Bond yields touched the lowest level since 2016 in a jam-packed information-filled week which included reporting on inflation and the monthly jobs report, the Fed Open Market Committee meeting, and renewed threats of increased tariffs on China.
The core PCE reading for June, the Fed’s favorite inflation reading, came in a tick lower than expected. Inflation remains a major conundrum for global central bankers. Even with ongoing massive stimulus programs in place, inflation readings in developed countries remain below targets. This is one of the big concerns for the Fed and is one of the main reasons that the Fed is comfortable lowering short term lending rates.
As expected, the Fed reduced short term lending rates on Wednesday by one-quarter of one percent. Equity markets fell during Chairman Powell’s press conference when he suggested that further Fed easing might not be necessary although not altogether ruled out either. Equity markets have become addicted to accommodative policies and stock pickers were looking for confirmation of ongoing rate reductions.
Trade discussions with China took a turn for the worse on Thursday, which is a big challenge facing the economy. It is hard to handicap how the trade dispute will influence monetary policy and what influence these talks will have on businesses. However, one should pay close attention to bond yields which dropped soon after the White House announcement. With some sectors of the economy slowing, the fear is the added costs of tariffs at both the business and consumer level could push the U.S. into recession sometime in 2020.
Friday saw a good June Jobs report with 164,000 new jobs created in the private sector. Unemployment remains near historic lows at 3.7%. This report supports the narrative of a strong domestic economy. However, the positive news on job creation was overshadowed by the trade tariffs threats made the previous day.
Rates are now so low absent a full-blown recession which does not appear to be likely near term, it is hard to argue against locking in interest rates. With many mortgage products at ultra-low levels, this has spurred both refinance and purchase activity. The monthly savings should be good for consumer spending and may keep real estate prices from falling further.
The rally in bond yields has increased mortgage applications dramatically and has also served as a boon for home buyers making the cost to owning a home more affordable.
The recent rate drop caught many off-guard as most economists did not forecast 10-year Treasury yields to trade at current levels given the strength of the U.S. economy. The drop in rates can be attributed to ongoing trade tensions with China, fear of a global economic slowdown, a potential recession, poor economic readings in Europe, Brexit uncertainty, and negative bond yields in Europe and Japan. However, a recent attack by Iran on an oil tanker in the Gulf of Oman did little to move rates lower indicating we may be nearing the trough in rates.
While the flattening of the yield curve with some parts of the curve inverting suggest that Fed policy may be too tight and a rate cut is warranted, remember those assumptions have already been priced into current rates. However, with rates now back near historical lows, borrowers should take this into consideration as some prominent investment banks such as Goldman Sachs do not necessarily believe the Fed will cut rates in the near term. In fact, by just speaking about lower rates, the Fed has moved interest rates lower. A wait-and-see attitude may be the policy the Fed takes, especially with inflation in check, tight labor supply, and the recent move higher in U.S. equities.
U.S. consumer confidence remains high and retail sales are strong, illustrating the strength and resilience of the U.S. consumer. With confidence high, but some other business indicators flashing warning signs of recession, there are many cross-currents to think about. With that thought in mind, we continue to be biased toward locking-in interest rates at these attractive levels. For perspective, sub- 4% 30-year mortgages were once thought inconceivable.
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.
The “Sell in May and Go Away” theory is on full display as stocks endure a tough week of trading to the benefit of lower bond yields. The main culprits are ongoing trade tensions with China and strong rhetoric from President Trump concerning Mexico. The U.S. will begin imposing tariffs on Mexican goods coming to the U.S. until Mexico applies stricter measures to help halt the illegal immigration crisis. This surprised the market on Thursday. Adding to the volatility is a slower growing global economy, negative interest rates on German and Japanese government debt, and fears of a potential recession. All of these factors have helped push U.S. Treasury yields to a many months low even against the backdrop of strong consumer confidence, a 3.1% GDP 1st quarter reading, and a fairly decent first-quarter earnings season. For the moment, it certainly is a tale of two stories with the “fear trade” winning.
Mortgage rates are also benefiting from lower rates and low inflation readings, but not as much as U.S. Treasuries. We continue to advise borrowers to take advantage of this very low rate environment as it would not take much to push yields higher should some positive comments come out of Washington or Beijing concerning trade talks.
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.