The Market Today

Persistent Flattening of the Treasury Curve Continues Despite Strong Week for Stocks

by Craig Dismuke, Dudley Carter

Today’s Calendar – Existing Home Sales:  Today’s economic calendar is, again, fairly quiet with one important report.  In the early data, the Chicago Fed National Activity index rose from 0.36 to 0.65, the index’s second highest reading since prior to the recession.  The index is an aggregation of 85 different economic metrics.  When the CFNAI’s 3-month average is above +0.70 following an expansion, a period of more rapid inflation is expected to occur according to the conventional wisdom.  The 3-month average is currently 0.28.  However, history shows the index lacks relevant predictive accuracy (see Chart).


The October Existing Home Sales report is scheduled for 9:00 a.m. CT and is expected to show a 0.2% increase in sales.  Existing home sales have disappointed recently but new housing activity has surprised to the upside.  While some of the weakness has been hurricane-related, the overall dynamics of the housing market continue to favor a slow, but steady rate of growth.


Overnight Activity – Longer Yields Remain Lower Despite a Strong Day for Global Stocks: Stocks were strong around the globe overnight but sovereign yields remained lower for most maturities in most countries. The MSCI Asia Pacific Index gained 0.8% while the Stoxx Europe 600 is 0.5% higher and near its daily peak half way through Tuesday’s trading session. That solid global momentum has helped push U.S. futures higher by between 0.3% and 0.4%, signaling U.S. equities should add to yesterday’s gain when the opening bell rings. Despite the strength in global stock indices, sovereign yields across Europe remain lower while Treasury yields have moved in a mixed fashion. The intraday path for European yields shows an initial U-shaped reversal that reflects an initial bout of steady buying that gave way to a steady reversal to the upside. However, yields have edged back lower again with Germany’s 10-year yield is down 0.9 bps and Italy’s is 2.4 bps lower. The Treasury curve has continued its persistent flattening trend, with the 2-year yield currently 0.9 bps higher at 1.76% and the 10-year yield 0.9 bps lower at 2.36%. The 2-year yield has risen almost exclusively in this month’s trading while the 10-year yield has had a tendency to decline. The Euro remains softer for the week after a dovish tone from ECB President Draghi yesterday piled on to the downward pressure from uncertainty surrounding German politics. Following her failure to finalize a coalition government over the weekend, German Chancellor Merkel said late Monday that she would prefer new elections to trying to lead a minority government. The renewed uncertainty in German politics has yet to have significant and widespread impact on markets, but will continue to be a key development to watch in the coming days and weeks.


Yesterday’s Trading Activity – Stocks Recovered as the Curve Continued to Flatten: Stocks rebounded Monday with the Dow’s 0.31% gain the best among the three major indices. Stocks spent the better part of the day accumulating gains that provided sufficient cushion to keep the indices positive despite a bit of late-session selling. The S&P peaked shortly after 2 p.m. CT and moved mostly lower into the close. Treasury yields rose and – yes, you guessed it – the curve flattened to a new 10-year low. The 2-year yield rose 2.9 bps to 1.75% while the 10-year yield added 2.3 bps to 2.37%. The daily price action trimmed the spread between the two maturities to 61.2 bps. This flattening trend continues to capture numerous headlines as it has been a consistent trading theme this year. Elsewhere, the 5-year yield rose 3.5 bps to 2.09%, its highest level in eight months, while the 30-year bond was nearly unchanged at 2.78%; the respective spread fell 3.3 bps to 68.7 bps, also a 10-year low. Fed funds futures nudged up the implied effective rate for the second half of 2018 and beyond and Fed Chair Yellen said she would leave the Federal Reserve once Jay Powell is sworn in. Historical precedents established this outcome as the base case expectation but there had been no formal confirmation. Higher yields in the U.S. were an outlier Monday after a late-session rally in peripheral Europe sent yields there lower. The Italian 10-year yield fell 3.4 bps after a slightly dovish testimony from ECB President Draghi before lawmakers in Brussels. His testimony also weighed on the Euro which was already under pressure from political turmoil in Germany.

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