Pascale’s Perspective

The 10-Year Treasury is up to 3.10%, rising 32 basis points in the last 10 days. Markets are concerned that Friday’s speech by Fed Chair Powell will lay out a more hawkish path than markets expected earlier this month. He is expected to say that a recession will not stop the fight against inflation. The usual assumption is that the Fed will react to a slowing economy by swiftly lowering rates. This is known as the famous “Fed put.” The fear is that Powell may remove that put this Friday. The futures market is now predicting a 60% chance of a 75 basis point increase at the September 21^st meeting. Remember, markets have whipsawed back and forth between predicting 50 basis points and 75 basis points multiple times in the last month. The Fed’s recent increases are hammering rate-sensitive sectors, such as housing. The National Board of Realtors said “We are in a housing recession,” as July saw the biggest monthly decline in prices since 2011.  Tightening conditions are also hitting employers, both local and corporate. Large companies, like Oracle, Walmart, Apple, and Ford, have announced layoffs.

According to the latest PwC survey of US executives and board members, 52% of companies are instituting hiring freezes. Weekly jobless claims rose to an 8 month high this week. The Fed has made it clear that they are abandoning the long-standing “dual mandate” of full employment and price stability (sometimes referred to as the “2 and 4” rule – targeting a 2% inflation rate and a 4% unemployment rate). They now realize that the inflation-curbing “demand shock” that is being implemented must include a cooler job market in order to calm price pressures. Higher unemployment will be seen as “collateral damage” in the pursuit of wage and price stability. Yet, some sectors of the job market are still “hot” with job shortages. Prices continue to rise (albeit at a slower pace). September will see the Fed increase rates into restrictive territory above the “neutral rate” it’s at today (2.50-2.75%).  Now the focus is “what is the terminal rate?” i.e., the peak rate. Powell may address that this week. The futures markets are pricing the peak at about 4.00% – 4.25%, occurring in the second quarter of 2023. The 2 Year Treasury (most sensitive to anticipated Fed increases) is at 3.39%, a 10 week high. This Friday is action-packed with the release of the July PCE index (the Fed’s preferred inflation gauge). The data will be intensely parsed for (hopeful) signs that inflation has peaked and is slowing. After that early morning release, the Powell speech. Stay tuned….

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

Yesterday’s release of Fed minutes from the July 27^th policy meeting reiterated the central bank’s determination to “promote price stability.” Markets were looking for clues regarding the path of the Fed Funds rate over the course of the next few meetings. Whereas the Fed embraced “forward guidance” during the beginning of Fed Chair Powell’s term (circa 2018-2020). Yesterday’s Fed is increasingly data-dependent. The minutes indicate that Fed officials feel that hiking the fed funds rate last month to 2.25% – 2.50% puts the rate at the “neutral” level (neither accommodative nor restrictive). Many participants feel that a “restrictive” level will be appropriate which means more hikes to come (Hawkish).

Also in the minutes: “as the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation” (Dovish). The futures market is now predicting a 66% chance of a 50 basis point hike at the September meeting. There is no meeting this month. The Fed also is concerned about its public image: “a significant risk…is that elevated inflation could become entrenched if the public began to question the Committee’s resolve to adjust the stance of policy sufficiently.” This speaks to consumer and employee behavior and expectations being a critical component of wage and price stability. Interestingly, yesterday’s derivatives markets predict that inflation will be approximately 3.3% over the next 12 months. Interestingly, the market prediction last August was also 3.3%. How did that turn out? The 10 Year Treasury has traded in a tight range this week between 2.77% and 2.90%, settling yesterday at 2.87%. Stay tuned…

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

The July CPI report indicated an 8.5% annual inflation rate, and flat for monthly inflation rate. Gasoline led the decline with a 7.7% drop monthly, but that was offset by increases in food (1.1%) and shelter (0.5%). These numbers were softer than estimates. Markets rallied accordingly on hopes that inflation had peaked. Markets also cheered Monday’s inflation expectations survey from the NY Fed: the median expectation of inflation over the next 3 years dropped to 3.2%. Down from 3.6% last month, and 3.9% in May. That is critical as consumers’ expectations of rising prices can become a self-fulfilling prophecy. The 10-Year Treasury dropped to 2.70% this morning and then settled back up to about 2.78%. Today’s auction of 10-Year Treasurys saw the highest demand in 6 months, a good sign. As far as inflation peaking, it will take multiple months of trending for the Fed to be comfortable that their rate increases have been effective (remember the Fed target is 2.0% annual inflation). Futures markets are already pricing in less hawkish Fed behavior: the futures market shifted from predicting a 75 point increase at the next meeting to a 50 point increase. Tomorrow’s PPI report will be closely watched along with Fed President Mary Daly’s speech. Stay tuned…

