Baker Market Update – wk220506

Here in the great plains, the month of May is traditionally considered “storm season” when the likelihood of tornados and severe weather is at its height. The first week of the month has also been volatile and stormy for financial markets. Indeed, it seems none have been spared. Stocks, bonds, gold… every asset class got hit hard at some point this week. To be sure, the trade-weighted dollar remains strong as an ox as it sits at 20-year highs, but assets denominated in the dollar (or any other currency for that matter) have gotten clocked. Remember, though, that nothing moves in a straight line. Volatility has been the word for the week as comments from the Fed chairman on Wednesday at first triggered a massive rally in both stocks and bonds, pushing the 10yr T-Note yield down below 2.90%, only to see a complete reversal of all that price action the next day, plus some. So what gives?

As the Fed strives to impress upon markets their seriousness in fighting inflation, the magnitude of their task is becoming more apparent. In their zest to get the fed funds rate to neutral (considered 2.5%-projected) or higher, they run the very real risk of choking the growth out of the economy and sending us into recession. The worst case would be a 1970’s-style period of “stagflation”. Historical reminder: As Fed Chairman, Paul Volker successfully crushed inflation during this period, but not without some pain. The level of the S&P 500 Index at the trough of the 1982 recession was about where it had been in 1976. Food for thought indeed. And this time around, there’s a gigantic Fed balance sheet that needs to be deflated. Storm season may be with us for a while.

The big data release for the week was this morning’s jobs report. On its face, the April employment report doesn’t rock anybody’s world… payrolls up 428K vs 380K projected, average hourly earnings YOY 5.5% vs 5.6% last month, and the UE rate remained at 3.6%. So at first glance we see slightly better payrolls growth and slightly less wage inflation than expected. There was an interesting downtick in labor force participation to 62.2% from 62.4% prior which feeds the narrative that the labor market continues to adjust to a post-pandemic world where labor supply is a major issue and the wide gulf between job openings and hires remains a head-scratcher. This keeps intact the fear that continuing (or resuming) upward pressure on wages will persist making the Fed’s job even more treacherous.

So, as we approach the weekend, we see the 10yr T-Note sitting at a lofty 3.10%. The range between 3.0 and 3.25% should serve as key yield resistance, but if we punch through 3.25%, it will bring us to the highest level in eleven years. We’ve also seen the yield curve steepen. The 2s / 10s yield spread is now out to 4bps, a notable difference from the inversion we had at the first of last month. More recession indicators (like the yield curve inversion) are starting to flash warning signs. The downdraft in financial markets may simply be adjusting to, and embracing the reality of an aggressive Fed. Bonds have led the way as the jump in yields has been rapid and substantial already. The wall clouds are forming, watch for rotation.

US Labor Force Participation: 2005 – Today
Prime-Age (solid line) and 55+ (dotted line)

Baker Market Update – wk220429

Stocks are weaker, the dollar is soaring, and bonds continue to range-trade as this week nears an end. The futures market is priced for a near 3% fed funds rate one year from now as policymakers stumble over themselves to telegraph how hawkish they are. Meanwhile, the Bureau of Economic Analysis reported yesterday that the US economy did not grow in the first quarter of this year, but rather it contracted by 1.4%. Many analysts shrugged off the report by pointing to the fact that most of the decline was attributable to net exports and the drawdown of inventories which had previously become bloated. Still, there is a reason that those components feed into the number and it is too early to suggest that these are temporary or one-off factors. The export sector in particular can be expected to suffer additional damage going forward from the strong dollar. Moreover, earnings of overseas operations for US corporations will be negatively impacted by the currency conversion if the greenback maintains its mojo.

There is an argument convincingly made by Dave Rosenberg of Rosenberg Research that we are much closer to recession than commonly thought, and that the Fed is likely to overplay their hand on tightening… something they historically and characteristically tend to do. An asset price bubble fueled by Fed ease and Treasury stimulus over the last two years has reached extremes that will be difficult to sustain much longer in the face of aggressive tightening. Fed Chairman Jerome Powell, singing the praises of his predecessor Paul Volcker, is determined to squash inflation rates that currently exceed 8.5%. That involves demand destruction at a time when real personal income is falling due to the sudden cessation of fiscal stimulus this year. As noted by Rosenberg, Fed tightening cycles are always followed by some sort of crisis. If not recession, a bubble burst of some sort may be on the menu. And if that happens, look for a safe-haven trade into the Treasury market.

