This week has been rather light on economic news but what it’s missed on the data front it’s more than made up for with a series of events on the geo-political stage. Those events have contributed to an increasingly risk-off tone that pushed Treasuries to year-to-date low yields yesterday and they are holding most of those gains this morning as the latest durable goods report disappointed. You can take your pick from several issues that are gnawing at investors with the increasingly deteriorating U.S./China trade war leading the pack. Just behind it, however, is the slow motion train wreck that is the Brexit process in the U.K. and the increasingly perilous looking E.U. parliamentary vote that is occurring now and through the weekend. We take a look at these issues in more detail below, but suffice it to say here that it has created a nervous, risk-off tone that has contributed to a safe-haven bid in Treasuries that shows no signs of relenting at the moment.
In assessing how far and fast sentiment has deteriorated one need only look at Wednesday’s release of the minutes from the April 30-May 1 FOMC meeting. In those minutes, officials talked of the improved global economic outlook versus the one that prevailed after the tumultuous fourth quarter. The recovery in stocks in 2019, the apparent economic improvement in China, stabilization in Europe, and, most importantly, a seemingly imminent trade deal with China were all cited as reasons to upgrade the economic outlook versus the January and March meetings. Thus, the tone of the minutes was one of confidence that the patient pause approach was working and providing the domestic economy some breathing room to reestablish momentum after the fourth quarter stumble.
The inflation discussion also exhibited confidence that the recent trend lower was “transitory”. The discussion specifically mentioned “idiosyncratic” factors like apparel costs and portfolio management fees as two items that inordinately forced inflation readings lower. They also mentioned the Dallas Fed’s trimmed mean inflation estimate was near 2% so they were generally in agreement that they were at, or very near, their 2% target. Thus, the inflation discussion showed very little concern or consternation that the lower trend would not soon reverse.
That discussion was met by a rally in Treasuries as investors were quick to pick up on the somewhat stale global outlook and the fact the that optimistic outlook was somewhat central to the patient pause stance on rates. With the U.S./China trade negotiations having deteriorated into increasingly shrill comments and accusations, the negative impact of tariffs, blacklists, restrictions, etc., looks to increase and that will dim the global outlook compared to the last FOMC meeting.
Meanwhile, Prime Minister Theresa May’s tenure is coming to end as she has announced she will resign on June 7 as her last gasp at a Brexit plan appears dead-on-arrival much like her previous iterations. What’s more, the U.K. is voting on its members to the E.U. Parliament this weekend and it looks like the architect of the whole Brexit movement, Nigel Farage’s Brexit Party, looks set to garner a plurality of votes. The early betting on a successor is the mercurial firebrand Boris Johnson who’s been a fervent Brexit believer from the beginning, something Theresa May tried to portray but could never pull off.
What that likely means is a period of paralysis as a new government is seated and then a new way forward on Brexit is formulated, and a no-plan Brexit possibly contemplated. In the meantime, not only are U.K. citizens voting on E.U. representation but the other 27 member states as well, and it’s looking increasingly likely that parties that range from E.U. skeptics to those more overtly hostile to the E.U. experiment will gain seats in the new E.U. Parliament. If that comes to pass it will send a chill through the myriad organizations that have operated under a unified E.U. banner for the past 62 years. One consequence of such an outcome is increasing market nervousness with Treasuries and the U.S. dollar the likely beneficiaries of safe-haven trades, and businesses pulling back on investment and/or expansion plans.
Meanwhile, the Fed may have expected the recent inflation downtrend to be “transitory” but if these geo-political factors intensify that will depress economic output in the rest of the world and add to dollar strength. Both of those factors will add to disinflationary pressures; thus, while the “idiosyncratic” factors that kept inflation trending lower in the first quarter may lift, there could be other factors waiting to take their place.
One more item that is solely a domestic issue that is no doubt aiding Treasury bids in the background is the increasingly hostile relationship between the Democratically-controlled House and the White House. As various House committees press forward on investigations, and as the Trump Administration fights those investigations, we are venturing into a constitutional crisis. If it eventually leads to impeachment hearings expect more confidence to ebb from investors with flight-to-safety trades into Treasuries accelerating and pushing YTD yield lows even lower.
10-Year Treasury Yields Hit 2017 Lows
With the outlook for a quick resolution to the U.S./China trade war having dissipated, investors are reassessing both the global growth and inflation outlook and the result has been a strong rally in Treasuries with almost all maturities hitting YTD low yields, and the 10-year Treasury yield dipped to levels not seen since late 2017. Almost all of the drop in yield is due to reduced inflation expectations as the combination of lower global growth and increased dollar strength due to safe-haven trades portends a disinflationary trend, at best. The Fed has to be more concerned over this prospect than they were at the May 1 FOMC meeting, and that is adding to odds a rate cut comes as early as September.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||2.35%||-0.03%||1 Mo LIBOR||2.44%||+0.01%||FF Target Rate||2.25%-2.50%||3 Year||2.120%|
|6 Month||2.38%||-0.03%||3 Mo LIBOR||2.52%||-0.01%||Prime Rate||5.50%||5 Year||2.114%|
|2 Year||2.15%||-0.02%||6 Mo LIBOR||2.57%||+0.02%||IOER||2.35%||10 Year||2.263%|
|10 Year||2.33%||-0.06%||12 MO LIBOR||2.67%||+0.04%||SOFR||2.37%|