Fed Offers a Little for Hawks and Doves Alike

Treasury Market Still Focused on Virus Case Counts

The Treasury market is finishing up the week pretty much where it started despite getting a lot of new information from the FOMC meeting, GDP, and today’s June personal income and spending numbers.  The income and spending numbers were part of the second quarter GDP release but will give us a sense of momentum, or lack thereof, heading into the third quarter. The lack of a shift in the recent trading range despite the additional information speaks to the one factor that really is driving the markets and that is the future outlook for the economy given the uncertainties stemming from the rise in virus cases. The virus trend continues higher, but the question is will it dent spending and growth as the Treasury market seems to expect? The second quarter GDP didn’t reflect hesitancy on the part of the consumer (more on that below), but will it in the third quarter if cases continue to spike? That is the question the market is grappling with at the moment while it mostly ignores  current economic releases.

Fed Meeting Had a Little for Hawks and Doves Alike

The Fed meeting did it’s job as being primarily a placeholder for later meetings as post-meeting analysis was pretty evenly split between being a hawkish meeting and being a dovish one. In our interpretation, we felt the statement tone didn’t soften to the extent we thought it would. There was no direct mention of the increasing virus cases and the economic outlook was as strong as the June meeting. That was the hawkish lean. The dovish lean came in the Powell press conference where he struck a slightly more cautious tone and that led to the late-day rally in Treasuries. The middling message can be seen in the after-effects of the fed funds futures market where December 2023 futures didn’t change much with a 0.68% yield, or nearly two rate hikes.

While futures markets were mostly unmoved by the meeting, we did learn a few things. Powell mentioned that tapering guidance would continue to be discussed during upcoming FOMC meetings (plural). That rules out Jackson Hole in August (not a Fed meeting), so September 22 is followed by November 3 which stands as a possible announcement date, or the last meeting of the year on December 15. Powell again stressed that while the economy continues to improve more progress on the employment front needs to happen. He is laser-focused on getting back to maximum employment and with 12.8 million people still garnering some type of unemployment benefit versus 1.7 million pre-pandemic there is still a lot of road to cover. Also from the meeting, when tapering does happen they will scale back the Treasury and MBS purchases simultaneously. There had been some chatter  they might move quicker on the MBS taper given the strength in housing. Powell also remained adamant that the inflation impulse is still “transitory” and we agree with him on that.  In summary, policy will remain extremely accommodative on the rate side, even as bond buying will start to be scaled back in early 2022.

Second Quarter GDP Misses Lofty Expectations but Sets Stage for a solid Third Quarter

The first look at second quarter GDP was released yesterday and while the headline gain of 6.5% missed loftier expectations of 8.4% there were nuances in the report that lay the groundwork for perhaps a more optimistic view for third quarter GDP. While the second quarter gain was expected to be the high water mark for this cycle, it did manage to edge past first quarter GDP which was revised a touch lower to 6.3% from 6.4%.

 

While the consumer certainly did their part once again with personal consumption climbing 11.8% versus 10.5% expected and 11.4% in the first quarter, inventory drawdowns slashed 1.13% off GDP and reduced housing investment, also due to lack of inventory, cut another 0.5% off GDP. Those inventory drawdowns speak to supply shortages and other supply-chain issues that should start to improve as we move through the third quarter and that could lead to a pick-up in GDP that is currently estimated to  increase 7.1% annualized.

Another positive indicator in the report was that the hand-off from the goods-side to the services-side of the economy appears to be happening, despite the challenges with the delta variant and increasing virus cases. Services spending increased 12.0% versus 3.9% in the first quarter while goods spending “slowed” to 11.6% versus 27.4% in the first quarter. The theory is that goods spending can’t continue at the lofty first quarter levels and that services spending would have to pick up the inevitable slack, but with increasing virus cases that may work to slow services spending. At least in the second quarter the spending did begin to shift towards more services and that bodes well moving into the third quarter.

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Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs)	2 Year	3 Year	4 Year	5 Year	10 Year	15 Year
0.25	0.13	0.35	0.60	0.91	1.70	2.16
0.50	0.12	0.32	0.55	0.81	1.56	2.05
1.00	0.11	0.29	0.51	0.76	1.47	1.92
2.00	–	0.28	0.45	0.68	1.35	NA
3.00	–	–	–	0.63	1.29	NA
4.00	–	–	–	–	1.24	NA
5.00	–	–	–	–	1.20	NA
10.00	–	–	–	–	–	NA