Pascale’s Perspective

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    Treasuries Stabilize as Asian Fears Subside, Inflation Rumbles

    Pascale’s Perspective

    January 16, 2018

    Both the Japanese and Chinese induced “taper tantrums” appear to be false alarms or saber rattling. The 10 year treasury yields jumped to 2.60% on rumors and reports of less bond buying (of Japanese bonds) from the Bank of Japan and less buying of US Treasuries from China. The Bank of Japan purchase adjustment may be technical and markets are not yet convinced that the stimulus policy has been abated. But the BOJ’s actions will be closely watched as it is the last major central bank in “maximum” accommodative policy mode with regards to aggressive bond buying. The China situation is interesting, the state foreign exchange regulator refuted the news reports of an end to bond buying as “fake news”. But why did they wait a full day as markets sold off? Maybe it was a reminder to the US as to the power and influence they have over our rates and economy in advance of some major trade decisions. What about inflation? Is 2018 finally the year that prices move upward in a meaningful way? Last week’s CPI showed some strength, oil seems to be strengthening at a key technical level of $60 barrel (considered a minimum level that encourages more capital spending and exploration) and some cities are reporting worker shortages and wage inflation (an all-important metric for the Fed). Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Asian News and Rumors Spark Bond Market Selloff, Yields Threaten Key Technicals, Auction Stabilizes Market

    Pascale’s Perspective

    January 10, 2018

    First off(rumors and expectations): The selloff started with the Bank of Japan’s unexpected move to reduce their purchases of their bonds rekindled the “taking away the punch bowl” narrative as the world’s central banks wind down the post-crash stimulus (as we approach the 10 year anniversary of the Lehman bankruptcy). As usual, the market reaction was magnified by the unexpectedness of the announcement.  The US Fed stopped buying bonds long ago and the ECB has assured markets that their wind down will be well telegraphed.  So the mini “taper tantrum” gained steam as Bloomberg reported that China is considering slowing down or even stopping their purchases of US Treasuries.  Note that China is the largest owner of US debt.  The fact that the report was not refuted by officials or insiders gave it legitimacy and the sell off was on.  The 10 year T hit 2.60% today, up 15 bps since last Friday.  The China stance is complicated and multi-faceted: (1)  China is the largest holder of Treasuries (approx. $1.2 Trillion) and illiquidity in the market can devalue their portfolio; (2) Major trade decisions on aluminum, steel and other commodities by the US are pending, this could be a “warning shot” against potential tariffs; (3) Destabilizing the US Economy would not help China’s export business, increasing interest rates lessens US consumer buying power.  As yields rose, markets pondered the “unthinkable”: China selling Treasuries as our Fed trims its balance sheet (also selling Treasuries) as tax cuts and growing entitlement obligations balloon the deficit and increase supply into a marketplace of dwindling demand.  The 10 year yield fell short of its key technical, the March 2017 recent high of 2.63%.  Then an actual auction calmed markets (for now) as $20 billion of 10 year notes were well received as buyers were attracted to the higher yields, the 10 year dropped to 2.55%.  Now, all eyes are on Friday’s CPI reports for signs of inflation. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    New Year, New Fed Chairman, New Tax Bill, Same Old Yield Curve

