Producer prices for August are out this morning and slightly hotter than expectations. Overall PPI was 1.8% YoY versus 1.7% in July. Forecasts were calling for a repeat of July at 1.7%. Core PPI (ex-food and energy) rose 0.3% for the month and 2.3% YoY, both one-tenth more than expected. On a trend basis, overall PPI has been in a gradual decline for twelve months as commodity prices have fallen while the core rate has been in a gentle decline since December. As a side note, tariffs are not included in this series thus the impact isn’t captured but with other cost inputs trending lower it will help offset their eventual impact. In any event, the more consequential CPI report is due tomorrow but even if we get an as-expected 2.3%YoY on core CPI compared to 2.2% in July it won’t deter a 25bps Fed rate cut next week. On the other hand, with odds of a 50bps rate cut currently at only 5%, the report would have to be staggeringly weak to stoke hopes for the larger cut and the PPI numbers today don’t project such weakness in CPI tomorrow.
Treasuries have had a rough go of it in September so the question quickly arises as to whether this move is the beginning of the end for the never-ending bond rally or whether it’s more technical in nature with limited potential? We think it’s the latter and because of that it could provide some interesting investment opportunities for those with funds to invest and looking for a good entry point.
The 10-year note hit a low yield of 1.46% on September 3 and since then has backed up to 1.73% for a 27bps move in a week’s time. During that same week the Dow industrials gained 700 points or 2.7%. That’s a nice gain to be sure but not exactly the huge risk-on rally that one might have expected given the selling in Treasuries and the more conciliatory tones on the trade front. Some of the additional pressure on Treasuries is no doubt springing from supply coming to market this week. Yesterday the Treasury sold $38 billion in 3-year notes and they’ll come to market with $24 billion in 10-year notes today and $16 billion in 30year bonds tomorrow.
The supply comes as the improved tone on the trade talks and the removal of a hard Brexit scenario have taken some of the steam out of the “recession-is-coming” outlook and reduced some of the near-term market uncertainty. Add in too that the ECB meets tomorrow and the increasing expectation is that while delivering another rate cut (from –0.40% to –0.50% on the deposit rate), they may refrain from reconstituting the quantitative easing program in the size the market was hoping for (i.e., $50 billion per month). The limited scope of the expected easing actions is disappointing markets, particularly longer-end bonds that would have been part of the QE program, and that disappointment is being felt early in the form of lower bond prices throughout Europe and that is feeding back to the U.S.
Finally, on a seasonal basis mid-September to year-end tends to be a bearish period for Treasuries as holiday season optimism and new year hopes start to inflate earnings expectations and GDP projections. The question is with Brexit looking to drag on into 2020, and despite recent conciliatory tones around trade talks, are we likely to see similar strains of optimism into year-end? We think fixed income investors will be more reluctant this year to go all-in on an optimistic 2020 outlook and as such the typically bearish year-end period for Treasuries may be tempered somewhat this year with a quick recovery in early 2020.
That’s why we think the current pullback in Treasuries will be limited and provide a decent opportunity for those with funds to invest but not wanting to buy at the earlier yield bottom. If the pullback is going to be limited, just how far might it go? With docile inflation and modest growth forecasts the Fed’s policy rate seems a good spot to encounter support. Assuming the Fed cuts rates 25bps next week that would move the fed funds range to 1.75%-2.00%, with expectations that another 25bps cut is likely before year-end. Thus, it seems 2% on the 10-year note should provide solid support in relation to the sinking policy rate, not to mention the psychological barrier it represents.
We think, however, that with a reduced level of the usual year-end optimism the back-up in yields will be hard-pressed to approach 2%. More likely, 1.75% to 1.85% seems a more realistic target and with the current 10-year rate at 1.73% some attempt to hold-the-line is getting very close. The twin hurdles of supply this week and the ECB policy decision on Thursday are sources of continued pressure and both could catalyze a move into the 1.75% to 1.85% range. If yields do reach that level we would, however, be interested in putting money to work as the 2% level may be harder to achieve in the near-term unless real breakthroughs in trade talks and Brexit appear and we are not optimistic on either of those fronts.
JOLTs Quit Rate Rises Again Amid Worker Confidence
After last Friday’s mediocre August jobs report, yesterday’s Job Opening and Labor Turnover (JOLT) survey provided more information on the state of the labor market. While the July report is a bit dated, it does have some additional indicators that are followed by the Fed. One of the primary indicators is the Quits Rate which measures the number of voluntary job quitters as a percent of total employed. It provides a measure of worker confidence as those quitting jobs voluntarily feel comfortable in finding other employment. The Quits Rate had plateaued at 2.3% for the past 13 months which was the high reading for this cycle until July’s 2.4% print. It’s just another sign that worker/consumer confidence remains solid.
Agency Indications — FNMA / FHLMC Callable Rates
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