This week saw another powerful equities market rally as the prospects of a U.S. tax cut, synchronized global growth, and low-inflation boosted equities higher. Bonds suffered a bit as interest yields for mortgage rates and government debt rose. While there are signals that inflation may be brewing, the Federal Reserve’s preferred measure of inflation, personal consumption expenditures price index (PCE), continues to run below its 2% target, and is a main reason that yields have not jolted higher.

The big news this week was the tax overhaul which is likely to pass before Christmas. The proposed tax reform will benefit corporations and earnings, and is one of the main reasons our stock market is roaring higher. The added fuel of these tax cuts on top of an improving economy should pressure bonds to rise at some point. There are simply too many positive economic factors at work, including unemployment at 4.00%, tighter employment pool of skilled workers, high real estate and equity valuations, and finally, strong signals from the Federal Reserve that it is now time to attempt to normalize interest rates. However, higher mortgage interest rates can be supported in a growing and robust economy combined with overall lower tax rates.

With the 10-year U.S. Treasury near 2.400%, we remain biased toward locking in interest rates given the many positive economic readings that we are seeing.

Mortgage bonds and long-term Treasuries ended the week unchanged after a volatile week of trading. Thursday saw a strong rise in equities with the House passing its tax reform bill. The next step is the Senate where it will meet some resistance from Republicans based on the current iteration of the tax reform bill. However, for the moment, Mr. Market likes what it sees.

Inflation remains muted but small signs of an increase in inflation data are emerging. If inflation does rise, bond rates are likely to rise as well. As long as inflation remains soft, mortgage and bond rates will continue to benefit from these benign readings.

We also continue to monitor both short-term and long-term interest rates. The so-called flattening of the yield curve continues to weigh on investors’ minds, as well as hurt bank profitability. Compression of the yield curve is often a sign of a slowing economy. With mortgage rates near support levels, we continue to be cautious on interest rates and believe locking-in interest rates is the right call.

Bonds ended the week on a sour note as yields rose in response to improved economic growth from Europe. They were also impacted by comments out of the European Central Bank (ECB) that a firm deadline on European bond purchases is needed. Government bond purchases have been an elixir for the marketplace and have been instrumental in pushing down global bond yields. A move away from this policy will result in higher interest rates.

The only economic report due for release today is Consumer Sentiment. While the reading came in lower than expected, the reading remains high and supports the the belief that people are upbeat about the economy.

With the 10-year Treasury touching 2.400%, we remain biased toward locking in interest rates. We are also closely monitoring the flattening of the yield curve (the relationship between short term and long term yields). The inverting of the yield curve has been a historical predictor of a slowing economy and is a margin squeeze for banks and lenders.

This past week was filled with a packed economic and corporate earnings calendar which included the nomination of a new Fed Chairman (Fed Governor Powell), the first rate increase in the UK in a decade, the proposed outline of the new GOP tax bill, and the monthly jobs report. Also, many major corporations announced positive third quarter earnings. Below is a summary of the key events of the week:

Fed Governor Powell is viewed as a safe pick for the Fed and is likely to maintain Janet Yellen’s and Ben Bernanke’s policies albeit with an inclination toward less regulation. The announcement came as no surprise and rates trended slightly lower into the announcement. It is believed that Mr. Powell will continue the slow path rates hikes approach.

In the U.K., the Bank of England raised short-term interest rates for the first time in over a decade. This was in response to a recent return of mild inflation and a synchronized  improving global economy.

Back in the U.S., the GOP unveiled its new tax proposal, which focuses on business tax rate deductions. Inevitably, there will be winners and losers in this plan. At the moment, it appears that cities with expensive real estate will be at a disadvantage due to the new caps on property tax deductions and the reduction in the size of the mortgage deduction.

Finally, the October jobs report came in under expectations with 261,000 new jobs created versus 300,000 expected. Due to the late summer hurricanes in Texas and Florida, this report has been discounted as these storms caused many temporary distortions. However, it is worth reporting that income remains flat which is a strong indicator that inflation is not existent in the economy at this time.

The 10-year Treasury yield headed lower this week and is trading at 2.333%. Given all of the positive economic data, robust earning, and possible pro-business tax plans, we are pleasantly surprised by where interest rates are holding, but we are maintaining bias toward higher interest rates.

Interest rates continue to move higher in the face of strong corporate earnings (rates rallied surprisingly today), a rip-roaring stock market, and indications out of Washington that the pro-business tax reform is moving along positively.

On the economic front, the Bureau of Economic Analysis reported Gross Domestic Product (GDP) grew by a solid 3%, an overall good reading, and yet another reason for bond yields to move higher.

Across the pond, the European Central Bank Chairman Mario Draghi clarified how the ECB will move forward with its own slow and steady reduction in Quantitative Easing. The ECB chairman’s tone remains dovish (bond friendly) and he has committed to keep monetary stimulus going at least through September of 2018. These bond-friendly comments did help to steady bonds late in the week.

With the 10-year Treasury breaking through 2.400%, we remain biased toward locking in interest rates. There are simply too many positive economic and corporate reports coming out of Wall Street to gamble on interest rates going lower. We are also carefully watching the 10-year to see if it breaks through the all important 2.62% level.

Mortgage and U.S. government bonds rallied Friday morning reacting to softer than expected retail sales combined with an anemic Consumer Price Index inflation reading.

