Pascale’s Perspective

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    “The Long Bull Market in Bonds is Over” “The Punchbowl is Being Removed”

    The headlines have been “on hold” for years, but are now coming fast and furious as the 10 year yield hit 3.10%, the highest level since July 2011. Traders are shrugging off geopolitical events (US-North Korea tensions flaring up again, Mid-East tensions, Trade Talks) based on this week’s solid growth and inflation news: retail sales growth (Macy’s is back!), housing starts, and industrial production – all reports came in strong. Combined with supply/demand concerns (US deficit, Fed balance sheet reduction), yields are busting through key technical levels. The velocity of the rise is also noteworthy. Yesterday we saw a quick 9 bp increase in the 10 year rate. It’s seeming more like a trend than a peak, but those pronouncements have been made before, only to see yields drop as growth sputters or events such as Brexit spook investors back to the safe haven of Treasuries. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasuries “Hang Out” at 3.00%, Loan Coupons Still Sub 5.00%

    Today’s auction of $25 billion of 10 year treasuries was closely watched to see if the yield would hit 3.00%, a key psychological level. The closing yield was 2.995%, so very close. The 10 year yield is seeing upward pressure from the recent US withdrawal from the Iran nuclear agreement as the market sees this as inflationary. Oil is firming up at a $70 per barrel figure for the first time since 2014 (when it slid down from a high of $110). The return of inflation is now an accepted reality, the 10 year yield trading tightly around 3.00% indicates the markets are looking for direction (data that will yield confirmation or possibly confusion). Last week’s employment report was very “Goldilocks” with tight unemployment but it was due to a smaller labor force and wage growth was tepid. Tomorrow’s consumer inflation report, if inflationary, could push yields above the recent key technical level of 3.03%. The CMBS market remains robust, with some recent widening due to underwriting dynamics in particular pools, not overall sentiment. Spreads for full leverage loans are about 1.70-1.80, so coupons are creeping up towards 5.00%. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Are We There Yet? Yes, Now What Happens?

    For years we have been in the world of the “new normal” where ultra-accommodative central bank policies (near zero interest rates, quantitative easing through massive bond purchases, etc.) result in little or no inflation. These metrics would be considered unthinkable in the pre-2008 era, when inflation was a constant and a real threat. During the last few years, the Fed has made it clear that their targets for full employment and normalized price increases were “2 and 4” (2.0% inflation and 4.0% unemployment). So Monday’s report indicating that the Fed’s preferred inflation gage, Personal Consumption Index (PCE), rose 2.0% for the year. Also, this is not an anomaly; the classic elements of a true inflationary environment are in place. Oil prices are firming up and the employment cost index rose 2.7% for the last year (and 0.8% in the first quarter alone). However, first quarter GDP cooled to 2.3% after hovering around 3.0% previously (this may be seasonal as consumers often cool off in the early part of the year). Today’s Fed meeting statement confirmed that inflation should “run near” 2.0% (this is an update from the March statement indicating that inflation would “move up” to 2.0%). The new fascinating term in the statement is “symmetric inflation”, this is being interpreted as a signal that the Fed won’t overreact to inflation at 2.0% and may tolerate a number slightly above that after so many years below. So two more hikes this year and possibly three are a certainty barring some unforeseen market issues. Keeping to the schedule of rate increases, it looks like June and September are the likely dates, with December as a “wild card” potential 4th increase in 2018. Note that the most influential Fed officials have targeted a “neutral rate” of 2.50% (a couple years ago the target neutral rate was 3.25-3.50%, the lower rate indicates officials believe a long period of “secular” low interest rates is appropriate). Last week’s dovish ECB statement putting off the end of their quantitative easing helped lower the 10 year T to 2.96% as 3.02% remains the recent peak (again). Always remember that the Fed controls a short term rate, long term rates are products of supply/demand dynamics and expectations for future inflation and growth. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    10 Year Treasury Over 3.00%, Is this a peak or a stepping stone?

