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Pascale’s Perspective

  • Treasury Yields Jump as Markets Price in a 50 Basis Point March Rate Hike

    Pascale’s Perspective

    January 18, 2022

    The 10 year Treasury yield spiked to 1.86% today as new assumptions for the Fed are being “priced in”. The 2 year Treasury (most sensitive to Fed moves) has jumped to a 2 year high of 1.00% (up 80 bps since September). The early January predictions of 3 or 4 rate hikes this year now seem “dovish” this week.

    Major factors include continuing high CPI numbers combined with:

    • Predictions of extended supply chain disruptions resulting in shortages/higher prices for oil, raw materials, computer chips, consumer staples, etc; and
    • A very tight labor market with “sidelined” workers that will demand higher wages to return to work.

    Markets are now pricing in a 0.50% rate hike in March (the first 0.50% rate hike since May 2000). Consumers, businesses and Congress are clamoring for action on inflation. It looks like the Fed will want to make a “whatever it takes” statement with a rare “double hike” in March (as soon as the monthly bond buying has ended). Fed governors are calling for as many as 5 rate increases in 2022. Also, the 10 year T is spiking on the “relative value trade” as the 10 year German Bund is climbing out of negative territory for the first time since May 2019. So the 10 year at 1.86% is now right where it was on 12/31/2019, the day of the first Covid alerts and before the unprecedented fiscal and monetary stimulus of the past two years. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • Treasuries Stable After Huge CPI Jump, Fed Stands Ready to Battle Inflation

    Pascale’s Perspective

    January 12, 2022

    Consumer prices rose 7.0% for 2021 according to the December CPI report released early this morning (core prices rose 5.5%). That is the highest rate in 40 years, all the way back to the Volker era. Fed Chair Powell has expressed concern that inflation may become “entrenched.” Via speeches, interviews, and Fed minutes released, the Fed committee members have laid out a path for 2022 and beyond. The December unemployment report at 3.9% indicated that there is a “labor shortage” according to Fed officials. This is very significant as it means that both the inflation and employment “test thresholds” have been met (the so called “dual mandate”).

    The 10 year T barely moved today as the big CPI numbers are not expected to change policy assumptions that are “priced in”. The 10 year closed out 2021 at 1.51% before a big spike last week, sending the yield as high as 1.81% on Wednesday. This spike was attributable to markets being surprised by the release of Fed minutes indicating that balance sheet runoff, aka QT (Quantitative Tightening) may occur this year. This was a surprise to markets. The Fed had already telegraphed the first two stages of policy tightening: tapering bond purchases (set to end two months from now) and raising the Fed Funds rate. The general assumption was that the “runoff” of the Fed’s balance sheet would not occur until 2023. The knowledge that the Fed may be a net seller of MBS and Treasuries this year was a jolt. The act of selling bonds removes liquidity from the system and will put additional upward pressure on rates. The consensus amongst major bank economists and the future markets is the following: Bond purchases end in March, then 3 or 4 rate hikes this year (March, June, September, December). That will bring the Fed Funds rate to 1.00-1.25%. This is halfway to the Fed’s “terminal rate target” which is now 2.50%. Balance sheet run off may start as soon as September, but definitely by December. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • “Hawkish” Fed Pivot Provides Certainty, Markets Celebrate

    Pascale’s Perspective

    December 15, 2021

    When does a hawk look like a dove? For today, the answer is: when the hawk’s arrival has been well telegraphed and it’s talons aren’t as sharp as feared. Today’s Fed meeting and announcement marks a full pivot away from ultra accommodative policy to a tightening anti-inflation stance.

    The headlines:

    • The Pace of the Fed’s Tapering of Bond Purchases Is Doubling.
    • Bond Buying is Now Scheduled to End in March 2022 (Not June). This means that interest rate hikes may begin in April. Speaking of hikes, the Fed’s “dot plot” now calls for 3 rate hikes in 2022 and another 3 in 2023 (bringing the cost of funds to about 1.6% from 0% as of today).

    Powell spoke of the “dual mandate” regarding inflation and employment thresholds which need to be met in order to begin raising rates. The inflation part of the equation has been met. He indicated that “Rapid progress to maximum employment” is underway, giving more certainty to a rate increase in April 2022. More on inflation – the recent record CPI and PPI increases are further proof that “transitory” is no longer appropriate. Powell today said, “The risk of higher inflation becoming entrenched has increased”.

