Pascale’s Perspective

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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

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    Wage Inflation Finally Arrives, Will it Stay Around?

    Pascale’s Perspective

    October 11, 2017

    The headline on last Friday’s monthly employment report was the first monthly decline in jobs in 7 years (down 33,000).  But the Fed found solace in the wage growth figure (up 2.9%).  This metric has been critical in the Fed’s decisions to keep rates low as many FOMC voters consider wage growth a critical part of their mandate.  The thinking is wage growth raises living standards and leads to general inflation.  The 2.9% increase was surprising and welcome news, but next month’s number will be closely watched as the increase could be hurricane related (exacerbating short term labor shortages).  Today’s release of Fed minutes all but confirms a rate increase in December (the futures market shows an 87% probability).  The minutes show some members voicing concern that the existing low inflation environment may be “persistent”, with others afraid that inflation could “run away unchecked” if they keep rates too low too long.  Meanwhile, the “great unwind” (balance sheet reduction) is beginning this month. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasuries Trading in a Tight Range, Looking for a “New Direction”?

    Pascale’s Perspective

    October 4, 2017

    The 10 year T has been sitting in the 2.30 – 2.35% range for a couple weeks, the market seems to be “waiting for direction” from a couple places: (1) The data: this Friday’s monthly jobs report will be closely scrutinized for the usual (general trends, wage inflation, etc) and the particular (fallout from recent hurricanes, will this cause a spike in hiring with labor shortages ?); (2) The next Fed Chair speculation: Washington’s favorite subject is often the next big appointment, who is the “favorite”? Is there a potential surprise “dark horse”? With Fed Chair Yellen’s term as Chair ending in January 2018, the rumor mill is in overdrive. The favorite is Fed Governor Jerome Powell, a “dove”, the other major contender is the hawkish former Fed governor Kevin Warsh. Powell is seen as a continuation of Yellen, while Warsh is a wild card that could accelerate the pace of rate hikes or the Fed balance sheet reduction. As one or the other is perceived to be the favorite, bond yields may spike or drop accordingly. (3) Congress and the Administration: Tax reform and/or Tax Cuts: On the agenda, the question is will something pass and if so, what will it look like? Higher deficits? How stimulative will it be? Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    “Reflation Trade” Is Back, But Is It Justified? 

    Pascale’s Perspective

    September 27, 2017

    Remember when Treasury yields spiked after the November election on expectations of a functional government implementing major fiscal policy?  The 10-year T went from 1.77% on election night to 2.60% in December as infrastructure and tax reform were “scheduled” for the “first 100 days”.   Those days came and went with gridlock and unsuccessful attempts to pass healthcare legislation and Treasury yields dropped.  Today’s announcement of some (but not all) of the details for tax reform spurred a bond selloff, the 10-year yield jumped from 2.24% to 2.31%.  Combined with last week’s announcement regarding Fed balance sheet reduction, aka the “Great Unwind”, the market is considering $5 trillion in tax cuts plus over $3 trillion in bond runoff will result in lots of supply.  The other side of the coin is that the devil is in the details and tax reform is by no means a “done deal” as warring factions within congress and an army of lobbyists can water down or kill any plan.  Also, the pace of balance sheet runoff is slow and gradual and could be even slower depending on future economic growth.  This week’s Fed committee member speeches have featured some disagreement on future rate hikes with Yellen seemingly setting a December rate hike “in stone” regardless of inflation.  Other speeches showed some dissent with that approach. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    The Path to Normalization: Long Awaited and Unprecedented Fed Balance Sheet Reduction Announced, But Investors Focus on Rate Hike Signal

    Pascale’s Perspective

    September 20, 2017

    Fed Chair Yellen has been very focused on telegraphing Fed moves well in advance, thereby avoiding “market shock” (see 2013 “taper tantrum”).  So today’s announcement of the “Great Unwind” (balance sheet reduction) was expected.  Still, there is some apprehension in the market for two reasons: (1) The Fed balance sheet expansion was unprecedented as will be the contraction and (2) The unwinding is another milestone signaling the end of the ultra-accommodative worldwide central bank intervention, or simply put: “you’re on your own, the training wheels are off”.  The pace of the contraction is very slow and measured: $10 billion per month through year end, then $20B in the first quarter 2018, $30 billion in Q2, $40 billion in Q3, then $50 billion per month ongoing.   At that pace, the “normal” Fed balance sheet of $1 trillion will not be reached until sometime in 2023.  That is assuming an uninterrupted pace which is very optimistic as the Fed may suspend the contraction if economic conditions deteriorate.  That is a much slower pace than the expansion rate of about $80 billion per month during most of QE.  Most likely a sell off at that pace would rattle markets.  The real news was more “telegraphing” as the Fed “dot plot” indicated a clear majority of committee members predicting a December 2017 rate hike.  The futures market jumped from less than 50% probability to 60%.  This showed a Fed willing to continue their pace of rate hikes regardless of recent reports indicating lower inflation than the stated 2.0% goal (however, last week’s CPI jump of 0.4% was a classic harbinger of inflation).  The dot plot also indicated a consensus for three hikes in 2018 and two in 2019, with a normalized overnight rate of 2.80% (up from 1.25% today. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasury Yields Rise as “Fear Factors” Subside, Fed to Unveil Balance Sheet Strategy

