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  • Inflation-adjusted returns on shorter-term Treasury notes remain slightly positive
  • 3-year T-note auction to yield near 1.59%
  • Congress returns to Washington with little time left for key issues
  • JOLTS job openings report is expected to show continued labor market strength

Inflation-adjusted returns on shorter-term Treasury notes remain slightly positive — Inflation-adjusted returns for shorter-term T-notes just turned positive about a month ago but remain narrow.  The current 3-year T-note yield of 1.59%, for example, is 0.19% above the 3-year breakeven inflation expectations rate of 1.40%. That means that buyers of today’s 3-year T-note auction can expect to earn an annual return of 0.14% on an inflation-adjusted basis over the course of their investment, if actual inflation turns out to match the current expected inflation rate.  The current situation is an improvement from the last nine years when T-notes with maturities of 5 years and shorter traded mostly below inflation expectations, meaning investors could expect to lose money on their T-note purchase on an inflation-adjusted basis.

The recent improvement in inflation-adjusted shorter-term T-note yields is due to (1) the rise in nominal short-term T-note yields caused by the Fed’s 75 bp rate hike seen since December, and (2) the sharp drop in inflation expectations seen in recent months due to falling U.S. inflation statistics and lower oil prices.

Even with the recent rise, however, T-note yields are still trading at paltry and unattractive levels relative to inflation expectations.  Treasury yields in our view will continue to move slowly higher in coming years and eventually produce more normal inflation-adjusted yields, assuming that the U.S. economy continues to expand and the Fed continues to normalize monetary policy by pushing up the federal funds rate.  However, this process could take at least several more years considering that inflation is lagging and U.S. economic growth remains tepid.

 

 

3-year T-note auction to yield near 1.59% — The Treasury today will sell $24 billion of 3-year T-notes.  The Treasury will then continue this week’s $56 billion coupon package by selling $20 billion of 10-year T-notes on Wednesday and $12 billion of 30-year bonds on Thursday.  The 12-auction averages for the 3-year are as follows:  2.80 bid cover ratio, $50 million in non-competitive bids to mostly retail investors, 4.4 bp tail to the median yield, 16.1 bp tail to the low yield, 54% taken at the high yield.  The 3-year is the second least popular security among foreign investors and central banks behind the 2-year T-note.  Indirect bidders, a proxy for foreign bidders, have taken an average of only 51.9% of the last twelve 3-year T-note auctions, well below the average of 60.2% for all recent coupon auctions.

Congress returns to Washington with little time left for key issues — Congress returned to Washington on Monday with little time to resolve key issues.  Congress will be in session for only the next three weeks (through July 28) and is then scheduled be on recess for the entire month of August.  Congress will then return to Washington in early September with only a month left before a potential government shutdown on Oct 1.

Senate Republicans for the remainder of July will likely be consumed with their internal battle over Obamacare repeal.  Senate Majority Leader McConnell’s current plan appears to be to release his revised health insurance bill by late this week, receive the CBO scoring by early next week, and then hold a Senate vote by the end of next week.  In theory, that would leave time for the House to vote on any bill the Senate might pass before the August recess, sending it to President Trump’s desk for his signature.  However, there are few observers who believe there is enough agreement among Congressional Republicans to get such a deal done in that time frame.

In any case, the stock market would likely react positively if Congress could get a deal done on health insurance, not because of the health bill itself, but rather because repealing Obamacare care would provide $1 trillion over 10 years of extra room to boost the size of the tax reform bill.  Without Obamacare repeal, and without contentious revenue raisers such as the border adjustment tax and ending the business tax deduction for interest, the Republican’s tax reform plan and corporate tax cut is likely to be relatively small.  On the timing of tax reform bill, Treasury Secretary Mnuchin has said the White House plan is to offer a comprehensive tax plan in September and win Congressional passage by the end of the year.

Aside from health care and taxes, Congress actually has more important issues to address simply to keep the U.S. government open and paying its bills on time.  Congress by October 1 must pass spending authority for the new 2018 fiscal year that begins on October 1 or there will be a government shutdown.  Congress must also pass a debt ceiling increase by early to mid-October, according to the CBO, or the Treasury will run out of cash and the threat of a Treasury sovereign default will arise.

 

 

 

JOLTS job openings report is expected to show continued labor market strength — The JOLTS U.S. job openings series in April soared by +259,000 to a new record high of 6.044 million jobs, which confirmed strong hiring intentions by U.S. companies.  The consensus is for today’s May report to show a -119,000 job decline to 5.925 million jobs, but that would still be a very strong level that is well above the 12-month trend average of 5.7 million jobs.  

The strong level of the JOLTS job openings series is a positive leading indicator for the payroll report since many job openings will turn into an actual job hire within 1-3 months when the hiring process is complete.  Recent market concern about weak payroll reports largely abated last Friday after the strong June payroll report of +222,000 and the overall upward revision of +47,000 for the previous two months.  The 3-month moving average for the payroll series is now a respectable +194,000, illustrating that U.S. businesses are still engaged in relatively strong hiring even though the U.S. economy is close to full employment.

 

 

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