Prior Week Summary
Yields in the Treasury market continue to decline, as market participants increasingly expect a more gradual pace of policy firming and a higher likelihood that the Fed will factor in the relatively weak global macro picture when determining the appropriate policy rate. Over the course of the last month, 5-year Treasury yields have declined approximately 34 bps while similar maturity swaps declined 26 bps, as swap spreads widened by 8 bps. Using the Fed’s yield curve model as a guide, the majority (60%) of the decline in yields at the 5-year maturity point is attributable to a 20 bp reduction in the market’s expectations for the average Fed Funds rate over the next 5-years, while the remaining 14 bps reflects a continued decline in risk premiums. The relative attractiveness of U.S. Government debt to overseas investors in negative interest rate regimes has contributed to the decline in the Treasury term premium to its lowest levels ever, on a data series dating back to the early 1960s. The risk metric sits nearly 140 basis points lower than its 53 year average and slightly below the troughs of the QE era.
The Fed minutes confirmed the committee’s data dependence and focus on the global economic environment when it said that “in determining the timing and size of future adjustments to the target range for the federal funds rate…the assessment would take into account a wide range of information including…readings on financial and international developments.” Importantly, the minutes revealed that “members continued to expect that, with gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace and labor markets would continue to strengthen.” However, the committee expressed the view that a cautious approach to raising rates would be prudent and raising the target range as soon as April would signal a sense of urgency that was not appropriate. As of this writing, the market is placing nearly 50/50 odds for one hike in what remains of 2016, at the December meeting.
The Look Forward
The data dependent market is looking forward to a wide range of new information scheduled to be released this week, including updated data on import prices, retail sales, producer and consumer price inflation, and gauges of consumer sentiment. There is also a full foster of Fed speaking engagements and it will be an active week for Treasury auctions, with $44b of notes and $12b of bonds expected to price.