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.
U.S. equities charged higher spurred on by low-interest rates, solid consumer sentiment, low unemployment, good corporate earnings, and the signing of the U.S.- China phase 1 trade deal. With the Dow likely headed to 30,000 and home builders accelerating construction starts, it appears the spring buying season should be favorable. Consumers feel flush as retirement plans swell and wages also move higher. All of this is positive for this year’s new and existing home sales. Keep an eye on prices. With such tight supply, we hope sellers don’t price new buyers out of the market given the strong consumer sentiment we are seeing.
The U.S. economy continues to be the best house on the block and with the Fed holding steady on its accommodative monetary policies we expect this Goldilocks environment to carry on for the near term. The presidential election could create volatility, but that won’t come in to play until the back half of the year. Interest rates remain attractive as the developed world is awash in low or negative-yielding debt, which has helped keep our own interest rates capped back home. However, inflation, which has been non-existent for the last decade, is showing signs of reviving. Should inflation move past Fed targets, we could see bond yields move higher and quickly. For now, most strategists have the 10-year Treasury yield pegged between 1.900 – 2.500%.
With that in mind, we continue to advise locking-in interest rates at these levels. It is a call we have been making for quite some time, but given the abundance of positive information hitting the markets, and the fact that the market has shrugged off negative-market-moving news so quickly, our feeling is interest rates have a greater chance of moving higher than lower. One interesting point: a study was recently completed that showed that negative interest rates have done little to boost economic activity in Europe and Japan. While I am not an economist, I have always thought that lending one dollar to get back less than the principal does not make much sense.
The U.S. equity markets traded at all-time highs on the last full trading week of the year. The market’s soaring prices were propelled to record levels by accommodative monetary policy, positive news on the U.S. – China trade deal, a strong consumer, and unwinding of recession fears. Final GDP 3rd quarter numbers were also released on Friday and were not revised, showing economic growth growing at a respectable 2.1%. Overall, the U.S. economy is in good shape and the recent stock market gains are a vote of confidence, supporting that narrative.
Homebuilders remain confident and housing starts surprised to the upside earlier in the year. Most economists had predicted the 10-year U.S. Treasury would end 2019 at above 3.000%. The plunge lower in rates (10-year U.S. Treasury currently at ~1.92%) has been a big factor in spurring home purchases and refinances, as well as underpinning the surge in equities and other asset prices. If rates remain low, we would expect the consumer to remain bullish and continue to spend on autos, homes, and other high-cost durable goods.
Banks remain aggressive on pricing and mortgage banks continue to serve the demand by self-employed borrowers who face challenges documenting their income. Rates are low and should be locked-in. Continued positive data both in the U.S. and abroad could lift rates higher. Then again, maybe they won’t.
In another volatile week in the markets, the September jobs report helped soothe recession fears with a report that came in close to estimates. After a poor ISM reading (Institute of Supply Management) and service sector reading earlier in the week, some forecasters were fearing a terrible jobs number. We are happy to report that this not come to fruition. While we are certain that volatility will be a given, it is hard to argue that a recession is on the horizon considering the very low 3.500% unemployment rate.
The September jobs report was solid for a number of reasons. First, the market was primed to expect a major dud. Secondly, there were upward revisions from the past previous reports (i.e. there have been even more people working). Thirdly, unemployment dipped to a 50-year low and the U-6 reading, which includes those working part-time and those “discouraged” workers who’ve stopped job-hunting, dipped to 6.9%. Finally, wage inflation is under control which puts a lid on bond yields.
Housing has rebounded, and low-interest rates are boosting mortgage applications. Lower monthly housing payments free money up in consumers’ budgets, which can be spent on other goods and services, which helps the overall economy.
With the September jobs report behind us, and the 10-year Treasury yielding around 1.51%, we are recommending locking-in loans at this level. While rates could go lower, it is hard to imagine a <1% 10-year Treasury yield for the moment, given the current generally healthy state of the U.S. economy.
Mortgage bonds had another good week as interest rates remain low. This week served up several market-moving headlines highlighted by impeachment headlines, positive news on the U.S.- China trade talks, and good housing numbers. Inflation picked up a touch, with the Fed’s favorite inflation gauge, the Core PCE, ticking up to 1.8% annualized inflation rate from a previous reading of 1.6%. However, this annual rate of inflation is still below the Fed’s 2% target and for the moment a non-threat to the bond market. Inflation and economic expectations for the future are what drive longer-dated bonds.
