Risk-on Tone Keeps Pressure on Treasury Prices

Mar 01, 2019
Packed warehouse inventory

A risk-on tone prevails this morning as some globally  less-bad-than-expected news is triggering modest stock rallies.  A Chinese factory report was slightly better than expected (but still in contractionary territory), and a German manufacturing report revealed some stabilization after several months of slowing and that has raised hopes  that the year-end slowdown is stabilizing rather than continuing lower. That has Treasuries in a spot of bother with a third straight day of losses looking to be the trade of the day unless things reverse before the close. That being said, the selling is keeping yields within year-to-date ranges with the 10-year note at 2.74%. We would be buyers if that yield approaches 2.80% as we still fail to see catalysts sufficient to turn this selling into more than an in-range correction.  Yesterday’s Treasury retreat came on stronger-than-expected fourth quarter GDP but that report came with a caveat that limited the Treasury damage (more on that below). As we mentioned, the yield back-ups remain within this year’s range, and with recent economic releases decidedly mixed the catalysts for further selling look limited. One item that remains a potential trigger is a trade deal with China. With the Cohen hearings in the history books, and the North Korean summit ended without much to show the administration is looking for a win. The market, however, will be keen to “deals” that are little more than increased soybean sales rather than more substantive agreements on intellectual property and other long-term structural issues. So even here the catalyst for higher rates may be limited.  


newspaper icon  Economic News


We finally got our hands on fourth quarter GDP (a month late and effectively the second estimate), and while superficially it beat estimates coming in at 2.6% versus the 2.2% Bloomberg consensus the  details provide a note of caution, particularly for the first and second quarters of this year.  The concern stems around excess inventories that are likely to be reversed in the early  months of 2019 if sales fail to take down the excess. We got a heads-up on the inventory issue Wednesday when December retail and wholesale inventory numbers came in much higher than expected. 


Over the last year or so, changes in inventories have varied around plus or minus $30 billion per quarter. For the third and fourth quarters, however,  inventories were +$90 billion and +$97 billion, respectively. Thus a significant balance looks to have accumulated. In analyzing GDP, one way to eliminate the volatile impact of inventories is to look at real final sales (which also eliminates the impact of international trade), and that number was a decent 2.5% which would lead one to believe the GDP number was on solid footing. The caveat there is that with the inventory build occurring over consecutive quarters the quarter-over-quarter change is virtually nonexistent. The inventory build-up is due to tariff and other trade-related fears along with slowing sales into year-end. The inventory will have to be worked off and that implies a slowdown in manufacturing is likely.  That’s why you see early consensus estimates for first quarter GDP at 1.8%-2.0%.  


While fourth quarter GDP exceeded most estimates, full-year GDP was 2.9% and just below the Fed’s 3.0% forecast. That being said, the Fed will like the rebound in business investment which rose 6.2% versus 2.5% in the third quarter. That bounce—which came mainly from the equipment category—helped to offset the slip in consumer consumption which dipped to 2.8% from 3.5% in the third quarter. The increase in equipment spending could lead to improved productivity numbers in future quarters as businesses reinvest in productivity-enhancing goods as wage gains continue to increase. 


One sector of the economy that could be looked on to turn from a headwind to a tailwind is housing. For the fourth straight quarter housing subtracted from GDP but that worm could be about to turn. We noted on Wednesday that with interest rates dropping by 50bps from November highs, and with annual price appreciation rates slowing from 6% to the low 4%’s, and with wage gains moving above 3%, housing affordability appears ready to improve. On Wednesday, the January pending home sales report surprised to the upside and that’s one of the few housing reports to have done that lately. 


Pending home sales are unique in that they are based on contract signings rather than the usual closing-based reports.  The  upbeat pending home sales implies an improvement in existing home sales in another month or so. That could lead to housing adding to GDP in upcoming quarters rather subtracting which has been the case for the past year.  


In the end, while fourth quarter GDP posted a respectable 2.6% rate the Fed is not likely to move from it’s recent shift to a patient pause in rate hikes. The inventory build will have to be worked off in coming quarters and consumer consumption—which is two-thirds of the economy —is predicted to slip to the 2.0%-2.5% range this year as the tax cut stimulus continues to fade. While business investment surprised to the upside—and that has productivity-enhancing elements— that’s a slow-developing trend and one not likely to shake 2019 GDP estimates from the 2.3% to 2.5% range. Thus, the recent back-up in rates is likely to remain a range-bound event without the necessary stimulus to drive the 10-year much above 2.80%.  We especially think this when considering that the inflation readings from the GDP report remained docile with overall prices increasing 1.8% and core prices increasing 1.7%. 




chart icon  GDP and the Building Inventory Question

While 4th quarter GDP beat expectations at 2.6% annualized quarterly growth and a 3.1% year-on-year rate, it also came with a caveat. For the second straight quarter inventories added to growth increasing GDP by 2.33% and 0.13%, respectively. The back-to-back large inventory gains clouded some of the quarterly change figures but it doesn’t change the fact that the inventory overbuild will have to be worked off in the coming months. Some slowing in factory orders seems likely in the coming months as companies work off their inventory oversupply and that may limit GDP growth early in 2019.


GDP and the Building Inventory Question



chart icon  Market Rates


Market Rates



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