    Pascale’s Perspective

    April 25, 2018

    Treasury yields are rising due to a combination of factors: easing of geo-political issues (North Korea-U.S. tensions, tariff/trade war); positive economic reports (consumer confidence, home sales) and inflation rumblings. The 10 year T hit 3.01% in late 2013 and dropped to 2.50% by mid-year 2014. That point is the recent high since 2011. Is 3.00% just a data point on an upward trend to (?) Or will inflation and growth slow (maybe because of high rates)? Monday’s market sell off to Caterpillars earnings report was interesting. The company indicated that the economy and earnings were at a “high water mark” and a leveling off or slowdown is looming. Investors fear a scenario of slowing growth and rising rates, it’s reminiscent of “stagflation.” Another interesting aspect of the report is it noted rising commodity costs along with an inability to raise product prices accordingly. This dis-connect may come up in future Fed debates about rising rates and what constitutes inflation. Commodities, finished goods and wages may disconnect in the “new normal” as technology and information access have changed the game. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasuries, Short Term and Long Term Trends Differ, Yield Curve Flattening Further (for now)

    Pascale’s Perspective

    April 11, 2018

    Treasury yields are being buffeted by many factors. The 10 year yield has dropped in the past few days (now 2.79%, under the recent trading range) on geopolitical concerns (possible US strike in Syria, USA/Russia tensions). Other factors indicate longer term increases in treasuries: possible easing of trade tensions between US and China, CPI report indicating an inflation spike, new US budget projections indicating regular trillion dollar deficits, etc. The 2 year Treasury jumped to 2.31%, combined with the lower 10 year yield, we are seeing the flattest yield curve in 10 years. The expectation is for the long end to rise. Today’s Fed Minutes showed officials seeing improving economic growth and higher inflation. A major shift in tone is coming as members are considering changing the description of monetary policy from “accommodative” (it’s been accommodative for a decade!) to “neural” or “restraining”. Note that the Fed’s own projections indicate a future short term rate above the so-called “neutral rate” (the neutral rate is the rate that is neither accommodative or restraining). So they actually foresee a day when Fed policy will be needed to rein in growth. Two more rate hikes are anticipated this year (June and September), with the “wild card” of a potential fourth increase this year possibly in December, futures markets indicate a 25% chance of that. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Volatility is the Newest Normal, LIBOR Run Up

    Pascale’s Perspective

    March 28, 2018

    Treasuries rallied this week, with the 10 year yield dropping to a level not seen since early February. The flight to quality rally is connected to the sell off in equities as markets whipsawed up and down on the possibilities of a trade war with China (markets rallied on Monday on the perception that the tariffs are resulting in negotiations, but the ultimate uncertainty of the outcome and effects will continue to weigh on markets until more issues are resolved) and tech headlines (Facebook, Tesla issues). Tesla’s debt is getting attention as spreads are blowing out on their corporate issuance. Overall credit spreads have widened slightly in the last few months. Combined with short term indexes rising (LIBOR, Prime, Fed Funds), the cost of capital to corporations is increasing. Speaking of the indices, 3 month LIBOR is up 61 bps this year, a period where the Fed Funds rate only increased 25 bps. The 3 month LIBOR is the commonly used benchmark for trillions of dollars of corporate debt. LIBOR’s “disconnect” from the Fed can indicate stress in the credit markets as in 2007-2008. But the culprit here may be US fiscal policy. Short term treasury bond supply is up due to the US budget dynamics and tax cuts. Also, corporations are repatriating cash or using cash for stock bybacks and other uses. That cash was often held in short term instruments. There is less demand and increased supply and that may be driving LIBOR’s rise. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Fed Chair Powell’s Debut Features Expected Rate Hike

