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.
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.
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.