This morning, Treasuries are following a pattern that has been in place all week and that is to suffer some selling at the open. Where it goes from there is anyone’s guess but we suspect the market will remain under some pressure until we clear the FOMC meeting next week. Yesterday, the early selling pushed yields close to YTD highs with the 10-yr reaching 3.09% (near the 3.11% May high) while the 30-yr touched 3.24%, (within a whisker of the 3.25% May high). After that, and a decent TIPs auction, buyers emerged and reversed most of the losses for the day. The increase in wage growth noted in the August jobs report kicked off the nominal yield increases this month but TIPs (real) yields are rising too on the back of higher oil and a suddenly weaker dollar, and most likely continued optimism over economic growth (Atlanta Fed’s GDPNow is estimating 3rd quarter GDP at 4.45%). Another source of Treasury selling could be that while the tit-for-tat tariff drama continues, consumer confidence and most other economic readings (save for housing) are solid if not touching yearly highs. Thus, the risk-on trading may be a sort of whistling-by-the-graveyard. All is well, for now. Given that scene, we expect yields will continue to test YTD highs through the FOMC meeting with a break or rally following the updated economic projections, press conference and statement.
|Economic News||Despite Climbing Yields 2/10 Spread Still Flat||Market Rates|
While many reasons are given for the yield back-ups this week, and they all may have some relevance, the curve remains quite flat, even with yields testing year-to-date highs. The 5yr/10yr spread has continued its march lower for the past several months, and even the recent giveback has stopped short of a longer-term downward sloping trend-line. As 3% 5-year yields become increasingly likely, if the updated Summary of Economic Projections, due at next week’s FOMC meeting indicate an upward shift in the Fed’s anticipated rate path it could accelerate the selloff in the intermediate part of the curve.
The so-called belly has borne of the brunt of selling this year as the market grudgingly adjusts to the Fed’s planned hiking schedule. Having just caught up with the June SEP expectations, any increase in the rate trajectory in the September SEP will spell more selling in the short to intermediate part of the curve which is likely to further flatten the 5yr/10yr curve.
Meanwhile, yesterday’s existing home sales were unchanged from July at 5.34 million which was slightly below the 5.36 million expectations. Median prices increased 4.6% year-over-year which is up from 4.3% in July, though below the 5+% norm seen between late 2016 and early this year. On net, the existing home sales release, which covers 90% of the housing market, doesn't change the potential medium-term risks to the housing sector. Higher rates and higher prices are working to keep the housing sector in something of a plateau phase. If rates continue higher we expect this will only exacerbate the gathering headwinds in the housing sector.
Also released yesterday the Philly Fed’s business outlook survey printed at 22.9 for September which was above the consensus expectation of 18.0 and a notable improvement from last month's disappointing 11.9. Within the details, prices paid dropped sharply to 39.6, the lowest since January. In summary, the housing data continues to reflect a moderation in activity with the Philly Fed indicating a decent rebound from the disappointing August reading.
President Trump nominated economist Nellie Liang to fill the final open seat at the Federal Reserve (with two other nominees awaiting conformation). Liang is a senior fellow at the Brookings Institution and is no stranger to the Fed, having spent three decades there as a research economist and then director of the Fed’s Office of Financial Stability, which was created after the 2008-2009 financial crisis to help the central bank better monitor risks of another major crisis.
If one can reasonably critic the hiring of questionably-qualified persons in other agencies, the Fed seems exempt from this criticism. In fact, given Trump’s voiced predilection for low rates, Liang’s nomination is indeed a curious one. Given her background in the Office of Financial Stability she is on record as saying the next crisis is likely to spawn from financial excesses and methods to prevent include prudential regulation and higher rates in order to stem runaway animal spirits. Thus, when combined with the middle-of-the-road hire of Vice Chair Richard Clarida, Randy Quarles and the nearly universally-praised appointment of Jay Powell as Chair, the Trump administration is filling vacancies on the Fed Board with apparently imminently qualified and experienced hands that should provide solid guidance and policy direction in the upcoming years.
In fact, this string of solid appointments is adding confidence in financial markets that when the next crisis comes the fully constituted Fed Reserve Board of Governors will be up to the task with competent capable officials. That confidence is perhaps one reason equity markets continue to rally despite the assortment of concerns. They always say bull markets climb a wall of worry but with investors confident with the overseers at the Fed that’s one less thing to worry about.
Despite Climbing Yields 2/10 Spread Still Flat
With longer maturity interest rates climbing within shouting distance of year-to-date highs one might have reasonably concluded some steepness was returning to the curve after approaching decade-long lows in late August, but alas, that is not the case. While the 2yr-10yr spread flattened to a low of 18bps in late August the recent back-up in rates has only steepened the curve to 26bps as the 10– and 30-year bond yields approached the May highs of 3.11% and 3.25%, respectively. Despite the well-advertised back-up in the long-end the short and intermediate parts of the curve are moving almost in lock-step keeping the odds of an inverted curve alive and well.