Weekly Bond Market Commentary

Who needs Mayweather vs McGregor… How about Fed vs Market?

By Doug Drabik, Drew O’Neil
June 19, 2017

Fight fans may clearly point to the buildup surrounding what is considered by many nothing more than hyped publicity toward a big pay check. After all, both men are considered the “best” in their respective sports; Mayweather among the greatest boxers of all time and McGregor, a vociferous well-respected ultimate fighter; however, the match-up will occur in Mayweather’s sandbox, tilting the scale towards his expertise. There’s another heavyweight brewing in our industry between the Fed and the market. The Fed, too, has been determined and unremitting in their efforts to raise interest rates while the market is basically indicating, “not so fast”. After all, the Fed controls and impacts short-term rates as demonstrated last Wednesday by raising rates another 25 basis points (bp). The actual event was perhaps built into the market as nearly 100% of experts anticipated the move for weeks in advance; however, the Fed does not dictate the economic environment and the market is prevailing on the hard core facts and tale of the (economic) tapes.

  • The Federal Open Market Committee (FOMC) kept the band of short-term rates low and constant from January, 2009 through December, 2015 from 0.00%-0.25%. Most of those years, but clearly in 2014, 2015, 2016 and 2017, market pundits generally shared in their conviction that the economy would be on an upswing and the Fed would cooperatively raise rates as many as four or five times in each year. In actuality the Fed only moved once in December, 2015, once in December, 2016 and now twice in March and June, 2017. That’s four hikes over eight and half years bringing the band to a mere 1.00%-1.25%. Most would consider the net position still to be accommodative, not restrictive.
  • The 10-year Treasury from January, 2009 to present is down 7 basis points and the 30-year is up 8 bp, all-in-all a very sedentary yield curve. On the year, long-term rates have dropped ~30 bp (both 10- and 30-year). By comparison, the 1 month T-bill is up 42bp. The Fed is dictating short-term rates but the market is paying attention to inflation expectations and key economic indicators, refusing to follow suit on the long-end of the curve. The result is a yield curve that is flattening.
  • Of the 16 Fed officials, 8 expect one more move this year, 4 expect two moves, and 4 expect no more. So 75% of the committee members expect at least one more move this year. Bloomberg probability for another move this year is a ~40%. Tidbits from Fed members: “inflation has declined recently”, “risks to economic outlook balanced”, “committee monitoring inflation developments closely”, “job gains moderated but have been solid on average”, “balance sheet unwind will be completed a few years down the road”, “expect balance sheet normalization to be started this year”.
  • (Punch - Counter Punch) On Wednesday, the 10-year Treasury fell 10 bp (~2.20% to ~2.10%) following the disappointing inflation and retail sales releases and then bounced back ~5 bp immediately following the FOMC announcement.
  • The FOMC decision once again came in the face of weakening key economic indicators. By example, CPI was lower than expected (1.9% vs 2.0%) and core CPI 1.7% vs 1.9% expected. Retail sales were down -0.3% versus expected 0.0%. These discrepancies all help to explain why the long-term rates are trending flat to down despite the Fed forcing short-term rates up.
  • Global interest rate disparity remains intact. Foreign participation in US Treasury auctions remains very strong and remains another factor counteracting Fed actions and influencing the yield curve.
  • The market sees a lack of inflation and a lack of wage pressure. Do not discount the idea that ultimately the numbers dictate rate direction (the shape of the yield curve) and Fed behavior, not the other way around.
  • Last Week….
    • Rates fell across the yield curve between 1- and 30-year Treasuries, this despite the FOMC raising short-term rates 25bp on Wednesday. This Fed move was highly anticipated and baked into the market. The week’s action concentrated more on continued soft inflation and labor market fundamentals (noted above). The market is hearing the Fed and seeing lackluster inflation but listening to the lack of wage pressures, nonfarm payrolls and other weakening economic indicators.
    • Oil took another beating hitting 1 year lows on Thursday at $44.46 (high was $57.21 on 01/06/17). All 3 Treasury auctions (3-, 10- and 30-year) showed strength with strong foreign participation meaning global demand continues for US securities.
    • The curve flattened another 8bp (30- to 1-yr Treasury) this week and is now 66bp flatter year-to-date. 

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.