2023 Interest Rate Wrap Up…Year of the Pivot?

George Smith used to enjoy reviewing the previous year’s interest rate predictions at year end. Last year’s Bloomberg survey of the top investment bank analysts indicated an average prediction of 3.48% for the 10-year Treasury at year end 2023. With one week to go the 10-year sits at 3.88% today, exactly where it closed at year end 2022. It dropped as low as 3.26% in April (flight to quality in the wake of the big regional bank failures) and then peaked at about 5.03% in October (as inflation seemed “entrenched” and “higher for longer” Fed speak spooked markets). It looks like Barclays and Deutsche Bank are pretty close with their predictions.

Speaking of the 10-year Treasury, Fed governor Goolsbee expressed “confusion” by market reaction to last week’s Fed meeting. He commented that markets “hear what they want to hear” and not “what the Fed Chair says.” Markets actually weren’t phased by his comments (these type of Fed comments lately are perceived as mandatory “more bark than bite” hawkish smoke screens). The futures market is predicting an 83% chance of a rate cut by the March 20 meeting (89 days from now but who’s counting?). As we say goodbye to a volatile year in capital markets, we wish everyone a safe and happy holiday season. Stay tuned…

 

END-2023 TREASURY YIELD FORECASTS
			10Y
Bank of America			3.25%
Barclays			3.75%
Citi			3.25%
Deutsche Bank			3.65%
Goldman Sachs			4.30%
JPMorgan			3.40%
Morgan Stanley			3.50%
MUFG			3.375%
NatWest Markets			3.35%
RBC			3.45%
Societe Generale			3.25%
TD			3.25%
2022 Closing Level			3.87%

By David R. Pascale, Jr., Senior Vice President at George Smith Partners.

Yesterday’s Fed Policy Meeting had a self-congratulatory feeling as Fed Chair Powell remarked, “The era of this frantic labor shortage is behind us. Overall, the development of the labor market has been very positive. It’s been a good time for workers to find jobs and get solid wage increases.” Powell has always stressed the Fed’s altruistic mandate, especially after the pain caused by the rate hikes. He cheered the long-sought “labor market balance” and cited increased labor-forced participation as extremely positive. “Recent indicators suggest that growth in economic activity has slowed substantially and that higher rates are slowing investment.” He noted that the Fed is now seeing progress on inflation across the three main core areas. Translation: we don’t have to raise rates further. The Fed’s new “dot plot” of interest rate predictions indicates they expect 3 rate cuts in 2024 (the last dot plot in September predicted 1 rate cut in 2024). The Federal Reserve is willing to cut rates even if the U.S. economy doesn’t dip into a recession in 2024, Powell said.  “It could just be a sign that the economy is normalizing and doesn’t need the tight policy.” Powell feels the Fed will accomplish the rarely seen “soft landing.” Of course, he had to add the “disclaimer” to demonstrate his inner hawk. “We are prepared to tighten policy further if appropriate,” he said at the post-meeting press conference. That mandatory quote must be taped to his podium.

Did you ever wonder how to say, “Let’s Get This Party Started!” in Fed speak? Here you go. “The question of when it will become appropriate to begin dialing back the amount of policy restraint in place…and is clearly a discussion topic…out in the world and…for us at our meeting …I would say there’s a general expectation that this will be a topic for us looking ahead.” Bam! Equity and bond markets immediately went on an epic rally. Dow hit a new closing high (above 37,000) and the 10-year Treasury dropped to 3.91% (down from 4.30% on Monday). The 5-year went below 3.90%. The 3 rate cuts predicted in the dot plot are about half of what the market now expects. Fed Futures indicate the market expects 6 rate cuts in 2024. There are 8 Fed meetings next year. Assuming there is no rate cut at next month’s meeting, that’s about 25 bps per meeting. 2024 being an election year (have you heard?) may be pushing Powell to “telegraph” rate cuts in advance and possibly front-load them earlier in the year to avoid the appearance of political meddling. The dovish pivot is causing some to wonder. What does the Fed know? Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners.

Over the past year, the Fed has been highly focused on labor market dynamics as they look to (hopefully) ending the hiking cycle.  This week’s data continued the cooling labor market narrative: factory orders down more than expected (Monday), lower than expected job openings (Tuesday), ADP report showing lower than expected private sector jobs added (Wednesday), and Initial jobless claims increased slightly (today).  The 10-year T is now at 4.11%.  Also, note that September and October payroll numbers were revised downward – continuing a stream of several downward revisions in employment statistics.   The Fed is hyper-concerned with wage inflation and labor market tightness coming out of the massive Covid fiscal stimulus.  When job openings per unemployed worker approached 2 to 1 (see chart), any chance of price increases moderating was slim to none.  The Fed is expected to keep rates steady at next week’s meeting with all of the action in the commentary, Powell’s presser and a new “dot plot” of predicted economic conditions for 2024. Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners.

