Morning Report: What does the flattening yield curve mean? 11/13/17

Vital Statistics:

Last Change
S&P Futures 2572.5 -7.0
Eurostoxx Index 384.9 -3.8
Oil (WTI) 56.9 0.1
US dollar index 87.7 0.0
10 Year Govt Bond Yield 2.38%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.95

Stocks are lower this morning after General Electric cut its dividend in half. Bonds and MBS are up.

We will have a lot of data this week, along with a plenty of Fed-Speak. None of the data should be all that market-moving, but watch the inflation numbers on Tuesday and Wednesday. We will also get housing starts and industrial production.

Many market participants are watching the slope of the yield curve and warning that it could be indicating a recession ahead. The slope of the yield curve is most often measured by the difference between the 10 year bond and the 2 year bond (the 2s-10s spread). The 10 year rate is usually higher than the 2 year rate, but that relationship can move around a lot, especially when the Fed is active. Most are using comparisons from the beginning of the year, which is somewhat exaggerated by the initial post-election jump in rates. The Trump Reflation Trade turned out to be relatively short-lived, and it exaggerated the slope of the yield curve. That said, we have typically seen a curve flattening during tightening regimes. Some participants are predicting the curve could invert next year, if the Fed can’t get inflation to rise. But supposedly the fast money is playing the yield curve flattening trade and this is one of the biggest trades on the Street.

One effect of a flattening yield curve will be to make the early payment pickup in ARMS less dramatic than it otherwise would be. ARMS are based off of LIBOR, while the 30 year rate is based more on the 10-year. If LIBOR is rising relative to the 10 year (which you would expect to see in a flattening yield curve environment) then borrowers would be better off refinancing out of an ARM and into a 30 year fixed. In a tough environment, this can be a way to get some loans in the door, along with the FHA to conventional without MI refi.

Tax reform will influence the shape of the curve as well. If tax reform doesn’t get done this year, it probably is doomed for the immediate future, as midterm elections will dominate 2018. One strategist sees a 15% correction in the stock market if tax reform doesn’t get done. Expectations for a corporate tax cut boosted the S&P 500 by 20% this year. Note that earnings have been increasing for the S&P 500 as well, so that provides support for valuations. Look at the chart below: The blue line is the absolute level of the S&P 500, while the orange line is earnings per share. Granted, the stock market theoretically looks at forward earnings and not contemporaneous or past earnings, but as long as earnings keep rising, the stock market

19 Responses

  1. From Ezra Klein:

    “For many Republicans, the organs of American journalism have become the out-group, the enemy. It’s easy to disbelieve the Washington Post because the Washington Post is #FakeNews — even the president of the United States says so!

    For decades, conservatives have been working to persuade Americans that the mainstream media is the opposition, that they’re hostile, that they’re lying. Those attacks have risen both in pitch and frequency since Trump took office. Those attacks have, for a significant percentage of the population, worked.

    A poll like this is implicitly posing a question: Do you believe the Washington Post, with its decades of hard-won credibility, its numerous sources, and its adherence to the standards of journalism? Or do you believe Moore? Few of us have the time or capability to investigate the story for ourselves, and so we have to choose.”

    Hmm. Now how does the Washington Post reflect it’s “adherence to the standards of journalism” in headline writing?

    “Photographer who protested White House restrictions gets revenge with revealing shot of Trump

    A series of photos of President Trump awkwardly trying to execute a group handshake in Manila shows the value of an independent press.

    By David Nakamura”

    Note the lack of irony in the second sentence. Because using your position to get revenge is the hallmark of independence.


  2. Another example of why people don’t trust the MSM as a “neutral arbitrator”

    NY Times analysis of the Republicans tax bill excludes all single filers to get their headline that the Republican bill will raise taxes on “almost half of the middle class”.


  3. $10 says he runs as an independent with Bill Weld as his running mate.

    And Weld will then endorse the Democratic nominee.



    I do think her focus away from home grown problems and her own unpopularity are background worth mentioning.


  5. The tax cuts nobody likes?

    HB1 would increase my income tax by the entire amount of my social security check net of the Medicare premium deduction. The Senate bill would only increase our taxes by about $4K.

    I am a believer that the national debt cannot be handled without higher taxes and am ready to take the hit – but not so Ivanka can get more shoes. That doesn’t compute.


    • Mark:

      I am a believer that the national debt cannot be handled without higher taxes and am ready to take the hit – but not so Ivanka can get more shoes.

      How about so Congress can give away more “entitlements”? Because any tax reform that is not accompanied with spending reform is going to result in exactly that. Guaranteed.

      The debt is a function of a spending problem, not a revenue problem. Focusing on the revenue side of the ledger is ignoring the real problem.


      • Both are needed.


        • Mark:

          Both are needed.

          In 2015 (the last year I could find data) federal revenues were at an all-time record high, both in actual and inflation adjusted dollars. Federal revenues per capita were also at an all time record high, again both in absolute terms and inflation adjusted. Of the 75 years since 1940, there were only 11 years in which revenues were higher as a percent of GDP than in 2015.

          Given these facts, I don’t think it can reasonably be said that we “need” more revenues. What we “need” to do is to decrease spending.


        • Coincidentally, just saw this link over at Ace:

          The federal government hauled in record total tax revenues in the month of October, taking in a total of $235,341,000,000 during the first month of fiscal 2018, according to the Monthly Treasury Statement released today.

          The federal government also brought in record individual income tax revenues for the month of October, taking in $127,832,000,000 in individual income taxes.

          Despite its record total tax intake of $235,341,000,000 for the month of October, the federal government still ran a deficit of $63,214,000,000 for the month because it spent $298,555,000,000.


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