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

Monday opened with yields plummeting on a “flight to quality” as geo-political tensions rose due to the “flight to Taipei” by a US Congressional delegation. Worries dissipated on Tuesday as the focus shifted back to economic data and remarks from Fed officials. Today’s ISM numbers indicate strong demand for services. Factory orders rose in June with surprising demand. Markets may have been expecting recessionary pressures to create demand slack and cool inflation, thereby avoiding predicted interest rate hikes.

Fed officials chimed in as Fed President Bullard said the central bank “has a long way to go” to get back to the 2% inflation target. Fed President Mary Daly then started the September speculation game by saying a 50 basis point hike next month would be “reasonable.” Fed Futures rates softened immediately to a 57% probability of a 50 basis point increase. The markets favored a 75 basis point increase the night before. The 10-Year Treasury dropped to 2.51% Monday, jumped to 2.85% today, and now is at 2.71%. The 38 basis point inversion between the 2-Year Treasury and the 10-Year Treasury went to 40 basis points. Stay tuned…

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

Today’s 75 basis point increase in the Fed Funds rate was expected as it was “telegraphed” in advance by Fed officials. Coming on the heels of June’s 75 basis point increase, the Fed Funds rate is now 2.25-2.50%. This is the Fed’s targeted “neutral” rate that is neither restrictive nor accommodative. Goldilocks is sipping her porridge. The rate is right back to the post Financial Crisis high as set by newly approved Fed Chair Powell in December 2018. The 10-Year Treasury in December 2018 was hovering around 2.75%, just like today.

Where are we and where are we going? Powell insisted we are not in a recession. “Recent indicators of spending and production have softened,” is his preferred terminology. What about the September meeting and the rest of the year? Markets rallied on perceived Fed dovishness going forward. Nasdaq saw its biggest one-day increase since 2020. He remarked that slowing down from the pace of 75 basis point rate hikes will be appropriate “at some point,” and the Fed is now in a “meeting to meeting” phase; and that it “likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.” The year-end target and possible “peak” is estimated at 3.25-3.50% – a full 100 bps into “restrictive” territory. Will that cause a recession? Again, Powell chose his words carefully, “This process is likely to involve a period of below-trend economic growth and some softening in labor market conditions, but such outcomes are likely necessary to restore price stability.” The 10-Year Treasury barely moved, closing at 2.76% as the yield curve flattened out (but is still slightly inverted). One-Month SOFR is 2.32%, Prime Rate is 5.75% as fixed and floating rates diverge. Now, time to watch the data – tomorrow: GDP, Friday: PCE, and employment report next Friday. Stay tuned..

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

Last week’s market consensus that the Fed would increase rates by 100 basis points at next week’s meeting has ebbed. Multiple Fed officials spoke last Friday, just before the traditional pre-meeting “quiet period” where they refrain from public comment. Each one indicated a 75 basis point increase was appropriate, clearly telegraphing their intent. Some officials feel that a big increase could damage the strong labor market. I guess that means that a 75 basis hike next week is “dovish”? With little economic data this week, treasuries are trading in a tight range. The 10-Year Treasury has been fluctuating between 2.90% – 3.10%, closing today at 3.02%. The yield curve inversion is holding with the 2-Year closing 21 basis points above the 10-Year.

Next week will provide much more direction as it is “action-packed” with: Consumer Confidence on Tuesday, Fed meeting and statement on Wednesday, Q2 GDP on Thursday, and the all-important PCE report on Friday (the Fed’s preferred inflation gauge). The GDP report may show that we are in a recession now (defined as 2 consecutive quarters of negative GDP). Stay tuned….

