Balancing Reopening vs. Increasing Case Counts
The worst jobs report in our lifetimes will arrive on Friday but it’s not likely to evoke much of a reaction in markets, which is another sign of the strange times we are living through. With April job loss estimates above 21 million, and an estimated unemployment rate near 16%, those sobering numbers are made less compelling only by the thought that the May report is likely to be even worse. That’s because the surveys are done in the second week of the month, and recall that after April 12 we still had several weeks of multi-million jobless claims. The market, however, is more focused on reopening activity balanced against the inevitable increase in virus cases. How that plays out will continue to drive market direction for much, if not all, of the second quarter.
Now comes the part about borrowing the money to pay for all the stimulus bills passed in the past two months. It’s expected that the new borrowing needs will total $4.5 trillion. Later this morning, the Treasury will announce the new funding schedule for coupon-based debt, and while it will be a sizeable increase, Treasury spilled the beans Monday that the majority of new funding will come in the bill market. The latest estimates have bill supply for the second quarter jumping by $2.7 trillion from a base line level of $2.3 trillion at the end of the first quarter. A more than doubling of bill issuance is now expected in the second quarter which should end June 30 with a bill balance around $5 trillion. If you see some spiking in T-bill rates it will be from this deluge of supply. So far, however, the news has been taken with little outsized market reaction. In the Treasury’s forecast, net market borrowing in all sectors would fall to $677 billion in the third quarter, with more than half of that funded again in the bill sector. Thus, the longer end of the curve has reacted with little concern over upcoming supply increases. The graph below is the Treasury 10-year note yield.
The above graph layers in Fibonacci retracement levels, along with moving averages, but as you can see, yields are residing closest to the last line of Fibonacci resistance at 0.54%. While Treasury will announce increased funding amounts for 3-year, 10-year, 20-year and 30-year maturities today, the expected increase in funding shouldn’t lead to permanent upward yield moves. Consider that with the world now firmly in a recession negative global growth is aiding bids, as is the gathering deflationary impulse from the pandemic. Commodity indices are searching for a bottom, while the U.S. dollar continues to strengthen. Finally, don’t forget the Fed and its unlimited QE program and there appears little catalyst beyond the upcoming supply to lift yields, and that doesn’t seem to be stirring much of a move either.
The Market’s Cruel Calculus
As mentioned earlier, the market is trading on hopes that reopenings continue to gain momentum, while the inevitable increase in virus case counts remains manageable. It’s a cruel calculus but it’s essentially the trade-off the market is making. Equities are looking beyond April and May’s economic results with hopes that the third quarter brings some type of bounce, preferably a V-shape.
The fixed income market, meanwhile, is more circumspect with regards to a hoped-for bounce. Perhaps they see a country that is essentially declaring victory and slowly opening while new case counts still average20,000 a day? Perhaps they see one possible result of that being increased case counts to the point it endangers all the flattening of the curve achieved with the lockdowns, requiring renewed shelter-in-place orders, which would be the dreaded W-shaped recovery. Let’s hope not.
In that regard, we thought we would revisit an old favorite to see if Treasury yields are fairly valued. The Copper/Gold Ratio versus 10-year Treasury yields has had an uncanny ability to track each other over the years. Copper is often called the doctor of the economy as so many items require copper. Thus, as it’s price increases due to economic demand the ratio increases and that healthy economic behavior more than likely leads to higher Treasury yields. On the other hand, when the economy slows and uncertainties increase—like in times of a pandemic—gold prices tend to rise sending the copper/gold ratio lower with yields likely following suit. And that is indeed the case today. You can see the copper/gold ratio (white line) has plummeted in 2020 and that coincides with the similar drop in 10yr yields (blue line). Perhaps if the reopening activities occur without excessive increases in virus cases we’ll see copper prices and the ratio begin to lift, but for the present time it’s still trying to find a bottom, as are Treasury yields.
Agency Indications — FNMA / FHLMC Callable Rates
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