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Are The Highest Interest Rates Behind Us?

Relative to the last 2 years of pain for rates, a sense of hope has emerged, seemingly overnight, as the 10yr Treasury yield (an important benchmark for longer-term rates like mortgages) broke through a key level.

3.05% had consistently blocked the advance of falling rates for more than 2 months.  The most recent bounce happened just last week.  Breaking through sets us up to challenge the big psychological barrier at 3.0%.2018-11-30 NL10

The catalyst for the late week surge was a speech by Fed Chair Jerome Powell. The Fed sets monetary policies that can have a direct impact on rates.  Those policies are largely a function of objective economic data, but there is some room for interpretation.

The Fed's interpretation has arguably been fairly balanced over the past few years.  On the one hand, they've been hiking at a much slower pace compared to past cycles.  On the other hand, they've been hiking regularly and their outlook has clearly called for those hikes to continue well into 2019. 

Powell's speech upset the balance as far as many investors were concerned.  Back in October, Powell said rates were "a long way from neutral, probably" before adding that the Fed may even raise rates past neutral (a level that neither promotes or discourages economic growth).  He'd been sticking to that script regularly until this week when he said rates are now "just below" neutral.

Beyond the comment on rates, Powell also noted that the Fed's rate hike outlook is no guarantee of a policy path (translation: they might not end up hiking as much as anticipated).  The determining factor in that policy path will be economic data.  On that topic, Powell said the Fed "will be paying very close attention."

Stocks and bonds both seized on the apparent shift in tone from the Fed Chair.  In general, when the Fed is perceived as less likely to hike rates, both sides of the market rally.  That can be seen in the following chart with stocks surging and rates falling.

2018-11-30 NL3

Combined with the positive move in rates that began 3 weeks ago, a sense of hope seems to be returning to the bond market.  Keep in mind that at least some of that "hope" will come at the expense of stocks and the economy.  After all, rates tend to fall when the economy is weak.

2018-11-30 NL9

You might notice that the blue line (bonds) was more willing to move lower than the orange line (stocks) in November.  Of course we just discussed the Powell effect, but well before Powell's speech, we can see bonds setting "lower lows" even as stocks try to hold the same defensive floor.  One potential reason is weakness in oil prices.  Oil has a bearing on inflation, and inflation has a bearing on bonds.  Falling oil prices can add downward pressure on rates.

2018-11-30 NL2

If these positive influences stick around, the highest rates for this economic cycle may indeed already be behind us.  That couldn't come a moment too soon for the housing market where sales continued to slump according to two reports out this week.

2018-11-30 HNS 1

2018-11-30 PHS 1

Still, it's not necessarily safe to assume rates will keep moving lower.  Keep Powell's comments about economic data in mind.  The Fed will be watching the data closely.  To whatever extent next week's important economic reports disappoint, hope will remain alive for rates.  But if those reports are stronger than expected, rates could easily bounce back toward recent highs.

Recently Released Economic Data

Time Event Actual Forecast Prior
Tuesday, Nov 27
9:00 Sep CaseShiller 20 yy (% ) +5.1 5.3 5.5
9:00 Sep Monthly Home Price mm (%) 0.2 0.3
10:00 Nov Consumer confidence 135.7 135.9 137.9
Wednesday, Nov 28
7:00 w/e MBA Purchase Index 247.8 227.7
7:00 w/e Mortgage Refinance Index 787.7 783.7
8:30 Q3 GDP Prelim (%) 3.5 3.5 3.5
10:00 Oct New home sales-units mm (ml) 0.544 0.575 0.553
10:00 Oct New home sales chg mm (%) -8.9 3.7 -5.5
Thursday, Nov 29
8:30 Oct Core PCE (y/y) (%) +1.8 1.9 2.0
8:30 Oct Personal Income (%) +0.5 0.4 0.2
8:30 Oct Consumer Spending (Consumption) (%) +0.6 0.4 0.4
10:00 Oct Pending Sales Index 102.1 104.6
10:00 Oct Pending Home Sales (%) -2.6 0.5 0.5
Friday, Nov 30
9:45 Nov Chicago PMI 66.4 58.0 58.4
Monday, Dec 03
10:00 Oct Construction spending (%) -0.1 0.4 0.0
10:00 Nov ISM Manufacturing PMI 59.3 57.6 57.7
10:00 Nov ISM Mfg Prices Paid 60.7 70.0 71.6
Tuesday, Dec 04
9:45 Nov ISM-New York index 840.8 831.9
Wednesday, Dec 05
7:00 w/e Mortgage Refinance Index 836.4 787.7
7:00 w/e MBA Purchase Index 249.9 247.8
Thursday, Dec 06
8:15 Nov ADP National Employment (k) 179 195 227
8:30 w/e Jobless Claims (k) 231 230 234
10:00 Oct Factory orders mm (%) -2.1 -2.0 0.7
10:00 Nov ISM N-Mfg PMI 60.7 59.2 60.3
10:00 Nov ISM N-Mfg Bus Act 65.2 62.0 62.5
Friday, Dec 07
8:30 Nov Non-farm payrolls (k) 155 200 250
8:30 Nov Unemployment rate mm (%) 3.7 3.7 3.7
8:30 Nov Average earnings mm (%) 0.2 0.3 0.2
10:00 Oct Wholesale inventories mm (%) 0.8 0.7 0.7
10:00 Dec Consumer Sentiment 97.5 97.0 97.5

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