Tuesday, September 13, 2016
Of Course No Sep Hike, But What of Rates?
Stepping back from yesterday’s pre-‘black-out’ ending speech by Fed Governor Brainard, we’d note that forces were at play which may not be so easily tempered as may have been assumed by some in the advancing Treasury prices late yesterday. Of course the reason for stronger Treasury prices late yesterday was because expectations had grown for Brainard to shape greater prospects for a September rate hike. Without her expressing such guidance, Treasuries rallied taking back some of that pricing. For guide, my odds for a September FOMC meeting policy response have been cut in half to 15% from 30% where it has stood since the release of the Beige Book (Sep 7).
The Treasury yield curve has been showing a different look these past months and it is causing some troubles in getting used to. First the front end of the yield curve has been experiencing significant pressures on funding costs stemming from money market fund reform. Money market fund reform has of course had a greater impact on unsecured lending rates than Treasury bills, but funding/liability managers have had a lot to deal with up the curve as credit spreads have become more volatile.
Out the curve, the longer-standing yield hunt brought on by incredibly low and negative foreign sovereign rates seems to have turned into a ‘buyers strike’. At least that was implied by some following the unexpected turns by both the Bank of Japan and ECB when both failed to add to or extend liquidity and securities purchase measures. Refrain by these central banks from adding or extending duration of QE or QQE measures caused some to wonder if these cb’s were looking toward an end of monetary policy support, sending global long bonds lower.
Longer term Treasuries fell too as it was felt by some that the impetus for foreign purchases of Treasuries had been removed. The dollar firmed and expectations grew that this all meant the Fed had more of a green light on moving forward on the policy of removing accommodation. Expectations for a move as soon as September were truncated by a failure of Fed Brainard to deliver on hawkish or rate hike rhetoric, paving the way for a hike next week. This does not rule out a ‘data dependent’ response later this year as the Fed’s latest Summary of Economic Projections (SEP) indicates.
The Treasury yield curve between 5 and 30 years had flattened considerably since early-May when it traded as wide as 142 basis points. It fell to 103 bps. two weeks ago before bouncing to 120 bps wide yesterday. The long end has been driving this move with higher long rates and somewhat steady front end rates.
All else equal, I would have expected the front end of the yield curve to have better held onto earlier overnight gains. Two year Treasury futures (TUZ6) rallied to 109-07+ and has fallen to 109-06 last. Instead, some of these gains have been relinquished. The front end of the curve should continue to outperform until such time as economic data is more overwhelmingly indicative of attainment of the Fed’s dual mandate objectives of full employment and steadily higher targeted inflation. There is no reason to expect the Fed would want to surprise with a rate hike at the September meeting next week (Sep 20-21).