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

Fed Chair Powell has made it clear in recent statements – the Fed’s inflation response will continue to be driven by “the data.” Today’s release of the June CPI report indicated stubborn price increases across a wide spectrum of goods and services. The “headline” number of 9.1% is the highest annual gain since November 1981, expectations were 8.8%. Core CPI (excluding food and energy) rose 5.9% (5.7% was expected) and the highly watched core monthly increase was 0.7% (0.5% was expected). Key categories were up sharply over the last month: food (1.0%), energy (7.5%), gasoline (11.2%), apparel (0.8%), household furnishings (0.4%). There was some speculation that non-food retail goods like clothing and appliances would see price decreases as many retailers indicated they are overstocked, so these increases are indicators of broad-based inflation pressure. The Fed is now expected to increase rates by 100 basis points at the July 27th meeting. Futures markets show a 78% probability tonight, yesterday it was about 10%. A full point increase would be the largest since Fed Chair Greenspan fought inflation in the summer of 1988. The increase would put the Fed Funds’ rate (and 30-Day SOFR) up to 2.50% by the end of the month. The September futures indicate a 70% chance of another 75 bps up to 3.25% after the September 21st Fed meeting (there is no August meeting).

The bond market sold off on the short end and rallied on the long end, inverting the yield curve farther than any time since 2000. The 10-Year started the day spiking up to about 3.07%, before dropping to 2.91%. The 2-Year jumped to 3.16%; a 25 bp inversion between long and short. The Fed is pushing to avoid inflation expectations to become entrenched and alter consumer, employee, and employer behavior. The fear is that workers who are expecting price increases to continue will negotiate higher wage increases. That will then put pressure on companies to raise prices in an “inflation feedback loop.” Markets seem “resigned” to the Fed’s harsh medicine likely triggering a recession. Note that the Atlanta Fed’s “GDP now” index indicates that a recession is happening now. It predicts a negative GDP for Q2 (the actual GDP estimate comes out on July 28). The hope is that inflation peaks soon and a short recession will be the perfect excuse to cut rates in early 2023. Stay tuned…

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

Today’s release of the Fed meeting minutes for June indicated that there is an agreement for another 50 – 75 basis point increase this month (after June’s 75 basis point increase). The officials also indicated that an “even more restrictive stance could be appropriate if elevated inflation…persists.” Another 75 basis point increase would put the Fed Funds rate at 2.25% -2.50%, right at the Fed’s “neutral” rate. So, further increases after July would put it officially in “restrictive” territory. Another takeaway from today is the Fed feels the battle is shifting to one of “messaging”. Expectations of future inflation are becoming prevalent for the first time in decades. Fed officials worry that this expectation can result in more entrenched inflation. The notes also show that Fed officials believe that their constant messaging on their willingness to tame price increases is critical in reassuring consumers. The bright side? Officials note that by raising rates quickly today, they will have more flexibility later to pause or slow down in the fourth quarter and early next year. This Friday’s release of the June employment report will be closely watched – especially the hourly earnings increase and participation rate. Stay tuned…

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

The treasury yield curve is indicating near-term rate hikes and long-term economic slowdown. The 2-Year is 3.04%, 5-Year is 3.14%, and 10-Year is 3.09% (41 bps below its recent high). The markets are betting against the “soft landing” unicorn, as continued hawkish comments by Fed officials indicate that fighting inflation is the priority. Higher unemployment and/or slower growth could be collateral damage. Markets are “treading water” in anticipation of tomorrow’s PCE Report – the Fed’s preferred inflation gauge. The critical component will be the Core PCE monthly increase. Last month’s increase was 0.3%, and the analyst consensus for this month is 0.4%. The report will be the major market mover as we enter the 2nd half of 2022.

Capital Markets Update: Market dislocation is occurring throughout capital markets as securitized lending (both fixed and floating) is slowing. Bond buyers are demanding higher yields, and some lenders are reluctant to clear their inventory and take losses. Some lenders are hitting the pause button on new originations, which then puts increased pressure and demand on lenders still active. New CMBS “full leverage” fixed-rate loans are pricing between 5.75% – 6.25%. “Full leverage” in this case is low leverage, as cap rates have yet to widen accordingly. We are seeing regional banks step up with rates in the low to mid 5’s with the ability to rate lock early. In the bridge lending space, active lenders are extremely busy as some competitors are on the sidelines. This is not a 2008-style “meltdown” as Bank balance sheets are strong and there is liquidity in the marketplace. It is a period of “price discovery” and uncertainty about asset values and the direction of the economy. Stay tuned…

