Yesterday the 10 yr note finally made a nice move lower taking MBS prices up 33 bps and the yield on the 10 down 5 bps to 2.45% after another attempt to push the yield over 2.50% on Wednesday failed. On Wednesday, economic reports, particularly the Jan CPI increased as did retail sales exceed forecasts. With the Fed poised to increase the Federal Funds rate at the March meeting, conventional wisdom would suggest interest rates would continue to increase not decline. Economic growth so far in Jan is increasing; it’s the first quarter and in the last two years the economy has slumped in the quarter, this quarter promises to be a big change from the past. Inflation is closing in on the Fed’s 2.0% goal, Janet Yellen told Congress this week she was concerned about falling behind and implied the Fed may be ready to move. Every conventional approach about rates would lead to continuing increases in interest rates. In early trading this morning the 10 yr note yield dropped another 3 bps to 2.42% and MBS prices after 33 bps yesterday were up another 20 bps.
Since late Dec the bellwether 10 yr note has been confined in a 20 bps range; 2.30% to 2.50%. The Trump stock market rally, concerns of higher rates and a growing economic outlook and data that implies inflation is getting a toehold; all of that yet interest rates held exceptionally well. In recent comments, we noted that the pattern was counterintuitive. Since the election when the 10 traded at 1.87% in the next month the 10 yr ran briefly to 2.60% before settling back to its current two-month range. We have continually noted that investors may be too optimistic about all of Trump’s plans and the time frame it would take to implement most of the goals that investors believed were just around the corner. Now we see investors beginning to re-think those optimistic goals. With stock indexes making new daily all-time highs the bond market held on; on the surface everything was golden in equity markets but money stayed in the bond market. The outlook began to change on Wednesday when interest rates didn’t faint over Yellen’s comments.
Economic optimism has been tempered by a variety of factors, including uncertainty over the details and timing of Mr. Trump’s policies as well as concern about developments in Europe, where far-right politicians are expected to put in strong showings in upcoming elections. Europe is increasingly becoming unstable. The UK next month will invoke Article 50 of the EU charter to leave the Union; when the vote occurred last June the conventional wisdom was dominated with surety that Britain would vote against leaving; you know what happened. Now France is going to elect a new president. One candidate, Marine Le Pen, has made it clear if elected she would move to take France out of the EU. She presently is behind in the polls but gaining. If she wins the European Union will be domed as other countries begin to exit. One key support for US treasuries.
Will the Fed move next month? The question of the month now. We watch the trading on the FF futures for clues; volatility is high now, on Wednesday there was a 30% chance of a March move, yesterday the percentage declined to 17% chance.
At 10:00, the only scheduled data today, Jan leading economic indicators, expected +0.5%, increased 0.6%; the best two month increase in LEI since June of 2015 (Dec was up 0.5%).
Under the headlines investors and traders are beginning to be concerned about the near future in the stock market. The VIX’s volatility index has increased the last two days. The way to look at the VIX index is to think about it is as a gauge of the balance of supply and demand between options contracts that give investors the right but not the obligation to sell or buy the S&P 500 at a future time. The lower the level of VIX the lower the demand from investors looking to buy protection compared with those aiming to sell insurance policies to protect against rapid changes in equities. The VIX jumped 11% on Wednesday, climbing even as markets were rallying. That doesn’t typically happen because investors tend to be sellers of protection as stocks rally, pressuring prices. The VIX’s current level still leaves it below its historic average of 20 and just around 12, which indicates a fair amount of complacency is still predominant.
Looks more and more as if the equity markets may be losing that unusual momentum since the election last Nov. We have commented recently that the stock market is ahead of reality making assumptions that are subject. The stock market in the wider view remains solid betting on increasing corporate profits from the Trump plans to cut corporate taxes but so far no definitive plans from the new administration; however the near term overdue for profit-taking. All that said, the mania for more investments in stocks still remains high. This morning the key indexes are declining. The importance is that if there is a bout of selling in stocks it will support the bond market.
Source: LO Socilabot