    Stocks rallied on a “relief trade” as market volatility has been high since Powell’s November 30 Congressional testimony indicating that a pivot was imminent. Today’s statement and Powell’s remarks calmed markets, providing a level of certainty. Today is a case of, “sell the rumor, buy the news”. A Fed funds rate of 0.9% at year end 2022 is not being seen as a major impediment to economic growth and it gives “cover” to investors worried about asset bubbles. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • Continuing Inflation Data, Political Considerations May Quicken Tapering

    Pascale’s Perspective

    November 29, 2021

    Last week’s release of the October PCE numbers continued the steady drumbeat of inflationary data. Some perspective: the PCE is the Fed’s preferred inflation gauge, the target rate is 2.0%. Since the Great Recession, the PCE has lingered below 2.00%, popping up to barely above 2.00% on a few occasions (2011, 2016, 2017). The July 2021 to October 2021 annual rates: 4.03%, 4.14%, 4.21%, 4.42%, 5.05%. “Transitory” inflation talk is in the rear view mirror. Not only that, inflation has “support”. Real consumer spending rose 0.7% last month alone. This indicates that higher prices are not dissuading consumers to purchase goods. Powell has been nominated for another term, markets seem to be happy with that as it means no major policy changes. However, Powell will need Senate confirmation. The release of Fed minutes last week showed some support for earlier than anticipated rate increases to reign in inflation. Powell may want to speed up the decline in monthly bond purchases ahead of his February hearing. Next month’s Fed meeting may feature a more hawkish Fed. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • “Data Driven” Rate Environment

    Pascale’s Perspective

    November 17, 2021

    This week’s comments from Fed member Thomas Barkin are telling: “I think it’s very helpful for us to have a few more months to evaluate, is inflation going to come back to normal? Is the labor market going to open up?” He made it clear that more data is needed before raising rates. Now that the tapering of the Fed’s bond purchases has been quantified and announced, the next move on rates will be dependent on the direction of the economy. The Fed bought some time with the tapering announcement. The bond buying will be lowered over the next 6-8 months while the Fed is able to further gauge if inflation is transitory or more permanent. Regarding the labor market, the labor participation rate is increasingly in the spotlight. Labor participation has historically been 63-64% since the Great Recession. It dropped to 60.2% in February 2020 during the “shutdown shock” and is back up to about 61.6%. More labor participation will help the inflation picture: worker shortages are affecting the supply chain, wage inflation is spiking, etc. Participation has been gradually rising in the last few months. This week, the 10 year Treasury hit 1.65% on a strong retail sales report. Today it dipped to 1.58% on a weaker than expected homebuilding report. Look for data driven ups and downs to be the norm for a while. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • Treasury Yields Spike After “Blowout” CPI Report

    Pascale’s Perspective

    November 10, 2021

    The 10 year T jumped 12 bps today (closing at 1.57%) as inflation is increasingly being perceived as more than “transitory”. Breaking down today’s CPI report shows some more persistent inflation signals that will most likely continue into 2022. The headline number of 6.2% annually was the highest in 30 years. Analysts were expecting about 5.9%. The monthly number was 0.9% (expectations were 0.6%). Core inflation was also the highest in 30 years at 4.6% annually. Food and energy prices are up significantly. Shelter costs, driven by higher rents, increased 0.5% for the month. The shelter metric is another example of the “stickiness” of this wave of higher prices. Treasury Secretary Janet Yellin struck a dovish tone. She again said that policymakers expect price increases to settle down in 2022 (to acceptable levels of about 2.0%). However, she pointedly added that if inflation turns out to be “endemic”, the Fed “would have a role to play to keep it under control”.

