Investors pushed already low Treasury yields even lower yesterday after a weekend of geo-political events that seemed to point to increased global uncertainty, and perhaps further slowing in the global economy. That move is in place again this morning as China threatens to ban exports of rare earth minerals, a market they control 80% of with the minerals used in all manner of smart electronics. Thus, trade-related angst remains high and the E.U. Parliamentary vote (including the U.K.) over the weekend added to concerns over the stability of global institutions and that has sent investors looking for safe havens including Treasuries. With the 2-year yield at 2.07% and the five-year yield at 2.02% the Treasury market is trying to force the Fed’s hand with the effective fed funds rate trading up at 2.37%. Odds of a rate cut at the September FOMC meeting are now 57%, while a December rate cut has risen to 86%. January 2020 fed funds futures are priced at a 2.00% yield, representing 37bps of rate cuts between now and then. With a June 19 FOMC meeting, the Fed may be forced to begin prepping markets for a rate cut, or cuts, in the second half of the year.
This week has a few first-tier economic releases but the trading has taken its direction more from the geo-political influence than what the releases indicate. We saw this yesterday with a flight-to-safety trade in Treasuries off weekend presidential tweets that intimated additional tariffs could be employed against China. This morning, China is threatening an export ban on rare-earth minerals which are used in all manner of smart electronics and a market they control 80% of. So trade-related angst remains very high and any tilt in news flow that hints at further deterioration will be positive for Treasury prices.
The other big political event from the weekend was the every-five-year E.U. parliamentary elections. While the big concern going into the weekend was whether euro-skeptic parties and parties overtly hostile to the E.U. could score big gains in seats such that the balance of power in the E.U. would shift away from the more centrist E.U. supportive parties. The results, however, were more ambiguous. The centrist parties did lose seats but the loss was split between the two fringes: the more liberal elements looking for even deeper E.U. power and the nationalist/populist parties looking for just the opposite. One country that did have an unambiguous result was Italy where the populist party gained even more seats so look for them to continue to provoke E.U. leadership with tax cuts and/or spending programs that violate E.U. budget requirements.
As for the U.K.’s vote, as expected soon-to-be-resigning Prime Minister Theresa May’s Conservative party was drubbed going from 18 seats in the E.U. Parliament to nine. Nigel Farage’s Brexit party gaining many of those lost seats. The Liberal Democrats picked up seats too so the U.K. vote in some ways mirrored the results on the Continent with centrist members (this case May’s Tory party) losing seats to both the far-right (Brexit party) and the far-left (Liberal Dems). The conclusion drawn by many of the contenders vying for May’s position is that her party must neutralize Farage by adopting his hard-Brexit approach, including leaving the E.U. without a deal if Brussels refuses to improve its offer.
In the meantime, the gains by the Liberal Dems will force the more centrist Labour Party to consider a second referendum on the whole Brexit question. The nub of all this is that the odds of crashing out of the E.U. without a formal divorce agreement have risen, but so too have the odds for a second referendum. As options seem to be dwindling to a binary choice (i.e., crash out without an agreement, or have a second referendum), Treasuries should be well bid through the summer as the U.K. Parliament hashes out its Brexit strategy.
Away from political machinations, home price appreciation rates slowed for a twelfth-straight month with the S&P CoreLogic CS 20-City Home Price Index posting 2.68% year-over-year appreciation in March versus 2.95% in February. The print, however, was better than the 2.50% expected. Ironically, the slowing in home appreciation is expected to encourage a pick-up in housing activity with moderating prices, combined with falling mortgage rates, and moderate wage gains allowing more potential homebuyers to enter the market. We’ll get a better view of that thesis tomorrow with pending home sales for April. Expectations are for a modest 0.5% gain in sales versus March. Recall that pending sales are based on contract signings versus closings which are used in many other housing-related reports so it provides one of the more contemporaneous looks at the state of the industry.
On Friday, another important release will give us personal income and spending numbers for April. Expectations are that incomes will increase 0.3% for the month versus 0.1% in March. Spending is expected to increase 0.2% versus the robust 0.9% in March. Spending adjusted for inflation is expected to be flat versus a 0.7% pick-up in March. So, the all-important consumer looks to have retrenched again in April after a pop in spending the prior month. Finally, the Fed’s preferred inflation measure (core PCE) is expected to increase 0.2% for the month and 1.6% YoY, same as in March. A retrenching consumer is not what the Fed wants to see, especially with the current muddled state of the global economy.
S&P CoreLogic Home Price Appreciation Index Slows Again
The S&P CoreLogic CS 20-City Home Price Index posted its twelfth straight month of slowing home price appreciation, this time with March posting a 2.68% year-over-year gain. A year ago, the index seemed to be stuck around the 6%YoY level and the strength in rising home prices was one reason for the slowing in housing activity in 2018. However, with home price appreciation slowing to rates below 3.3% annual wage gains, and the continued decline in mortgage rates, better affordability should bring about an increase in sales activity. The first indicator for this could be tomorrow’s pending home sales report for April.
Agency Indications — FNMA / FHLMC Callable Rates
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