When interest rates get whipsawed the way they have in the last couple of weeks, we believe some explanation is necessary. First and foremost, we don’t believe it is one particular issue but instead, a lot of balls in the air at the same time that are creating uncertainty. China, Europe, Brexit, Iran and political infighting all play a piece in falling interest rates. However, the China trade talks have undeniably been the catalyst that put us in this interest rate tail-spin.
China’s unwillingness to admit or change their mindset on theft proves to be a sticking point in any negotiations. Coming to an agreement that doesn’t fundamentally change the way China views our intellectual property would not be worth the paper it is written on. It looks as though the U.S. is finally sticking together on both sides of the aisle to rectify this situation. When the extreme ends of both U.S. parties are on the same side, it becomes a unified issue worth fighting for. This unification makes it more likely to be a long drawn out process that America thinks it can win.
Given this, the market has totally eliminated any Fed rate hike for the foreseeable future and has now actually priced in an ease by year-end. The market is now pricing in a 70 percent of a 32-basis point ease by year-end, which seems a bit aggressive given the strength of the U.S. economy, but it’s there nonetheless.
The result of this thinking has been a flight to safety in U.S. Treasuries that has brought some issues to a 12-month low. In fact, the 2-year Treasury at 2.14 percent is back to levels we haven’t seen since the beginning of 2018 and the 10-year Treasury has fallen to 2.35 percent, which is a 14-month low. When the 10-year and the overnight money market funds yield the same amount, you better be extremely confident the market is correct when you go out the curve.
At this point, we believe the market may have gotten in front of itself and swung the pendulum too far the other way with anticipation of lower rates. Staying short and waiting out the interest rate decline seems to be the prudent move at this moment until rates again “normalize.”