Georgia on my Mind

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Last Two Weeks: Long term interest rates stuck to their well-worn ranges and equities advanced amid light trading. News that a Brexit agreement took shape and the US Congress, and the President passed a coronavirus relief package helped keep rates steady. The yield on the US 10-year note traded within a 0.97% to 0.91% range, 1-month LIBOR orbited around the 0.145% mark, and SOFR logged a .06% to .10% trading range. The price of a barrel of West Texas Intermediate crude oil steadily rose above $48.50, while the US Dollar weakened as it has done since March, and Gold strengthened. Treasury yield volatility, a key driver of the cost of rate caps and swaptions, steadily logged higher highs over the holidays.

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Markets closed out 2020 with a 1% Treasury yield in their crosshairs. The US 10-year Treasury yield peaked at 0.971% as 2020 came to close, pushed higher by positive UK Brexit negotiations and progress on the US fiscal aid package front, which diminished the appeal of US Treasuries, thus increasing rates. While the widely watched 10-year yield largely trended higher in the last month, it failed to break through the psychologically important 1% level last seen early in the pandemic.

Markets are now looking toward a major catalyst – the January 5th Senate election in Georgia – to allow the 10-year Treasury to finally breach 1%. The thought is that should Democrats win both Senate seats – and therefore control of Congress – the 1% yield resistance could finally fall, as the party appears more willing to unleash even more fiscal stimulus to get America’s economy on more stable footing. The most likely scenario is that any new fiscal stimulus will be dependent on how quickly vaccines are rolled out.  The fly in the champagne? The Fed and Covid-19. The Fed plans to keep interest rates near zero for a long time, while reserving the option to hold down long-term interest rates – like the 10-year Treasury yield – if needed, with the purchase of longer dated Treasury bonds. Another is that the still-raging coronavirus is casting doubt on the ability of the US and global economies to return to normal anytime soon. For now, we are watching a key resistance level of 0.973%. Should the 10-year Treasury yield breach it, the path to 1% becoming a new floor is clearer. While we could see a 1% or higher 10-year Treasury yield after the Georgia Senate election, its ability to stay above that level in the short-term is questionable.

Clobbering of personal incomes screamed need for more stimulus last month. In a slate of economic data releases just before Christmas, data showed that personal incomes dropped a jarring 1.1% in November and were even weaker than most economists’ forecasts. The plunge was mostly due to the expiration of federal stimulus programs, including the paycheck protection program (PPP), assistance for farmers and unemployment benefits. Actual wages and salary income rose 0.4%. On the flip side, the personal spending reduction was less severe than the income pullback as households drew upon their savings to keep the spending motor humming.

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Why you should care: November’s personal income and spending data illustrate the overarching factors driving America’s economy in the near-to-medium term. The lack of personal-income growth will constrain overall demand, shackling the prices of goods and services to earth. While the Fed is doing all it can to stimulate economic activity, overall demand will be subdued until the slack in the jobs market has been more fully absorbed, a catalyst that looks to be a long way off. With the current level of jobs remaining 9.8 million below their pre-pandemic peak, consumer incomes on their back foot and a subdued inflation outlook, the Fed’s primary focus for the foreseeable future is job creation. Layer on raging virus infection rates, hospitalizations, deaths, and a stalling vaccination rate and what have you got? An economy that will struggle to create any meaningful number of new jobs in the near-term and an ultra-low interest rate environment that will struggle to post any meaningful, sustained rise.

What to Watch This Week: It’s all about the January 5th Georgia Senate race and the January 8th jobs report for December.

As the latest data on personal income and spending revealed, household incomes decelerated sharply as various government support programs wound down in recent months. While the income hole was partially plugged by Congress’s recent passage of a fiscal aid bill, the fall in consumer incomes, and the expected weak pace of new job creation, could still lead to a deeper contraction in Q1 and flatten the slope of economic recovery in 2021.

The outlook will become clearer after this Friday’s release of the jobs report for December. Our gut tells us that the dramatic surge in job creation, after the initial Covid-19 lockdown ended, has likely come to a crashing end. For some perspective, the large downside miss in new jobs created in November relative to what was expected – a time when lockdown measures were considerably less restrictive than they were in December – is a troubling indication of a lack of resilience in the roaring jobs recovery of recent months. As such, we expect that a disappointing number of jobs were created last month, joined by a rising unemployment rate.

For the Georgia Senate race, the impact it will have on determining which political party controls Congress, President-elect Biden’s agenda and the scope for further fiscal stimulus, keep in mind that the results likely won’t be known for days, and vote counts will almost certainly face legal challenges. Once the election results do finally come through, Democratic victories could push yields higher given the inclination for more spending coming from the Biden administration.

Big Picture: The health of the economy is regressing as the pandemic intensifies. Unemployment filings have erased the last two months of improvement and consumer confidence has retraced back to August levels, dragging down household spending – which drives about 70% of America’s economic activity – along the way. The economy has rebounded impressively from the record steep declines earlier this year, but significant impairment remains; a little over 50% of jobs lost have been recovered, leaving nearly 10 million workers still displaced. While talk of the Fed’s eye-popping, $7.5 TRILLION balance sheet and calls for higher inflation are entertaining, they are mostly a distraction. What we need now are jobs, jobs, and more jobs. The Fed knows it and will act as such by keeping short-term rates anchored near zero and long-term rates on a leash near their current levels.

Current Select Interest Rates:

Rate Cap & Swap Pricing:

LIBOR Futures:

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Source: Bloomberg Professional

10-year Treasury:

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Source: Bloomberg Professional