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

Markets are whipsawing back and forth between worrying about stubborn inflation, recession, or both- stagflation. The conundrum is partially a result of Fed policy. Remember, the Fed’s toolbox consists of “hammers not scalpels.” The central bank is not able to fine-tune or tweak sections of the economy. Instead, it’s interest rate increases are macro-monetary policy moves that affect capital markets, personal finance, consumer behavior, etc., on a large scale. Much of today’s inflation is due to a massive supply shock, as manufacturing and logistics underwent disruption due to COVID. So, the Fed’s “hammer” is to create a demand shock by raising interest rates. Example: Existing home sales volume is plummeting as mortgage rates spike (the 30-year fixed mortgage rate has spiked to over 6.00%, up from about 3.10% last year). Also, there are signs that gas prices have actually dropped slightly in recent days. Markets are looking at this as “good news and bad news” as high prices and increased interest rates are causing consumers to curb purchases. The 10-year Treasury hit 3.50 on June 14 on the narrative that inflation was possibly out of control. Today, it is at 3.16% on slowdown fears. No matter what, the focus will be on the data over the next couple of weeks. This week will include jobless claims and consumer sentiment. Next week will include durable goods and Thursday’s big PCE release. Stay tuned… By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

“Seinfeld” was a must-see show on TV and “Forrest Gump” was packing cinemas back when Fed Chair Greenspan raised rates by 0.75% in November of 1994. Today’s rate increase was expected after last Friday’s CPI report of 8.6% overall, with a 6.0% jump in core inflation. The news broke Monday and was confirmed by many bank analysts. This led to a huge jump in the 10-Year Treasury from about 3.04% (Friday morning) to as high as 3.50% (Yesterday). Stock markets plunged with the Dow losing about 10% of its value in the last week.

Today’s Fed announcement and press conference by Fed Chair Powell, while hawkish, actually calmed markets. Why? It was a case of “Sell the rumor, buy the news.” Stock markets rose and the bond market rallied – the 10-Year dropped to 3.29%. Markets see a Fed that is determined to fight inflation and Powell provided more clarity on the future. Markets were in free fall largely due to the uncertainty of monetary policy going forward. Today, Powell and his colleagues helped assuage those concerns with the following comments: (1) The planned increase at next month’s meeting will be “50 or 75 basis points” (so a 75 bp increase is not “for sure”), (2) “75 bp increase is a large one, and I do not expect moves like this to be common”, (3) Predictions from the Fed: the Fed Fund’s target rate for year end 2022 is 3.4% (note that this estimate was 1.9% in March) and 3.8% for year-end 2023, before tapering down to 2.4% – the neutral rate. The Fed Funds rate is at 1.50% – 1.75%, 30-Day SOFR is 1.48%, and 30-Day LIBOR is 1.50%. Sign of the Times: “Collars” are back. Interest rate caps are now also being offered with a “collar” that can alleviate costs. The cap purchaser also “sells a floor” to the cap provider by agreeing to pay a minimum interest rate if rates drop. Stay tuned…

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

Today’s $33 billion auction of the 10-Year Treasury Bonds saw tepid demand.  Bids were submitted for 2.41x the amount offered – the last six auctions have been averaging 2.50 times.  Investors are in a wait-and-see mode as they are anticipating this Friday’s CPI release.  Recent data shows that inflation is peaking (good news), but the question is what is on the other side? A stubborn plateau or a downhill?   The core CPI report (excluding food and energy) is expected to drop to 5.9% – after April’s rate hit 6.2% (with a 0.6% month-over-month gain).  Wage growth will also be in the spotlight. Recent data indicates that more expensive “large goods,” such as autos, appliances, and furniture are experiencing slower price gains on softening demand. However, the services sector is still suffering from high demand and a shortage of workers. The European Central Bank is set to announce new projections for growth and inflation. This week’s meeting may see a commitment for their own 50 basis point hike.   France’s central bank is describing the potential move as “normalization but not tightening.”  The US Fed meets next week and has communicated their intent to raise the Fed Funds rate by 50 bps, followed by another 50 bps in July. The September meeting is the subject of speculation, hence the focus on Friday’s CPI and the accompanying commentary at next week’s meeting. Stay tuned… By David R. Pascale, Jr. , Senior Vice President at George Smith Partners