    Pascale’s Perspective

    March 21, 2018

    The 0.25% Fed Funds rate increase that was announced today was expected. Bond market reaction was mild as the 10 year traded in a tight range between 2.88% and 2.92%, settling at 2.88%. The 2 year increased to 2.30% after hitting a high of 2.34, so the yield curve remains flatter than usual. Powell’s first press conference as Fed Chair was smooth, he did not roil markets as he seemed to have “something for everyone”. He was relatively dovish on this year’s rate increases, the hotly discussed potential 4th increase for 2018 doesn’t seem to be in the cards. It looks like 3 increases in 2018 and 2 in 2019 (up from 2.5 and 1.5 respectively). Note that this puts the “end rate” at about 3.4% which is 0.5% of the Fed’s stated “neutral rate” that neither inhibits or stimulates growth. This means that the Fed is foreseeing a day when they may have to put the brakes on the economy. (The Fed has not taken such a stance in over a decade). This comes as the forecast for GDP growth is up to 2.7% for 2018 (0.2% increase over December’s prediction) and 2.4% for 2019 (0.3% increase). When will inflation finally hit the Fed target rate of 2%? According to Powell and the committee, it will be 2019 (predicted to be 2.1% after hitting 1.9% this year). Interestingly, Powell displayed the traditional independence of Fed Chair from the administration during the presser. He did not go along with the predicted 3.0% GDP that accompanied the pitch for the recent tax reform but indicated that number was “well above all estimates, current estimates of potential long-run growth”. He also took on the subject of tariffs, indicating that regional Fed banks are hearing from concerned business leaders about potential retaliation. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Tamer Inflation, Washington Musical Chairs, Tarriff Uncertainty Rally Treasuries, Lower Yields

    Pascale’s Perspective

    March 14, 2018

    Remember that last month’s wild volatility all started with the January employment report release indicating the highest wage inflation since the Great Recession. Last week’s “Goldilocks” February report was greeted with elation in stock and bond markets. Higher than expected job gains AND lower wage inflation, a perfect mix. Long treasury yields also dropped on “flight to quality” as the potential effects of tariffs are still unknown (the latest fear is reprisals by China, stifling worldwide growth), Secretary of State dismissal. With the 2-year Treasury yield spiking, the yield curve is flattening. This can be a sign of a slowing economy. Stay tuned.By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Tariffs, Wages and Inflation

    Pascale’s Perspective

    March 7, 2018

    Much of last week has been spent reacting to and wondering about the potential tariff announcement expected tomorrow or Friday. The market reaction is vastly out of proportion to the actual effect of the expected tariffs on steel and aluminum. In actuality, steel and aluminum imports make up less than 2% of our GDP. The major volatility is caused by the uncertain “after effects”. Will there be any exemptions? (Today’s indications of exemptions for Canada and Mexico rallied markets this morning.) The “Cohn Groan” selloff was in the wake of the resignation of a key advisor and Wall St. friend. Will this spur a retaliatory measure from the EU and Asia? Will this result in a full blown trade war? Markets don’t like uncertainty. When first announced, the tariffs caused the Treasury ‘s to plummet on a flight to quality. Then, this was followed by a selloff in bonds and rising yields as markets realized that trade wars / tariffs most likely will be inflationary. This week’s announcement of the actual policy will be closely watched, as will the identity of the successor of Gary Cohn.

    Now, wage inflation: this Friday’s employment report will be closely watched. One month ago, the January employment report indicated spiking wage inflation and set the stock and bond markets on a roller coaster of volatility. This Friday’s wage inflation number should indicate whether it was an aberration or a trend. The Fed’s Beige book release today contains anecdotal economic data from each of the 12 Federal Reserve Districts. The report indicates tight labor shortages in certain markets. The wage inflation’s have not yet translated into higher prices for consumers. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Powell’s Debut Stirs Talk of a “Fourth Hike”