    St Louis Fed President Brainerd remarked last night that he sees two interest rate hikes in 2022. The Fed futures market is now predicting 2 rate increases for 2022 and a 44% likelihood of a 3rd hike. Not a great day for Treasuries as an auction of 30 year bonds went poorly pushing that rate to 1.94%. Inflation expectations as measured by the 5 year “breakeven” rate jumped to an all time high of 3.113% (the difference between the treasury yield and the inflation protected security of the same term. It is a key indicator of investor expectations of inflation) Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • “Dovish Tapering” Announcement Keeps Yields from Spiking (For Now)

    Pascale’s Perspective

    November 3, 2021

    Today’s Fed meeting announcement and subsequent presser by Fed Chair Powell confirmed that the tapering of monthly bond purchases has begun. The muted market reaction is a testament to how unsurprising the well telegraphed announcement was to investors (Dow and S&P up slightly, 10 year T yield jumped 6 bps to 1.60%). Pick your metaphor: “the punch bowl is not being taken away, it’s just less full”, “the Fed didn’t put the brakes on, it just eased off the accelerator”. Highly accommodative monetary policy is still in place: Fed Funds rate is at zero, billions of dollars of MBS and Treasuries are being purchased every month, the Fed’s balance sheet is at nearly $9T of bonds that they have no intention of selling anytime for years.

    What is changing? Powell no longer refers to inflation as purely “transitory” and that supply/demand imbalances are persistent. Everyone is looking for clues on when rate increases will occur. Note that Bank of Canada, Bank of England, Bank of Australia are all aggressively raising rates to combat inflation. Powell pointedly remarked that, “Our tools cannot ease supply constraints” and that “the dynamic economy will adjust to imbalances and inflation will decline to levels much closer to our 2.0% longer run goal”. This is being interpreted as highly dovish and the Fed may not need to aggressively raise rates. The risk is waiting too long to raise rates (while other major banks increase) which could lead to runaway inflation and multiple rate increases in a short period. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • Interest Rate Scenarios

    Pascale’s Perspective

    October 20, 2021

    In the wake of last week’s Fed announcement (tapering bond purchases) and continued “sticky” inflationary data, a future path is becoming clearer. What’s next? Fed plans on decreasing monthly bond purchases from $120 billion (now) to zero (June/July 2022). If inflation is still persistent, expect the Fed to start raising rates in Q3/Q4 2022. How much? Recent “dot plots” and comments from Fed officials suggest an eventual target rate of 1.75%. Call 1.75% the “near term neutral rate”. So that means about 6 quarter point rate increases. Note that the post Great Recession high point was 2.50% in 2018. The CME futures index shows a 50% probability of an increase by June 2022, 60% by July, 73% by September, and 60% expect two increases by December.

    Fixed Rates: As the Fed buys fewer Treasuries, Mortgage Backed Securities and signals rate increases; Treasury yields are expected to rise to attract more private buyers. Less buying of MBS may impact loan spreads.

    Floating Rates: LIBOR and its likely successor, SOFR, are both expected to fluctuate in nearly lock step with the Fed Funds overnight rate (the “headline” rate that leads the Fed meeting announcement). Of course, floating rate borrowers would see increases in their monthly debt service.

    However, this is “the plan” and plans can change based on market conditions and/or unforeseen disruptions. As the stock market hits another record high today during the “perfect storm” of low rates and high consumer demand, it’s not hard to imagine that a “mark to market” may occur across many asset classes. As the pandemic’s impact has been unprecedented in the era of the modern global economy, the recovery is uncharted territory. Central bankers will have their hands full in navigating it. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • Fed Notes Provide Full Clarity on Taper, Treasury Yields Drop

    Pascale’s Perspective

    October 13, 2021

    After all the months of prepping markets, “telegraphing” and promising almost unprecedented transparency on the subject, the taper announcement and structure has arrived. Interestingly, it was communicated by a release of Fed Minutes, not an official meeting date with a Powell appearance.

    Summary of the Minutes and Commentary from Fed Officials: The “next meeting” (November 2-3) is an appropriate time to announce tapering. Bond purchases are now $120 billion per month ($80B treasuries, $40B mortgage backed securities). The purchases will be cut at a rate of $15 billion per month. This will result in an 8 month tapering period, completed by July 2022. It looks like the markets were ready, the 10 year actually dropped about 7 bps to 1.54%. Hopefully the market will be able to price future rate risk without a lot of volatility. What comes after tapering? The runway will be clear for a rate increase in 4Q 2022 (the futures market indicates this is likely). Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • 10 year Spikes above 1.50% As Powell Calls Inflation “Frustrating”