The Fed is expected to hike its policy rate by 50 basis points and launch quantitative tightening at next week’s FOMC meeting. We will also see from the labor department how the job market performed in April. Most analysts expect a healthy 375,000 new payrolls were created. Next week will also see the release of manufacturing and trade data as well as construction spending and factory orders.

Baker Market Update – wk220422

Bond yields continued to march higher this week as Fed Chairman Jerome Powell reinforced expectations of aggressive tightening policy including a likely 50bps hike at the next FOMC meeting. Futures markets now project a fed funds rate of nearly 3.00% one year from now. Speaking on a panel with other central bankers, Powell said he sees it as appropriate to move more quickly and suggested that “front-end loading” the pace of rate hikes was a good idea. This follows earlier comments along the same lines from his colleagues on the FOMC. Treasury yields across the maturity spectrum drifted higher on the week as maturities from five years out traded above 3% at times during the week. As we approach the weekend, 10-year is trading around 2.90%, and the spread between 2-year and 10-year T-Notes hovered around 16bps.

The other component of the Fed’s tightening campaign is their intention to reduce the size of their balance sheet beginning next month. Formally announced plans call for a reduction of $95 billion a month in MBS and Treasury holdings. The effect on MBS is expected to be ambiguous depending on coupon and structure. The specific MBS-types held by the Fed will, of course, be affected, but others may perform quite well as the net supply of securities this year will be far less than originally forecast. In any case, much of what the Fed has telegraphed has already been priced-into markets.

Another point of focus for the Fed right now is the very tight US labor market. At 3.6%, the unemployment rate is near a 50-year low, and worker shortages in key sectors are putting upward pressure on wage inflation. Average hourly earnings YOY through March are clipping along at a pace of 6.7%, feeding concerns about a wage-price spiral and the risk that expectations of high and rising inflation could become embedded into decision-making of businesses and households. In his remarks, Powell referenced Paul Volker, his predecessor who squashed the double-digit inflation of the late-1970s with aggressive rate hikes and clarity in communication to the market, saying that Volker understood the critical importance of “dismantling the public’s belief that elevated inflation was an unfortunate, but immutable, fact of life.” The risk, as is well-known, is that this cure for the inflation problem involves some painful economic weakness. It’s a difficult balancing act indeed, but the Fed has no choice. The massive and unprecedented fiscal and monetary stimulus that was injected into the economy over the last two years, coupled with continuing supply chain sclerosis, has now caused a massive imbalance between aggregate supply and demand. And the Fed runs the greater risk of moving to slowly and allowing inflation to continue erosion of real wages, earnings, and returns on investment.

The economic data released this week included monthly numbers on housing starts and building permits, as well as existing home sales. All of these numbers came in stronger than expected (or less-weak than expected in the case of existing home sales). The “Philly Fed” manufacturing index was reported to be a touch lower than estimated, and Leading Economic Indicators was right on the screws at +0.3%, or 6.9% YOY, continuing a year-long downtrend. Next week we can look for fresh data on capital expenditures, consumer sentiment, and new home sales among other things.

US Federal Funds Futures Projections

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Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

*The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc.

For More Information

Jeffrey F. Caughron

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The Baker Group LP
jcaughron@GoBaker.com
800.937.2257

INTENDED FOR USE BY INSTITUTIONAL INVESTORS ONLY. Any data provided herein is for informational purposes only and is intended solely for the private use of the reader. Although information contained herein is believed to be from reliable sources, The Baker Group LP does not guarantee its completeness or accuracy. Opinions constitute our judgment and are subject to change without notice. The instruments and strategies discussed here may fluctuate in price or value and may not be suitable for all investors; any doubt should be discussed with a Baker representative. Past performance is not indicative of future results. Changes in rates may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

Baker Market Update – wk220408

One month ago, it cost the US Treasury 1.85% to borrow money for ten years. Now that cost is 2.69%, an 84bps difference. The increase for a two-year maturity has been even greater. The magnitude of this year’s rise in bond yields is profound no matter how you look at it. Even the sharp increase in 1994, an infamous year for the bond market, wasn’t quite as painful in as short a period of time. The good news is that for investment officers with money to spend, it’s a very welcome opportunity to put higher yields into the bond portfolio and boost earnings.