    Pascale’s Perspective

    January 3, 2018

    Happy New Year to all as the macro-economy is roaring into the New Year. Retail sales over the Holidays were solid, both e-commerce and in-store. Stock markets are still hitting new highs with very little volatility. The 10 year Treasury continues to trade in a tight range, after spiking over 2.50%, it is back down in the low 2.40’s this week. Tax Bill Effects: The bill contains positive provisions for REIT’s and other owners of commercial real estate due to favorable treatment of “pass through” income. The residential market effects may be more “checkered” with limits on mortgage interest and state tax deductions may negatively impact high end housing markets in California, New York, New Jersey and other high tax states. Increased purchasing power among regular consumers is complicated by uncertainty over corporation passing savings/bonuses to workers (some major companies have started) and the sunset provision for many of the individual cuts set for 2025, setting up a potential “fiscal cliff” for future congresses to deal with (or not). Interest rates: Higher rates are expected as increased deficits will necessitate a bigger supply of Treasuries. Today’s Fed Minutes release from last month’s meeting showed classic policymaker dilemma over the tax bill:tax policy does not dictate corporate or individual behaviors. For example: Will corporations increase investment in capital spending, which can increase economic capacity without spurring inflation? Or will they use it to execute financial investments such as stock buy backs or debt reduction? This could spur inflation. The Fed’s stated course is three rate increases in 2018 and their projections indicate, that will be sufficient. 2018 Government Action: Dodd Frank “adjustments” are on tap, including the elimination of stress tests for many regional and community banks, this may spur lending among these middle market players. Also, various proposals for Fannie Mae and Freddie Mac “reform” are being discussed, but the main stumbling block is the lack of a pure private market in mortgage bonds, even 10 years after the crisis. It is doubtful that Congress will want to increase uncertainty in that market so quickly on the heels of the tax bill. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Tax Bill, Data, Relative Value to the Bund Combine to Push 10 year to 2.50%

    Pascale’s Perspective

    December 20, 2017

    After trading in a relatively tight range for many weeks, the 10 year T jumped 14 bps in 2 days as the tax bill passed the House, Senate, the House (again) and is now ready for signature (note that the bill most likely will be signed after New Year’s). The rise actually started with an allocation announcement by Germany regarding their bond issuance. Germany is the Euro zone’s benchmark bond issuer and they announced that they will borrow more in 2018, specifically by issuing more than expected long bonds (30 years in particular). This supply news caused a selloff in 10 and 30 year bonds in Europe, driving yields up internationally and domestically. With stronger than expected existing home sales in the United States combined with the final tax bill passage convinced investors that growth and deficits are on the horizon. The combination of expected events (tax bill) and unexpected (Euro announcement) proved to be volatile. All of this is exacerbated by end of year illiquidity as many institutions have filled their allocations and are winding down 2017. The movement spiked the 10 year yield past key technical levels including the October top of 2.46%, the next test is the March top of 2.62% (before the legislative dysfunction that slowed down policy movement). The next test for Washington is avoiding a government shutdown on Friday. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

    On December 18th, David Pascale was interviewed by Howard Kline, Esq. of CRE Radio to discuss the most recent December Fed meeting and rate hike. Click here to listen to the podcast.

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    Yellen’s Swan Song – A Highly Telegraphed, Expected and Non-Unanimous Rate Increase

    Pascale’s Perspective

    December 13, 2017

    The mid-December rate increase has become a holiday tradition over the past 3 years. Today’s rate hike was no surprise, the “action” was all in the commentary and the two no votes. Yellen’s final press conference as Chair was notable for commentary on the tax cut (it may deplete ammo to fight future recessions), bitcoin (highly speculative), her greatest disappointment (inability to achieve the Fed’s target inflation of 2.0%). The inflation “miss” was highlighted by this morning’s lower than expected CPI report. The lack of wage inflation is especially troubling to the Chair. The rate hike is notable as it shows confidence in the strength of the US Economy. The two “no” votes show some members afraid that rate hikes may damage the recovery and/or that the recovery is weak. The “dot plot” indicating three rate hikes for 2018 (and 2 or 3 more in 2019) is being looked at skeptically by markets, the futures index indicates they expect 2 next year. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Yellen’s Finale, “Sticking to the Script” ?