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Today’s PCE release indicated monthly core PCE increasing 0.2%, which puts the 3-month annualized average at 2.4%. That’s getting closer to the Fed’s target of 2.0% (remember this average was over 7.0% in mid-2022). The 10-year had another big week of moves. Starting at about 4.50% on Monday, rallying to 4.25% yesterday and up to 4.32% this morning.

Hawkish and influential Fed Governor Waller moved markets this week as he is “confident that policy is positioned to…get inflation back to 2%.” The “higher for longer” narrative that dominated the recent months has receded. Waller added he could imagine the Fed lowering rates after seeing continuing disinflation over the next 3 months. Watching the data (labor market, consumer strength), continuing jobless claims hit a 2-year high, and big Black Friday retail sales were aided by a big increase in “buy now pay later” purchase plans. Inside the PCE data, goods were down 0.3%, and services were up 0.2%.

Fed Futures markets indicate no rate increase at next month’s meeting. That will mark 3 straight pauses and (hopefully) mark this as the “pause before the pivot.” July was the last rate increase and the last few tightening cycles have averaged about 9 months between the last increase and the first cut. Could the pivot come at the May 2024 meeting? 150 days from now, but who’s counting?…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners.

Tuesday’s release of October CPI indicated prices were unchanged for the month – the first time since July 2022. The previous month saw a 0.4% increase and market analysts were expecting a 0.1% increase.  Core CPI has now climbed to 4% for the year, the lowest yearly increase since September 2021. Energy prices were down month over month. Food price increases moderated significantly as annual food inflation of 3.3% is the lowest since June 2021. This is significant as the Fed has been concerned about inflation becoming “entrenched” with consumers growing to expect daily needs expenses to climb. These trends are definitely mitigating that concern (for now). Treasuries saw their biggest rally since the March flight to quality in the wake of the regional bank failures. This was a welcome “bullish” rally that saw the 10-year T drop from 4.65% to 4.42% in about 10 minutes. Rates jumped about 10 bps yesterday even after a PPI report (manufacturers’ prices) DECREASED by 0.5% last month (the lowest since April 2020 during the pandemic, analysts were expecting a 0.1% increase). The rates jumped due in part to some profit-taking after the big rally Tuesday.

Markets instead focused on revised retail sales numbers that showed a 0.9% increase in September. Retail sales actually dipped 0.1% for October. This actually fits in with the booming 3Q GDP numbers that aren’t expected to last into 4Q. Today’s initial jobless claims report of 231,000 was 9,000 more than expected. Bond markets feeding on the “contrarian” news cycle (economic bad news is good news) rallied again today with the 10-year now at 4.43% (60 bps below the 10/23 high).

What about the Fed? Fed futures markets reacted positively to this week’s data – markets are now convinced that rate hikes are “done” and rate cuts are coming: the chances of no increase at next month’s meeting are now 100% (up from 85% last week) and they show a 68% chance of a rate cut in May 2024 (up from 35% last week). UBS analysts made news last week predicting 275 bps of rate cuts in 2024. That’s an outlier; note that Goldman Sachs’ projections call for 0.25% rate cuts in each quarter starting in late 2024. One thing for certain is that the Fed will keep “talking hawkish” until the job is done. Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

The 10-year treasury market started the week strong after last week’s big rally. The treasury held auctions of 3- and 10-year treasury notes that showed strong demand, especially considering the volume was larger than last month’s auctions. The 10-Year was sitting at 4.50% Thursday morning (down over 50 bps from the recent high). Then came Thursday’s $24 billion treasury auction of 30-year bonds. It did not go well. Primary dealers (money center banks) stepped in to purchase 25% of the issuance- meaning there weren’t enough bids from the market to clear all the bonds. The auction also was disrupted by a hacking/ransomware attack at the Industrial and Commerce Bank of China’s US Division. This was followed by Fed Chair Powell’s remarks: Fed officials are “not confident” rates are high enough to finish the battle with inflation and that the inflation battle “has a long way to go.” Perhaps he is being overly hawkish after last week’s drop in yields after the Fed meeting as he worries about overconfidence. The 10-Year Treasury spiked to 4.63% in hours and now sits at 4.65%.