The first quarter chaos is largely due to the Fed’s scrambled attempt to get back in front of the market after failing woefully to acknowledge the sustainability of the current decades-high rates of inflation. Now they’re walking a tightrope and hoping to keep hold of the baby while ditching the bathwater. The minutes from the March FOMC meeting, as well as a parade of Fed officials, are reinforcing their commitment to aggressively tighter policy. Market sentiment as evidenced by the flat-to-inverted yield curve is flashing some early warning signs of recession at some point, but the timing is tricky. Futures markets at last check were calculating a 2.55% “implied” rate for Fed Funds by the end of the year, and the spread between 2yr and 10yr T-Note yields has ranged between -2bps and 20bps in recent sessions. A slight re-steepening of the curve that took place after release of the minutes can be viewed as quiet applause for the Fed’s newfound seriousness.

Among Fed speakers this week, James Bullard was again the alpha-hawk, bluntly stating that the Fed was behind in its mission to get an “exceptionally high” rate of inflation under control and suggesting that they’ll need to move “forthrightly” in order to get to the “right level” to deal with it. For him, that means a Fed Funds rate above 3%. Several policymakers favored a more aggressive interest rate hike in March (rather than the 25bps they did) to kick off a series of increases this year, but the FOMC held off due to uncertainty regarding the war in Ukraine. Fed Chair Powell said later that nothing would keep them from hiking rates by 50bps in coming meetings if that was deemed appropriate. Markets seem to be building-in that expectation.

Another key takeaway from the minutes is that they plan to begin balance sheet reduction or Quantitative Tightening (QT) as soon as the May meeting. That is welcome news to those of us concerned about market distortions and artificial asset price bubbles from a Fed balance sheet that now approaches $9 trillion. The QT process introduces potential complications for reserves targeting. They’ve created an asset/liability mismatch for themselves by buying assets further out on the maturity spectrum, funded by the creation of bank reserves. Reversing that won’t be easy. Stay tuned.

The data this week was relatively light: factory orders, durable goods, and manufacturing activity came in largely as expected. Next week promises to be more exciting as we’ll get data for inflation, retail sales, and consumer sentiment among other things. And next Friday will be a Good Friday indeed.

Federal Reserve Balance Sheet: 2005 – Today

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The Baker Group is one of the nation’s largest independently owned securities firms specializing in investment portfolio management for community financial institutions.

Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

*The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc.

For More Information

Jeffrey F. Caughron

Chairman of the Board
The Baker Group LP
jcaughron@GoBaker.com
800.937.2257

INTENDED FOR USE BY INSTITUTIONAL INVESTORS ONLY. Any data provided herein is for informational purposes only and is intended solely for the private use of the reader. Although information contained herein is believed to be from reliable sources, The Baker Group LP does not guarantee its completeness or accuracy. Opinions constitute our judgment and are subject to change without notice. The instruments and strategies discussed here may fluctuate in price or value and may not be suitable for all investors; any doubt should be discussed with a Baker representative. Past performance is not indicative of future results. Changes in rates may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

Baker Market Update – wk220325

The equinox has come and gone and the end of the first quarter is near. And boy what a quarter it’s been. If lingering COVID effects were our only worry, life would be pretty good. But soaring inflation, now exacerbated by a commodities price surge courtesy of the war in Ukraine, has focused a spotlight on an aggressive shift in Fed policy and the consequent impact on markets. Policymakers lifted the fed funds rate by a quarter of a percent last week and announced the intention to reduce the size of their balance sheet sooner rather than later. The Fed Chairman subsequently emphasized the need to move “expeditiously” and act more aggressively going forward if necessary. As to market behavior, it’s been well-noted that the yield curve, particularly the maturity spectrum past two years, has shifted higher and flattened or inverted in response. It’s a moving target to be sure, but right now the sentiment that’s built into current bond yields reflects the expectation of an eventual fed funds rate of around 2.50% one year from now, a level many would view as a return to “neutral”. We’ll see if that actually plays out.

