Life Support | August 31, 2018

The yield curve is on life support and the dynamics that impact it from week to week merit watching! Here is what moved the curve last week.

Tariff Talk

President Trump announced $200B in additional tariffs slated for September 6th. Markets reacted negatively to the news, but not as sharply as past announcements. Tariff talk strengthens the dollar, but also weakens long-term interest rates.

Federal Reserve Board

The FRB Chair, Jerome Powell, indicated the path on rate hikes for the remainder of the year is subject to ongoing data. This is likely to be interpreted as a loosening of expectations to perhaps only one hike. FRB activity as of late has lifted the short end of the curve, giving us less than .30% difference between a 2-year bond and a 10-year bond.

EU Risks

Headwind risks are increasing in the European Union. Italian bank debt has become a larger concern as Italian spending may breach the limits set by the EU. This may cause a showdown of Italy’s participation in the EU.

Brexit has been a concern for 2 years now, however the rhetoric is becoming more heated as the risks of a ‘no deal’ Brexit increase.

Sweden is the latest on the list of countries where a risk of leaving the EU has increased with their upcoming election. The risks in the EU have increased long-term interest rates in the region, which should give room for our 10-year to start increasing (however slightly).

Japan

The Bank of Japan (BOJ) announced modifications to their security buying program last week. They are consolidating their buying process not the amount of which they buy. Volatility in response was likely due to concerns of the unknown effect in the timing change. BOJ changes create uncertainty which brings demand to the 10-year Treasury.

Life support may be a bit of an exaggeration. Equity markets have performed well as of late, but even with those market gains, the flat yield curve lurks as a reminder that this could go south very quickly. To continue to raise rates, the FRB would likely need to start unloading some of the $884B in longer dated bonds on its balance sheet to keep the curve from inverting.

 

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