Right now, the trifecta of strong demand for 10-year Treasuries, a strengthening dollar and tepid inflation, which all combine to push interest rates down, is holding sway over a strong U.S. economy and the Federal Reserve’s inclination to raise rates. In the wake of this ongoing tension, the gap between the 10-year and 2-year Treasury has narrowed to just 23 basis points, the slimmest margin since the financial crisis. What’s ahead of the flattening interest rate curve? An inflation report is due out next week, and the Fed meets Sept. 26. Stay focused and keep your eye on the curve!
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Hello everyone and welcome back to the Mortgage Rundown.
Today we are going to talk about what’s happening with interest rates.
If you’ve been following the market, you’ve likely noticed that interest rates have come down ever so slightly over the last few weeks. While it may seem like near certainty that the Federal Reserve is going to raise rates two more times this year, there are certain dynamics that are keeping long term rates down.
The spread between the 2yr and 10yr Treasury is continuing to shrink and is hovering right around 23 basis points. That’s the lowest level since the financial crisis. What this spread tells us is two things, number one is there is great demand for long term Treasuries and two, inflation is not a concern.
Remember that investors don’t just care about the level of interest rates but the level of real rates. The easiest way to explain real rates is the following: the current 10yr is trading right around 2.85%. If inflation is running at 2.0% then the investor is only getting a 0.85% return in comparison to inflation, which is quite low.
However, when an investor buys a US Treasury, not only do they get the 0.85% return but they also get an investment in US Dollars. The return they get on dollars is a greater return than the bonds themselves, if the value of the dollar goes up.
In fact over the past few months, you can see how strong the dollar is in comparison to the price of gold. The higher the value of a US Dollar, the more gold it can buy which means the price of gold goes down in relation to the dollar.
In summary, on one hand we have strong demand for long term treasuries, a strong dollar and mild inflation. And on the other hand we have a strong economy and a Federal Reserve that wants to keep raising rates. As the two of these paths come together, it’s flattening the yield curve and may eventually intersect. The next Fed meeting is not until September 26th so it’s unlikely the yield curve will invert before then.
In the coming weeks you should keep an eye on the following items:
• The curve, the curve, the curve. Keep watching the spread between the 2yr and 10yr. How close can it get to inverting before the Fed moves or speaks.
• Also, some important inflation data comes out next week with PCE. If it’s over 2.2% on an annualized basis then we could see rates move up rather abruptly. Remember, higher inflation means investors need higher interest rates to get a return.
If you would like a recap of today's Rundown, please visit our blog. Thanks for watching and have a great day.
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