After touching a high of 1.75% this week, the 10-year US Treasury yield retreated in response to the closely watched employment report, which came in under expectations. There were 156,000 new jobs created, which was below the 176,000 expected. The unemployment rate nudged up to 5.00% from 4.90%. Some positives in the report related to the increase in the Labor Force Participation Rate (LFPR) and a small increase in wages.

With employment being one of the two mandates of Federal Reserve (the other mandate being inflation), a closer look at the LFPR illustrates one reason the Fed has been slow to raise interest rates. Currently, there are 94 million people out of the labor force. This is a huge number and represents those who are either no longer working such as retirees, and/or those who have given up on full-time employment.

However, given the “OK” employment report, the financial experts are saying there is a more than 60% chance of a rate hike of .25% by the end of the year.

At the moment, we are carefully watching the 10-year Treasury yield. If we see yields hovering just above 1.75%, we could see rates drift higher. Therefore, we remain agnostic on where interest rates may trend and we can foresee that rates may go either higher or lower.

U.S. Treasuries and mortgage bonds closed in the red on Friday with yields worsening in response to some consumer reports that suggested inflation had increased a touch. August Core Personal Consumption (PCE), which strips out food and energy, rose 0.2%, up from 0.1% in July. Core PCE, the inflationary indicator favored by the Fed, increased from 1.60% to 1.70%. The Fed would like to see core inflation at 2.00% or higher. Further pressuring bonds was a very strong day on Wall Street with equities across the board trading nicely. Oil also had a good week of trading. Oil closed the week up trading over $48 per barrel.

As we enter the fourth quarter 2016, it will be interesting to see where rates head. There are many political and economic factors to think about: U.S. election, Japanese deflation, central bank easing, oil, low rates, etc. Based on this week’s trading, we continue to remain cautious and are biased toward locking in rates in the face of so much uncertainty.

This past week, we’ve observed ongoing dovish commentary from both the Japanese Central Bank and the United States Federal Reserve. Japan initiated the rally towards lower bond yields with its dovish statements including an announcement that it will target a zero rate 10-year government bond and negative interest rates on short term bonds to combat deflation. Here in the U.S., our central bankers punted on raising short term interest rates even though there were three dissension votes on this decision.

The decision to keep rates steady was based on continued anemic long term growth forecasts, mild inflation, and low wage growth. However, the Fed did leave open the possibility of increased rates later this year. With two Fed meetings remaining in the year, the odds of a rate increase on the short term lending rates is 60%. Some on Wall Street are beginning to become concerned that “low rates for longer” could create unforeseen bubbles in certain asset prices. We would not be surprised to see the Fed raise short term rates by ¼% before the end of 2016.

As of the time of this writing, we are cautiously biased toward locking in interest rates as has been our opinion for quite some time.

The Consumer Price Index (CPI) was stronger for August and beat expectations by rising .2% month over month. Rising CPI indicators are inflationary and increase the likelihood of increasing bond and mortgage yields. Core CPI, which excludes the impact of food and energy, also came in above expectations.

The above inflation numbers will put additional pressure on the Federal Reserve to give strong consideration to raising short term interest rates by the end of the year.

With core CPI running at a 2.30% annualized rate and with the unemployment rate below 5%, there are calls from prominent Wall Street veterans such as Jamie Diamond of JP Morgan to increase short-term lending rates by year’s end. With this in mind, we remain mindful that the 10-year Treasury Note is still at a very attractive sub 1.750% and locking in interest rates in the face of the inflationary data is a prudent decision. However, given the poor state of the global economy, lowered interest rates would not surprise us. In summary, the world is very complicated from a macro level.

The big news this week was a surprise Fed speech by Fed Governor Lael Brainard who is wildly considered the Fed’s most dovish official. These comments Friday morning, which surprised both the bond and equities market, resulted in a heavy sell-off in U.S. equities, as well as an increase in bond yields. With the world economies addicted to extraordinarily low yields, Friday was a perfect example of how sensitive our markets are to low interest rates and how volatile the markets may become if the Fed raises interest rates near term.

From abroad, a less dovish stance by the European Central Bank put further pressure on bond yields.

Economic reports remain mixed, so there will be a lot of discussion over the coming days as to what matrices the Fed Reserve is studying in deciding future rate movements.  The Fed’s mandate is to support maximum employment and inflation. Based on these two indicators, one could argue that a rate hike is warranted.  However, with the global economies so intertwined, one could also argue there’s a need to keep rates low for longer.

Given the spike in the 10-year Treasury yield from 1.500% to a Friday close of 1.67%, we are biased toward locking in loans. The next couple of weeks could be very volatile from both political and economic standpoints.

As with each new month, all eyes were on the August Jobs Report, which came in lower than expected with 151,000 new jobs created versus expectations of 180,000 new jobs. The unemployment rate remained at 4.90% and the Labor Force Participation (the amount of people actually in the labor force as % of population) held steady at 62.80%.

This probably means no rate hike announcement at the next Fed meeting. One wonders how many more times the Fed will talk up a rate hike only to be disappointed by a lackluster economic report.

With the 10-year U.S. Treasury Bond trading a touch above 1.600%, we are biased toward floating interest rates at these levels ever so cautiously.

Have a great Labor Day Weekend!

Not much to report on this week with respect to economic news. The one headline that caught some attention was the diverging opinions within the Federal Reserve concerning the timing of a rate increase. There appears to be no clear message out of the Fed as to what will be the trigger for an increase in interest rates. The bond market had a muted response to the Fed Minutes as bonds are mildly off their lows from earlier in the week and fell range bound (1.500% to 1.600% on the 10-year U.S. Treasury note).

When it is all said and done, bond yields are all about inflation and economic data. We see little inflation at the moment (although WTI oil traded up $4 this week to barely over $48.00 per barrel) and we are keenly aware of the global economic troubles that are abound.

It sure feels like a goldilocks scenario with the market being stoked by low-to-negative interest rates, slow growth, and low inflation. That said, new highs were hit this week for the troika of the stock indexes. The U.S. 10-year Treasury closed at a touch under 1.500%.

The ongoing benefits of massive global central bank stimulus include low debt in all sectors, including mortgages. As low as interest rates are in the United States, we may see interest rates go lower especially when considering 10-year Italian Treasury bonds are trading for .500%, a full percentage point lower than U.S. government debt. Go figure.

The downside to low rates is bank margin compression. That is one reason why we continue to remain biased toward locking in interest rates at these levels.