Bond yields dropped precipitously and global stocks were volatile as tensions rose over the U.S.-China trade talks, which has dampened investor expectations of a near-term resolution between the world’s two biggest economies. Further pushing yields lower was the ongoing Brexit non-resolution which has forced Theresa May’s resignation. Finally, Europe continues to stall under a huge debt burden and the unintended consequences of negative bond yields which have done little to spur economic growth.
The U.S. economy remains strong, so part of the low-interest rate story has to do with how low bond yields are across the pond and in Japan. Many European bonds trade at or below zero. With unemployment near a 50-year low, tame inflation readings are the other major story that has placed a ceiling on domestic yields. Bonds traded this past week at a near a 17-month low.
Housing has rebounded from a poor 4th quarter, but high prices continue to weigh on prospective buying decisions. Locally, our own real estate market has seen a strong increase in applications as the busy season is upon us and interest rates on multiple product types are very attractive.
With the 3-month 10-year Treasury curve inverting, we will continue to monitor the bond market closely for recession clues. A prolonged inversion of short-term against long-term yields is a respected indicator of a looming recession. However, for the moment, we believe the U.S. economy is performing well and interest rates this low should be locked-in at these levels; the 10-year Treasury is trading under 2.30% as of Thursday, May 23, 2019.
In a volatile week on Wall Street, bonds have traded well with the 10-year Treasury note touching 2.350% for the week. Market strategists have had to react to both tough trade talk on China by the Trump administration, as well as elevated tensions with Iran in the Middle East in directing trades this week. Traders flight to quality investments benefited high-quality bond yields such as government-guaranteed and A-paper mortgage debt with yields moving slightly lower but within a tight band.
Back home, the U.S. economy is humming, job growth is robust, and inflation is tame as evidenced by GDP expanding at a 3.2% annual pace in the first quarter. Unemployment touched a 50-year low and year-over-year CPI is running at 1.9%. This begs the question “why are rates so low?” The answer probably lies in long-term economic growth forecasts as well as fears of a looming recession given the potential for an elongated trade negotiation with China and anemic economic growth out of Europe and Japan. Continue to keep an eye on the 2-10 Treasury spread as signs of looming trouble ahead. For the moment, the spread is around 19 basis points and rebounding from the 9 basis point spread just a short while ago. Treasury inversions are one of the most reliable indicators of a recession and need to be taken seriously when they occur.
Home sales have rebounded due to both the time of year as spring is an important home buying season enhanced by the low-interest rate environment. Our feeling remains that the economy is strong and rates should be higher. However, we have no magic ball and so for the moment, we continue to advise clients to lock-in interest rates at these highly attractive levels.
U.S. consumer prices rose moderately in April but less than expected. Low inflation readings will keep a lid on bond yields, as well as reinforce the Fed’s position keeping short-term lending rates unchanged for the rest of the year. With inflation in check, some are opining for the Fed to lower interest rates. We tend to disagree and believe a wait-and-see position by the Fed is wiser, as there are some indicators that inflation may pick up and that ultimately these low inflation readings may be transitory.
In other important news, trade talks fell apart this week with China. This resulted in higher tariffs being placed today on Chinese goods imported into the U.S., which will likely lead to retaliation from China sometime in the near future. How these negotiations go is anyone’s guess, but the consensus is that a deal will be struck eventually. However, there is always a chance that negotiations could fall apart and a full-blown trade war will occur, or that these negotiations will drag on much longer than expected. Those fears, while remote, have helped push long-dated treasury bonds lower in what is known as a “flight to quality.” The trade tensions also dented equities this week as analysts reassess the effects of ongoing trade tensions on future economic growth and corporate earnings.
Low rates do benefit our borrowers and have spurred both a good home buying season, as well as our clients who have refinanced into lower rates. With the 10-year Treasury note trading under 2.500%, we remain biased toward locking in interest rates. Should the U.S. strike a trade deal with China, we could easily see rates move up from here.
