October Rates Update

Monthly Commentary

November 03, 2017

After a blockbuster September macroeconomic calendar, October was decidedly less eventful as year-end begins to move into view for market participants. While the sheer volume of market-moving news was considerably less than September, October did see the ECB make baby steps towards an exit from their asset purchase program as well as the race for FOMC Chair whittled down its final contestants. Not unlike September though, the U.S. Treasury market experienced continued yield curve flattening as the spread between 2y notes and 30y bonds pressed tighter on a monthover- month basis for the third month in a row and the eighth out of the last 12. The flattening of the curve has been something to behold as neither better growth nor inflation numbers have been able to deter the relentless flattening trend.

U.S. Treasury Market Overview

Source: Bloomberg

At its October policy meeting, the ECB announced the main changes to the Asset Purchase Program for 2018 which consist of a “recalibration” of the program whereby the Governing Council pledges to extended net purchases under the APP for another nine months to September 2018, but at a reduced rate of EUR30bn per month from the current pace of EUR60bn. The Governing Council left the program ‘open-ended’ and signaled that purchases would continue beyond September 2018 if it is deemed that inflation is not on a self-sustaining trend at that point. Broadly, the combination of a reduced purchase rate over a longer timeframe was in line with market expectations. Although he did not discuss specifics, ECB President Draghi hinted that the reduction in the monthly purchase pace will come from sovereign purchases and that corporate bond purchases will remain sizeable. In maybe the most important component of its policy plan, the ECB maintained its intended policy sequencing, implying that the policy rate will not rise until ‘well past’ the end of new net purchases, thereby maintaining its forward guidance on rates. The result was a bullish-flattening of the German curve, a peripheral spread-tightening, a -1.3% decline in the EUR, and a 1.4% rally in the DAX.

Now that the Europeans have set their policy plans for the foreseeable future, the next major policy announcement globally will be the naming of the next Chairperson of the FOMC. In recent months, it was thought that Director of the National Economic Council Gary Cohn, Current FOMC Chair Janet Yellen, Former FOMC Governor Kevin Warsh, Current FOMC Governor Jay Powell or noted economist John Taylor would earn the nomination to fill the role, but it seems as if this list was reduced further in October. According to several publications, the list of candidates narrowed to Powell and Taylor, with the Wall Street Journal reporting that President Trump went so far as to conduct an informal show of hands among members of congress to gauge support behind the two.

As of writing it appears that Jay Powell will be nominated as the next Chairman of the Federal Reserve early in November with Mr. Taylor potentially earning a Vice Chair nomination sometime after that. For the most part, the nomination of Powell represents continuity at the Federal Reserve since most of his policy leanings closely mirror those of current Fed Chair Yellen. However, Mr. Powell has also made comments suggesting he would be amiable toward the current administration’s stance of reducing financial regulation, something current Chair Yellen did not seem as willing to support. This combination of continued dovish-leaning monetary policy with an acceptance of deregulation is presumably just what the current administration had in mind for its progrowth regime. It should be kept in mind though; this administration has a penchant for changing its mind, so nothing should be assumed until a new FOMC Chairperson is officially confirmed by Congress.

Maybe overshadowed somewhat by ongoing political rumblings, has been the resurgence of growth. U.S. economic data for Q3 showed a 3.0% annualized increase in GDP for the third quarter. The gain follows a 3.1% annualized increase in Q2 and marks the first back-to-back quarterly rises of better than 3% since mid-2014. On a year-over-year basis, real GDP growth has been steadily firming, reaching 2.3% in Q3, the best performance in two years. Notably, the private domestic economy continues to outperform, expanding on a year/year basis for a third straight quarter by either 2.8% or 2.9%. Forward looking cyclical survey data also suggests positive momentum could persist into Q4. The ISM non-manufacturing index rose 4.5pt to 59.8 in September, well above consensus and the highest level since August 2005. Digging into the report a bit deeper, the new orders (+5.9pt to 63.0) and business activity (+3.8pt to 61.3) sub-indices both rose meaningfully. The increase in the employment component was more modest but continues to suggest a firm underlying pace of job growth in the service sector. Similarly, ISM manufacturing saw a headline result of 60.8, a 161-month high. Correspondingly, new and existing home sales, retail sales and capital goods shipment numbers rose in excess of consensus in October, all suggesting strong economic activity is occurring going into the end of the calendar year.

Real Gross Domestic Product

Source: NatWest Markets

With only two months to go in 2017, a majority of the macro calendar is behind us save potential hikes from the BoE in September and the FOMC in December. As always, that is subject to change but it feels as if the major macro flashpoints for 2018 like the nomination of a new FOMC Chair and the eventual conclusion of QE in Europe at some point are coming into view while other narratives like global disinflation fade to the background for now. That is not to say it should be expected that asset markets see low volatility and smooth sailing for the rest of the year but more of the same could indeed be possible with the list of potential known catalysts for risk aversion in 2017 dwindling.


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