U.S. Rates: Lower Bound?

Mid Week Bond Update

U.S. Rates: Lower Bound?

The Fed's rate cut rippled through markets, but the longer-term effects are as yet unknown.


The off-schedule 50 basis point rate cut by the Fed at 10:00 AM on March 3 was the first major step taken by a G-7 central bank to soften the impact of the spreading COVID-19 coronavirus. Fed Chair Powell stated that G-7 leaders are coordinating their efforts in the face of this challenge; the Fed’s move is likely to be first among many within the G-7.

In the words of Western Asset’s John Bellows, “The speed and decisiveness of [the] Fed action reflect both the economic seriousness of the ongoing coronavirus/COVID-19 situation, as well as the Fed’s proactive stance when it comes to supporting the US economy”. And Brandywine Global noted that while monetary policy indeed has limits, it “can have a powerful impact on risk sentiment and boost risk asset valuations – at least in the short term.”

That was certainly true the day of the decision. Ten-year Treasury yields plummeted to a world-record low of 0.9043% before recovering slightly; the 30-year spiked briefly to 1.7518% but then notched downward, reaching as low as 1.5041% before reversing. Shorter-term rates also moved downward in reaction to the move, preserving the upward slope of the yield curve from 2 years to longer, and maintaining its slight upward tilt between 3-month and 10-year maturities.

U.S. 10-Year Treasury Yield, Jan 1, 2019 – Mar 3, 2020

Chart inspired by Western Asset. Source: Bloomberg, as of March 3, 2020. Yield shown are high, low and closing for each trading day included in the chart. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Market dislocations on this scale can be useful for value-driven managers. Along those lines, Western Asset recently commented that credit spreads can widen more than warranted by fundamentals, offering opportunities that might not be available in more settled times.
 

On the rise: Turkish Lira

Turkey’s February inflation reading came in at 12.37%, up from January’s 12.15%. The reaction in the relatively illiquid market for Turkish lira was to drive the currency upward, reaching as high as 6.0319 vs. the U.S. dollar before falling back to the 6.1 lira range.  The relatively positive reaction was due to the inflation figure coming in below the consensus of 12.7%.  Core inflation came in at a 9.97% annualized rate, also better than the expected 10.4%.

The news was a welcome bit of sunshine for the country, whose military activity on its border with Syria continues to create tensions, given the nose-to-nose proximity with Russian forces, Kurdish separatists, and Syria itself.
 

On the slide:  The dollar, finally

After peaking on February 21, the broad dollar index broke through 97 on the downside, a fall of a significant 0.71% on the news of the Fed’s surprise rate March 3 50 basis point rate cut. That brought the index down by more than 2.9% since the February 21 high.

The rising dollar has been a source of frustration for U.S. companies, whose export businesses can become relatively uncompetitive vs. foreign suppliers as a result.  A rising dollar can also work against the stated earnings of companies with operations and profits from outside the U.S., and has been a concern in advance of the upcoming quarterly earnings season which starts in the beginning of April.

Some analysts expect that lower rates in the U.S. will continue to put the dollar under pressure due to the decrease in income from the carry trade vs. other majors, including the Japanese yen and the euro.  That is, until other G-7 central banks follow the lead of the Fed in adding support to the world’s economies.

 

All data Source: Bloomberg, as of Mar 3, 2020, 5:00 PM ET, unless noted otherwise.

Note: The year for all dates is 2020 unless otherwise indicated


Definitions:

COVID-19 is the World Health Organization's official designation of the current coronavirus.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

A credit spread is the difference in yield between two different types of fixed income securities with similar maturities, where the spread is due to a difference in creditworthiness.

A spread is the difference in yield between two different types of fixed income securities with similar maturities.

G7 refers to Canada, France, Germany, Italy, Japan, United Kingdom, and United States.

The Turkish lira is the national currency of the Republic of Turkey.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

The DXY Broad Dollar Index measures the value of the U.S. dollar relative to the exchange rates of six major world currencies (the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc) which represent a majority of its most significant trading partners.

 

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