- Stocks gain as dollar pushes higher. (10:30am ET) Domestic indexes are on the move upward in early trading, as investors shrug off continued dollar strength following the Federal Reserve Bank’s (Fed) decision to raise rates last week and guide to three hikes in 2017. Yesterday’s session saw modest gains for stocks; strength in the technology sector helped both the S&P 500 (+0.2%) and Nasdaq (+0.4%) advance. Asian markets were mixed overnight; the Nikkei received a boost from dollar strength against the yen and closed higher by 0.5%, though the Shanghai Composite and Hang Seng both fell half a percent. European markets are slightly higher in afternoon trading, despite several terror attacks in the region the day prior; the STOXX Europe 600 is up 0.4%. In commodities, WTI crude oil ($53.52/barrel) is up 0.9%, whereas COMEX gold ($1,130/oz.) is down 1.2%. Finally, the yield on the 10-year Treasury is back up to 2.58%.
- 10-year continues to rise following Fed rate hike. The 10-year Treasury yield moved higher again last week, closing Friday at 2.60%, its highest level since September 2014. Markets had largely priced in the impact of a December rate hike heading into last week’s Federal Open Market Committee (FOMC) meeting, but yields did move higher across the curve as markets digested raised guidance from the Fed, putting the possibility of three rate hikes in 2017 on the table.
- Foreign rates diverge. U.S. Treasury yields have followed along with German and Japanese yields for much of the year, as the impact of lower rates overseas helped increase demand for Treasuries and keep a cap on yields. However, the Fed’s recent rate hike has led to one of the few divergences among rates this year, as U.S. yields moved higher, while German yields moved lower following the European Central Bank‘s move to extend its quantitative easing program earlier this month. Japanese yields have remained relatively flat, as the Bank of Japan (BOJ) has indicated it is targeting a 0% rate for the 10-year Japanese Government Bond. Treasury yields have become even more attractive relative to bunds and Japanese government bonds, which means that foreign demand will likely continue to be a factor that pushes down on rates for the near term.
- Inflation expectations fall post FOMC. Increasing breakeven inflation expectations, as measured by the difference between 10-year Treasury Inflation-Protected Securities and Treasury yields, have helped push Treasury yields higher in recent months. This changed last week, as inflation expectations moved lower based on the Fed’s addition of the potential for a third rate hike in 2017, though Treasury rates still managed to move higher, driven by higher growth expectations. Breakeven inflation had reached nearly 2% in recent weeks, but backed off to 1.85% as the week ended. The Fed’s own median forecast of inflation expectations didn’t change in its statement (1.8% for 2017, and 2% in 2018), though we continue to expect that headline inflation could exceed the Fed’s 2% target in early 2017 as we approach the anniversary of the worst of the oil price declines in Q4 2015 and Q1 2016.
- Rate hike expectations rise following Fed meeting. The widely watched dot plots, a set of forecasts where each FOMC member gives expectations for rate hikes, showed an increase in the median forecast, in line with Fed Chair Janet Yellen’s comments that three rate hikes are possible in 2017. Fed funds futures are currently pricing in a 10% chance of a rate hike at the Fed’s next meeting (February 1), a 73% chance of a hike by June, and a 96% chance of a hike by December 2017. Markets are still pricing in a slightly slower trajectory than the Fed, but expectations are much more in line with the Fed than earlier in 2016. We continue to believe the economy, labor market, and inflation will track to or possibly just above the Fed’s 2017 forecasts, leading to at least two, and possibly three, rate hikes during 2017.
- Libor continues its rise. Libor continued to move higher last week, ending the week near 1% following the Fed’s largely priced-in rate hike. Bank loans have continued to benefit as Libor has increased in recent months, with the S&P/LSTA U.S. Leveraged Loan 100 Index seeing the second strongest gain (2.32%) of all fixed income sectors over the past three months. This strength continued last week as bank loans saw the strongest performance (0.37%) of any bond sector, which mostly saw losses as rates moved higher. We continue to like bank loans in this environment for their low duration and ability to float with overall rate levels. The asset class may not perform as well if rates fall, though above-average yields mean that the asset class could perform well on a total return basis even if rates don’t continue to rise in the near term.
- Municipals lower on the week. As of the week ending 12/14, municipal bond funds saw outflows of $2 billion according to Lipper data. The increased selling pressure, coupled with the Fed’s decision last week, led to higher yields (lower prices) on the week. Yields were higher by 8 basis points (0.08%) on two-year municipal bonds, by 19 basis points (0.19%) on 10-years, and by 11 basis points (0.11%) on 30-years. The Bond Buyer 30-day visible supply is light at 5.7 billion.
- Bank of Japan stays status quo. As expected, the BOJ left monetary policy unchanged at its meeting early this morning. Short-term rates remain negative at -0.1%, and the BOJ left its current pace of asset purchases at “more or less the current pace” of about 80 trillion yen annually, roughly $680 billion. The market has already done a lot of the BOJ’s work for it. They yen has been weakening and longer-term interest rates have been rising, with yields on the 10-year government bonds now positive (though just barely) for the first time since February 2016. The BOJ statement issued with the rate announcement suggested that the BOJ is more positive on the economy than it had been previously, though it did not provide a numerical prediction for gross domestic product (GDP).
- Strange action recently. Yesterday was a strange day, as the S&P 500 was flat, yet the CBOE Volatility Index (VIX) sank 4%. This is even rarer when you consider it happened on a Monday, as that day is historically the most common day for higher volatility. You have to go back to early January to find the last time the S&P 500 was flat on a Monday and the VIX was down more than yesterday. Additionally, volatility in the S&P 500 has been nonexistent during the past three days, as for the first time ever (using reliable data going back 50 years) there have been three consecutive inside days. As the name suggests, this means the high and the low of the day fit inside the range from the previous day. It is rare to have two in a row (only 20 the past 20 years), but to see three in a row has never happened before.
Japan: Bank of Japan Meeting (No Change Expected)
Existing Home Sales (Nov)
Leading Indicators (Nov)
Durable Goods Orders and Shipments (Nov)
Russia: President Putin Holds His Annual Press Conference in Moscow
New Home Sales (Nov)