Oct 5 2015 - Rate Brief
A services-based economy with a relatively small export sector shouldn't have been hampered too much by a drop in international demand. That was the thinking at least as economists took solace in the idea that the U.S. would be insulated from a global economic slowdown.
That theory was put to the test when U.S. businesses added a much smaller number of jobs than the Briefing.com Consensus expected in September. Even worse, payroll growth in prior months was revised lower.
That's not all. Another large group of unemployed workers left the labor force as their hopes of finding employment disintegrated.
The impact on the Treasury market was clear. Buyers flooded the market, pushing the 10-year Treasury yield below 2.00% for the first time since April.
Despite the positive rhetoric from Fed officials prior to the release of the employment report, the fed funds futures market put the odds of a rate hike by the end of the year at just 30.5%.
|Fed Fund Futures Rate Prediction||Mar. 2016 (52.0%)||Jan. 2016 (50.6%)||---|
|10yr Treasury - 2yr Treasury||141 bps||147 bps||-6 bps|
|High Yield - 10yr Treasury||637 bps||571 bps||66 bps|
|Corp A - 10 yr Treasury||144 bps||135 bps||10 bps|
|10 yr Bund - 10 yr Treasury||-143 bps||-154 bps||11 bps|
|5yr, 5yr Forward Inflation Breakeven||1.80%||1.80%||0 bps|
The classic joke of a one-armed economist stems from the idea that positive and negative conclusions can be derived from just about any piece of economic data. On that note, the data within the September employment report should have been construed in such a way that economic bulls and bears could be satisfied.
That was not the case. In fact, classifying the September employment report as a disappointment would be a complete understatement.
There was nothing good about the data. Payroll growth has slowed notably over the past couple of months. The employment rate remained steady only because several hundreds of thousands of workers felt that they had no hope of finding a job and left the labor force.
The U.S. economy was expected to grow unabated even as the surrounding global economy was slipping toward a recession. That adage may not be true.
Long-term Treasury yields collapsed, with the 10-year bond yield falling 18 basis points (bps) from the prior week's close. Shorter-term 2-year Treasury yields declined 12 bps and closed at 0.58%. That was the lowest 2-year yield since early July.
The flatter yield curve came as the fed funds futures market reduced its forecast for a 2015 rate hike to 30.5% from 38.9%. The market now expects the first rate hike to occur in March, but only by the smallest of majorities (52.0%).
The U.S. economy, it seems, is not immune to the sickness stemming from the global economic softness. Default risk spiked over the past week. Surprisingly, most of the increase in default risk came before the market was aware of the poor employment data.
The spread-to-Treasuries for high-yield bonds rose 66 bps over the week, but 52 bps came before Friday's employment report. Likewise, the investment-grade corporate spread increased 10 bps, with 9 bps coming before Friday.
Corporate welfare is very tied to global economic growth, and the weakness outside of the U.S. is wreaking havoc on the default risk.
As it currently stands, the default risk on high-yield corporate debt is at its highest point since June 2012. Investment-grade is only doing slightly better (August 2012).
The flight-to-quality was a global phenomenon. German 10-year bund yields dipped 7 bps and closed at its lowest yield (0.56%) since the end of August.
The spread-to-Treasuries narrowed to -143 bps from -154 bps, but that move only came about because the U.S. Treasury bond has more room to move.
Weak global economic growth trends kept downward pressure on inflation expectations. The five-year, five-year forward inflation breakeven remained at 1.80% for a second consecutive week.