Treasuries Selloff Continues

Treasuries Selloff Again

Action in the bond market has been absurd this week. As you can see from the chart below, the long bond ETF TLT ended its 100 day streak of being above its 50 day moving average. That was its longest streak in history. The selloff that I had been waiting for occurred in full force. It's difficult pinpoint what catalyzed the selloff as economic data has been weak. 

When everyone is on one side of a trade it can get risky if the dam breaks. The selloff continued on Friday as the 10 year yield rose 12 basis points to 1.9%. It was recently at 1.43%. That’s a massive 47 basis point increase. A scary part of this selloff is the steepening of the yield curve that has come with it.

Now there is a 10 basis point gap between the 10 year yield and the 2 year yield. I’m not saying the economy is currently in a recession. But when the gap increases after inversions, there has been recessions in the past. Specifically, the 2 year yield rose 8 basis points to 1.8%. That’s 4 basis points of steepening. A few more days like that and the signal will be in full force. Finally, the 30 year yield also increased 12 basis points to 2.37%. It is also exactly 47 basis points above its recent low.

Fed To Make A Big Decision

This extremely quick selloff in treasuries and more modest, but still significant steepening in the yield curve has altered the situation for the Fed. Now there is only at 79.6% chance of a rate cut next Wednesday. I would be shocked if the Fed doesn’t cut rates, but the odds are more realistic now. It’s a small possibility instead of being virtually impossible. 

Investors aren't fully on board with this steepening being consistent with a recession. But if the Fed is, it can decide to give neutral guidance so that the short end of the curve increases with the long end and keeps it flat. Fed was late to the game when it comes to avoiding an inversion. On the other hand, if the data is weak this fall, Fed can’t avoid its mandate for full employment just to manage the curve. Maybe the curve’s warning is a foregone conclusion.

Good news is the stock market is no longer relying on many more rate cuts. Literally last month, investors were worried about the Fed cutting too early and too much without there being a recession. There were discussions about negative rates. Now, there’s a possibility the September rate cut is the last one of the year. 

There is a 37.9% chance it’s the only cut of the year and a 41.8% chance there is one more cut in October or December. We got through the Fed not cutting rates quickly without the stock market crashing; all we needed for that happen is a mini treasury crash.

Housing Market Could Weaken

The housing market hasn't fully recovered from its weakness in late 2018 because house price growth never bottomed. Good news is some of the excess inventory was worked through and new home sales hit a new cycle high. A main problem is it did this with near record low mortgage rates. I think if rates stayed low for another few months, we would have seen a full recovery. 

That being said, the housing market can’t rely on near record low rates as we have seen with this selloff in treasuries. The higher treasury yields go, the more likely the housing market is to weaken further. We might even see a negative yearly growth reading in the Case Shiller index.

Problems have already arrived for the housing market as Mortgage News Daily reported that the average 30 year mortgage rate increased 36 basis points from its trough on September 4th. It had its biggest short term increase since the week after Trump was elected President. 

The number of borrowers with good credit and at least 20% equity in their houses who could save money by refinancing fell from a record of 11.7 million to about 9.7 million. Hopefully some home owners refinanced and saved money. More importantly, it looks like there will be a negative impact on affordability this fall.

Q3 GDP Nowcasts

Average estimate for Q3 GDP growth is 1.9% and the median is 2%. That’s out of 12 estimates calculated by CNBC. We are now at the point in the quarter where the GDP Nowcasts are somewhat accurate. Especially as the first month of hard data is fully in and some of the data from the 2nd month is starting to come in. 

Growth will probably be close to the current estimates. There won’t be an inflection point in September. I only expect an inflection point in capex investments after a trade deal is made.

With that being said, the Atlanta Fed’s GDP Nowcast fell from 1.9% to 1.8% which is near the consensus as you can see from the chart below. There were small declines in the estimates for real consumer spending growth, government spending growth, and real net exports. Estimates for real gross private domestic investment growth improved slightly. On the other hand, the NY Fed’s Q3 Nowcast improved 4 basis points to 1.59%. The 2 estimates converged. Retail sales report helped the Nowcast by 7 basis points.

NY Fed model is much more bearish on Q4 as the estimate improved 3 basis points to 1.11%. Maybe Q3 and Q4 are the trough of this slowdown. Finally, the St. Louis Fed Nowcast was 2.65%. Even the bullish St. Louis Fed model can’t get away from a weak estimate. I see growth coming in between 1.7% and 2.2%. 

Consumption growth should be solid. I’m more worried about real residential investment growth in Q4 than I was before this rise in mortgage rates. It’s interesting to see stocks ignoring these low estimates. If 1.5% GDP growth in Q3 won’t cause a bear market, there won’t be one.

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