Will the Treasury Back-Up Hold or is it a Buying Opportunity?

Nov 06, 2019
Ship at Dock being Loaded

Despite positive vibes on a potential U.S./China trade deal, and an ISM Non-Manufacturing number that beat estimates, equities couldn’t hold early gains yesterday and Treasury yields backed off of levels that essentially reversed the Fed rate cut-inspired rally. To be sure, a risk-on tone still rules but as we discuss below, at some point improvement in intangible aspects of the economy will have to be followed by tangible improvements, and GDP estimates for the current quarter and first quarter 2020 don’t call for a material turn higher. Plus, third quarter productivity was just released and disappointed with the first negative print since 2015. The year-over-year rate is back down to 1.4% versus 1.8% in the second quarter. The productivity decline will work to keep long-run GDP potential in the sub-2% range. Thus, we’re left with the impression that the back-up in Treasury yields since early October may be more a buying opportunity rather than the long-awaited return of the bear market in Treasuries.


newspaper icon  Economic News

Some apparent good news on the U.S./China trade front set  a risk-on tone early yesterday and Treasuries were on the back foot despite equities giving back much of the early gains to end the day near unchanged. Some things to consider that are both driving rates currently and things we think will limit the back-ups to buying opportunities rather than a shift to a more bearish scenario.

  • China wants the U.S. to drop tariffs on $360 billion in imports before Chairman Xi agrees to go to the U.S. to sign a partial trade deal. They are also considering easing market access for foreign investment and Xi didn’t hammer Trump in an opening speech at an import conference. Those were all spun as good news for a trade deal. The Chinese currency strengthening to a sub-7 handle for the first time since August 5th was also seen as a conciliatory gesture on China’s part.
  • The ISM Non-Manufacturing gauge came in better than expected at 54.7 versus 52.6 in October and 53.5 expected and that contributed to further selling in Treasuries yesterday. Even with the improved reading versus the prior month, the index remains well below 2018 levels, consistent with an economic expansion that continues but at a slower pace.
  • Despite the good vibes on  a China deal, and a services sector that while slower than 2018 continues to expand, GDP estimates for fourth quarter point to continued slowing. Bloomberg consensus expects fourth quarter GDP to be 1.7% and the Atlanta Fed’s GDPNow model is even more pessimistic at 0.9% in its early estimates. Oh, and the JOLTs Job Openings number yesterday was the lowest in eighteen months, perhaps a sign of slowing momentum in the labor market.
  • The U.S. dollar’s long-running strength relented after the Fed’s last rate cut and that has contributed to the more favorable risk-on tone of late given the positive trade implications of a weaker dollar. That weakening, however, reversed on Monday and continued to strengthen yesterday. Further dollar weakening will have to occur for the move to have any real benefit to the long-run trade picture.
  • So far the Treasury move has merely reversed the “policy-error” rally following the Fed meeting .  For the selling to signal a more durable recovery in economic “animal spirits”  the 2.00% level will have to be challenged as that’s a level that has held since late July. Presently, the 10yr yield is 1.83%, up 9/32nds in price in early trading.
  • While we may have passed peak pessimism on the global outlook, it remains to be seen if the tentative improvement in intangibles will give way to  more tangible signs of an expansion that is returning to 2018-like growth rates.


line graph icon  Regulatory Corner — Community Bank Leverage Ratio is Here


Regulators last week finalized the Community Bank Leverage Ratio (CBLR) Rule that will allow qualified banks to adopt a simpler method for measuring capital adequacy. The community bank leverage ratio framework will be available for banking organizations to use in their March 31, 2020 Call Report.


To qualify for the rule a bank must meet the following criteria: (i) a leverage ratio of greater than 9%; (ii) total consolidated assets of less than $10 billion; (iii) total off-balance sheet exposures (excluding derivatives other than sold credit derivatives and unconditionally cancelable commitments) of 25% or less of total consolidated assets; and (iv) the sum of total trading assets and trading liabilities of 5% or less of total consolidated assets. As of March 31, 2019, the FDIC supervised 3,465 institutions, of which 2,705 are considered small entities for the purposes of the rule. Of these FDIC-supervised small entities, 2,297 (85%) meet or exceed the qualifications for adopting the community bank leverage ratio framework.


Under the final rule, the community bank leverage ratio framework incorporates tier 1 capital as the numerator and the denominator being average total consolidated assets as calculated in schedules RC-K, HC-K, or Form FR Y-9C, as appropriate.  You can expect to see more information and further instructions from your regulators prior to the March 31, 2020 filing dates but it looks like some paperwork reduction is heading your way in 2020.



line graph icon  Muni Supply Surge Coming-Could Spell a Buying Opportunity


Municipal supply is set to ramp-up as year-end approaches with cities and states set to offer more than $24 billion in new muni debt, the busiest schedule since the record-setting end of 2017.  With the Fed signaling that they are apt to pause further rate cuts into 2020, local governments are racing to sell bonds while their borrowing costs hold near half-century lows. The increase in supply coupled with the recent back-up in market rates should provide an attractive entry opportunity for muni investors that have perhaps heretofore balked at higher prices and lower tax equivalent yields.


Supply Surge



bar graph iconAgency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 1.81 1.90 2.00 2.10 2.46 2.71
0.50 1.74 1.84 1.95 2.06 2.42 2.68
1.00 1.63 1.74 1.85 1.96 2.33 2.60
2.00 - 1.58 1.69 1.81 2.23 2.46
3.00 - - - - 2.10 2.36
4.00 - - - - 2.00 2.29
5.00 - - - - 1.90 2.22
10.00 - - - - - NA


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