    Pascale’s Perspective

    February 28, 2018

    Markets are all about expectations and when those expectations change or are modified, volatility ensues. Fed Chair Powell’s first congressional testimony roiled markets and true to the contrarian nature of news relating to rates: “good” news roiled the markets. The new Fed Chair indicated his “personal outlook for the economy has strengthened since December“ and that “fiscal policy has become more stimulative.” The Feds possible response: “further gradual increases” are the preferred method to “promote attainment” of the Fed’s desire to stabilize prices at full employment. With markets previously expecting three hikes this year (March, June, December most likely), the language was enough to create speculation of four hikes this year. The question is, how will Powell react to his market moving remarks? Was that his intention? Will he be more or less direct in future remarks? His predecessors (Bernanke and Yellen) both became more opaque after triggering major volatility (Bernanke “Taper Tantrum” and Yellen’s discussion of rate hike timing). Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Powell on Deck as Yellen’s Final Minutes Move Markets

    Pascale’s Perspective

    February 21, 2018

    Today’s release of the January Fed minutes (Yellen’s final meeting as Chair) definitely roiled both bond and equity markets. Again, the contrarian nature of the bond markets inverse relationship to economic news is in focus. The Fed statement indicated increased confidence and surety in the economic recovery (as opposed to last year’s “spotty” recovery). The committee increased economic projections from their December meeting. One of the most interesting phrases contained in the statement: “upside risks” referred to increased growth estimates due to a variety of factors including the tax cut and other recent economic reports. So all this good news caused selling in both bond markets (the 10 year T hit a 4 year high of 2.95%) and stock markets. Note that stock traders initially saw the minutes as “dovish” as the statement discounted the possibility of runaway inflation and rallied, but then sold off as they saw the bond market yields spike and realized that the statement may indicate four rate hikes this year instead of the previously expected three hikes. Today’s volatility demonstrated that the return to “normalcy” will be a bumpy road as all asset classes try to find their “market” price/value without extraordinary measures from the world’s Central Banks. Next up: New Chair Powell’s first congressional testimony next week and more closely watched post holiday employment and inflation reports. Our borrowers can take some comfort as spreads have tightened, keeping loan rates relatively low for now. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasury Yields Spike and Seemingly “Spar” With Stock Market as Yellen’s Goal is Realized on Her Final Days

    Pascale’s Perspective

    February 7, 2018

    The market’s extreme volatility over the past few days has many “ironic” elements: (1) A historic market crash was triggered by long awaited good news. The January unemployment report released last Friday indicated a spike in wage growth.  This has been a longstanding goal of the Fed during it’s decade long extraordinary stimulus measures. Of course the first goal was to stabilize the economy out of the 2008 crash. But in recent years, the “endgame” and return to normality was to be triggered by evidence of wage growth and accompanying inflation as the “full employment” goal has been reached, per the Fed’s definition (4.0% unemployment). This goal implied an altruistic Fed, intent on improving life for the average American. (2) This data came out on Janet Yellen’s final business day as Fed Chair; (3) The “good news” sent markets crashing, triggering a selloff in stocks AND treasury bonds with the 10 year yield spiking over 2.80%, reaching 2.89% on Monday. Why? The “new normal” of worldwide central bank stimulus is finally ending and a return to “normal” may be soon. It’s been so long since central banks have adopted a “normal” stance that investors have seemingly forgotten what its like. A quick summary of “normal”: Fed rate at about 3.00%, balance sheet down to about $1 trillion (meaning another $3 trillion of bonds sold). The warnings from many hawks may be true: The decade of stimulus and “easy money” has encouraged risk taking, leverage and inflated the prices of nearly all asset classes including stocks, government bonds, corporate bonds, junk bonds, commercial real estate, etc. The “fear” in the market is that all of these assets will be, “marked to market” after the Fed returns to “normal stance”. The relationship between stocks, bonds and expectations took an interesting turn on Monday.  During the peak of volatility, as the Dow was crashing over 1000 points, the 10 year treasury rallied from 2.86% down to 2.65% as markets were convinced that the Fed would possibly slow down on rate increases due to the market volatility caused by the expectation that the Fed would raise rates. It was like a cat chasing its tail!  Regarding inflated asset values, Janet Yellen mentioned the relationship between CRE “rents and values” in her CBS Sunday Morning extended interview. Wow, the outgoing Fed Chair warning about cap rates! Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners