Fixed Income Market Commentary by Kevin Giddis

July 18, 2018

The Treasury market is trading slightly higher this morning as investors have fully digested the Fed Chair’s comments, and don’t seem to have a problem with where the Fed is headed. The FOMC knows where the weaknesses lie, and have communicated the relative “fixes” for them. The real question on the minds of investors really boils down to: will it work? Raising rates to stem inflation when most of the inflation is resistant to increases in the Fed Funds rate can be tricky. Demand for oil will stay pretty strong, no matter what the Fed does or doesn’t do. The same can be said for food and the other energy components. Raising rates will affect lending, borrowing, housing and rents. These are the economic variables that, if the Fed keeps going down this path, could actually hurt the economy the most. My point is that where we are now, it could get real tricky if the FOMC keeps pushing short rates higher in the face of a 2% core rate of inflation, with little increases in wages. I thought that Chairman Powell laid this out pretty well in his testimony to the Senate, and will pretty much repeat that today when he visits with the House. Housing Starts in June fell a whopping 12.3%, and Building Permits for the same period fell 2.2%. Not sure what this really means because history has proven that this number can be all over the board, and several factors away from interest rates can weigh heavily in where this data falls on the reporting line, so I wouldn’t expect the market to react too much in either direction. The Fed Funds futures Probability Index seems to indicate that there could be two more rate hikes in 2018, though the numbers did fall a bit since Chairman Powell testified. While today’s testimony is likely going to be very similar to yesterday’s, pay attention to the questioning from House members. He will likely be greeted with tougher questions and a less friendly group than the Senate. While the short-end of the curve seems to be comfortable moving higher, the long-end of the yield curve remains unconvinced that inflation is going to be a big problem. The march to an inverted yield curve got a basis point flatter as the spread between the 2-year and the 10-year tighten this morning to 24 basis points. If everything stays the same, this part of the curve could invert by the end of the year…if not sooner.

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