Equities have been on a tear this week and bond yields ripped higher as recession fears take a back seat to positive commentary out of the U.S. and China on trade talks. Further calming fears about the state of the U.S. economy was better than expected August retail sales report and the steepening yield curve. With the U.S. consumer comprising a majority of the economy, this report reinforces that there is no imminent recession in sight. Just last week the 10-year Treasury note was trading around 1.500% versus the current rate of 1.87%, a remarkable move in just a few days. With rates on the rise, the recent flood of applications by U.S. individual and corporate borrowers will subside, especially if rates move a bit higher from here. However, as we have opined previously, our feeling was that the U.S. economy is in pretty good shape and that a 10-year treasury under 1.500% was an alert to lock-in rates.
Across the pond, the ECB eased their monetary policy in response to their stalling economy and doubled down on negative interest rate policies. It is becoming unclear how much negative rates help economic viability, but with rates already so low and Europe teetering on recession, the ECB believes it is best to err on the side of more easing. These policies are creating havoc with respect to how to evaluate risk and are pushing investors into riskier asset classes in search of yield. The one positive for the U.S. borrower is negative rates abroad will limit how high interest rates will move back home.
The next big news event is the Federal Open Market Committee meeting next week. Odds heavily favor a rate decrease of one-quarter of one percent on the Fed Funds rate to keep pace with the easing going on in the rest of the developed world. It will be interesting to hear the commentary from the Fed Chair after the rate decision is made and how the markets respond to more easing.
Bank earnings this week support the notion that the U.S. consumer is feeling pretty upbeat about the economy. With consumer confidence high, the unemployment rate sitting at a 50-year low, and wages slowly rising, the consumer is doing just fine. Businesses and institutional analysts are not as upbeat citing slowing manufacturing data, slowing global growth rates, a flattened yield curve, and ongoing trade tensions with China as causes for concern.
The Fed is set to lower interest rates by .25% and possibly 5% at the end of July. All signs point to this being a done deal. However, with a strong June jobs report, solid bank earnings, and some other positive manufacturing related data coming in better than expected, some economists are torn as to whether a rate reduction by the Fed is necessary. Other economists believe it is important to act fast and aggressively with monetary policy as the U.S. economy shows some signs of slowing, especially with interest rates already so low.
With attractive interest rates for everything from car loans to home mortgages to corporate debt offerings, there has been increased demand for debt both in the corporate and consumer space. Mortgage activity has been strong. However, home prices in coastal areas are already very expensive so it’s still unknown whether lower interest rates will continue to drive on home buying trends.
Many did not see a return to 2% 10-year Treasury yields, so we remain cautious with respect to how much lower rates can go and we continue to advise locking in interest rates at these ultra-low levels
The prospect of lower rates has propelled the purchase of riskier asset classes such as equities. U.S. equities hit all times highs this week with the S&P index surpassing the 3,000 mark.
Fed Chairman Powell spoke Wednesday and Thursday with Congress and all but assured the markets that there will be a .25% point decrease in the Fed Funds rate later in the month. Market forecasters have already baked this rate increase into their investment strategies, but Chairman Powell used the visit to drive home the point.
Even with the prospect of lower short term rates, longer-dated Treasury bonds have moved higher with the all-important 10-year Treasury yield rising from below 2.00% to over 2.10% this past week. This steeping of the yield curve is a good sign and has put to the side recession concerns for the moment. An increase in the CPI reading this week also put pressure on bond yields. So long as the inflation readings do not get too hot, a little inflation is another positive indicator of a good economy.
Economic readings remain a mixed bag of good and bad. Consumer confidence remains high, and unemployment remains at historic lows. Both are positives. However, some key manufacturing and other producer related reading are starting to show signs of a slowdown. Also weighing on the direction or long term growth are the ongoing trade negotiations with China and their uncertain outcome.
With respect to the mortgage market, rates continue to remain at very attractive levels and are spurring purchases and refinances in both the residential and commercial marketplace. We continue to be biased toward locking-in loans at these levels as bank profitability remains under pressure due to the flattened yield curve. However, we do believe interest rates will remain low and do not foresee a big move up in rates in the near future.
Equities surged this week with the S&P 500 reaching a record high in response to an accelerated fall in global bond yields. The 10-year U.S. Treasury benchmark fell to 2.00% for the first time since 2016 while German government yields went further negative. All bonds issued by first world nations are trading well below where most economists predicted just a few months ago as the ongoing trade tensions and tariffs with China, as well as a sputtering European economy, and low inflation readings weigh on central bankers.
With rates already low, Fed Chairman Powell commented on the need to be pro-active (dovish) with a potential rate cut should the data support further accommodation in order to stave off a recession. Earlier in the week, the ECB reiterated a willingness to push yields lower through QE measures in order to spur economic activity. With bloated government balance sheets that were amassed during the Great Recession, the drop in bond yields reflects the difficult position the Fed and other Central Banks are in as the path to more normalized monetary policy has stalled. The real fear is that with rates already so low all over the world, there is not much more the monetary policy can do to boost economic growth.
The big beneficiary of low yields are borrowers, as evidenced by the surge in home buying and refinance activity in the past few months. Rates are incentivizing new home purchase and reducing borrowers monthly expenses with new lower mortgage payments on refinances. Lenders remain hungry for business and the drop in rates has increased borrower affordability.
With rates near 2.00%, a level we admit caught us off-guard, we are strongly biased toward locking in rates because lending institutions are at capacity and will need to raise rates to meet turn times. While we can see rates go lower, the benchmark 10-year Treasury near 2.000% is pretty sweet.
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 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.
Bonds have been on a tear as rates have dropped in response to a variety of factors including a very volatile December for equities, a slowing global economy, Brexit, Italian debt fears, trade tensions with China, and dysfunctional political system in Washington.
The Fed this week confirmed that it will continue to be data-dependent and that monetary policy is not just simply running on auto-pilot. This was positive for both equities and those relying on debt financing.
On Wednesday, the Fed chose to keep overnight lending rates at current levels and also opined on the direction of the Fed draw down its balance sheet, also known as Quantitative Tightening (QT), as well as future rate hikes. A few months ago, most economists had three rate hikes forecasted for 2019, now, the consensus is for probably only one rate hike. All of this has pushed the 10-year Treasury yield (the benchmark lending rate to under 2.75%) which has helped increase mortgage applications, amongst other requests for credit.
The widely watched monthly jobs report did not disappoint and pushed up yields a touch this morning. The report was very positive with 304,000 jobs created in January. The unemployment rate ticked up to 4%, but so did the Labor Force Participation Rate (LFPR). Three-month average job creation is running at 240,000 jobs per month, a very strong number. During the Obama presidency, many economists though numbers like this would be unattainable this late into an economic expansion. Wage inflation remains in check (as do other inflation readings). Geopolitical concerns have taken a back seat to the resilient domestic economy for now. The U.S. equities market snapped back from an awful December with the strongest January in years. Historically low rates are still in play along with strong U.S employment and positive earnings from many big companies.
It is worth noting that some consumer confidence readings have slipped and how this will play out may not be felt for several months in the economic readings.
With rates on the rise after this strong jobs report, we believe it is prudent to strongly consider locking-in interest rates at these levels.