The Market Today

Fedspeakers Speak Out Against More Rate Hikes, Treasurys Rally in Sharp Risk-Off Trade

by Craig Dismuke, Dudley Carter

Today’s Calendar – Refinancing Activity hits Strongest Level Since June as Mortgage Rates fall to Mid-November Levels: In the early morning data, the Mortgage Bankers Association (MBA) reported application activity rose 3.3% in the week ended September 1 on improvement in both purchases and refinances. Purchase applications rose 2.3%, the first increase in four weeks. The refinance index jumped 4.9% to its strongest level since the middle of June. As longer Treasury yields have returned recently to their mid-November levels, so too has the 30-year fixed mortgage rate according to the MBA. Based on their data, the average 30-year mortgage rate fell to 4.06% last week, the lowest since the middle of November.


Data from the Census Bureau showed the trade deficit widened $0.2B to $43.7 in July after June’s deficit was narrowed slightly from $43.6B to $43.5B. The July result was $1B better than expected. The deficit in the trade of goods narrowed marginally on improvement in petroleum related products. Excluding those products, the goods trade deficit widened $1.2B. Services activity was slightly less accretive to the trade balance, with the surplus tightening by $0.15B.


Later this morning, Markit will release its revised August services and composite PMIs. The initial releases showed both at their strongest levels since April 2015. Shortly after, the ISM will release its latest services index which is projected to show a rebound to 55.6 in August. An as-expected result for August would put the index at its weakest of the year and replace last month’s 53.9 as the weakest reading since August 2016.


At 1 p.m. CT, the Fed will release its latest Beige Book in anticipation of its next meeting in two weeks’ time. That last edition from July reported economic growth ranged from “slight to moderate” across the Fed Districts, a marginally weaker characterization than the “modest or moderate” growth in the May report.


Overnight Activity – Yields Bounce Slightly After Big Tuesday Drop Even as Equities Remain Nervous: In the absence of a positive catalyst to brighten the geopolitical gloom overhanging sentiment, global equities continued to weaken overnight. After yesterday’s U.S. sell-off (more below), stocks in Europe have inched lower following a soft start in Asia. Despite the weakness elsewhere, U.S. futures point to a rebound for the major stock indices which tumbled the most Tuesday in nearly three weeks. Global yields have stabilized, if for no other reason than exhaustion from yesterday’s significant shift lower. Yields in Germany and France are roughly 1 bps higher on average inside of 30 years. Looking to U.S. Treasurys, the 2-year yield is unchanged at 1.29% after dropping 5.2 bps Tuesday. The 10-year yield is 1.2 bps higher at 2.07% after dropping 10.6 bps. Gold prices are flat after rising more than 1% through the first two days of trading this week. With refining activity in Houston starting to show some signs of life, crude oil and gasoline prices have reversed roles relative last week. So far this week, gasoline prices are down and U.S. crude prices are up, both by more than 4%. Hurricane Irma, which became the strongest storm ever to form in the Atlantic, may cause more volatility in energy commodities depending on its path.


Yesterday’s Trading Activity – Stocks Sell Off and Treasury Yields Plummet as Investors Flee Risk Assets: U.S. stocks sold off sharply during the first half of Tuesday’s session as the Dow, S&P, and Nasdaq dropped 1.3%, 1.2%, and 1.6%, respectively, by the lunch hour. However, the indices had risen off of those lows by the closing bell. The Dow finished 1.1% lower while the S&P dropped 0.8% and the Nasdaq fell 0.9%. The steep losses for U.S. equities was just one force that helped push the 5-year and 10-year Treasury yields to their lowest levels since mid-November. According to a midday note from Vining Sparks’ Director of Trading, Mark Evans, “There are several factors which seem to be combining to spur the risk-off moves. Most prominent among them are the North Korean concerns, the pile-up needing Congressional action (including the debt ceiling), and the Category 5 Hurricane Irma which is headed toward the Caribbean/South Florida area.” On the day, the 5-year yield fell 9.7 bps to 1.64% and the 10-year yield fell 10.6 bps to 2.06%; both were the biggest single-day drops since March 15. In addition to all of those risk-off forces, shorter Treasury yields also responded to dovish Fed commentary (more below). The 2-year yield dropped 5.2 bps to 1.28%, the biggest single-day decline since May 17. The Dollar weakened against every other major currency, ending at one of its weakest levels since January 2015, and fed funds futures projected a slower rate path. Those futures contracts closed pricing in the first month with a greater-than-50-percent-chance of a Fed rate hike as July 2018.


Fed Doves Fight Forcefully Against Further Rate Increases: Two of the most dovish Fed officials spoke out Tuesday in support of delaying any further rate increases until there is more confidence that inflation is firming:


Brainard: In remarks before markets opened, Fed Governor Brainard stated, “My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target.” These comments were similar to those in a speech she made on July 11 in which she also stated that “the neutral level of the federal funds rate is likely to remain close to zero in real terms over the medium term. If that is the case, we would not have much more additional work to do on moving to a neutral stance.” However, on Tuesday she signaled even more patience, adding, “It could take a considerable undershooting of the natural rate of unemployment to achieve our inflation objective if we were to rely on resource utilization alone. …I believe it is important to be clear that we would be comfortable with inflation moving modestly above our target for a time.”


Kashkari: Minneapolis Fed President Kashkari showed an aversion for future rate increases and an even stronger contempt for those already carried out. According to Kashkari, who has dissented to each rate increase this year, the four rate increases so far this cycle may be “doing real harm” to the U.S. economy. Kashkari said,  “It’s very possible that our rate hikes over the past 18 months are leading to slower job growth, leaving more people on the sidelines, leading to lower wage growth, and leading to lower inflation and inflation expectations. …These premature rate hikes that we are embarking on, they’re not free, and I think we need to remind ourselves of that.” Kashkari cautioned that the Fed “might be overestimating how tight the labor market is,” and “may have allowed inflation expectations to drift lower. Both of those, if those really happened, could explain the low wage growth, the low inflation, and the seemingly tight labor market.”

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