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
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.
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.
July 26, 2017
Today’s Fed meeting closed with no rate increase (as expected). The real action was in the inflation outlook in the accompanying statement. Earlier this year, the weak inflation environment was described as “transitory” with anomalies such as cell phone billing plans cited as factors. Today’s statement indicates a “puzzled” Fed wondering why a strengthening job market is not spurring inflation. It seems that the Fed is wondering why the “new normal” is not conforming to traditional economic metrics. The Fed’s preferred inflation index is stuck at 1.4% so markets are interpreting this stance as potentially staving off any increases for the rest of the year. The assumed December rate increase is now in doubt. The Fed also continued telegraphing their other major policy issue, the “normalization” of the balance sheet, i.e. trimming their holdings of mortgage bonds and treasuries. The statement said that normalization will start “soon” (September is assumed as the Fed probably doesn’t want to start increasing bond supply in the summer months). The wild card is the debt ceiling. The Treasury is estimated to run out of extraordinary measures to keep paying government obligations. Congress has a end of September deadline to increase or risk roiling capital markets worldwide. The Fed would most likely not start the process in this case. Already, the 3 month Treasury yield has spiked to its highest yield since 2009 on default worries. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
July 19, 2017
This week’s economic data is being looked at through the prism of last week’s testimony by Fed Chair Yellen in which she indicated that the Fed is “watching” inflation (instead of considering sluggish inflation as “transitory”). This week’s reports saw import prices falling 0.2%, oil prices dropping, and slowing retail sales. These factors and the inability of Congress to pass health care legislation casts doubt on the major financial pieces of the administration’s agenda (tax reform/tax cuts and infrastructure) contributed to this week’s rally in Treasuries. Now all eyes will be on Europe Central Bank President Draghi’s policy announcement and press conference tomorrow. Eurozone inflation recently dropped to 1.3%, down from 1.4%, well below their 2.0% target (numbers are very similar to ours). What markets will be watching are any hints as to when the ECB plans to stop buying bonds. Remember that Draghi sparked a major spike in yield’s a couple of weeks ago on his use of the term “reflationary pressures” (as opposed to deflationary pressures). This led to a global consensus (and fear?) that the world’s central banks were pulling back on accommodating policy. Even though other officials sought to downplay that sentiment, markets were not convinced. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
July 12, 2017
After hitting a high of nearly 2.40% last week in the wake of the positive jobs report and central banks indicating that the QE era is nearly “done”, the 10 year T rallied this week to 2.30% today, now closing at 2.31%. Today’s testimony from Fed Chair Yellen encapsulates the dilemma of the worlds’ central banks. Nearly a decade of ultra accommodating monetary policy has resulted in very low growth and inflation (as compared to previous post WW2 expansions). The feeling is that this is “as good as it gets” and continuing present policies risk dangerously inflating assets across the board. Last month, the Fed indicated that recent low inflation data was transitory and that rate increases would proceed “on schedule”. Today, she indicated that the Fed is monitoring inflation and “stands ready” to alter policy. Also she mentioned that the “neutral rate” is lower than previously estimated (this is the rate at which the Fed is neither being accommodating or restrictive on growth). Bond markets rallied on this dovish sentiment. The Fed may be listening to comments from Chase CEO Jamie Dimon warning of potential market disruptions when they start trimming the balance sheet and selling bonds back into the private market. Bond market are also rallying on this week’s seemingly all consuming Russian controversy surrounding the Administration which casts doubt on any major fiscal policy being passed by Congress, further dampening inflation expectations. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
July 5, 2017
The 10 year Treasury has risen about 20 basis points in the last week as markets are parsing recent remarks by the ECB, Bank of England, and our Fed. A consensus is emerging that the extraordinary quantitative easing measures over the past 9 years are coming to an end or a “tapering”. Interestingly, this development is occurring before inflation has picked up (above the stated 2.0% Fed target). Why? As today’s Fed minutes indicated, the Fed believes that recent tightening in the labor market will result in wage inflation down the road. Also the Fed mentioned that some “transitory” factors such as cell phone bill discounts and drug prices are temporarily holding inflation back. We’ve heard this before, it could be a case of the Fed making the data match their course of action (raising rates in the absence of inflation). Central bankers are also concerned as worldwide debt hits all time records. US Treasury yields are also rising as European yields jumped at their highest weekly level since 2015. Our treasuries were a “value play” even at 2.00% when German yields were near zero. However, the US Treasury yield actually dropped today as the Fed minutes revealed divisions as to the speed and frequency of future rate hikes. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
June 28, 2017