    Pascale’s Perspective

    December 6, 2017

    Next week’s Fed meeting, policy announcement and accompanying statement/presser has been heavily telegraphed in advance. There should be no surprises. First off, a 0.25% rate increase is a slam dunk, with the futures market at about 90% likelihood (note that the other 10% is on a 0.50% increase). Also, with Jerome Powell set to take over in early 2018, Yellen is unlikely to lay out policy for next year. So the focus will shift to Powell’s upcoming speeches/remarks and his first meeting as Fed Chair next month and beyond. Meanwhile, 30 day LIBOR is already up from 1.25% to 1.40% in the last month on anticipation of the move and year end liquidity issues. LIBOR’s “expiration date” of year end 2021 is gaining certainty as the Bank of England last week announced it is requiring participating banks to continue reporting until 2021, but they may stop reporting after that. This should add momentum to the alternative rates being discussed (SONIA in England, Overnight Treasury REPO in the USA). There is a lot of work to do in the next 4 years as trillions of dollars in derivatives and contracts need to be adjusted. Treasuries: The yield curve is flattening even more dramatically as the short end is certain of increases (see above) and the long end is still “show me the inflation and/or growth”. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    “Full Potential” Has Been Achieved, What Comes After That?

    Pascale’s Perspective

    November 29, 2017

    Today’s 3rd Quarter US GDP report showed a 3.3% expansion. This is the strongest in 3 years and indicated that total economic output was near the “maximum sustainable output” as determined by the Congressional Budget Office, for the first time in 10 years. This means there (finally) should be very little slack in the labor and purchased goods markets, which should lead to inflation. Fed Chair Yellen’s testimony today had some interesting comments about inflation. She said that the Fed is committing to gradually raise rates even in a low inflation environment to avoid a “boom-bust condition”. She mentioned moving from “accommodative” policy to a more “neutral” policy (that means moving the Fed Funds rate, now 1.25% closer to the stated neutral rate of 2.75%). This indicates a Fed still feeling as if some of the factors holding prices down are “transitory”. The 10 year T hit 2.39% today (after dropping to 2.31% earlier in the week). High sales figures for Black Friday and progress with the Tax Bill are also pushing yields up. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasuries “Whipsaw” on Reports, Expectations

    Pascale’s Perspective

    November 15, 2017

    This past week has been pretty volatile for Treasuries. Last Friday was technically a holiday but trading still occurred. The 10 year T jumped 7 bps up to 2.39% as investors focused on (1) The progress of the proposed tax bill, ie. an increased supply of Treasuries next year due to expanding budget deficits and (2) An updated European GDP forecast indicating robust growth and increasing the possibility of an earlier than expected end to quantitative easing over there. Then Tuesday’s PPI numbers came in much higher than expected (0.4% vs 0.1%) indicating strengthening inflation. However, lower than expected growth numbers from China brought up global growth concerns and yields didn’t rise as much as they should have (however the 10 year hit 2.41% yesterday morning). Today’s CPI numbers were softer than expected, but still strong enough to add certainty to the widely expected December rate increase by the Fed. Note that the Fed’s preferred gauge of inflation, the PCE, is still under the stated target of 2.0%, the next release is Nov 30. The soft CPI and statements by some senators against the tax bill rallied yields down today back to 2.32%. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Powell, Germany, Inflation Keep Treasuries in Tight Range, CMBS Rally Continues

    Pascale’s Perspective

    November 8, 2017

    As investors continue to analyze the new Fed chair nominee, the “Powell trade” is a key factor keeping yields below recent highs. Also, the ECB’ s recent announcement that it is tapering purchases is being seen as dovish as Chairman Draghi indicated that the planned end date of September 2018 is a “target” and may be extended. This is keeping German bond yields low (10 year at 0.33%, after hitting a high of 0.60% over the summer). Treasuries are benefiting from a “relative value” trade as the spread between the Bund and Treasury narrowed this week. Finally, the stubborn low inflation numbers continue to confound economic theory as employment numbers heat up without a corresponding rise in prices and wages. For now, the market seems to be ignoring the consequences of the proposed tax cut in Washington. CMBS: Spreads keep tightening as the rally continues. 10 year AAA bonds priced at Swaps + 76 last week are down about 7 bps from the previous week. The best in the 2.0 era (post crash) was about Swap + 70 in 2014. (Note that the 1.0 low was about Swap + 30 in late 2006). Many full leverage loans are pricing in “the low 4’s” again. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    All Eyes on Washington

