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
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 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.
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.