Market Snapshot
Rates and equities moving higher in tandem at the open. Optimism over a potential new fiscal stimulus package on the horizon along with a positive prognosis that U.S. President Trump may soon recover from COVID-19 and be released from the hospital later today is fueling the rally.
Reflation Trade
Recent data from the Commodity Futures Trading Commission (CFTC) and the Chicago Board of Trade (CBOT) show over 317,000+ futures contracts for shorting U.S. Treasury bonds, a nearly 209,000 net short position. Each contract has a $100,000 face value. The spread shows that investment managers are positioning for a steepening of the yield curve theme.
Meanwhile, data from the St. Louis Federal Reserve show rolling record-breaking holdings of 10-year U.S. Treasury securities.
Similarly, premiums have risen for swap options to hedge against a 25bps interest rate increase in long-term rates.
The reflation trade is likely In response to the increased money supply and ultra-low interest rates set by the Fed. Additionally, while the view that only a Democratic Party win at the November elections will open up the possibility for greater deficits, it is likely that we will see increased financial investment into the U.S. economy from either Republican or Democrat political party.
We will see the spread between the U.S. 10-year Treasury Note and U.S. 30-year Treasury Bond yields test its year-to-date high today. As of this writing, the spread has widened to 80bps, one basis point shy of the year-to-date high reached in June this year.
Inflation Rising
The Fed’s preferred gauge of inflation, the Core PCE deflator, increased by 0.3% month-over-month in August. The preceding two months showed 0.4% monthly gains. The annualized rate rebounded to 1.6% from 1.4%. However, the three-month annualized rate increased strongly to an elevated 4.7%. Should core prices increase at a muted pace of 0.2% month-over-month, the annual core inflation rate would reach the Fed’s target inflation rate by year-end. With the supply-side continuing to be constrained and physical distancing measures adding to budget costs, there’s a possibility that inflation will edge above 2%, though it is unlikely, in the near term, for the Fed to react by hiking interest rates.
Jobs Rebound Slows in September
Last Friday’s jobs report showed a weaker than expected 661,000 gain in non-farm jobs. However, much of the downward shift came from the drop in employment in public education (as the new school year shifted online.) Private payrolls rose by 877,000 largely from the hospitality, retail, and healthcare sectors.
While the unemployment rate declined from 8.4% to 7.9%, it reflects 695,000 people dropped out of the labor force. The drop in unemployment was due to a fall in temporary layoffs with permanent layoffs rising 2.3%.
Weighing heavily on the broader market are:
- The U.S. November Elections
- Investors and traders are bracing for a volatile election year as the ultimate Presidential and Senate winners may not be known until December, pushing out typical November hedges into December and January 2021.
- With less than a month remaining before the elections, President Trump contracted the novel coronavirus last week throwing the U.S. markets into a tailspin.
- U.S. fiscal stimulus package
- President Trump tweeted over the weekend to “get it done”, referring to a fiscal stimulus package.
- House Speaker Nancy Pelosi also announced over the weekend that lawmakers are “making progress” on more US stimulus.
- She also asked of the airline industry to hold off on the job cuts as “relief is on the way.”
- We may see long-end rates push higher, on inflation expectations, should Congress agree on a $2 trillion+ fiscal stimulus plan.
- U.S.-China relations, as both countries fight on everything from trade to defense issues, monetary policy, and the coronavirus.
- Second Coronavirus wave
- While there are numerous potential COVID-19 vaccines and therapeutics currently being developed, the limited production capabilities, timing, and acceptance for people to receive the medical solutions are of concern and could be drawn out to the end of 2021.
