Stimulus Hopes and Vaccines in the Driver’s Seat

Last Week: Long term interest rates rose, and equities traded near record-high territory, underpinned by increased hopes of additional near-term US fiscal stimulus and expectations of a fast rollout of several coronavirus vaccines. Markets continued to look past the worsening COVID-19 trend, driving the yield on the benchmark US 10-year note higher for the second consecutive week, to 0.95% from 0.86% a week ago. 1-month LIBOR mostly treaded water, falling slightly to .152% from .154% this time last week.  The price of a barrel of West Texas Intermediate crude oil rose $0.75 to $46 amid a global reflation trade that is lifting commodities and undermining the US dollar. Treasury yield volatility, a key driver of the cost of rate caps and swaptions, rose steadily throughout the week.

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Weak jobs report increased stimulus urgency on Capitol Hill. America’s jobs engine added just 245k new jobs in November, roughly half of what markets had anticipated. The weakness was concentrated in private sector services, which are most vulnerable to lockdown measures. Private sector hiring saw a significant deceleration (344k vs. 877k), driven by slower job creation in both the goods-producing sector, which has been relatively resilient throughout the pandemic, as well as a sharp slowdown in the services sector, which has borne the brunt of lockdown-induced job losses.

Despite the gloom, the job gains were strong enough to help the unemployment rate fall further – from 0.2% to 6.7% – albeit in concert with many giving up their job search after exhausting unemployment benefits, thereby dropping off the unemployment radar altogether. The US labor force participation rate is down nearly 2% since February. Wages surprisingly increased last month, but likely reflect low-wage workers falling out of the tabulation amid a new wave of layoffs. All told, the pandemic has tremendously reduced demand for workers in certain service-related industries, weighing on any meaningful wage gains in retail and leisure and hospitality. Yet, labor shortages in construction, manufacturing and information are prompting employers to raise compensation to attract workers, equating to an obscure wage picture as we enter the holiday shopping season.

Our take: The paltry 245k increase in jobs last month puts the number of new jobs created after the initial March lockdowns at 12.3 million, 9.8 million below their pre-crisis peak, and a far cry from the 22.2 million jobs lost over the March-April period. In what is historically the most impactful piece of economic data on interest rates, the November jobs report spurred long term interest rates higher, reacting to the market’s logic that the suddenly tepid pace of job creation will nudge Congress toward a targeted stimulus deal sooner rather than later, especially as a number of CARES Act programs – which have helped the unemployed shoulder the economic blow in past months –  face a hard stop later this month.

Overall, the striking slowdown in new job creation last month serves as an ominous warning of a tough slog ahead for America’s economy amid renewed Covid-19 lockdowns, and surging case counts and the implementation of considerably more aggressive containment measures across the country means that job creation in December will likely be much worse. In the meantime, it seems we are once again dependent on Congress to steer our near-term economic fortunes, and the direction of interest rates along with it. Should a meaningful stimulus deal come to fruition pre-inauguration, long term rates should continue their drive higher, although only modestly so. Should fiscal stimulus not come to pass, or negotiations drag on for weeks through year’s end, expect long term rates to trade near the middle of their recent ranges. Early last week, a bipartisan group of lawmakers proposed a $908 billion package that has become the basis for the ongoing talks. Aid for state and local governments and liability protections for businesses remain the big stumbling blocks.

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LIBOR’s sunset got delayed. We will spare you the gory details here but know that a cornucopia of statements from regulators and market administrators effectively granted an 18-month extension of LIBOR’s sunset, pushing out the deadline to June 2023 from December 2021. While it’s a lot more complicated than just a “delay” – the change effects the spectrum of users of LIBOR in different ways, and there are many nuances lying in wait – just know that you’ll likely have a bit more time to figure out and prepare for how LIBOR’s cessation will impact your business as a lender or borrower. If you need a succinct way of gaining knowledge on the topic of LIBOR’s sunset, what will replace it and what it means, check out our SOFR University Webinar Series.

What to Watch This Week: Given last week’s disappointing jobs report, deteriorating economic momentum will be the critical theme for interest rate markets over the next few weeks. As such, upcoming data on small business sentiment (Tuesday), unemployment insurance filings (Thursday) and household sentiment (Friday) will take precedence over lagging indicators of activity, such as consumer and producer prices (reported on Thursday and Friday, respectively).

On a similar note, news relating to renewed support to offset the deteriorating momentum – such as the passage of additional fiscal stimulus – will hold at least as much sway over financial markets as an increasingly sour streak of economic news.

Big Picture: Long term interest rates – like the 10-year Treasury yield – will enter the week carrying their upward momentum from last week. Should we see any progress toward fiscal stimulus and success at the US Treasury’s sale of $118 billion of Treasury notes and bonds – close to a weekly auction record – the 10-year Treasury yield could breach 1.00%. We suspect the 10-year yield will fall short of 1.00% through year’s end though, but could easily breach that level and more, after the Georgia Senate runoff on January 5th gives markets a clearer view of the political landscape going forward, and by definition, the likelihood and size of additional, targeted fiscal stimulus.

Know that the market’s focus is clearly not on the here and now, but rather on the there and then – that point in the future when stimulus helps offset the impact of lockdowns, and vaccines obviate the need for economic disruption at all. In the meantime, America’s economy will do its best to bridge the gap of a deteriorating economic picture and hopes of more help from Congress, or to a world where vaccines are readily available to all.

How is your business positioned for such a rate environment?

Current Select Interest Rates:

Rate Cap & Swap Pricing:

LIBOR Futures:

Source: Bloomberg Professional

10-year Treasury:

Source: Bloomberg Professional