Pascale’s Perspective

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    Oil Price Slump Keeps Inflation (and Growth) Expectations Low

    Pascale’s Perspective

    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.

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    Fed Increase And Yield Curve Flattens

    Pascale’s Perspective

    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.

     

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    Geo Political Concerns Push Bond Yields Lower as Fed Increase is “Certain” for Next Week

    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.

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    Yield Curve Flattening, Tight Spreads Keep All-In Coupons At Low

    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.

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    Fed Reveals Key Element of “Normalization”

    Today’s Fed minutes were all about the guidance regarding the unwinding of the balance sheet and the markets liked what they learned.   Fed Chair Yellen has learned the lessons stemming from market volatility during the 2013 “Taper Tantrum” when former Fed Chair Bernanke outlined the slowing down of quantitative easing (QE) without preparing markets.  For the unwinding (letting the securities purchased during QE roll off of the balance sheet as they mature), Yellen indicated that there will be monthly cap limits on how much it will allow to “roll off” each month.   Both stock and bond markets rallied on this news as they feared a Fed on “autopilot” would potentially disrupt treasury markets by releasing too much supply into the marketplace and cause disruptive rate spikes.    The 10 year T is at 2.25%, it rallied on the “measured approach” news.   The 2 year  T remains high based on the now “certain” expectation of a June rate hike.   The yield curve is the flattest its been in a while. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    Political Events Driving Market Moves, Flight to Quality

    Recent turmoil in Washington has dramatically lowered investor confidence that any major economic legislation is forthcoming in this year’s “window” (next year’s mid-term elections make major legislation less likely).    The stock market sold off and the 10 year treasury yield dropped about 10 bps and is now down to 2.22%.    Combined with recent reports dampening inflation expectations, long bonds may be headed back to pre-election levels.   Expectations of upcoming Fed increases are raising yields on the short end which is flattening the yield curve into a “slow growth” predictor. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    Treasuries Moving Up (Again). Is this time “for real”?

    The 10 year T yield spiked up to 2.41% today, the highest level since March.   Factors include:  (1) Recent Fed speeches indicate that they are “on track” for an increase in June and another increase before year end.  Also, there are more indications of shrinking the Fed balance sheet this year, increasing the supply of bonds in the private marketplace; (2) Supply/Demand dynamics – the Treasury is auctioning about $190 billion in treasuries and bidding was weaker than in recent auctions; (3) Inflation-Fed officials and others are dismissing recent weak inflation reports as seasonal in anticipation of inflation (finally) returning above 2.0%.  Also oil prices increased with their largest one day gain since December; (4) Washington – investors seem to be unconcerned with unpredictability stemming from the firing of FBI Director Comey yesterday.   The eruption of inter-party hostility after the dismissal can be interpreted as increasing the difficulty of passing major legislation (taxes, infrastructure, etc).   So far, that risk doesn’t seem to be priced in. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    Yields Up Slightly After Fed Statement

    Today’s Fed statement basically put markets on notice to expect a June increase barring any unforeseen negative economic news and/or major risk events (geopolitical, etc).    The Fed is viewing recent soft economic reports (1st quarter GDP, lower inflation, weaker consumer spending) as being “transitory” and seasonal, not structural.    The 10 year T jumped up slightly up to 2.32%, partially due to “relief selling” as a government shutdown is being averted for now.  September could get dicey as the 2018 budget year must be funded with both sides girding for battle and a debt ceiling deadline looming.  Note that these potential legislative battles and brinkmanship may make it difficult for the anticipated September increase by the Fed.  Another factor is the long awaited shrinking of the Fed balance sheet is starting to be discussed.  They are floating “trial balloons” indicating an intention to curb reinvestment of existing bonds (Treasuries and Mortgage Back Securities) in the portfolio as they mature.   This could lower the now $4.5 trillion balance sheet to about $2.8 to $3.0 trillion.   The Treasury has already issued a guidance note that it may be increasing the supply of new Treasuries as rates will rise due to increased supply.  Many economists feel that the balance sheet trimming needs to occur after a few more increases in the short term rate to avoid major disruption in the financial markets.   Of course, its all theoretical as the massive quantitative easing “experiment” was unprecedented and we are in “uncharted territory”. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    “Reflation” Trade is Back On?