Moody’s has cut the US Credit Rating Outlook from “stable” to “negative – citing polarization in Washington as driving large deficits (note that the government is 7 days away from a shutdown unless an emergency bill is passed).  Moody’s did affirm the US’s top rating of Aaa. If Congress and the White House can’t help, who can? Will the Fed be forced back into Quantitative Easing (buying Treasuries)? Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

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Wednesday’s unanimous Fed decision to keep rates unchanged was significant. This marked 2 consecutive meetings with no rate increase – the first “double pause” since early 2021 (before the current hiking cycle). Fed Chair Powell delivered the usual “warnings” that the Fed stands ready to increase rates if inflation perks up (aka “policy firming”). But, the comments seemed obligatory, more of the usual “Hawkish signaling.” There’s a growing consensus that if there is no increase at the next Fed meeting, they are “done” for this cycle. The bond rally started in the morning as Treasury Secretary Janet Yellin released the long awaited funding schedule for the next round of Treasury sales. Markets had been apprehensive in recent months about supply issues as growing budget deficits have expanded debt issuance. Markets cheered the release as the auction levels were lower than feared – spurring a “relief rally” as the uncertainty was eliminated. Powell’s “dovish tilt” at the meeting continued the rally. And don’t forget “the data” – this week has seen more signs of a softening economy: lower than expected job creation, a drop in manufacturing activity, productivity increases (lowering wage pressure), and an unexpected drop in labor costs. Today’s release of the October jobs report indicated a cooling jobs market: 150,000 jobs were created, less than half of the previous month’s gain. Significantly, the economy saw less broad based hiring as healthcare, government, and leisure/hospitality accounted for nearly all of the increases. This means that several sectors of the economy saw near zero job growth. The overall narrative is now focused on the Federal Reserve’s commitment to pausing rate increases as the economy cools with possible rate cuts occurring in mid-2024 (see chart above on future rate expectations yesterday and today). Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

Yesterday’s 3Q GDP report indicating 4.9% annual growth, the strongest since 2021.   This indicates a strong consumer….but for how much longer?  Spending rose at a 4% annualized increase in Q3 while income gains lagged well behind that pace.   Savings rates are falling.    Initial jobless claims for last week came in higher than expected – the strong labor market is propping up consumer spending.  Treasury yields actually dropped yesterday as traders focused on the jobless claims (forward guidance) as opposed to 3Q GDP (the rear view mirror)  The 10 year dropped from 4.96% to 4.85%, settling at 4.83% at today’s closing.   Today’s PCE report release (the Fed’s preferred inflation gauge) showed a 0.3% monthly increase in core inflation and a 0.4% “headline” increase.   Of course, 0.3% monthly increase translates to 3.6% annually, still well above the Fed’s 2% target.   The report was within expectations and is not expected to change the Fed’s “no increase” stance at next week’s meeting.   It does show some worrisome inflation “stickiness”  as the path from 3.5% to 2.0% may be a slow grind…stay tuned…..

This week started with a flight to quality as markets reacted to conflict in the Middle East and potential escalation. The 10 Year began trading Tuesday after the long weekend and immediately dropped from its previous close of 4.80% to 4.65%, as markets opened. The mid-week economic reports drove trading on Wednesday/Thursday. First off, PPI (wholesale prices) was up 2.2% annually with core up 2.8% (slightly higher than previous months). Notably, goods inflation outpaced services – is this signaling the long awaited cooling in services employment/costs that are so closely watched by Fed officials? Speaking of Fed officials, Philly Fed President Patrick Harker’s comments in Delaware gained a lot of attention: ‘I believe that we are at the point where we can hold rates where they are.’ Wow. Of course, I think it is assumed that his (prepared) remarks had the blessing of Fed Chair Powell. Harker also nodded at higher treasury yields, noting that the higher fixed rate index is “doing our work for us.” Perhaps the recent run up in Treasury yields is acting as a substitute for the contemplated rate increase in one of the final two Fed meetings this year. This changes the “higher for longer” narrative to “high for longer”- aka we are already there at the top. It’s way too early to spike the football or assume raises are over. And it seems even if the Fed is done raising, it’s a long way from “even thinking about thinking about” cutting. To paraphrase Chair Powell’s comments about raising rates in June 2020 vs Thursday’s CPI was slightly hotter than expected at 0.4% monthly/3.7% annually (0.1% above expectations). With core up 0.3%/4.1%, exactly at expectations, markets took it as a “win” as it won’t spur the Fed to unexpectedly hike. Again, the “controversial” shelter cost component was a huge part of the increase, a possible lagging indicator. Friday saw a continuation of the “peak yield narrative” rally along with flight to quality. The 10 Year ended at 4.61%. Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

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