    Pascale’s Perspective

    September 13, 2017

    Last Friday, the 10 year T yield dropped to 2.01% on a huge “risk off” trade.  Today the 10 year T closed at 2.19%.  Why?  Investor fears have subsided due to: (1) Hurricane Irma damage (while very serious) was less than anticipated as the storm’s path avoided the heart of Miami-Dade and it weakened as it moved inland; (2) North Korea did not provoke hostilities (no missile launches, etc.) on it’s anniversary over the weekend; (3) Weekend chatter in Washington in the wake of the debt ceiling deal turned to further cooperation on tax reform.  This week’s economic reports included an all-time high in median household income (but disparities are increasing) and an increase in PPI (but less than expected and the increase was partially driven by a spike in energy costs due to Hurricane Harvey’s effect on the sector).  On the Fed front, it looks like there is only one more opportunity to raise rates this year and that will come in the December meeting.  There are only two meetings remaining that will be accompanied by a press conference by Fed Chair Yellen (September and December).  Next weeks’ meeting is expected to feature an unprecedented announcement whose effects cannot be easily predicted: the beginning of the Fed’s balance sheet reduction.  The press conference and it’s aftermath will be closely watched.  The reduction will increase the supply of Treasuries in the private sector.  The move has been telegraphed since early this year in the hopes of avoiding a 2013 style “Taper tantrum” that led to major volatility in treasuries. Market reaction could influence the Fed’s rate decision in December.  As of now, the futures market is slightly weighted toward no change in rates, but it is very close.  Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Debt Ceiling, Inflation Dilemma

    Pascale’s Perspective

    September 6, 2017

    With the debt ceiling solved (for 3 months anyway), a potential market calamity has been avoided (for at least 3 months, Happy Holidays).   This week’s speech by Fed governor Lael Brainard indicated a reluctance to raise rates further until they are confident they can get past the “persistent failure” to reach their stated goal of 2.0% inflation.  Last week’s PCE came in at 1.4%, down from 1.6% earlier in the year.  It’s another sign that central banks are now trying to comprehend the “new normal” where the old model of the inverse relationship between interest rates and inflation is “broken” as years of accommodative policy has failed to increase prices.  It’s interesting to note that this may indicate that its easier for central banks to quell inflation (by raising rates as the Fed did effectively periodically from the mid 1980’s until 2007) than increase inflation (by lowering rates).  Two recent reports, one by Morgan Stanley and another by the Bank for International Settlements, shed some light on other factors including: (1) Aging populace in first world countries increasing savings; (2) Decline of labor unions (decreasing workers’ ability to demand pay raises), (3) Globalization (same effect as #2 and creating a “race to the bottom” for manufacturing costs); (3) Disruptive technologies (Uber, Airbnb, etc.) are eliminating middle men, increasing competition and forcing traditional companies to compete on price;  (4) Amazon and other huge firms are concentrating on market share rather than profits; (5) Lower inflation expectations, i.e. a long period of low inflation leads to market participants (consumers, manufacturers) expecting tomorrow to be like today and yesterday.  The Dallas Fed joined the “thinkfest” by announcing it is studying globalization’s affect on inflation.  The 10 year T broke through a key technical level of 2.13% this week, dropping to 2.06% and is now at 2.10%.  The flight to quality is still on as investors are watching the continued saber rattling with North Korea and the U.S. and the unquantified economic fallout from Hurricane Harvey and the approaching Hurricane Irma.  Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Current Events and Economic Reports Keeping Rates Down, Fiscal Policy Emerging?

