Bloodied Treasuries Take a Standing 8-Count
The February bludgeoning in the Treasury market continued yesterday with yearly highs set in the 10-year (1.61%) and the 30-year (2.39%). The 5-year joined the party yesterday leaping 26bps in one day to 0.86%, but that’s 30bps short of the yearly high of 1.16% set exactly one year ago today. Yields came off those mid-day highs and are in the green this morning as investors sense it was all a bit too much too soon. The 10-year note price is up 14 ticks and the yield at 1.47% . The Fed continues to voice little concern and sees the higher yields as a sign of investor optimism about the economic outlook. With the selling moving further down the Treasury curve, the market is implying the Fed will be moving sooner than they have projected. We delve into the subject in the next sections where we still think the Fed has plenty of reason to be patient with its present monetary policy path and will continue that messaging.
The market is convinced that the economy will grow strongly enough this year and that will feed into inflation forcing the Fed to move quicker than its expected 2023 or later timeframe. Some futures markets now put the first rate hike in the third quarter of 2022. The Fed, meanwhile, has been pretty consistent in wanting to get back to full employment before hiking, as long as inflation and inflation expectations remain “anchored” around their 2% target plus/minus some leeway. As to the full employment question one of the Fed’s thought leaders, Lael Brainard, gave a speech to a Harvard Econ 101 class on Wednesday—didn’t we all have a Fed governor speak at our Econ 101 classes?—and she talked at length about what they will be considering as they tackle the full employment question. For starters, she said the Fed will be looking at a host of indicators and not just the unemployment rate to help inform them as to determining when full employment has been achieved.
One of the unique features of the pandemic was how it has forced caregivers and working mothers out of the labor force. They went home to care for home-schooled children, etc., and left their jobs and the labor force. Today, they are neither counted as unemployed or in the labor force. There are more than four million in this category. Also, there are several million more working part-time that want full-time employment but can’t get it. Once you include those categories into the unemployed or underemployed the rate moves closer to 10%. Not quite the picture of recovery that 6.3% portrays and surely far from the 3.5% rate pre-pandemic. The Employment to Population ratio avoids some of the labor force classification issues and as you can see it’s still well below pre-pandemic levels and still below the levels coming out of the last recession. The Fed will surely want it back to pre-pandemic levels before saying we are back to full employment and that still appears to be a long road back.
Durable Increases in Inflation will Come When Wages Accelerate
In regards to the Fed’s price stability mandate, an indicator Brainard said the Fed will be watching is the Employment Cost Index (ECI). This index tracks not only wage/salary gains but benefits as well. It is the most comprehensive cost measure for employment that there is. While the Fed expects there will supply -side price pressures that will spike from time to time due to fiscal and monetary stimulus they aren’t worried about those, they consider those will be temporary moves, like commodity price spikes. The more durable price increases will come as payrolls regain their pre-pandemic state along with increasing wages to those workers. The Employment Cost Index is shown below and it tracks annual gains in wages/salaries and benefits to workers. As you can see it remains well below the pre-pandemic levels when it was slowly climbing towards 3.0%. Note, however, it never approached the gains from the previous period before the Great Financial Recession. Probably not until we start to get back to those levels will the Fed really be worried about a durable hike in inflationary pressures.
Mortgage Spreads Finally Widen
Over the last many months we’ve been marveling at the relentless tightening in mortgage yield spreads versus Treasuries. As the graph shows it’s been pretty much a one-way march since the pandemic spikes last March. The tightening trend finally abated this month with the sell-off in longer term Treasuries on the back of growth and inflation fears. As the graph shows the yield spread of a current coupon FNMA 30yr MBS bottomed around 65bps but has rebounded to 87bps most recently. So as Treasury yields have moved nearly 45bps higher in February the MBS yield has moved up nearly 65bps. Investors that have waited patiently to invest into the MBS sector may be getting close to having that patience repaid.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||0.03%||Unch||1 Mo LIBOR||0.11%||Unch||FF Target Rate||0.00%-0.25%||3 Year||0.447%|
|6 Month||0.05%||+0.01%||3 Mo LIBOR||0.19%||+0.01%||Prime Rate||3.25%||5 Year||0.884%|
|2 Year||0.16%||+0.05%||6 Mo LIBOR||0.20%||Unch||IOER||0.10%||10 Year||1.541%|
|10 Year||1.46%||+0.16%||12 Mo LIBOR||0.28%||-0.02%||SOFR||0.02%|
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