Next week will be a big week with the September jobs report. Given the slowdown in manufacturing and the recent lower reading on consumer confidence, we will be watching the jobs report with much interest. The U.S. economy has been resilient through the present moment and is the envy of the developed world. The big question has been how long can the U.S. continue to outperform other large economies. The jobs report will shed some important light on this question.
In housing news, the National Association of REALTORS® reported a pick up in homes under contract, thanks to lower interest rates. With interest rates near all-time lows, we continue to believe that locking-in interest rates are the way to go as playing the market is simply too risky, especially with lenders near capacity.
The Federal Open Market Committee (FOMC), as expected, lowered short term lending rates by .25%. The effect on equity and bond markets was muted as the 10-year Treasury closed right under 1.73% for the week. Stocks closed down a touch on Friday. The Fed also opined on the state of the U.S. economy and confirmed that the job picture was good, inflation was under control, and that the worry was on manufacturing data which has slowed considerably. However, given the strength of consumer spending and the small uptick in wage inflation, the Fed does not seem to see a looming recession on the horizon.
Further supporting the no recession thesis, there has been a rise in housing permits and good data on existing home sales. With 7 million-plus more job openings than people available to fill them, we agree that the recession fear narrative was maybe overdone. However, by late Friday, China cut off talks early with the U.S. on trade discussions, and if the U.S. and China negotiations on a trade agreement turn south, the disruption could be big enough to push the world into a recession. Also, worth noting is the fact that most developed countries besides the U.S. are not experiencing great economic growth. For the moment, the U.S. remains the envy of the world.
Regarding interest rates, we continue to believe a sub 2.000% 10-year Treasury is a gift to borrowers and that loan programs should be locked-in at these levels. The low rates have definitely spurred buying in the higher-priced coastal markets as borrowers are able to qualify for more home which is also a positive sign for our domestic economy.
U.S. bond prices rose (yields moved lower) and stocks went negative quickly Friday morning as a result of tough talk out of both the U.S. and China regarding trade. This has become a tug of war over the direction of the U.S. economy against the backdrop of unprecedented trade negotiations with the world’s second-largest economy.
U.S.-China trade tensions, an inverted yield curve, and political issues in Italy, Argentina, and Hong Kong all support the lower rate narrative, while low unemployment, tame inflation, slowing but better than expected global manufacturing data, and good corporate earnings suggest that the U.S. economy will continue to grow. Only time will tell which camp is right.
The inverted yield curve is a very respected recessionary indicator, in which short-term yields move above long-term yields. This inversion suggests that the market is signaling slower growth long-term and that the current money supply may become too tight (banks can’t make money when interest rates are inverted), which could inhibit lending. The Fed will certainly address this inversion in its upcoming FOMC meeting, and the odds are on another rate cut by the Fed in the coming weeks.
However, other indicators are not flashing recession and the U.S. economy is healthy. Mortgage applications are surging and we are in the camp that believes that the lower rates will help boost consumer spending as overall financing costs for everything from autos to mortgage to business loans will move lower.
With the 10-year Treasury trading near 1.500%, we continue to be biased toward locking-in interest rates at these incredibly low levels.
This has become a tale of two narratives, one in which trade tensions and dropping bond yields portend an imminent slow-down in the U.S and world economy and a heightened risk of recession, and a totally different tale of healthy consumer spending, low unemployment, good business confidence readings, and better than expected earnings, which support the no-recession narrative.
Complicating the recession narrative further was a positive revision on GDP on Thursday even as global bond yields moved lower in the U.S. and more negative in Europe and Japan. While our own personal belief is the recession talk may be overdone, at some point even with the U.S. economy in good shape, should the economic slowdown in Europe and China continue, the U.S. will be affected. This ideology will play a role in the Fed’s September meeting. Odds favor another rate cut as the U.S. looks to keep its interest rates in line with the rest of the developed world.
Mortgage activity has picked up big-time as rates have returned to near historic lows. While the high-priced coastal housing market remains sluggish, we are optimistic the current low rate environment will motivate on the fence buyers.
The drop in monthly payments from refinance transactions will also benefit the economy as more money will be freed up for the purchase of other goods and services. Given our belief about the resilience of the U.S. economy in conjunction with where interest rates are at the moment, it is hard to argue against locking-in purchase and refinance transaction as these levels. However, as evidenced by central bank policy in Europe and Japan, rates could go even lower or even negative in today’s world.
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.
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