Treasuries Tread Water Before Fed Decision

May 02, 2018

While the market awaits the Fed decision later today the ADP Employment Change Report for April was just released this morning and it narrowly beat with 204k new private sector jobs  versus 198k expected and 228k in March (revised down from 241k). Friday’s official jobs report is expected to show 191k new jobs versus 103k in March. Treasuries are trading near levels prior to the report as the ADP report hasn’t been much of a harbinger of the official jobs numbers lately. The 10yr note is yielding 2.97%, down 2/32nd in price on the day. As mentioned, the Fed concludes its two-day meeting this afternoon with a 2pm EDT statement. While no hike is expected, investors will be looking for any hints or indications that a fourth hike may be in the offing later this year. We don’t think the Fed will show that hand quite yet. Rather we think the statement will certainly exude a positive outlook on the economy with increased confidence in meeting the Fed’s labor and inflation mandates. While teeing-up a rate hike for the June meeting we doubt it will suggest the pace of hikes needs to accelerate. That may be a story for a later meeting but with stock volatility of late there’s no need to add that element to the mix at this point.  We’ll be back this afternoon with a recap of the rate decision and statement.


  Economic News


One defining, and perplexing, trend in the rise of Treasury rates, was the concurrent weakness in the U.S. dollar. Typically, a currency that has the backing of a central bank that is in the midst of a tightening campaign enjoys a period of strengthening, especially if other major currencies are enmeshed in accommodative (read low rates) central bank policies.  That, however, was not the case for the dollar which suffered through a 15% drop in value from January 3, 2017 to February 16, 2018.


Why the dollar suffered a 15% decline in the midst of a tightening Fed and an accelerating economy doesn’t have a ready  answer. There are myriad factors that impact currency trading  and valuation, and each can rise and fall in importance at any given time. The outlook for a given country’s government can impact values and certainly the Trump administration’s unorthodox approach has probably given foreign investors reason for pause. Another oft-cited reason for the weakness was the perception that other central banks (namely the ECB, BoJ and BoE) were about to embark on their own tightening campaigns given ascendant economies, and thus investors wanted to get in on the early stages of that tightening.


While we are a little suspect of that last reason, the recent turn higher in the dollar has coincided with a turn in sentiment among other central banks. From mid-February to today, however, the dollar has staged an impressive comeback rising nearly 5%. Recently weaker economic results in all three regions: EU, UK and Japan, has tempered  the tone of those central banks regarding rate hiking expectations, and/or tapering of quantitative easing programs. The economic slowdowns and hiking hesitations may be temporary but for now the idea that the Fed is the only major central bank employing tightening policies, and likely the only one for awhile, seems to have boosted the dollar’s prospects.


The stronger, and strengthening, dollar has at least a couple implications for the economy and for the level of rates. For one, the yield differential between other sovereign debt has been substantial but the weakening dollar had been a limiting factor for many foreign accounts. With dollar strength returning, unhedged investments in Treasuries look a lot more attractive to foreign investors; thus, a renewed source of demand may have returned.  Second, import costs will decline with a stronger dollar while export costs increase. That may have negative implications that slows foreign trade and hence economic output. All this is very early, and the rise in the dollar could be nothing more than a bounce after the year-long 15% drop, but with foreign central banks sounding more cautious, and their economies looking the same, the recent strengthening trend bears watching.


The first bit of economic news for April came yesterday and it had some troublesome details that may give some rationale to the recent stock selling. The ISM Manufacturing Survey for April came at 57.3 versus a 59.3 expectation. Also, the hiring plans index fell to 54.2 from 57.3, the second consecutive decline for both the headline and employment categories. In addition, the prices paid component rose and order backlogs rose to 79.3 from 78.1, indicating increased orders and/or supply constraints. Some anecdotal observations in the report pinned the cost increases and supply constraints on tariffs on steel and aluminum, which has hampered some producers.


In summary, while the report noted expansion in the manufacturing sector it’s the second straight print showing a month-over-month decline with the headline number below the twelve-month average. The decline in employment expectations and the prices paid component rising to the highest in seven years adds another fly in the ointment. In fact, the numbers back up some of the narrative in recent quarterly calls that earnings in the first quarter may be the best for awhile given rising input costs and limited capacity to pass those costs on, thus, margins may compress in subsequent quarters. 


While inflation is one of the few factors that could cause a material selloff in longer-term Treasuries, what we’re seeing here is more supply-side price pressures that are mostly self-inflicted, temporary increases. Hence the market has reacted in a more benign fashion. Given that, we see any push higher in longer-term rates as limited and see the flattening trend as still in  solidly in place.




Market Update  Manufacturing Survey Notes Cost Increases & Supply Constraints


The ISM Manufacturing Survey for April had some interesting observations about the economy. First, it picked up some softening in expectations as the overall reading was the lowest since July 2017, and the 57.3 reading was under the 58.4 twelve-month average. Second, when setting tariffs maybe don’t target intermediate goods because what flowed through the report was increasing costs and supply constraints that are slowing delivery times, crimping margins and softening employment plans. If the services survey on Thursday shows a similar slowdown in hiring plans, estimates for the Friday jobs report may get lowered.

Demand-Supply Gap



Agency Indications Agency Indications — FNMA / FHLMC Callable Rates


Agency Indications — FNMA / FHLMC Callable Rates



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