue to weigh on bonds. The recent drop in rates has pushed several wealthy nations debt to trade at zero % or below. In the U.S., the 10-year Treasury bond briefly dropped below 2.4% this week and the 3 month to 10-year Treasury yields inverted, a potential ominous signal of a looming recession should the inversion hold. An inverting yield curve has predicted most recessions and the inversion is the result of fears of economic growth globally as well as a lack of inflation. These fears will keep investors on their toes and may create a more volatile rate environment in the coming months.
Given that we believe most of the concerns we’ve mentioned are priced in, we are biased toward locking in rates at these very attractive levels. Any unexpected good news could move rates up higher quickly.
The highly anticipated Fed meeting this past Wednesday did not disappoint. The Fed went “max dovish” in their policy statement by stating no more rate hikes for 2019 and possibly only one rate hike in 2020. Many market watchers actually believe the next Fed move in interest rate policy will be lower, a far cry from just this past December where the Fed believed that two more rate hikes were likely for 2019. Less understood but equally important was the Fed’s timeline on the end of the balance sheet run-off, which will be ending later in the year.
Bonds responded as expected as both government and mortgage bond yields fell precipitously. Stocks responded with caution, falling Wednesday, rallying Thursday, and as of the time of this post, falling hard on Friday.
What’s next? The big question being asked is what does the Fed see that others don’t with such a quick shift in policy. Low rates will help borrowers buy new homes, cars, refinance debt, and also aid corporations, but the return of low rates due to the fear of either a brewing U.S. recession or quickly slowing European, Japanese, and the Chinese economies is quite worrisome. Longer-dated German bunds have gone negative for the first time in quite a while, and our own 10-year U.S. Treasury bond is trading at 2.45%, well below the 3.25% seen just a couple of months ago.
For those who qualify, low rates are another bite at the apple, which will help boost the spring buying season, as well as spur refinances, which will result in more savings or more disposable cash flow to buy other items, so in that sense we are grateful to the Fed.
Should the U.S. avoid recession (keep an eye on the flattening yield curve), rates at today’s levels are very attractive, but should the U.S. slip into a recession, expect rates to fall lower. At the moment, we are in a wait-and-see mode on rate direction and would not be surprised if rates were headed lower.