    Pascale’s Perspective

    August 30, 2017

    The 10 year T dropped to 2.09% yesterday, hitting their lowest levels since the day after the 2016 Presidential election (when yields spiked on expectations of imminent fiscal policy out of Washington).    A combination of factors are contributing to the “risk off” trade (1) North Korean missile test over Japan (worries were somewhat tempered by initial indications of UN sanctions instead of hostilities); (2) Hurricane Harvey’s massive devastation in America’s fourth largest city, expected to lower GDP by 0.2%; (3) Persistent low inflation; (4) Mixed messages from politicians regarding September’s “must pass” debt ceiling increase.   Interestingly, the administration is beginning to outline parts of their long awaited tax package, but few details have emerged such as “revenue neutral” metrics. Will the big cuts be offset by increases and/or deduction adjustments? That’s always the “heavy lifting” in negotiations around forming tax proposals. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    All Eyes on Washington, Jackson Hole

    Pascale’s Perspective

    August 23, 2017

    Today the 10 year T Yield dropped to 2.18%, the lowest in months.  Today’s “risk off” trade was spurred by last night’s Presidential speech in Phoenix that included a threat of a government shutdown if border wall funds are not approved by Congress.  Shutdown talk before September’s “must pass” debt ceiling increase definitely spooked markets.  September’s Congressional session is crucial:  debt ceiling, tax reform and/or tax cuts, budget or continuing resolution are all on the docket.   Recent feuding among politicians is not providing any certainty.   The old adage is that Wall Street loves gridlock, but that means “old school” gridlock where the government still was open and free of default.  This week’s annual Jackson Hole symposium features speeches by the world’s major central bankers.  Will this be an opportunity for the “big rotation” out of monetary policy hinted at by Draghi and Yellen earlier this year?  The ECB has already indicated that this will not be the time to announce their long anticipated tapering of bond buying, but that is coming soon.   The bankers are expected to discuss the “confusing” lack of inflation worldwide after nearly a decade of accommodating policy. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasury Yields Drop on Fed Minutes Inflation Chatter, Lowered Expectations from Washington

    Pascale’s Perspective

    August 16, 2017

    Looks like the Fed is starting to accept the “new normal.”  Today’s release of Fed notes from the July 17 policy meeting indicate that the policy setters “saw some likelihood that inflation might remain below 2% for longer than they expected.”  The Fed has been clinging to “classic” economic theory (pre-crash) that dictated that full employment leads to inflation (especially wage inflation, which is part of the Fed’s stated mission).  Now, after a period of describing low inflation readings as “transitory” or “seasonal”, reality is setting in that wages are not rising as planned.   Much of this may have to do with generational factors and other macro structural changes in the post crash economy.  Low inflation may be a secular reality.   The minutes release combined with today’s mass defections and disbanding of the Manufacturing Council and Strategic Policy Forum (indicating more Washington dysfunction) caused investors to assume a more gradual pace of rate hikes and no growth inducing fiscal policy.  Stay Tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasury Auctions Signal Potential Concern Regarding Balance Sheet Trimming

    Pascale’s Perspective

    August 9, 2017

    Today’s relatively weak demand auction of 10 year T’s followed a strong 3 year T auction yesterday.    This could be an indication that the market believes that future Fed hikes will be slow and gradual, and that low short term rates may push inflation.    Also, recent statements by Fed committee members indicate that the long awaited balance sheet reduction may start next month.   Since those holdings are mostly long dated Treasuries and MBS, the unprecedented public to private “demand transfer” may lead to higher long term rates.   As of now, the 10 year is 2.24%, so still trading in a tight range.  Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    Treasury Yields Hold Steady, End of LIBOR Coming

    Pascale’s Perspective

    August 2, 2017

    The 10 year T continues to trade in a tight range around 2.25-2.30%.  Yields dropped yesterday due to anemic market data including a larger than expected decline in auto sales.  An interesting report surfaced yesterday indicating that inflation is “lurking beneath the surface” based on rising commodity prices that should affect consumer prices in late 2017 and early 2018.  As of now, Treasury yields aren’t reflecting that expectation.  Today’s Treasury Department announcement regarding 3rd quarter issuance did not include any announcement of issuance of ultra long (50 and 100 year term) bonds, even though a May 2017 announcement indicated they were considering the possibility.  This should help demand for 10 and 30 year bonds.  LIBOR Replacement Update:  The quest to replace LIBOR has been in the works since 2013 in the wake of the LIBOR fixing scandal.  The UK Financial Conduct authority recently announced that the goal to transition to alternative benchmarks is now the end of 2021.   Note that over $300 trillion of financial instruments (derivatives, swaps, etc) are tied to LIBOR at present.   It looks like the US is settling on a Treasury overnight repurchase (repo) rate based on the cost of overnight loans that use US Treasuries as collateral.   This rate will be regularly published beginning next year and is an indicator of a highly liquid market (about $660 billion in daily volume).    It looks like the UK will be using the Sterling Overnight Index Average (SONIA), other Euro countries may use EONIA (Euro Overnight Index Average), while Japan is leaning towards TONAR (published by the Bank of Japan).   Only the US alternative is a “secured” rate as it is backed by Treasuries.   The other rates are similar to existing LIBOR as they are not collateralized and will have to be closely monitored to avoid the corruption charges that doomed LIBOR.  Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.