The market got a big dose of risk-on news yesterday after it was announced the US and China had reached a trade deal in principle. Add to that the after-hours news that Boris Johnson’s conservative Tory Party romped to a landslide victory in UK parliamentary elections (making Brexit by January 31 nearly certain). What’s interesting to note is that with all that risk-on news Treasury yields held support. Overnight, after the election results were evident, the 10-year note yield peaked at 1.95% a 15bps move higher in a 24-hour span but still below the 1.97% support level that has held since November 7. Then this morning, news hits that the Chinese are balking at the hard target ag purchases outlined in the latest trade deal putting some doubt into the status of the deal. That news plus a weak retail sales report (more on that below) has Treasuries bouncing back with the 10-year note yield back at 1.87%. The question is if two big uncertainties overhanging the market (trade and Brexit) are seemingly settled, or at least taken off boil, and Treasuries still remain resilient what’s left to push yields materially higher? That’s not to say we can’t push through 2% on the 10-year, but one would think the apparent resolution would have produced more. The trading action of the last two days adds to our conviction that these yield back-ups will be limited and thus offer a decent buying opportunity.
While geo-political events currently drive trading we’d be remiss if we didn’t offer some final thoughts on the outcome of last Wednesday’s FOMC meeting.
- The median FOMC 2020 fed funds estimate was for no change to the target range over the coming year. While one would think the bar for cuts (or hikes) is quite high at this point given the consistent reiteration of the desire to stay on hold absent a material reassessment of the outlook, we’re not entirely convinced.
- While the dot plots have rates increasing a quarter-point in 2021, 2022 and again to the 2.50% ‘longer run’ rate, recent history suggests one should view the Fed’s projections as skewed in favor of being overly optimistic. Think of it more as wishful thinking than a real expectation. Thus, we still think the next move (whether this year or next) will be another rate cut and not a hike. Fed funds futures feel essentially the same way as the year-end 2020 rate was 1.33% before the meeting and 1.36% after, not exactly a major move.
- One other clue that the next move will be a cut was in the press conference Chair Powell mentioned that “inflation is barely moving up notwithstanding unemployment at 50-year lows.“ In addition, in the updated economic forecast the central tendency of core PCE expectations in 2021 and 2022 are at or above target, and yet no FOMC member submitted a 2021 fed funds dot even at the longer-run neutral estimate (2.50%). It’s a somewhat subtle sign that the FOMC is getting serious about letting inflation run a bit above the 2% target.
- Finally, Chair Powell was asked again about the impact the Fed Listens Tour had on him in regards to low-to-moderate income communities just recently beginning to experience the job-creating benefits of the decade-long expansion. He mentioned that certainly with modest wage pressures, and inflation still lagging, conducting policy to extend the expansion and its job-creating benefits seems the right answer. That doesn’t imply a rate hike but if conditions weaken it certainly could see the Fed back in easing mode.
Finally, away from the Fed and away from geo-political concerns, we did receive some first-tier economic numbers this morning in the form of the November Advance Retail Sales Series. With two-thirds of the economy tied to consumer consumption the monthly read on retail sales, especially around the all-important holiday selling season, is a critical tell on expected GDP growth.
Even with the trade and geo-political handwringing during the summer the consumer was mostly unfazed; however, spending did soften in September with bit of a bounce in October but it looks like another dip in November. Overall sales rose 0.2% missing the 0.5% expectation and behind the 0.4% print in October. Sales ex-autos & gas were unchanged missing the 0.4% forecast and behind the prior month’s 0.2% print. The Retail Sales Control Group (a direct GDP input) increased 0.1% missing the 0.3% expectation and 0.3% October increase.
A case can be made that the late Thanksgiving played havoc with the seasonal adjustments so it probably pays to consider the November/December two month totals rather than be led astray by a one-month result. That being said, it does put more emphasis on December sales to help meet fourth quarter consumption and GDP expectations. Bloomberg consensus for fourth quarter GDP is 1.7% annualized and consumer consumption at 2.2%. These are both down from the third quarter when GDP printed at 2.1% with consumer spending at 2.9%. Current expectations for first quarter 2020 GDP are similar to the current quarter’s with 1.7% GDP and 2.0% consumer spending. That expected slowing in growth is another reason we see these yield back-ups being contained and thereby offering a decent buying opportunity.
Our Record-Breaking Expansion
One of the questions Chair Powell fielded after the FOMC meeting on Wednesday was about the impact the Fed Listens Tour had on him in regards to low-to-moderate income communities just recently beginning to experience the job-creating benefits of the decade-long expansion. He mentioned that with modest wage pressures, and inflation still lagging, conducting policy to extend the expansion and its job-creating benefits seems the right answer. And while it’s said that no expansion died of old age, given the record span of this one, it probably pays to treat it gingerly and that means letting it run without undue interference like rate hikes.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||1.55%||+0.02%||1 Mo LIBOR||1.74%||-0.03%||FF Target Rate||1.50%-1.75%||3 Year||1.647%|
|6 Month||1.55%||+0.01%||3 Mo LIBOR||1.89%||UNCH||Prime Rate||4.75%||5 Year||1.678%|
|2 Year||1.62%||-0.01%||6 Mo LIBOR||1.89%||UNCH||IOER||1.55%||10 Year||1.813%|
|10 Year||1.87%||+0.02%||12 MO LIBOR||1.94%||+0.02%||SOFR||1.53%|