The highly watched Monthly Jobs Report put to rest concerns about a slowing economy as the report beat estimates with 196,000 jobs created versus 177,000 expected.
This data should put to rest for now fears on a looming recession and thus help boost stocks and slightly lower bond yields. Unemployment remained at a multi-decade low of 3.80% and hourly earnings rose to 3.20% year over year from February (which is bond-friendly as wage inflation remains tame). The Labor Force Participation Rate (LFPR) remained unchanged at 63.20%.
In other good news, the yield curve steepened. The potential flattening of the curve was a major concern just a few weeks ago, as that would be a sign of impending recession. However, a positive sloping yield curve is an indicator of a healthy outlook for the economy. Also, China and U.S. trade talks appear to be going well for the moment which has also helped stocks move higher. However, concerns remain as global economic growth has slowed in Europe, China, and Japan as central bankers continue to provide massive stimuli to their respective economies to spur growth. Finally, a Brexit deadline is looming in what is turning out to be a very complicated matter. So far, the markets have not been spooked by a no-deal Brexit, but that could change as the deadline approaches.
Here in the U.S., low rates have spurred home buying and refinances. We recommend taking advantage of the low interest environment because if the U.S. economy continues to surge, the Fed rate hike conversation will be back on the table. With this thought in mind, we remain biased toward locking-in interest rates at these very attractive levels, especially with the strong jobs report confirming no recession and the positive chatter regarding U.S. and China relations coming out of Washington.
The U.S. economy grew at the best clip in almost a decade even in the face of a slowing global economy, China-US trade tensions, and political uncertainty in Europe. The strong job market and tax reform helped spur consumer spending and on-going positive business investment. Fourth quarter GDP closed the year out at 2.6%. With the White House gunning for 3% economic growth and the Fed pausing on interest rate hikes, the good times look likely to roll on at least for a while.
Further supporting keeping interest rates on hold was the Fed’s favorite measure of inflation, Personal Consumption Expenditure (PCE), which came in at 1.9%, as expected. Low inflation readings cap bond yields and force investors to invest in riskier but higher-yielding assets classes.
Stocks continue to climb the wall of worry and are re-approaching all-time highs. Market risk-taking is back in vogue even in the face of a decline in earnings. A return to low rates has triggered increases in mortgage refinances and have certainly helped on-the-fence home buyers jump into the housing market.
With Europe and China slowing, and the Fed being very careful about its next move, we can see interest rates remaining low for the next several months. With the 10-year Treasury yield under 2.67%, we advise locking rates except for those borrowers willing to play the market in search of a marginally better deal.
U.S. Treasuries and major equity markets continue to trade benevolently as investors adjust to a more a “risk on” environment. A December wash-out in stocks and subsequent dovish commentary out of the Fed stoked this move upward in stocks and a move downward in interest rates. For the moment, Mr. Market has moved aside global growth concerns, some weak earnings guidance from analysts, and the fear of Brexit and Italian bond defaults. Positive talks with China are encouraging and have helped ease the markets. No less important is the fact that low interest rates spur risk-taking in equities and have arrived just in time for the spring buying season. Refinance volume has also improved amongst other debt-related activities.
The Fed pausing on their rate hike forecasts does raise some concerns given the supposed strength of our economy and near all-time highs in the stock market. Historically, the Fed mandate was to watch over employment and inflation, but it is clear that supporting equity and asset valuations is no less important in today’s world. Low rates have probably distorted true price discovery and the Fed will need to be very careful about how to move rates as December’s vicious stock market decline is evidence of what one misstep can bring on.
Next week will be an important week for Fed-related news. We believe they will be very careful with policy statements and promote their “patience” policy to Congress.
We are grateful for the low interest rates and continue to advise clients to be cautious with respect to floating rates. One quickly forgets how fast stocks and bonds can move against you should the market have a change of heart. A 10-year U.S. Treasury bond trading under 2.700% was not forecasted by many this time last year.