    Pascale’s Perspective

    November 1, 2017

    Breaking News, WSJ reporting that Jerome Powell is going to be nominated as the new Chairman of the Federal Reserve, replacing Janet Yellen in 2018 (subject to Senate confirmation). This is a “Goldilocks” pick that allows the administration to “change direction” (Powell is less supportive of post crisis regulations such as Dodd Frank than Yellen, especially for small banks) and “stay the course” (Powell is seen as “dovish” on rate increases and balance sheet reduction, likely to continue on the path set forth by Yellen). That path is assumed to be gradual quarter point increases from today’s 1.25% short term rate up to a “neutral rate” of 2.75-3.00% in 2020, ie. about 10 more rate increases or about 3 per year. Also, Congress is expected to (finally) release the details of the tax reform plan. Early buzz tonight indicates that some of the expected features are being scaled back, including estate tax repeal, lowering of the top bracket rate and designating the corporate tax rate cut as temporary. The real estate sector will be watching closely as the mortgage deduction, property tax deduction and 1031 rules have been discussed as “on the table”. Today’s Fed meeting and announcement left rates unchanged with a unanimous vote. Language in the announcement described the economic growth as “solid” (up from “moderately growing”), but inflation was referred to as “soft” (note that the Fed’s preferred inflation gauge, PCE, came in at 1.6% last week even with a spike in gasoline prices). Regardless, they are setting the stage for a rate increase next month. Data watch: look for wage inflation in Friday’s unemployment report. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasury Yields Spike on Perfect Storm of Data, Euro Actions, Speculation and Expectations

    Pascale’s Perspective

    October 25, 2017

    The 10 year T yield is at 2.44%, having broken though a “key technical” barrier of about 2.42%. This is a 7 month high, back to nearly the peak of the post election “reflation trade.” Why? (1) Data: The US Economy has shown strength as recent housing sales and durable goods orders have outpaced expectations; (2) Fed Chair speculation: continuing rumors putting John Taylor in the Chair for 2018 are spooking the bond market. This week’s report that an influential group of lawmakers are pushing for his nomination is definitely causing a selling in bonds. Note that Yellen led Fed’s “neutral rate” is 2.75%, while Taylor’s is estimated at 3.75-4.00% (note that the “neutral rate” is the appropriate overnight rate for this macro-economic cycle, today the rate is 1.25% with gradual rate increases expected). Bond bulls are hoping for Powell or Yellen, as many believe that some top economic advisors are warning that equities could see a big sell off on a Taylor nomination. The consensus is that the decision could come this week; (3) Euro “taper” – the ECB’s big announcement this week is expected to be continued tapering of bond purchases, with an end date of approx. Sept 2018. This is important as the ultra low German 10 year bund rate has been keeping US Treasury yields low as a “relative value” trade; (4) Fiscal Policy expectations – Congress and the Administration are inching closer to passing tax reform/tax cuts, but the details have not been announced. However, the procedural hurdle clearing and the continued dialogue is stoking expectations that some stimulative and deficit growing legislation is in the offing. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Taylor to Rule in 2018?

    Pascale’s Perspective

    October 18, 2017

    The recent buzz in Washington regarding the next Fed Chair is centering on a new favorite, Stanford professor, John Taylor.  He is the author of the “Taylor Rule” which is designed to provide recommendations to central banks based on data such as inflation, economic activity, etc.  Proponents of the rule argue that it takes out much of the leeway and discretion from the FOMC in setting rates.  The markets view Taylor as “hawkish” and some analyses indicate that the application of his rule would triple short term rates.  His interview was said to “go well”, but interviews with dovish candidates such as Powell and Yellen are scheduled for the coming weeks.  General sentiment towards higher rates and a flatter yield curve are coming from Chinese President Xi Jingping’s speech (pro-growth), progress on tax reform in Washington, and record highs on Wall Street.  The 2 year T (sensitive to short term rate expectations) jumped to its highest level in 10 years on reports of Taylor’s strong interview, the 10 year is up nearly 10 bps in the last week (2.34% today). Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners