Rate snapshot: Are US interest rates too low?

by MPA09 Jun 2014

Interest rate markets started weaker early this morning;
US stock indexes in pre-open trading were about flat. Last Friday’s May employment report was about as markets were expecting, the initial reaction rallied treasuries and MBSs but by the end of the day MBS prices and the 10 yr note were unchanged from Thursday. Today there are no economic reports scheduled but there are three Fed officials on tap later, at 9:3 St. Louis Fed Pres. Bullard, at 12:45 Fed governor Tarullo and at 1:30 Boston Fed Pres. Rosengren. Not sure if any of them will have anything new but it is not likely.
This week the Data that is critical doesn't happen until later in the week (see calendar). Treasury takes the lead this week with $62B of auctions beginning tomorrow with $28B of 3 yr notes, Wednesday a more significant $21B 10 yr auction and Thursday $13B 30 yr auction. Both the 10 and 30 are reopens of issues in May.
Are US interest rates too low, or just right and may head lower? A very interesting multiple question; the debate continues within the fixed income markets. On the more obvious side, at least as most see it, with the economy improving interest rates are very likely to increase. History is on that side of the question, and with US Treasury rates so low the demand isn’t likely to continue. There is no longer a safety bid in treasuries over the Ukraine/Russia situation that pushed rates at one point to 2.40% (briefly). The global economic outlook is still mushy and has been a motivation into US treasuries; that view is a slippery one, with each report from the EU, China and emerging markets the outlook changes a little. There are though, some things to consider in the debate over the level of rates:
  • China is buying US treasuries to accumulate dollars and weaken their currency. China bought $55.8B of treasuries in Q1, last year the country bought $81.1B in the entire year so the pace of buying has increased substantially.
  • In Q1 US banks increased treasury holdings to $237B the highest level since 1995. Banks adding treasuries to meet capital and liquidity standards required by the Fed .
  • Mutual funds and ETFs saw inflows of $21.7B in May, for all of this year $64.6B.
  • US interest rates are higher than interest rates in most other key economic countries; Germany 1.31% on its 10 yr bund, Japan 10 yr 0.60%, Spain’s 10 yr, a not so strong economy, is at a very low 2.65%, Italy at 2.77%; the higher US rate remains attractive to global investors.
  • The supply of new treasuries is shrinking; the total amount of new treasuries this year is going to be about $680B, last year new issues totaled $836B last year and hit $1.56trillion in 2010.
  • The annual budget is shrinking as increased tax dollars cut into the debt as the economy has slowly improved; the CBO is forecasting the US budget deficit this year at $490B the lowest since the recession began.
These are a few of the issues that are holding rates down; how long they will continue to play into low rates is where traders are today.
At 9:30 the DJIA opened unchanged as did the other key indexes; the 10 yr at 9:30 2.62% +3 bps and MBS prices -14 bps.
Nothing yet from St. Louis Fed Pres., Bullard speaking on the US economic outlook.
This Week’s Calendar:
          10:00 am April wholesale inventories (+0.3% from +1.1% in March)
                        April JOLTS job openings (4.025 mil from 4.014 mil in March)
          1:00 pm $28B 3 yr note auction
          7:00 am weekly MBA mortgage applications
          1:00 pm $21B 10 yr note auction
          2:00 pm May Treasury budget balance (-$139B)
         8:30 weekly jobless claims (309K -3K from previous week)
                May retail sales (+0.6%, ex auto and truck sales +0.4%)
                May import and export prices (imports +0.2%, exports +0.2%)
        10:00 am April business inventories (+0.4%)
         1:00 pm $13B 30 yr bond auction
         8:30 May PPI (+0.1%, ex food and energy +0.1%)
         9:55 am U. of Michigan mid-month sentiment index (83.0 from 81.9)
Last week the trade in treasuries and MBSs turned technicals from bullish to bearish as the tight trading continues. The 10 yr note that sets the direction for MBSs has not closed above 2.60% since May 12th, this morning the yield at 2.62% will keep traders awake. There is a valid down trend line on the 10 yield chart that has held any recent selling in check, that trend line is in play today.


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