    Pascale’s Perspective

    April 26, 2017

    Today’s announcement of a proposed major tax cut and last weekend’s French election “relief” has put the brakes on the Treasury rally.   The 10 year is back up to 2.30% after hitting a recent high of 2.33% yesterday.   The lack of specifics in the tax plan “tapped the brakes” on the sell off.  Details on the plan and the likelihood of it passing will affect Treasury yields for the foreseeable future. stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    Bonds Are Back

    Pascale’s Perspective

    April 19, 2017

    The recent “Trump reflation trade” related bond selloff that caused Treasuries to spike may have been premature or overdone.    The 10 year T spiked from 1.77% on election night to 2.60% last month which led to speculation that the “great bond market rally is over.”   Note that every time this prediction is floated in recent years, the bond market comes back as if in a state of equilibrium that can’t be deviated from: a.k.a. the “New Normal.”   Today the 10 year T is 2.21% after hitting a recent low of 2.18% early this week.   Why?   (1) Fiscal policy expectations are being dialed back significantly as Congress and the administration indicated that tax reform is not happening soon and there’s no consensus among the factions on the final structure.   Administration officials are indicating that August would be the earliest for a package to be done and this would probably push it to the 2018 tax year at the earliest.   Also, the expected “big infrastructure” program is nowhere in sight.   (2) Weaker than expected US economic reports (CPI actually went negative, 1ST quarter GDP expectations flattening, etc.); (3) Geo-political concerns – French elections later this month may pave the way to their exit from the EU, tensions on the Korean peninsula, Syria turning into a Cold war style proxy war, etc.; (4) Inflation – The 10 and 30 year Treasuries are indicators of growth/inflation expectations. With lower CPI and oil prices dropping, the yield curve may be flattening despite the Fed raising short term rates. stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    Fixed Rates “Watching and Waiting” for Washington’s Next Move

    Pascale’s Perspective

    March 29, 2017

    Treasury yields hit a 3 week low on Monday as the 10 year yield dropped to 2.36% on Monday (interestingly, that is exactly 1% higher than its all time low of 1.36% in the wake of the Brexit vote last July). The twin forces at work are (1) Higher yields due to continuing strong economic reports (Consumer Confidence, Pending Home Sales both outperformed expectations) combined with potential inflation (Oil is again above $50 per barrel) or (2) Lower yields due to lower expectations for tax reform and infrastructure fiscal policy in the wake of last week’s failure to pass health care reform and lingering Euro worries (Brexit fallout, Greece is “fixed” again, but Italy is in trouble). stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.

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    Floating Rates Rise With Fed, Fixed Rates Drop As the “Reflation Trade” is on Hold

    Pascale’s Perspective

    March 22, 2017

    Last week’s Fed rate hike increased floating rate indices in lock step with the Fed’s pace.  The 30 day LIBOR is almost at 1.00% (up 0.75% since Dec 2015 after sitting at nearly 0.25% for years in the wake of the financial crisis). The bank prime rate is 4.00%, also up 0.75% from a longtime low of 3.25%. However, the 10 year Treasury yield has dropped from a high of 2.62% last Monday to 2.40% today.  Why?  (1) Washington:  The uncertainty and political wrangling over the first major piece of legislation by the new administration, the highly anticipated health care overhaul, has cast doubt on Washington’s ability to execute major fiscal policy such as infrastructure investment and tax reform.  The rise in Treasury yield’s was largely predicated on the stimulative effects of the policy. (2) Inflation expectations are dampening:  Not only is the 10 year yield dropping,but the yield curve is flattening.   This is an indicator that markets do not expect much inflation.   This month’s survey of U.S. Consumer Inflation expectations indicated a record low this month.  Oil prices stubbornly remain low below the $50 benchmark yet again as stockpiles rise and cooperation among producers to limit production wanes.   Note that the Fed’s preferred inflation gauge (Personal Consumption Expenditures) is still below 2.0%. Notes from GSP’s Staff Meeting: George Smith Partners’ weekly staff meeting often includes comments and observations from our brokers based on their conversations with lenders, investors, sales brokers, etc.   A major subject this week:   transaction slowdown.  The cost of capital for construction and bridge financing is rising and rent growth is seemingly stagnating in several markets (especially for apartments as the recent boom in construction sees new units coming on line).   Also, we are seeing labor and subcontractor costs rising in some major markets due to a combination of political issues, labor shortages, supply/demand dynamics, etc.  The result is a lot of deals “don’t pencil” and there is a lull out there in the marketplace. Cap rates remain very tight in a “seller’s market”  on stabilized assets, but buyers are now underwriting higher fixed rate debt and causing a pause and reconsider their offer.  The logjam should “break” when sellers start to capitulate on price.   There is still plenty of capital (both equity and debt) looking to transact. stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.