Global bond yields: Curveball

Global bond yields: Curveball

Fixed-income markets finally looked to believe the world's major central banks about normalization; crude-oil markets searched for a steady price; U.S. jobs told a tale of two trends.

“The potential is huge. The ability to export means we can continue to drill for new oil."
Danny Oliver, senior vice-president for oil pipeline company NuStar Energy

Global bond yields: Curveball Yields for US and European sovereigns are continuing to twist, apparently (and belatedly) firm in the belief that there's been an epochal change in the interest rate stance of the world's major central banks. After some concern in the U.S. that the flattening of the Treasury yield curve presaged a recession, term spreads have risen sharply – largely due to the long end. The spread between 2- and 10-year Treasuries (97.9 basis points, or bps)1 joined the 2y-30y spread (152.3 bps) in rising after the flock of central-bank pronouncements the week of June 27; the 10-30 spread has joined them (54.4 bps) on the back of Friday's jobs report. European bonds have reacted similarly, despite the European Central Bank's continued buying; the 2y-10y Bund spread also reversed at the end of June and is now at 117.9 bps.

Term spreads are notoriously fickle, but trend-spotters are quick to see patterns, even in the short run.  If this trend holds, it could foreshadow a more generally bullish economic outlook – replacing today's recession worries with the well-known symptoms of withdrawal as the monetary punchbowl begins to empty.

U.S. jobs and the Fed: Behind the good news Non-farm payrolls rose 222k in June, well above expectations; average weekly hours worked rose slightly, to 34.5 hours, also beating expectations. Not only that, the economy appeared to call workers off the sidelines, with the labor participation rate rising slightly, to 62.8% -- the positive reason behind the unemployment rate rising slightly, to 4.4%.

The muted market response appears to be related to the downbeat side of the report: Average hourly earnings rose 0.2% in June vs. May, slightly worse than expected, bringing the year-on-year rate to a slightly below consensus 2.5%. While that might please employers in the short run, it suggests that wage-earners might not be benefitting from the slow but steady growth in the economy.

All of which brings observers to a key question: how will this report affect the Fed's decisions to raise rates during the four FOMC meetings remaining in 2017? Speeches given by Fed Governors, including Fed Chair Janet Yellen, have left the clear impression that the FOMC is on balance in favor of getting on with the business of raising rates.  But the fed funds futures market appears not to have gotten the message: the implicit probabilities are a low 16% for a hike in September, and don't rise above 50% until the December meeting.

This week will provide more direct evidence about the FOMC's thoughts on the matter: Chair Yellen is scheduled to deliver the Fed's semi-annual "Monetary Policy Report" to the Senate and the House in separate sessions.

Crude oil: Back to the new normal?  Hopes for a trend reversal in crude-oil prices faded rapidly last week. After a bullish inventory report on June 28, the July 5 report showed US crude and refined-product inventories continuing to rise.  Worse, US gasoline prices continued to soften, with the American Automobile Association reporting the daily average unleaded gasoline price falling from $2.38 to as low as $2.23 during the start of the summer driving season in June and July. That leaves crude-oil prices headed back down: West Texas Intermediate (WTI) traded at $43.90 during the day on Friday July 7; Brent crude traded at $46.37.

One factor behind the inventory glut:  a parallel surplus in investment capital chasing opportunities in U.S. shale oil producers. One estimate: $57 billion in cash invested in the sector over the past 18 months in the form of high-yield bonds and stock sales. Al Walker, the CEO of Anadarko Petroleum, summed it up in a recent presentation to investors: "We really need the investment community to show discipline."  



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