Rates Tread Water as Vaccine Wait Begins

Last Week: Long term interest rates were lower, and equities advanced broadly to record highs through the Thanksgiving week, following continued positive news on COVID-19 vaccines and the progression of the Presidential transition. The yield on the US 10-year Treasury note fell two basis points from a week ago to 0.84% while 1-month LIBOR rose one basis point to 0.15%. The price of a barrel of West Texas Intermediate crude oil surged to $45.28 from $41.75, as the US Dollar and Gold both weakened. Treasury yield volatility, a key driver of the cost of rate caps and swaptions, fell notably throughout the week to a near record low.

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Presidential transition calmed jittery investors. The biggest news in the holiday-shortened week focused on the pending Presidential transition. On Monday, the General Services Administration Chief told President-elect Joe Biden that the Trump administration is making $7 million in federal funding available for his transition into office after withholding her decision for weeks. As a direct result, President-elect Joe Biden announced his intended nominees for top cabinet and national security positions in advance of his scheduled January 20th inauguration. Most important for interest rates, markets cheered the planned nomination of former Fed Chair Janet Yellen as Treasury secretary, as she is expected to focus on fixing the US economy and not pursuing a new regulatory regime for banks that some on Wall Street feared. If she secures the position, Yellen will be the first person ever to have been chair of the White House Council of Economic Advisers, Fed chair and Treasury secretary, not to mention being the first woman to lead the Treasury Department.

Our take: It’s a certainty that Yellen and Fed Chair Powell – who is expected to survive the Presidential transition – will work very closely to bring the U.S. economy back to where it was before the coronavirus pandemic. That means that the Fed won’t hike interest rates until it sees the whites of inflation’s eyes, likely not until late 2021 at the earliest. The Fed may also wait until inflation takes hold, which could extend a low interest rate environment.  Yellen’s nomination is also an early signal by Team Biden that they do not expect much cooperation on Biden’s economic agenda from what could be a Republican-controlled Senate. If that turns out to be the case, the Yellen-Powell dynamic duo is probably the best scenario if more stimulus from Congress remains elusive and the Fed is left to continue to do the heavy economic lifting.

Economic data showed America’s economy is losing momentum. Jobless claims, one of our favorite barometers for gauging the economic recovery, surged to 778K, suggesting that widening restrictions to combat the spread of the coronavirus are starting to have an adverse impact on the labor market recovery. Most economists expected a decline to 700K. With almost 13.7 million people combined now on Pandemic Unemployment Assistance (PUA) and Pandemic Emergency UC (PEUC) programs in the week ended Nov. 7, programs expected to expire at the end of the year, the pressure is on Congress to at least address the need for more stimulus. A Democratic president and divided Congress likely mean a persistent fiscal impasse going into 2021.

Elsewhere, a steeper drop than expected in consumer confidence last month – a measure of household attitudes – doesn’t bode well for the holiday shopping season, especially with the expected end to Congress’s income support before year-end. Given that consumer spending drives 70% of America’s economic activity, any hesitation by consumers reverberates negatively throughout the economy. While a unique feature of the COVID-induced recession is a historically large increase in savings, the extra cash is drying up quickly for households with lower-incomes and a higher propensity to consume. For higher-income households, future spending will be particularly dependent on economic activity ahead of widespread vaccine availability. In the meantime, slack in the labor market is high, and wage expectations should remain depressed.

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On a positive note, another strong month for durable goods orders in October leaves company capex spending on track to scrape out a positive Q4 for the gauge. However, as pandemic-related risks accumulate as infections and hospitalizations mount, the question now is: Can it continue? Looking ahead to 2021, the capex outlook – a notable driver of new jobs – will likely vary significantly by industry. New equipment purchases will stay strong, helped along by Boeing aircraft deliveries, while spending on new structures will adjust to the needs of the post-pandemic operating environment.

Lastly, according to the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, US home prices saw their biggest spike in six years producing the largest annual gain since September 2014. Prices are now nearly 23% higher than their last peak in 2006.

What to Watch This Week: The calm seen in interest rate moves over the last few weeks likely won’t change anytime soon, although the worsening pandemic and updates on the state of America’s economy could liven things up a bit in the week ahead.

On the economic data front, the focus is on Friday’s November jobs report, historically the most impactful piece of economic data for interest rates.  Expectations are for the number of new jobs to once again be in stratospheric territory (~500K) as the economy remains in recovery from the swoon in the first half of this year. Even so, the pace of job gains will nonetheless likely continue to slow relative to what was seen earlier this year, given the recent surprise surge in jobless claims and the reinstitution of virus-related lockdown measures and surge in case counts. Regardless, with such heady job gains, the unemployment rate should continue moving lower, to somewhere near 6.7%, particularly if labor participation remains depressed.

Interest rates will continue to take it all in stride, given that the steady drip of dismal news has failed to move them much. 10-year Treasury yields, currently at 0.84%, have remained in a range between 0.50% and 0.97% since August.

Big Picture: The road back to America’s pre-COVID economy is steepening. Following a dramatic recovery for both the jobs market and overall economic activity for much of the second half of the year, growth momentum seems to be fading at present. Extended federal government-sponsored unemployment benefits are expiring while filings for new unemployment benefits are rising, highlighting renewed stress in the jobs market as lockdown measures intensify. As such, consumer confidence and wages are deteriorating at a time when overall growth prospects are almost entirely dependent on household demand.

All told, it’s a scenario where America’s economy – starved of fiscal stimulus – will likely be challenged to keep the growth momentum growing as it waits for a broad distribution of a coronavirus vaccine.  It’s unlikely the 10-year Treasury yield will break out of its August to November 40 basis point range anytime soon, especially given the muted reaction seen from last week’s stellar stock market surge and successive Mondays with positive vaccine news.  We cannot emphasize enough the need for immediate and significant fiscal stimulus prior to the end of the year.

How is your business positioned for such a rate environment?

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