    Pascale’s Perspective

    September 29, 2021

    The 10 year T has jumped from 1.17% (August 3) to 1.56% this week. Two Fed officials came out today in favor of tapering bond purchases, adding to a growing chorus. Fed Chair Powell is having a rough few days: 2 resignation of Fed officials over conflict of interest allegations, Senator Warren announcing her opposition to his re-nomination for another term, and his statements to Congress that inflation is more than “transitory” Powell indicated that supply chain bottlenecks, once thought to be “worked out” by the end of 2021, will now persist well into next year and in some cases are worsening. As the Covid era accommodative policies are being removed, a benchmark for the 10 year T comes into focus: 1.85%. That was the 10 year T rate at year end 2019, before the Covid pandemic. Meanwhile, Treasury Secretary Yellen has indicated that the “x date” is estimated to be October 18. That is when the US Treasury will exhaust cash reserves and will be unable to meet it’s obligations without an increase in the debt ceiling. That increase is now fraught with political wrangling and no clear path is in sight. The countdown is already distorting the short term treasury market, as yields are spiking as buyers are unsure if the securities will be liquid at maturity. Rates will also be dependent on upcoming data releases: PCE this Friday, Employment next Friday. Capital markets may be affected if the debt ceiling remains unresolved into mid-October. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • Talking About Tapering, In December

    Pascale’s Perspective

    September 22, 2021

    After many months of “telegraphing” the first pullback of accommodative policy instituted in the wake of the Covid financial meltdown of March/April 2020, Fed Chair Powell indicated that we should expect a formal announcement “soon” (most likely at the next meeting in early November) and tapering to begin in December. Keep in mind that if the Fed lowers purchases by $10-$15 billion per month, there will still be over $500 billion of bonds purchased during a 6-9 month process. The Fed statement today indicated that, “If progress continues broadly as expected, a moderation in the pace of asset purchases may soon be warranted”. Significantly, the consensus amongst Fed members was unanimous. Inflation continues to be the unknown factor, transitory or sticky? The Fed core inflation projections increased (3.7% this year vs 3.0% months ago, 2.3% in 2022, 2.2% in 2023). So inflation may be a little stickier than estimated early in the summer, with future years at just over the Fed’s target of 2.0%. Powell indicated that economic growth is progressing (although the Delta variant spikes have dented earlier optimism) and conditions warrant tapering. He also said that the economic growth threshold for “liftoff” (raising rates from 0%) is nowhere near being met at this time. However, 9 of the 18 members now predict a rate increase in 2022, with 3 members predicting 2 increases. Projections for 2024 show an expected “neutral rate” of 1.75% or 7 increases in the next 3 years (neutral rate is the predicted “Goldilocks” rate, neither stimulative nor slowing). Markets seem very receptive to the Fed’s plan, no “tantrum” today as the 10 year T yield actually dropped about 3 bps this afternoon, closing at 1.30%. The big question is how will treasury markets react to the expected announcement at the next meeting? Meanwhile in Washington, markets are watching the Congressional debate on the upcoming debt ceiling with trepidation. The US has never breached their obligations (treasury bonds) which are an underpinning of the entire financial system Moody’s has indicated that a default of the US treasury obligations could cost $15 trillion in stock losses and 6 million jobs would be erased. Many expect a solution “just in time”. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

  • Data Indicates “Cooling” of Inflation (for now)

    Pascale’s Perspective

    September 15, 2021

    This week’s release of the August CPI report indicated lower than expected inflation. The headline numbers were the annual price increases: 5.3% actual vs 5.4% expected. Markets focused on the monthly increase in core CPI which rose just 0.1% vs 0.3% expected. Supply chain issues are proving to be “stickier” and less “transitory” than previously thought, (example: computer chip shortages which are shutting down major segments of auto production and delivery are expected to continue well into 2022). This report should give the Fed some breathing room to start pulling back on bond purchases near year end and not push tapering to start sooner. The 10 year is at 1.30%.

    The Fed meets next week. Speaking of “the data”, the traditional CPI report from the Labor Department’s methodology does not track prices of goods purchased online. Adobe Digital Insights released a report this week indicating that online prices have risen for 15 consecutive months and increased by 3.1% year over year. This is significant as online prices fell at a 3.9% annual rate from 2015 to 2019. The willingness of online sellers (Amazon) to accept lower margins for greater market share has helped keep inflation in check for much of the post Great Recession era. Also, online purchases grew from 16% of consumer spending in 2017 to 20% today. The pandemic increased this of course as people are now buying a wider variety of goods online. The inflation “sticky” vs “transitory” debate is not settled. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners