Fixed Income Market Commentary by Kevin Giddis

December 12, 2018

The Treasury market is trading lower this morning as money is coming in and out of bonds at a torrid pace. Risk-on, risk-off. Bonds are in favor, bonds are old news. The curve is flat, the curve is inverted. Stocks are down and it’s the bond market’s fault. Stocks are up because maybe there will be a trade deal. Stocks are falling because maybe there won’t be a trade deal. The dollar is up because the rest of the globe is struggling. My point is that the current trading environment is one that is being lived virtually in the moment. Throw out growth. Throw out earnings. Ignore the fundamentals. Today’s trading is about rhetoric and the Fed. There, now I feel better. Yesterday we got an upsized PPI number, which on the surface isn’t great, unless those higher costs can be passed on to the consumer. This morning, we got our answer. The Consumer Price Index for November came in flat as a headline number and up 0.2% as a core number. This takes the core year-over-year number to 2.2% vs. 2.1% last month. So far in 2018, the YOY core rate has been as high as 2.4% (July) and as low as last month’s 2.1%. That’s it. The whole ball of wax only produced one stinking candle! So let’s turn our attention to the Treasury and the latest refunding. Yesterday the Treasury auctioned $38 billion of 3-year notes at a yield that was below the current 2-year note yield (2.748%). Bad auction huh? No, it was actually a good auction from a coverage ratio, along with the smaller amount of the auction taken by the dealers. In other words, a solid, going away bid for a maturity that is yielding below a bond that is roughly one year shorter. What does this tell us? It tells us that the bond market isn’t worried about inflation, and its confidence in the growth track of the U.S. economy is dropping. Whether that means we are about to recede is still a ways away, but if you believe the bond market, then we are moving in that direction. So we need to start paying attention to housing, borrowing, and bank balance sheets. If banks are pulling back on lending because rates have priced out a number of qualified borrowers, then there is a good chance that we have turned. The same goes for investment-grade corporate debt. Spreads are widening. Is that just a function of supply and demand, or are some cracks beginning to show in the world of credit? In the middle of all of this is the Fed. While there is a good chance that they will tighten next week, they may also suggest that they are done raising rates for a while. At the end of the day, the market looks to be in the later rounds of a heavyweight fight. It has been knocked down couple of times, its legs are unsteady, and there is a cut above its eye. Can it rally one more time, or is it lights out? My guess is that there is one more “second wind” in this long battle for the championship. “Stay thirsty my friends!”

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