Market Update Industry News

There is a scene in the movie where Will Smith’s character says “you know, somehow ‘I told you so’ just doesn’t quite say it”.  After what’s transgressed over the past month I think the entire market is saying this to the Fed.  The Fed admitted this week they misread the oil market; it’s not transitory, it could very well be trading a very low levels for years.  Oil traded at $60/barrel in the middle of 2015 and closed yesterday at $26.    Supply is not slowing down and there is nothing structural that will likely cause oil to rise back to those 2015 levels anytime soon.  This is creating recessions and massive budget issues for oil exporting countries.

The Fed acknowledged in the testimony by Janet Yellen before Congress this week that there are deteriorating financial conditions, diminished international growth prospects and the aforementioned fallout from low commodity prices.   Ms. Yellen also admitted that the four rate increases for 2016 was probably aggressive and many market forecasts are calling for two or less.  The futures market suggests only one change or less.   Technically the market has priced a 25% chance of one rise, a 3.5% of two and 0.2% of three for 2016.

The Fed very easily could defy market expectations and raise rates (but not likely until June).  The Fed is focused on the labor market, growth, financial conditions, international growth risk, inflation and inflation expectations; prioritized in that order.  Labor is still strong but growth and financial conditions are at risk, along with international issues and commodity prices.   As witnessed by the 10yr Treasury, rates have fallen dramatically in 2016 so far.   On Dec 31st the 10yr closed at 2.27% and yesterday it closed at 1.66% (there is a lot of resistance at this level).   That’s about as fast of a move down in rates as we’ve ever seen, especially when there was no single world event triggering it.

Let’s examine the change in rates a little more in detail to get a 40,000 foot view of what’s happening:


                                        2013 Av.               2014 Av.               2015 Av.                   Current

2yr Treasury                       0.30                        0.45                        0.68                       0.67

5yr Treasury                       1.16                        1.63                        1.52                       1.18

10yr Treasury                     2.34                        2.53                        2.13                       1.73

Notice that the 2yr Treasury (short term rate) is about as high or higher than the average of the previous three years but the longer term Treasuries are lower.  This is called a flattening yield curve; the spread between short and long term rates is decreasing.   It’s directly correlated to the interest rate difference between ARMs and Fixed Rate mortgages.  Fixed rates have become more advantageous versus ARMS and the drop in mortgage rates is generally only happening on fixed rate loans.  Why are long term rates dropping and short term rates are going up?

The Fed drives short term rates directly and the expectation is that those rates will rise in the next couple of years, hence short term rates have moved higher in the past three years.  Short term rates plus inflation and inflation expectations drive long term rates.  Commodities, especially oil and a weakening global economy are driving inflation and inflation expectations down which in turn is driving long term rates down.  Want to watch mortgage rates, watch commodities, especially oil.

A quick look at world 10yr yields:

US                     1.73

Canada              1.12

UK                     1.41

France                0.65

Germany             0.26

Italy                    1.65

Japan                  0.07

Switzerland         -0.30

US yields look very healthy relatively speaking.  Should keep the demand for Treasuries strong even if the US outpaces the world in growth.  Also the lower international yields reflect the growth issues they are experiencing.  My outlook is that it will be very challenging for the 10yr to get below 1.65% but very probable to remain below 2.00% for some time.