<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=905697862838810&amp;ev=PageView&amp;noscript=1">

LenderHub

SWBC's LenderHub blog is a one-stop resource for lenders.

 

Looks Like Lower and Flatter for 2016


money.jpg

Wednesday afternoon’s reaction to the release of the Federal Open Market Committee (FOMC) was quite interesting. For equities and the currency markets, the Fed had finally done what the market has been begging them to do for over a year. They provided clarity. The Fed essentially stated that they will raise the funds rate by 25 basis points at the FOMC meeting on Dec. 16, and then in 2016, raise rates in a very gradual manner. I assume (based on the Fed Fund Futures Curve) that the market interprets this as perhaps three 25 basis point hikes within the eight meetings scheduled next year.

Bravo, Yellen and company! The markets and the Fed are finally in sync. And with that, equities surged, and the U.S. Dollar’s rampage against both the major currencies (Euro, Yen, Pound, Swiss Franc, etc.) and emerging market currencies was finally halted. It felt like Waterloo!

However, seemingly off in the corner from all the hoopla, the U.S. Treasury yield curve did a rather odd thing. For perhaps the first time in history, 10-year notes to 30-year bonds at the long end of the curve actually rallied off the news that the Fed was “lifting-off” imminently. If you read last week’s post, we predicted this strange phenomena would occur if the Fed persisted with lift-off. In fact, as I write this, the long end continues to rally while the front end is relatively unchanged. I think the yield curve can continue to flatten significantly as first 10s and 30s rally. Then, as we go through the first quarter of 2016, the rally can spread down the curve.

How did I come to this conclusion? Well, can anybody tell me what the European Central Bank (ECB) is going to do in 2016? From the minutes of The ECB’s October meeting, it appears they thought about increasing their Quantitative Easing (QE) program in back in October but are now leaning very strongly toward December 2015 (The ECB’s next meeting is Dec. 3).

Are we to assume (as some do) that this move is fully priced in, and once the ECB expands their QE and lowers their deposit rate next month, they’re done—as in, no more stimulus in 2016? This is a mighty big assumption in my opinion. To expand this argument would imply that the Euro should stabilize around where it is now (1.06–1.08), and the thought of parity—or USD/Euro trading through parity—is not very probable.

The Eurozone seems very susceptible to sinking back into recession. The ECB has said they will do whatever it takes to prevent this, and I believe them. That could mean more stimulus and more monetary policy divergence from the Federal Reserve. Moreover, I believe this argument can be carried over to the other major central banks and their respective monetary policies and currencies.

I am not bearish on the U.S. economy. I think it can keep chugging along at 2–3% for a while. However, what does the USD look like in an environment where the developed economies of Europe and Asia stagnate and emerging markets get poorer as their growth engine (commodities) continues to get crushed? Currently, as measured by Bloomberg’s U.S. Dollar Index (DXY), the USD hasn’t been this strong since the spring of 2003. If the scenario stated above plays out, the USD can certainly increase at least another 10% in 2016. I think this can happen even if the Fed doesn’t tighten at all in 2016. It just takes the easing of the other major central banks to achieve this.

Therefore, as we look toward 2016, I think that the long end of the U.S. Treasury curve can rally significantly. Then, as we go into the first quarter of 2016, the Feds will have to choose between increasing global monetary policy divergence and a prohibitively stronger USD, or staying their hand with regard to further policy tightening, which would lead to a strong rally in the belly of the curve (five- and seven-year notes).

Member SIPC & FINRA. Advisory services offered throughSWBC Investment Company, a Registered Investment Advisor.

- Not for redistribution -

New Call-to-action 

 

SWBC may from time to time publish content in this blog and/or on this site that has been created by affiliated or unaffiliated contributors. These contributors may include SWBC employees, other financial advisors, third-party authors who are paid a fee by SWBC, or other parties. The content of such posts does not necessarily represent the actual views or opinions of SWBC or any of its officers, directors, or employees. The opinions expressed by guest bloggers and/or blog interviewees are strictly their own and do not necessarily represent those of SWBC. The information provided on this site is for general information only, and SWBC cannot and does not guarantee the accuracy, validity, timeliness or completeness of any information contained on this site.  None of the information on this site, nor any opinion contained in any blog post or other content on this site, constitutes a solicitation or offer by SWBC or its affiliates to buy or sell any securities, futures, options or other financial instruments. Nothing on this site constitutes any investment advice or service. Financial advisory services are provided only to investors who become SWBC clients.

money-2.jpg

Leave a comment below!