By jared.pfeifer@nafinc.com
May 30, 2014
GDP for Q1 2014 came out this week showing that the economy contracted 1.0% versus 0.1% growth in Q4. A reduction was for the most part expected, but not necessarily to the extent of a 1% drop (most predicted a 0.5% drop). Many were blaming the weather on poor economic activity during the winter months. However as we moved into spring it was clear that as temperatures rose, nothing really changed. In fact momentum seemed to gain on the theory that it wasn’t the weather, “it’s the economy stupid”. Let’s stop blaming everything other than the reality of the fact that the economy is what it is, stuck in the mud. The reality is sinking in and investors are not happy about it. Yields on fixed income (Treasuries and mortgages) are too low and there aren’t many alternatives. Yields at these levels force investors to take on risk to get return. Credit standards are loosening up and will continue to do so. Investors have a choice, hate the yield or hate the asset. I can’t paint a big enough picture of how much money is now being put to work to find yield. Treasury yields are inching closer and closer towards the levels of last year when Bernanke made his infamous ‘taper’ comment. The Fed is tapering assets faster than most had imagined and yields continue to fall. That’s how big this move in rates is. The 10yr is currently at 2.47% and if it continues to close below 2.50% then yield expectations continue to shift. The more buyers get comfortable with the new reality of rates and their returns, the more likely we stay at these levels or push lower. We are in unchartered territory and if yields can get to 2.40% or below, then watch out, it could fall all the way to 2.20%. There aren’t many risks that could push yields higher. The biggest risk was the Fed tapering, which has had the opposite affect; then it’s the Fed themselves. Nothing has come out of their mouths other than an ‘extended period of accommodation’. Fed Reserve San Francisco President John Williams said the Fed needs to boost jobs well after inflation takes root, furthering the argument that the Fed will keep rates low for a very long period of time. Some Fed members feel otherwise and there will likely be a huge debate about it: inflation and jobs are the battleground for interest rates. Those will be the main risks to rates moving higher. Until then, the main topic on everyone’s mind is how much lower will rates continue to drop until they find some major resistance. Right now we are in the 2.45% to 2.60% range but it’s probably a transitory range. What we are transitioning to is anyone’s guess so these next couple of weeks will be very pivotal. Everyone is almost 100% convinced rates will keep dropping, which usually is an indication that the market is going to move the other direction. The question is, what’s the trigger? Is it 2.40% or 2.30% or 2.20%? We have payroll data next week which may be the true equalizer in the debate. For now let’s just put the Polar Vortex talk behind us and focus on the economy. Economic Data Release Calendar: Monday June 2nd Construction Spending, ISM Manufacturing and Prices Paid Tuesday June 3rd Factory Orders Wednesday June 4th MBA Mortgage Applications, ADP Employment Change, ISM Non-Manuf. Composite and Trade Balance Thursday June 5th Initial Jobless Claims, Continuing Claims and Bloomberg Consumer Comfort Friday June 6th NonFarm Payrolls, Unemployment Rate, etc.