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Thank You Jay Powell

March 3, 2019

Last Week This Morning

  • 10 Year Treasury up 0.11% to 2.76%
    • German bund up to 0.19%
    • Japan 10yr yielding -0.01%
  • 2 Year Treasury up to 2.56%
  • LIBOR at 2.48% and SOFR at 2.58%
  • On Wednesday, Powell conceded the Fed had sent mixed signals but reiterated a dovish stance
    • He also confirmed balance sheet normalization would end this year, with the final balance between $3.2T – $3.4T (off the peak of $4.5T)
    • Powell’s testimony to Congress was only the second most interesting Congressional testimony of the week
  • Larry Kudlow rounded up a 2.6% GDP print to “I’m just going to call it 3.0%”, I wish I could have had him as a teacher in school
  • Core PCE (Fed’s preferred inflation measure) came in at 1.9% y/y
  • Personal consumption fell significantly, down from 3.5% last quarter to 2.8%

Why the Fed’s Change in Heart is Such a Big Deal

Yes, I know I am beating a dead horse.  Last week’s newsletter was mostly a gripe session about traveling 600 miles for club volleyball, but it also wondered if rates were ready to move higher.  Financial conditions are a big reason why.  Powell’s softer stance in early January completely reversed the tightening trend.

Source: Bloomberg Finance, LP

Remove the event risk of a Fed hiking us into a recession and the market is more willing to take some risk.  Rates move up – risk on!

In his semi-annual Congressional testimony, Powell reiterated the FOMC’s newly dovish stance.  I think the Q4 spike in financial conditions, coupled with tanking markets, scared Powell straight.  I cannot overstate how critical this shift in Fed mentality is for the 2019 outlook.  Using my very precise model of picking a number out of thin air, I’d say the odds of a recession this year have dropped from 33% to 10%.

But looser financial conditions also keep the door open for a rate hike(s) this year.   If GDP keeps surprising to the upside, can we really rule out a hike in June?  Or December?  Can’t you see a situation where the economy is doing just fine and the markets seem open to a hike, so Powell squeezes another one in?

But here’s the rub – Q1 GDP is notorious for being the weakest and most volatile of the four quarterly reports, so I don’t think we’ll hear much about hikes any time soon.  Check out Q1 GDP over the last three years.  Not exactly the sort of numbers that demand a hike.


2018    2.2%

2017    1.8%

2016    1.5%

Atlanta GDPNow forecast for Q1 GDP was just revised lower to 0.3%.  Goldman Sachs, the firm that was calling for four rate hikes in 2019 just last month, is now forecasting 0.9%.  Consensus forecast is about 1.1%.  Even if everyone knows Q1 is typically the weakest print of the year, Powell can’t risk talking about hikes based on the hope that GDP will rebound in Q2.

A cynic by nature, I’m usually the one highlighting the risks and downsides; however, I can’t help but wonder if the recent fears are overblown, particularly now that the Fed is taking its foot of the neck of the market.

  • If the Fed stops hiking, the dollar should stop strengthening, and this should help stop the bleeding in emerging markets.
  • If Trump reaches a deal with China over tariffs (while the Chinese central bank is ramping up accommodation)
  • Oil prices down off the 2018 highs down to $55/barrel
  • Easing financial conditions (duh)
  • Inflation around 2% with little risk to upside
  • Unemployment at or below 4%
  • Bryce Harper guiding the Phillies to another WS ring

Don’t get me wrong, I haven’t gone full Kudlow.  I don’t think the US is set to see 3% GDP in 2019.  But if it’s 2.5%, is that really that bad?

2020 could be a different story, particularly if GDP trends lower and unemployment trends higher over the course of this year.  But for now, 2019 feels like a mixed bag of data and more of the same.

Yield Curve 

What does this all mean for yields?

The long end has room to move higher as long as bad news doesn’t derail it.  It was fear, not true economic weakening, that drove the 10 Year Treasury lower in December.

The steepness between the 5T and 30T hit the highest level in a year.  That could help drag the more traditional measure of yield curve steepness, 2T vs 10T, to higher levels.  With the front end firmly anchored around 2.50% because of Fed policy, this means the 10T will be the primary driver of yield curve steepness fluctuations.

If the curve returns to the levels from Powell’s infamous misstep, the 10T would have 0.15% more room to climb.  Here’s a one year history of yield curve steepness.

Source: Bloomberg Finance, LP

Absent bad news, there is room for the 10 Year Treasury to move back towards 3.00%.

And for those of you with floating rate loans, you’ve weathered the storm and are unlikely to see your rates climb much, if at all, for the next two to three years.

This Week

Relatively mild week of data that will be headlined by Friday’s job report.  Consensus forecasts are 187k jobs added and an unemployment rate of 3.9%.

Because the Fed is officially back in the data-dependent business, this report will start taking on increased significance going forward.  An outlier report could have an outsized impact on yields.

The ECB meets and thus far has committed to keeping rates unchanged through the summer.  While a formal policy change to push back that timeframe is unlikely, slowing Eurozone growth means the market will be watching the statement for cues about a future change.  Basically a repeat of what we’ve seen from Powell.

And because I know you are just dying to know what’s going on in the NC-9th, disgraced GOP candidate Mark Harris has endorsed Stony Rushing, a real life (and I am not making this up) Dukes of Hazzard Boss Hogg impersonator.

This is where I live.  You should discount everything I tell you appropriately.

Click to Open: The Pensford Letter PDF