- U.S. consumer confidence expected to fall back from 15-1/2 year high
- U.S. home price squeeze expected to continue
- 5-year T-note auction to yield near 1.92%
- Treasury securities with maturities of 5 years and less remain at negative inflation-adjusted levels
U.S. consumer confidence expected to fall back from 15-1/2 year high — The market consensus for today’s March Conference Board U.S. consumer confidence index is for a -0.8 point decline to 114.0, giving back part of the +3.2 point increase to 114.8 seen in February. A small setback in the Conference Board’s index in March would not be surprising since the index has soared by a total of +14.0 points since the November election to post a 15-1/2 year high of 114.8 in February.
U.S. consumer sentiment remains very strong due to the firm labor market, recent record highs in the stock market, steadily-rising home prices, low gasoline prices, and expectations for personal tax cuts. However, strong consumer confidence has not yet translated into a sustained boost in consumer spending. U.S retail sales were strong at +1.0% in December and +0.6% in January, but then barely showed an increase in February at +0.1%. Some of the weakness in spending in February was due to delayed IRS tax refunds but consumer caution was likely a key reason for the weak February retail sales figure.
Consumers have not embarked on a sustained spending spree because of only a modest improvement in wages and because of some political uncertainty. Indeed, some Q1 GDP tracking estimates have been weak. The Atlanta Fed’s GDPNow is currently estimating Q1 GDP at only +1.0%, partially because of recent data suggesting that personal consumption will contribute only +1.0 point to GDP growth in Q1, down from the +2.0 point contribution seen in the second half of 2016.
U.S. home price squeeze expected to continue — The market consensus is for today’s Jan S&P CoreLogic composite-20 home price index to show another strong increase of +0.7% m/m. The CoreLogic Composite 20 index, which measures home prices in the top 20 U.S. metropolitan areas, went flat in the spring and early summer of 2016 but then came roaring back in late 2016 with an average monthly increase of +0.8% during Sep-Dec. The index in December was in very strong shape at +5.6% y/y and +41.5% from the housing bust low.
The sharp rise in home prices is being driven by strong home demand as well as by tight supplies. Jan existing home sales rose by +3.3% to a new 10-year high of 5.69 million units. Meanwhile, the supply of existing homes on the market is currently at a record low of 3.5 months. Higher mortgage rates may cool demand slightly, but until more homes come on the market to satisfy demand, U.S. home prices are likely to keep on rising. The current 30-year mortgage rate of 4.23% is up by +69 bp from the pre-election level of 3.54%.
5-year T-note auction to yield near 1.92% — The Treasury today will sell $34 billion of 5-year T-notes. The Treasury on Wednesday will then conclude this week’s $101 billion T-note package by selling $28 billion of 7-year T-notes and $13 billion of 2-year floating rate notes.
Today’s 5-year T-note issue was trading at 1.92% in when-issued trading late yesterday afternoon, which translates to an inflation-adjusted yield of -0.03% against the current 5-year breakeven inflation expectations rate of 1.95%. Buyers of today’s 5-year T-note auction can therefore expect to earn essentially a zero inflation-adjusted return over the course of their 5-year investment if inflation turns out to match current market expectations of 1.95%.
The 12-auction averages for the 5-year are as follows: 2.43 bid cover ratio, $44 million in non-competitive bids, 5.1 bp tail to the median yield, 13.4 bp tail to the low yield, and 51% taken at the high yield. The 5-year is moderately popular among foreign investors and central banks. Indirect bidders, a proxy for foreign buying, have taken an average of 61.4% of the last twelve 5-year auctions, which is moderately above the average of 59.2% for all recent Treasury coupons.
Treasury securities with maturities of 5 years and less remain at negative inflation-adjusted levels — The Treasury curve of 5 years and shorter remains at negative inflation-adjusted levels, which is obviously not a sustainable situation over the long run. Investors will not be willing to accept negative inflation-adjusted returns forever on shorter-term Treasury securities.
Investors are currently being forced to accept such low returns on shorter-term Treasury securities because (1) the Fed has the funds rate pegged at the very low level of 0.75%-1.00%, (2) there is still strong safe-haven demand for Treasury securities following the Great Recession and global financial crisis, and (3) there is strong demand by foreign investors for Treasury securities due to near-zero shorter-term yields in Europe and Japan.
However, Treasury yields on shorter securities should steadily rise in coming years as the Fed raises its federal funds rate, eventually restoring a more reasonable return for buyers of the Treasury’s shorter-term securities. The Fed’s plan, as indicated by the Fed dots, is to raise the funds rate by another 213 bp to 3.00% by the end of 2019, producing a real federal funds rate of 1.00% against the Fed’s inflation target of 2.0%. The market, however, believes that the Fed will only be able to raise the funds rate to 2.00% by the end of 2019, falling one full percentage point below the Fed’s target of 3.00%. That would suggest that the funds rate even by the end of 2019 will not yet be at a positive inflation-adjusted level, thus keeping shorter-term Treasury yields at continued unattractive levels relative to inflation.
