Treasuries Finally Acknowledge Strengthening Economy

Was it the solid first quarter GDP report and the hints of more to come? Was it the resolutely dovish Fed? Was it the string of solid earnings reports? Was it the expectation of another bang-up jobs report next week? Well, perhaps it was all the above that finally caught the Treasury market’s attention and sent yields backing up early in the day but as it wore on buyers slowly returned. We’ve written plenty about the factors that are keeping yields at the low end of the 1.55% – 1.74% range that has prevailed since the first of April.  With the weight of the factors mentioned above, investors sent yields into the middle of the range at 1.67% but buyers emerged even at those limited levels and drove yields down to 1.64%. That’s only about 8bps in yield pick-up in a week that all the stars aligned for something higher. Even so,  we feel the bias higher will remain into next week until we get past the April jobs report on Friday. That report is expected to be as strong, if not stronger, than March with the consensus at 950 thousand new jobs. While the month of April was characterized by a Treasury market oblivious to economic strength, could May be the opposite story where solid reports finally lead to higher yields? Maybe so, but if it is it seems it will be a grinding, laborious climb.

 


Consumer Spending Surge Lifts First Quarter GDP

First quarter GDP was just about as strong as expected, growing at a 6.4% quarter-over-quarter annualized pace versus 6.7% estimated and 4.3% in the prior quarter. The outsized gain was driven by a 10.7% jump in personal consumption—the second fastest pace since the 1960’s—as two fiscal stimulus bills helped goose consumer spending with billions in stimulus checks distributed during the quarter.  A big chunk of that spending growth was in the goods category (23.6%) and of that a 41.4% gain in durable goods spending. Services, meanwhile, saw a smaller pick-up at 4.6% and that where the second quarter will need to see a shift as the services-side of the economy re-opens at a faster pace and provides another venue for consumer spending.

All-in-all it was a solid read on the economy. The only quibble is that it was perhaps a little heavy on the durable goods spending which is not likely to persist after the stim checks are spent. That’s where the services-side will have to ante up if second quarter estimates are to be realized.  GDP is now at an inflation-adjusted $19.1 trillion versus the pre-pandemic peak of $19.3 trillion, so almost back to where we left off, not including the 2%-3% gain we would have had sans the pandemic. Inflation readings in the report were about as expected too with core PCE quarter-over-quarter annualized coming in at 2.3% versus 2.4% expected and 1.3% in the prior quarter. The Fed is starting to get core inflation readings over 2% but much of that bump in the quarter came from supply shortages that should resolve in the months ahead as supply chain disruptions ease.  Bloomberg consensus expectations for second quarter GDP are looking pretty ambitious at 8.1% with consumer spending continuing its surge with an expected 8.1% gain, thanks to the last of the stimulus checks being spent.


FOMC Message: Steady-As-She-Goes

The message coming out of the Fed meeting was about what we expected with a steady-as-she-goes statement and little to no hint that policy is changing anytime soon. While the characterization of the economy and the public heath situation improved from the March statement, and in Chair Powell’s post-meeting comments, he didn’t show his hand as to when the tapering discussion may begin despite being asked in several different ways. His response was that beginning in December they laid out the Substantial Progress criteria and he said one good jobs report in March does not constitute substantial progress. So there!

While not yielding one bit on the QE taper discussion, if we get to the June meeting with three 1.0+  million job reports in hand, substantial progress may be close.   We still lean on August and Jackson Hole as the venue to open tapering discussions but if the economy does everything right between March and June it may be hard to ignore until August. Even when the discussion begins it will be late 2021 to early 2022 before actual tapering will begin, and even then the balance sheet will continue growing for the many months it will take to taper to zero.  Like we have written before, this will all take some time while investors wait impatiently in the back seat yelling, “are we there yet?”


30-Yr MBS Yield Spread Near Decade Low

Speaking of the Fed’s Quantitative Easing Program and when the discussions may start as to when to begin tapering, the impact on the MBS market of the Fed’s $40 billion per month in purchases is unmistakable. The graph below shows the yield spread of a current coupon FNMA 30yr MBS to a blend of 5yr and 10yr Treasury yields. The current spread of 63bps is rivaled only by the spike low of 61bps back in September 2012 which then was quickly erased by the 2013 Taper Tantrum that sent spreads back over 150bps. That’s what Powell and the Fed don’t want to happen this time so expect some very carefully worded statements once the discussions of when and how fast to taper begin. The runway will be long and wide for these discussions to give investors plenty of time to adjust, accordingly.

 

30-Yr MBS Yield Spread to 5yr/10yr Treasury Blend


Market Rates

Treasury Curve Today Chg Last Wk. LIBOR Rates Today Chg Last Wk. FF/Prime Rate Swap Rates Rate
3 Month 0.01% -0.01% 1 Mo LIBOR 0.11% Unchanged FF Target Rate 0.00%-0.25% 3 Year 0.485%
6 Month 0.03% Unchanged 3 Mo LIBOR 0.19% +0.02% Prime Rate 3.25% 5 Year 0.964%
2 Year 0.16% +0.01% 6 Mo LIBOR 0.20% -0.02% IOER 0.10% 10 Year 1.649%
10 Year 1.64% +0.08% 12 Mo LIBOR 0.28% Unchanged SOFR 0.01%

 

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Published: 04/29/21 Author: Thomas R. Fitzgerald