The Dow’s climb above 20,000 was all the buzz of this week. However in other news, housing and economic data were not so rosy. New home sales fell sharply in December as a result of both increased housing prices and interest rates. Also, Gross Domestic Product (GDP) growth in the final quarter of 2016 was weaker than expected. GDP grew by 1.900% in the last quarter of 2016, below the 2.2% expected and down from the 3.5% reported in the third quarter. Overall, in 2016 GDP grew by a tepid 1.9%, down from 2.6% in 2015 and it was the worst showing since 2011.

Bond yields are trading modestly lower in response to both the poor GDP and the slow economic growth.
With rates virtually unchanged this week, we continue to closely monitor the 10-year Treasury Bond, which is trading a tad under 2.500%. We remain biased toward advising clients to lock in interest rates, although we could foresee the possibility of a small drop in interest rates given the current economic and political environment.

U.S. government bond yields surged this week and touched their highest level since 1/3/17 as the 10-year U.S. Treasury traded above the very important psychological 2.500% mark on the morning that President Trump was sworn in.

Bond yields rose in response to several factors:

1. Inflations reports out this week confirmed an uptick in core inflation.
2. Janet Yellen, Fed Reserve President, reaffirmed that she sees short-term interest rates continuing to rise.
3. The inauguration of President Trump and the idea that more business-friendly policies will lead to an increase in inflation, as well as higher income and economic growth.

While bond yields have moved higher, there are still many skeptics who do not see interest rates rising much further. One reason is that compared to Europe or Japan, US interest rates remain very attractive. This may serve as a ceiling for how high US rates may go. The next few months will be key as the markets have moved on the promise of a better tomorrow. How the new President and his team implement the actual policy is yet to be seen and our economy is still only growing ever so gingerly.

Technically, mortgage bonds are looking weak so, for now, we remain biased toward locking-in rates due to the potential of a continued climb in bond yields.

Interest rates rose Friday morning in response to a slightly hotter-than-expected wholesale inflation report, but this early sell-off reversed course as bonds traded better toward the end of the business day. The sell-off was prompted by a .3% increase in the Producer Price Index (PPI), also known as the wholesale inflation number. This was in line with estimates, but still suggests increased inflation. Core PPI, which strips out volatile food and energy, also reported slightly higher inflation numbers. Finally, year-over-year PPI, increased 1.60%.

Bonds remain oversold but technically have been unable to break out above key price points. We continue to advise clients to be cautious and we feel that locking in rates is prudent. Bill Gross, the famed bond manager, recently wrote that the key data point he is watching is the 10-year U.S. Treasury bond. His belief is if the 10-year Treasury rises above 2.60%, then rates will indeed go much higher. If not, the bull market in bonds is still intact.

Interest rates rose in response to a lackluster December jobs report. Within the report, there was an increase in hourly wages from November to December, which is inflationary and probably the reason for the sell-off in bonds. Wages also increased year over year at 2.90%, the largest increase in many years. The headline jobs number came in lower than expected with 156,000 jobs created versus 175,000 projected. The unemployment rate ticked up to 4.70% and the closely watched labor force participation rate and U6 reading ticked up as well.

Going forward, we don’t envision rates shooting straight up, however we are mindful that it’s more likely that interest rates will increase in the coming months given the President-Elect’s desire to create a more pro-business and pro-growth environment.

As we quickly approach the symbolic Dow 20,000 benchmark, some of Wall Street’s best and brightest are calling for an end of the 30-year bull run in bonds. The U.S. 10-year Treasury Note, the world’s benchmark for pricing everything from mortgages to long term corporate debt, broke through the psychologically important 2.500% threshold this week. The 10-year note has surged almost 1 percentage point since the November election. This is a drastic and destructive move and the pain is being felt by bond holders who have seen their bond portfolio trade sideways in response to the increase in both domestic and global yields.

The reason for the increase in bond yields is not complicated: it is driven by prospects of a more business-friendly government and the expectations of lower taxes, increased wage growth, and ultimately future inflation.

On a positive note, while rates are going higher, we should not expect the purchase market to slow materially. In fact, if we do see economic growth, higher confidence, and whiffs of inflation, then we should expect the purchase market to do well.

Rates should be locked based on the fact that the current market is highly volatile.

Equity markets surged higher as the Trump rally continues at the expense of bonds. The 10-year U.S. Treasury Bond rose to 2.467%, but closed below the psychologically important 2.500% mark. We were somewhat encouraged earlier in the week by how U.S. bonds responded to the European Central Bank’s (ECB) remarks about trimming their quantitative easing (QE) programs next year. One would think that the reduced monetary stimulus would have major negative impact on bond yields. This has yet to prove true, but Friday’s sell-off in the bond market could mean bond yields will go higher.

