Fixed Income Market Commentary by Kevin Giddis

February 23, 2017

The Treasury market is trading higher this morning as traders continue to see value in the bond market, even more so after the Fed released the Minutes of the last FOMC meeting. The takeaway from that was quite simple: if the conditions exist for the Fed to raise rates…they will. So for those that trade this market, they took that to mean that the data is still king and the White House card is still wild. Some believe that the Fed could still go next month, but the Fed Funds Probability Index suggests that there is only a 34% chance of that happening, down 2 percentage points since yesterday. Treasury Secretary Steven Mnuchin is on the tape today saying he “hopes to have tax reform ready by August.” In that same vain, I hope to lose 15 pounds in that same timeframe! Neither is certain. My point is that the administration, mostly compiled of business people, is great at creating a plan, but doesn’t have a clue as to how to get it through Congress. That’s not their fault and I believe that tax reform will become a reality, but not likely in the same spot on the calendar as the administration desires. I push this point home because the markets are beginning to adjust or hedge their positions based more on when you might see the real reforms vs. the promise of them. There are many trading days in front of any possible change, so as we turn our attention back to the U.S. economy, it feels a little more like the past three years rather than some new rising sun of growth. Growth in the 4th quarter is expected to come in at 2.1%. If so then the 2016 average GDP growth rate will remain under 2.0%, about the same as it was in 2015. Those aren’t “rate rising” numbers, and if you add back in the 2.5% year-over-year Average Hourly Earnings increase, it begs to imply that the Fed will once again, be in more of a position of waiting vs. acting. This really isn’t about the numbers or whether the economy and the markets can absorb a rate increase, which I believe that they could, it’s about credibility. The FOMC has stood on the fact that the data was going to dictate the next move, but the numbers don’t currently support it, which is why you are hearing members question the “policy path” and are lobbying for a potential change in that path. Stop me if you have heard this before.

February 22, 2017

The Treasury market is trading higher this morning as investors continue to have questions about the President’s ability to come through with his pro-growth, inflationary programs. If you remember, the rally in yields stems from what is expected, not what has happened. Yes the U.S. economy continues to grow. Yes the country is still producing jobs. Yes some inflation is around the corner. The issue at hand is that unless significant reforms follow this ever so slight economic momentum, we could see a repeat of 2016…2015…2014… well, you get the picture. I often wonder if I am one of those perennial bulls for bonds, or just another guy who hung around too long with his low yield resolve. The yield on the 10-year note has increased 55 basis points since the election, but has fallen 20 basis points since December 15th. Why? Because in Washington D.C., politics is real and compromise is in the eye of the beholder. The President may be just figuring that out, and this may take longer than you might think. On the flip side of things, if he can push through some significant change in the country’s tax policies, and if enhanced spending makes its way into the economy, then almost certainly interest rates will move higher and the price slack could tighten enough to generate inflation. The Fed is doing what the Fed has done for a number of years, and that is, “if this happens, then we will respond with this action.” My point is that the Fed can say they want to raise rates three times in 2017, but in reality, the data is the “daddy” in this house, and it appears that some of the previous years “squishiness” is coming back. Today we will get Existing Home Sales for January (exp. Up 1.1%) along with the Minutes from the last FOMC meeting. The Treasury market continues to be in favor, regardless of what many experts believe. Yesterday’s 2-year note auction was very well received with almost half of it (49.8%) going to foreign central banks via the indirect bidding process. The bid-to-cover ratio was a stellar 2.82 times, and at 1.23%, the buyers stepped in. Today we will get the sale of $ 34.0 billion of 5-year notes, and $28.0 billion of 7-year notes on Thursday. Even though a lot of this buying is coming from overseas, buyers are buyers, yields are yields, and the funeral for bonds remains premature.

February 16, 2017

The Treasury market is trading higher this morning as investors, as they have done in the past, found value in the sell-off and have added to their positions in the overnight session, and today. Some of this is risk off, some of it comes from extension swaps from large accounts, and some of it is coming from investors who don’t think that the Fed will be able to raise rates more than two times in 2017. It has been a while since we have seen a true tug-of-war between two competing opinions where the bond market is concerned, but that is what is happening now. The fears are on both sides. One group sees much higher rates, massive central bank selling of Treasuries and complete mayhem in the streets. The other side sees a normal progression of what we have seen in the last five years, with minor improvements along the way. In other words, solid but contained economic growth with a gradual uptick in the inflation data, giving the Fed the complete rein to raise rates no more than twice this year. No gnashing of teeth, and no blood in the streets. What I have learned in my 30-plus years is that everything is controllable…until it isn’t. In fact, I think you could see both scenarios in 2017, albeit closer to the end of the year vs. the beginning of the year. Almost all of my forecasts for higher rates are on the other side of June, more likely sometime in the 4th quarter vs. the here and now. Housing Starts for January fell 2.6% vs. an expected flat number. Building Permits however rose 4.6%, creating a mixed view of housing, but signs do point to a higher yield effect on homebuilding. There was an outsized surprise from the Philadelphia Fed Index which came in at a whopping 43.3 in February vs. 23.6 in January. The Treasury will auction $7.0 billion of 30-year TIPS (Treasury Inflation Protected Securities) which should go well, especially those investors who see both sides of my earlier argument. While the attention recently has been about the Fed, most of the entire forward interest rate forecast comes back to how much Washington can get done in the calendar year. In absence of a new ACA, significant tax reform, or a rollback in regulation, rates aren’t likely to move much higher this year. If they do, I suspect that it won’t come until later in the year…if at all.

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