ECB Chair Mario Draghi remarked today that “deflationary forces” are being replaced by “reflationary forces.” Coming from a longtime “dove” and major advocate of quantitative easing, bond markets reacted with a sell off. This brought back memories of ex Fed Chair Ben Bernanke’s 2013 remarks regarding slowing down on bond purchases and accompanying market volatility. Draghi and the ECB indicated that the comments were misinterpreted as imminent policy change when he actually was trying to prepare markets for a possible slowdown in QE this fall, depending on the data. The Fed, Bank of England and other central banks are noting that assets are overpriced and worldwide debt is hitting a peak, implying that its time to tighten policy. As always, much of the decision processes will be data dependent, employment, CPI reports, etc will be closely watched. The great post-recession stimulus experiment “results” may come soon: will economies grow on their own and stimulate inflation, steepening the yield curve? Or are the rate increases too soon and choking off the recovery? Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
June 21, 2017
Further reading into the Fed’s rate increase, accompanying statement, press conference, and subsequent commentary indicates they are bent on “normalization” regardless of weak data. The price of oil dropped to $42.50 per barrel, a 10 month low and officially entered “bear” territory for the year. The 30 year Treasury yield hit a 7 month low at 2.72%. Note that the 30 year T is the one most sensitive to inflation conditions. The Fed’s description of recent low inflation reports as “transitory” or “seasonal” shows they are looking “past the data” and their own stated inflation thresholds in order to effect normalization (higher rates, shrinking holdings). Perhaps they are trying to get ahead of events to prevent a panicked series of rapid rate increases in the future. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
Correction: In my column last week, the Fed Balance sheet was quantified at $4.2 billion, the correct number is $4.2 trillion.
June 14, 2017
The Fed raised short term rates for the second time in 3 months and set forth the procedures for reducing its $4.2 billion balance sheet. The 10 year Treasury rallied today with the yield dropping to 2.13%. This was due to lowered expectations for growth and inflation: (1) The Fed lowered their inflation forecast for 2017 to 1.7% and now expects to reach the elusive 2.0% target in the “medium term”; (2) This week’s CPI and Retail Sales reports both disappointed; (3) Oil prices are back well below $50 per barrel on reports that OPEC may be relatively powerless to raise prices due to massive shale production here; (4) the long awaited “Infrastructure week” of announcements was short on specifics or a major cohesive plan; (4) The very act of raising short term rates will dampen growth and inflation. Balance Sheet: The Fed will finally trim its balance sheet, Fed Chair Yellen indicated that “normalization” could be “relatively soon” with a cap on reduction of about $6 billion per month, increasing by $6 billion increments every 3 months over a 12 months period until it reaches $30 billion per month. This would suggest a pace of about $1 trillion of reduction every 3 years. The Fed will most likely pull back on that target during volatile economic periods, so who knows how long or how deep the reduction will go. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
June 7, 2017
The 10 year T hit a 2017 low of 2.13% this week, before bouncing back up to 2.17% today. Several global factors are contributing to lower bond yields including: (1) Middle East diplomatic crisis as other Arab states are attempting to isolate Qatar. As Qatar is a major oil producer, the involved countries are OPEC members, and other countries are starting to take sides (Turkey sending troops, etc). The uncertainty and potential oil price concerns contributed to a flight to quality; (2) China is buying Treasuries again. The world’s largest holder was selling during 2016 in order to bolster the Yuan. With the currency now stabilizing, China can resume its purchases; (3) “Brexit” is back, the UK election is tightening, markets prefer Theresa May’s conservative party to hold on to power in order to assure an orderly exit from the European Union. A new leader may result in a chaotic exit; (4) Back home: Former FBI Director Comey’s scheduled testimony for tomorrow was also a “fear factor” until the advance release of his opening statement lacked any major bombshells. On the economic front, last week’s employment report was lacking in job creation and wage inflation, further dampening growth/inflation expectations. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.
May 31, 2017
The long end of the curve is rallying with the 10 year Treasury hitting its second lowest level of 2017 at 2.198%. The month of May saw an overall decline of 8.4 basis points. A couple of factors are in play feeding the “contrarian” long end rally when recent economic reports seem to confirm the Fed’s stated intent to raise rates two more times this year (once “for sure” in mid-June, and then again in September or December. Note that the second increase is most likely dependent on a “least messy” outcome of this summer’s debt ceiling increase drama in Washington. An increase in short term rates may slow down the economy and hinder long term growth, especially if there is no major tax reform or infrastructure program enacted by Congress. Again, all eyes are on Washington. Long term bonds are dependent on inflation and growth expectations, so the yield curve may continue to flatten as the short end rises along with the Fed rate increases. CMBS: Meanwhile spreads are tightening for CMBS loans with the 10 year Swap nearing 2.00%. All-in rates are again in the low 4’s for full leverage loans. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.