Regarding the CPI readings, the Core CPI reading (which removes food and energy due to their volatility) came in at a meager 0.1%. This reading was well beneath expectations of 0.2%. This left the year-over-year CPI at 1.7%, well below the 2.00%-plus that the Federal Reserve would like to see on CPI. The Fed also closely analyzes the Personal Consumption Expenditure (PCE), which is also trending well below the Fed’s target inflation rate.

While the Fed continues to believe low inflation readings are transitory, ongoing low inflation readings are a strong sign that interest rates will remain low for the near term. While many economists believe a December rate hike of .25% is still on the table, the Fed’s reason for raising rates has more to do with rising asset prices and high valuations on some types of real estate. After 10 years of low interest rates, the Fed would like to move the short terms interest rates back to historically normal levels. A return to normalcy does make sense given the strong jobs market, stable inflation, and all-time highs in U.S. equities.

Given the weak inflation data, we are biased toward floating interest rates, but we advise to be very cautious in doing so.

U.S. government debt yields rose this week in response to ongoing positive economic data, all-time highs for equities, and nascent signs of inflation from today’s job report. While the September Jobs Report headline was that job creation fell by 33,000 jobs, the assumption is that the jobs numbers were highly impacted by the two major hurricanes that hit the U.S. in September. We fully expect to see the jobs numbers quickly rebound in the coming months.

Within the Jobs Report, the experts homed in on the hourly earnings which surged by 0.5% versus the 0.2% expected. Hourly earnings are up 2.9% year over year. In addition, the Unemployment Rate fell to its lowest level in 16 years to 4.2%, while total unemployment, a.k.a. the U6 number, fell to 8.3% from 8.6% and down from 9.3% in September 2016.

As we have written previously, should the Federal Reserve’s belief in inflation prove transitory, the 10-year Treasury could easily approach 3.000%. Further complicating matters is the Federal Reserve’s intention to begin unwinding its enormous balance sheet, which may very well bid up mortgage and U.S. government debt. Given that the 10-year Treasury is still trading under 2.400%, we remain biased toward locking in interest rates.

As the markets continue to digest the Fed’s intention to slowly unwind its $4.5 billion balance sheet (also known as quantitative tightening), the bond market has taken the news in stride. Perhaps the market doubts that the Fed can execute the unwind effectively. Perhaps it’s just a nonchalant response to Europe and Japan’s ongoing massive quantitative easing that has kept their interest rates at nearly zero.

In economic news, housing inventory remains in low supply and demand is strong. With housing prices rising amidst flat wage growth, experts are concerned that housing is becoming unaffordable. Something will have to give.

The Trump administration also provided some context as to their proposed tax overhaul. We like the ideas of corporate taxes being lowered. Stay tuned.

With the 10-year trading above 2.30% this week, we continue to be concerned about rising interest rates and so we remain biased toward locking in interest rates at still attractive rates.

Bond yields drifted gently higher this week in response to the Fed’s comments on the improving U.S. economy and its belief that this economy can absorb an increase in short-term rates.  The smart money’s on penciling in one more rate hike in December, bringing the short term lending rate from 1.250% up to 1.500%.  More importantly, the Fed also discussed its intention to unwind its massive bond portfolio. This wind down will take several years and the Fed has discussed the wind down formula very clearly to the marketplace in order to avoid another “taper-tantrum”. However, the wind down of a portfolio of this size is unprecedented as the Federal Reserve currently holds $4.5 trillion of US and mortgage bonds.  While we hope this will go smoothly, one cannot be sure given the massive void in the marketplace the private sector and other Central Banks will need to fill.

There are two reasons that both the equity and bond market have responded favorably to the Fed commentary this week, even in the face of increased interest rates and a less accommodative monetary policy. First, inflation remains low and there is a growing feeling among economists that a 2% inflation-growth rate may be too high.  This benefits stocks and bonds greatly.  Second, while the Fed is beginning to tighten, central bankers in Europe and Japan continue to buy bonds and other assets. These purchases continue to keep global yields low.

In other news, the U.S. and North Korean tension continues to escalate, but to date the markets have not been adversely affected by this potential scary geopolitical event.

Given the extraordinary technical nature of the large central bank’s unprecedented involvement in the financial markets, we remain biased toward locking-in interest rates especially now that the Fed has confirmed its intentions to move away from extreme monetary policy.  While we can make the argument for lower interest rates, we feel it is prudent to remain cautious while interest rates remain so low.

Mortgage and U.S. Treasury yields rose slightly this week in response to less-than-expected destruction from the double whammy of Hurricanes Harvey and Irma, in conjunction with improving inflation data. The markets continue to discount ballistic missile tests by North Korea with little to no negative responses to this geopolitical risk as evidenced by the S&P closing at a record high on Friday.

The big economic news this week was nascent signs of a pick-up in inflation. As written previously, the lack of inflation continues to perplex the Federal Reserve given the rate of unemployment of 4.500%, the longevity of our economic recovery, and the high prices of equities and real estate. The lack of inflation has kept interest rates low, which has benefited equities and real estate. It’s clear that Federal Reserve wants to continue to raise short-term interest rates to stave off a potential stock and real estate bubble, but it is less clear precisely when they will next hike rates.

At this time, we continue to remain biased toward locking-in interest rates given the improving economy, a potential rise in inflation, and attractive interest rates.