All eyes will be on the Federal Reserve next week as the futures market has all but confirmed that the Fed will be increasing short-term overnight lending rates. With a hot stock market, unemployment under 5%, and a pro-business administration about to take office, there is no reason not to increase. Experts have stated that this Fed increase has already been backed into the bond market and the reaction to the Fed’s increase will be a non-event.

We continue to watch both the equity and bond markets carefully. It is hard to argue against locking interest rates as they are swiftly rising, but one can make the argument that equity markets may have gotten ahead of themselves and that bonds are due for a positive bounce.

U.S. treasury and mortgage bonds have had a rough few weeks. The 10-year treasury hit 2.44%, which is up significantly from the beginning of November. The rise in interest rates is due to the pro-business policies that President-elect Trump intends to implement, with the idea that this will increase GDP, kick-start the economy, and increase overall inflation.

Today’s November job report was the big ticket item of the week. The report came in as expected with new job creation of 178,000 versus 180,000 expected. The unemployment rate fell to 4.60% and the U-6 dropped from 9.50% to 9.30%. The U-6 rate is defined as including all unemployed people as well as “persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the labor force”. Wage growth declined in November, which is bond-friendly and is partly responsible for the mild rally today in bonds.

Given the recent rise in rates, we are biased toward floating interest rates ever so cautiously at these levels. However, we could see the 10-year treasury yield quickly going above 2.50%, so this recommendation may be short lived.

U.S. bonds continue to rip higher in response to the new Trump administration. Further adding fuel to the fire were comments made by Madam Chair Yellen which all but confirmed a December rate increase on short-term interest rates. Her reasoning was that by not raising rates now there is a fear that the Fed will need to raise rates rapidly in the future to fend off inflation.

While there are still many worries in the world, Trump’s message has pushed yields higher in the hopes of a better economy and less regulatory business environment. The jury is out on how this will unfold given that he doesn’t take office for another two months and new policies do take time to implement.

However, at the moment, the trend is not our friend, and interest rates, especially the long end of the bond curve, continue to march higher. We are biased toward locking in interest rates at this point, but do not see the 10-year Treasury Note rising above 2.500% in the near term, and we would not be surprised to see it settle in around 2.250% to 2.300%.

U.S. bond yields rose sharply in response to the unforeseen Trump presidency. The experts had predicted a Trump victory with 20% odds going into election night. While the initial reaction to the Trump presidency was a plunge in stock market futures and plummeting bond yields, both markets quickly turned around with stocks soaring to all-time highs and bond yields rising. The thought behind the rise in stocks and rise in bond yields is that a Trump presidency will be pro-business and that the pro-growth initiatives by his presidency will finally stimulate the economy, increase wages and increase inflation.

However, Trump’s fiscal stimulus initiatives have yet to be articulated. Until his vision is clear, we cannot discount the potential for volatile days ahead in the market. With continued displeasure over the poor growth results of monetary policy over the last several years, tighter monetary policy may be in our future. If so, expect to see interest rates rise, but still remain attractive. President-elect Trump’s stance on foreign policy, immigration, and trade remain a wild card. Yet, his rather gracious acceptance speech put markets at ease with his emphasis being on economic growth, jobs, and infrastructure spending.

With rates rising so dramatically this week, our posture is to cautiously float rates due to what some experts see as an overreaction to an unexpected outcome.

On a separate note, on this Veteran’s Day, we want to give pause and thanks to our military.

U.S. bonds traded flat to mildly positive in response to the closely watched monthly jobs report. The Labor Department reported that October non-farm payrolls rose by 161,000, lower than the 175,000 expected. To date, average job growth per month has been 181,000 new jobs created per month, which is well below the 229,000 new jobs per month created in 2015. The slowdown in job growth may be keeping interest rates in check as we head into the last days of the presidential election and the final two months of the year.

One area of concern regarding rising interest rates was the data within the jobs report confirming that hourly earnings rose by 0.4%, above the 0.3% expected. This rise in earnings is an inflationary indicator. If hourly earnings continue to rise, we could see wage-based inflation pick up and this would definitely put pressure on the Fed to hike rates down the road.

Based on historical measures out of the Federal Reserve, 5% has been the mark for full employment which is measured by the Unemployment Rate. The October Unemployment Rate fell to 4.9% from 5.0%, and the U-6 number, which measures total unemployment, fell to 9.5% from 9.7%, while the Labor Force Participation Rate edged lower to 62.8% in October from 62.9% in September, still a multi-decade low. These figures continue to improve, albeit ever so slowly, and based on current employment data, we would not be surprised to see a Fed rate hike this December.

With the Fed and the Jobs Report behind us, bonds have jumped over two hurdles. With the election coming Tuesday and bringing nothing but uncertainty, it remains wise to float as long as the 200-day Moving Average holds and the 10-year Treasury note remains under 1.800%.