After a so-so jobs report and a docile CPI read on inflation Treasuries faced a tougher trading environment yesterday with a solid Retail Sales Report for December and positive comments around the U.S./China trade deal. We go into more detail on the trade deal below but the retail sales numbers for December were encouraging in that 12 of 13 categories posted gains with the notable exception of auto sales. The 0.5% control group reading, which is a direct GDP feed was better than the 0.4% expected but November was downwardly revised from 0.1% to –0.1%. We mentioned before that with Thanksgiving occurring so late in November conclusions on the consumer should wait until December’s results and that seems to be the case. With a solid increase in overall sales of 0.3% (matching expectations) and ex-auto and gas up 0.5% (versus 0.4% expected), it’s clear that the consumer waited until the last few weeks to begin spending. It’s not all wine and roses, however, as the results combined with downward revisions to November and a flattish October point to mediocre consumer consumption for fourth quarter GDP. Bloomberg consensus expects fourth quarter consumer spending at 2.0% versus 3.2% in the third quarter. That leaves fourth quarter GDP estimates at 2.0% versus 2.1% in the third quarter. Looking forward, first quarter GDP estimates are even more modest with the Bloomberg consensus at 1.6%. So, if you’re looking for reasons behind the resilience in the Treasury market, moderating growth expectations is surely one of them.
One of the big drags on global economic growth last year was the never-ending trade hostilities between the U.S. and China, so with the signing of the Phase 1 trade deal on Wednesday we wanted to dig into some of the details and see if there really is something to the deal that may curtail those uncertainties and lead to a better global trading environment in 2020. Let’s take a look at some of the important takeaways in the trade deal.
- “During the two-year period from January 1, 2020 through December 31, 2021, China shall ensure that purchases and imports into China from the U.S. of manufactured goods, agricultural goods, and energy products exceed the corresponding 2017 baseline amount by no less than $200 billion.” These additional purchases represent nearly a 50% increase over current import levels which begs the question whether it is even reasonable to expect such an increase? And if the increase is not achieved does it create the possibility of recriminations, including increased and/or additional tariffs? In fact, that’s the main issue we have with the deal in that it sets a high bar for the Chinese in several places such that a shortfall or miss seems almost inevitable.
- “China recognizes the importance of establishing and implementing a comprehensive legal system of intellectual property protection and enforcement as it transforms from a major intellectual property consumer to a major intellectual property producer. China believes that enhancing intellectual property protection and enforcement is in the interest of building an innovative country, growing innovation-driven enterprises, and promoting high quality economic growth.” This is a notable element of the deal and one that wasn’t really expected as part of the Phase 1 deal. The main complaint here is the deal is light on specifics as to enforcement. So while the sentiments expressed are certainly positive, it remains to be seen if the deeds will match the words.
- “The Parties affirm the importance of ensuring that the transfer of technology occurs on voluntary, market-based terms and recognize that forced technology transfer is a significant concern. The Parties further recognize the importance of undertaking steps to address these issues, in light of the profound impact of technology and technological change on the world economy.” In that regard, the deal requires China to stop pressuring U.S. companies to share technology with local joint venture partners or sell licensing to their technology at below market prices for access to China's market. This tech transfer issue has been a key U.S. business concern in doing business in China, but again enforcement and follow-through will be important.
- “A mechanism has been established to deal with issues related to exchange rate policy. When a dispute arises it will be heard by a newly created Bilateral Evaluation and Dispute Resolution Arrangement. If there is failure to arrive at a mutually satisfactory resolution under the new board the Treasury Secretary or the Governor of the People’s Bank of China may request that the IMF, consistent with its mandate: (a) undertake rigorous surveillance of the macroeconomic and exchange rate policies and data transparency and reporting policies of the requested Party; or (b) initiate formal consultations and provide input, as appropriate.” The resolution process, especially if it involves the IMF, appears time-consuming and cumbersome; thus, will it even be used and/or be timely and effective?
The deal also allows U.S. financial firms more access to Chinese financial markets including rights to participate in the securities, fund management and futures sectors. Ratings agencies will also be given rights to rate Chinese debt. These areas will take years to fully develop but for large, multi-national financial firms the opportunities are promising. In the end, the deal removes some uncertainties but the bar is set high for the Chinese in several areas such that failure to deliver seems almost inevitable, and what will follow that? Also, the 800lb gorilla left in the room is state-provided subsidies to key industries. Until that is addressed the relationship between the U.S. and China will remain somewhat contentious.
Refi Rates Spike Again Portending Increasing Pre-Pays
With the drop in mortgage rates during the past year (blue line), refinancing and hence prepayments have become a bigger concern to MBS investors recently. Refi activity, however, paused a bit in the second half of 2019 as the huge drop in rates from January to June stabilized for the balance of the year. However, as the graph shows refi activity has spiked again and last week exceeded the highest rate experienced in 2019. That should manifest in increased prepayments once again over the next several months. That’s one reason we like new issue MBS pools as they are more likely to avoid excessive prepayments versus the more seasoned varieties given the rate and refi history of the last year.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||1.55%||+0.02%||1 Mo LIBOR||1.67%||-0.01%||FF Target Rate||1.50%-1.75%||3 Year||1.638%|
|6 Month||1.56%||+0.02%||3 Mo LIBOR||1.84%||UNCH||Prime Rate||4.75%||5 Year||1.661%|
|2 Year||1.57%||UNCH||6 Mo LIBOR||1.87%||UNCH||IOER||1.55%||10 Year||1.806%|
|10 Year||1.85%||+0.03%||12 MO LIBOR||1.95%||-0.02%||SOFR||1.55%|