- U.S. April new home sales expected to remain strong near 9-1/4 year high
- Markit U.S. PMIs expected to edge higher
- 2-year T-note auction to yield near 1.29%
- Short-term Treasury yields will likely take beyond 2019 to reach positive inflation-adjusted levels
U.S. April new home sales expected to remain strong near 9-1/4 year high — U.S. new home sales in March rose by +5.8% to 621,000 units, which was just slightly below the 9-1/4 year high of 622,000 posted last summer in July 2016. The consensus for today’s report is for a mild -1.8% decline to 610,000 units, giving back a bit of March’s +5.8% increase.
The strength in new home sales remains impressive. New home sales are being driven by strong consumer confidence, improved household balance sheets, and pent-up demand in the aftermath of the Great Recession. In addition, new homes are easier to buy than existing homes since there are 5.2 months worth of new homes on the market versus the severe shortage of 3.8 months worth of existing homes. The median price of a new home was $315,100 in March, just mildly below the record high of $332,700 posted in Dec 2016.
The strength in new home sales continues to support strong home building activity. The NAHB home builder confidence index was very strong at 70 in May, only 1 point below the 12-year high of 71 posted in March. April housing starts in April fell by -2.6% to 1.172 million units, but were not far below the 9-3/4 year high of 1.328 million units posted in Oct 2016. The strength in new home sales is boosting the stock prices of home building companies. The SPDR S&P Homebuilders ETF (XHB) is up +12% year-to-date and is only -1.4% below the 1-3/4 year high of 38.42 posted in late April.
Markit U.S. PMIs expected to edge higher — Today’s Markit U.S. PMIs are expected to edge higher, indicating continued buoyancy in U.S. business confidence. The recent political turmoil in Washington is a negative factor, but U.S. business confidence remains generally strong due to the solid U.S. economic data and the improvement of global economic growth. The U.S. business community is also still hoping for the Republican growth agenda to come through with reduced regulation, lower taxes, and some infrastructure spending.
The consensus for today’s May Markit U.S. manufacturing PMI is for a +0.3 point increase to 53.1, reversing part of April’s -0.5 point decline to 52.8. Meanwhile, the consensus for today’s May Markit U.S. services PMI is for a +0.2 point increase to 53.3, adding to April’s +0.3 point increase to 53.1.
2-year T-note auction to yield near 1.29% — The Treasury today will sell $26 billion of 2-year T-notes. The Treasury will then continue this week’s $101 billion T-note package by selling $13 billion of 2-year floating rate notes and $34 billion of 5-year T-notes on Wednesday, and $28 billion of 7-year T-notes on Thursday. Today’s 2-year T-note issue was trading at 1.29% in when-issued trading late yesterday afternoon. That translates to an inflation-adjusted yield of -0.23% against the current 2-year breakeven inflation expectations rate of 1.52%.
The 12-auction averages for the 2-year are as follows: 2.71 bid cover ratio, $169 million in non-competitive bids, 4.0 bp tail to median yield, 20.9 bp tail to the low yield, and 59% taken at the high yield. The 2-year is the least popular Treasury coupon security among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken only 43.6% of the last twelve 2-year T-note auctions, which is well below the average of 59.9% of all recent Treasury coupon auctions.
Short-term Treasury yields will likely take beyond 2019 to reach positive inflation-adjusted levels — Treasury securities with maturities of 5 years and shorter continue to trade below their respective breakeven inflation expectations rates, meaning buyers of those securities can expect to lose money on an inflation-adjusted basis if actual inflation over the course of their investment matches the current inflation expectations rate. For today’s 2-year T-note auction, for example, buyers can expect to lose -0.23% annually if inflation turns out to match the current 2-year breakeven inflation expectations rate of 1.52%.
Shorter-term Treasury securities continue to trade below inflation expectations because (1) the Fed still has the federal funds rate pegged at an extremely low level relative to inflation expectations, and (2) investors continue to buy the Treasury’s underwater securities because there are few other safe-haven alternatives with negative interest rates in Europe and Japan.
However, this situation cannot last indefinitely because investors will not agree to keep losing money on an inflation-adjusted basis forever. The real return will have to rise to a positive level down the road, most likely through a rise in shorter-term Treasury yields as the Fed normalizes its monetary policy and raises the federal funds rate. However, this could take several more years or even longer.
The Fed’s forecast for the federal funds rate (i.e., the Fed dots) indicates that the Fed would like to push the federal funds rate up to 3.00% by the end of 2019, which would produce an inflation-adjusted federal funds rate of 1.00% against the Fed’s +2.0% inflation target. That would suggest that yields on T-bills and short-term Treasury securities by that time would also rise above inflation expectations, thus producing positive real returns.
However, the market currently believes that the Fed will only be able to raise the federal funds rate to 1.72% by the end of 2019, far below the Fed’s goal and still below the Fed’s +2.0% inflation target. If the markets are right about the Fed’s limited ability to raise interest rates, then short-term Treasury securities will likely remain under water compared with inflation expectations until well after 2019.
