We have the Fed minutes from their end of January meeting tonight but little is expected in the way of new information following on from the Fed Chair Powell’s testimony last week. Of more interest will be the Fed speakers over the coming days as the market tries to assess what the impact will be of the ongoing coronavirus on growth rates.
Fed member Kaplan, who is thought of as a centrist voter, was on the wires yesterday sticking to his December 2019 view that the 1.5% to 1.75% funds rate was appropriate through 2020 although he did acknowledge downside risks to growth. The market, however, disagrees and has now swung to an 83.1% conviction that there will be a cut by December with a cut before September now at 71%.
What has been interesting is the swing in the 3 month Treasury bill rate versus the ten year Treasury note rate. If we look back, during August last year that rate got down to minus 50bp, a strong signal that the market had a recession on its mind. The Fed, who had already cut rates in July, cut again in September and then October to correct this situation. Indeed, the rate had been falling steadily since Trump got elected back in 2016 where it peaked at just over 200bp after the election. However, with the three rate cuts we traded back up to a positive 36bp; recessionary fears faded and growth has been maintained around the 2.1% annual level. Currently, the rate has moved down again to trade today at minus 3bp, a swing of nearly 40bp from year end 2019 so the market is once again pricing in downside risks. If we get to the extremes of last August IE -50bp, without a Fed cut, that would price the UST 10 year at a yield of around 1.1% a move in price terms of about 4 points.
Now what is really interesting is what happens if the long bond maintains its current 45bp spread over the 10 year; the bond would rally over 10 points in price. We shall see if we can get to the extremes, we are still looking for falling yields but such levels as 1.1% on the ten year UST and 1.5% on the bond are not as fictional as some may think.