Treasuries Continue to Rally into the Holiday Weekend

May 25, 2018

With a holiday weekend and an early close (2pm EDT) just hours away, investors have one more box to check on this week’s to-do list and that’s the April Durable Goods Report. Overall orders were down –1.7% versus 2.7% in March and –1.2% expected. Orders ex the volatile transportation sector rebounded to 0.9% versus 0.4% in March.  Perhaps most important metric, shipments ex-air and defense (a proxy for business investment), were up 0.8% versus –0.7% in March and 0.4% expected. One of the selling points for tax cuts was the business investment it would spur but through the first three months of the year the results have been lackluster (Jan. –0.3%, Feb. +1.0%, Mar. –0.7%). The solid April print will help the investment argument but it will take more than one decent month after a weak one to establish a trend. Meanwhile, Treasuries continue to enjoy strong bids as we mark time until the weekend. The 10-year note is up 10/32nds in price this morning to yield 2.94% as the market continues to work off the oversold yield high of 3.12%.  The longer yields remain in a range loosely set between 2.90% - 3.00% it will consolidate the recent gains and build a base for further rallies, but that’s a trade for next week.


  Economic News


The announcement  yesterday by President Trump that the North Korean summit was called off sent another dose of flight-to-safety bids into Treasuries as geopolitical risks ramped up once again. The cancellation was just one in a string of geopolitical events that are catching the market’s attention this week.  When you add the news of the cancelled summit with the new populist government of Italy threatening the EU experiment, not to mention the quality of its debt obligations, and the increasing stresses in emerging markets characterized by the decline in the Turkish lira, the geopolitical risk factors have had quite a run this week.  All that has led to a risk-off tone that has contributed to the rally in Treasuries.


The other issue driving the Treasury rally this week was the somewhat dovish tone of the minutes from the May FOMC meeting that were released Wednesday afternoon. We had speculated prior to the release that the minutes may shed light on an increasing inclination on the part of Fed members to lean towards a four-hike 2018. Instead, the minutes seemed to lean in the other direction with little inclination shown to move to a faster pace of tightening. In essence you could call the minutes near-term hawkish and long-term dovish.


The minutes exuded very strong signals that the membership were inclined to go ahead with a rate hike at the June meeting, saying that “a rate hike would be appropriate very soon.” However, concern was expressed over the uncertainty of fiscal and trade policy, inverting the yield curve and several comments suggested they would welcome a slight overshoot of inflation by reiterating the “symmetrical” nature of the 2% inflation benchmark. All of that suggested there’s no urgency to shift to four hikes this year. And, if anything, the aforementioned geopolitical events probably only add to the list of concerns for Fed members on top of the those expressed in the May 2 minutes.


The net result of the minutes was for a strong rally across the curve but with more buying on the short-end as the interpretation of a Fed comfortable at a three-hike 2018 lent additional bidding to the shorter end of the curve, especially from 2- to 5-years. And even though the longer-end participated in the rally the curve steepened given the stronger buying of shorter maturities. Attention now turns to the June 13 FOMC meeting where a rate hike is widely expected, but now the guessing begins as to whether the rate forecast will remain at three hikes in 2018 and whether the longer-term rate scenario remains at a 3.5% terminal rate.


Speaking of the Fed and rates, Societe Generale SA did an analysis of the impact of rate hikes along with the reversal of quantitative easing and concluded we may be closer to the end of the hiking cycle than some may realize. The most recent Fed “dot-plots” suggest the Fed will finish raising rates in 2020 to a terminal rate of 3.5%. In the Societe Generale research, they calculate a “shadow rate which tries to incorporate the impact of quantitative easing and its reversal to the nominal Fed Funds rate changes. The so-called “shadow rate” hit bottom in May 2014, at about minus 3%.  As the Fed ended QE, it steadily rose starting in late 2014, reaching zero by December 2015.  Add the Fed’s rate hikes so far -- about 1.7 percentage points looking at the effective federal funds rate -- to that increase and the cumulative tightening in the current cycle has reached 4.7 percentage points according to the French bank’s research.


In past hiking scenarios the range in Fed Funds has averaged 5.5% in the post-stagflation era so the research posits we could be just three hikes away from completing this rate-hiking cycle. That would put the terminal rate at 2.5%, a level that could be hit early next year. The research also claims that rate-cycle peaks typically are followed by recession within an average of six months. While trying to put a number to the impact of quantitative easing and its reversal is obviously subject to some error, there is no arguing that there is some impact and it does give one reason to ponder whether we may be closer to the end of the hiking cycle than many think.



Market Update  Highlights of the Dodd-Frank Revision Legislation


On Tuesday, the U.S. House passed the Senate’s version of Dodd-Frank reform on a bipartisan 258-159 vote with the bill signed yesterday by President Trump at the White House.  Because of the politics involved, the House didn’t make any changes to the Senate version even though many conservative members wanted more expansive rollbacks of Dodd-Frank.  The chart highlights the key measures of the bill. One important change for banks under $10 billion is the relaxed capital and leverage requirements (Section 201). Many of the major benefits, however, go to banks with assets between $50 and $250 billion which will enjoy relaxed stress testing requirements. The banking agencies will now get busy crafting the regulatory changes wrought by the bill.


Highlights of the Dodd-Frank Revision Legislation



Agency Indications  Market Rates


Market Rates



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