The Fed appears quite confident that the US economy can withstand a quick and decisive ratcheting-up in the cost of money to households and businesses. Indeed, that sudden upward jolt in the cost of borrowing will come right as the beneficial effects of massive fiscal stimulus fades as well. No more stimulus checks, enhanced unemployment benefits or PPP loans. And now, the cost of short-term borrowing is expected to go up tenfold. Demand destruction indeed. Not that it isn’t the right medicine for painful and persistent inflation, especially when there’s concern about inflationary psychology taking hold and driving economic behavior and decision-making. The cost of success in taming inflation, however, may well be recession, and that’s part of the explanation for the quickly flattening curve. If the economy weakens too much, the tightening process could be derailed early. As Atlanta Fed President Bostic said “The risks go both ways. Should demand falter in the face of economic uncertainty or removal of monetary policy accommodation, then the appropriate path may be shallower than currently projected”. Others on the FOMC, like James Bullard of the St. Louis Bank, are encouraging a “damn the torpedoes, full speed ahead” approach, arguing that the faster we get to restrictive policy, the better off we’ll be. All are hoping for the proverbial soft landing. Fingers are crossed.

The economic data this week showed slower new home sales and weaker capital goods orders versus expectations. Consumer sentiment was a touch weaker than estimates as well. The weekly labor market statistics, however, continued to shine. Continuing Jobless Claims are now at a multi-decade low, further evidence that the Fed is correct to focus on tightness in the labor market, and maintain their inflation-fighting diligence.

US Continuing Claims for Unemployment Insurance

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The Baker Group is one of the nation’s largest independently owned securities firms specializing in investment portfolio management for community financial institutions.

Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

*The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc.

For More Information

Jeffrey F. Caughron

Chairman of the Board
The Baker Group LP
jcaughron@GoBaker.com
800.937.2257

INTENDED FOR USE BY INSTITUTIONAL INVESTORS ONLY. Any data provided herein is for informational purposes only and is intended solely for the private use of the reader. Although information contained herein is believed to be from reliable sources, The Baker Group LP does not guarantee its completeness or accuracy. Opinions constitute our judgment and are subject to change without notice. The instruments and strategies discussed here may fluctuate in price or value and may not be suitable for all investors; any doubt should be discussed with a Baker representative. Past performance is not indicative of future results. Changes in rates may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

Baker Market Update – wk220318

This week March Madness arrived in every sense of the word. The ongoing war in Ukraine continues to send shockwaves through the world, including profound effects on financial, foreign exchange and commodities markets. In the midst of that angst, the Fed began a tightening campaign that’s been well telegraphed to markets, and is expected to be the most aggressive in a decade and a half at least. On Wednesday the Fed lifted the Funds rate by 25bps in the first of what is currently expected to be six or seven hikes over the next year, accompanied by a steady reduction of the Feds balance sheet which may begin as soon as this spring. The bond market, always discounting future events, has very quickly priced-in the anticipated tightening. So much so that the yield curve has flattened dramatically to the point where much of the curve is already flat as a pancake at yield levels undulating in a range of 2 – 2.15% as we approach the weekend. The closely-watched yield spread between 2s and 10s is now inside of 18bps. It seems the move communicated by the Fed’s guidance is well baked into the cake already.

Market prices on any given day are a reflection of the discounting future events, but it’s notable how quickly the bond market has adjusted to Fed policy expectations. The math of current yields tells us what the market expects at different points in the future… the so called “forward yield curve.” It’s a moving target to be sure, but today it projects that one year from now the 2yr yield will be 10-20 basis points higher than the 10yr… the sort of inversion that almost always precedes recession.

So, it seems that the market has already made a 1994-type of move… a massive jump in yields in anticipation of a process that the Fed has just barely begun. It leads some to question whether the Fed will actually be able to achieve what they propose. It may well be the case that they will get halfway through the process and find that economic weakness is coming on faster and more intensely than they had expected. Remember too that the gigantic multi-tiered fiscal stimulus that was pumped into household and corporate balance sheets for two-year has also ended. The one-two punch of aggressive and simultaneous monetary and fiscal policy tightening could choke the growth out of the economy and send it into recession, putting an end to rate hikes earlier than expected. All of this is worth considering, but markets cannot and will not ignore the ongoing threat of sustained inflation, particularly concern about the psychology of inflation becoming embedded into economic decision-making. This is why the Fed’s aggressive stance remains the right message and the right plan of action. From that standpoint Paul Volker would be proud. Still, if the inflationary psychology can be kept at bay, and the supply-side bottlenecks and transport issues resolved, the Fed may find that the demand destruction of six or seven rate hikes is more than the economy can stomach. Time will tell.

The economic data released this week was nothing so exciting as to sway the Fed from their task. Jobless claims continued to show improvement in the labor market, core producer prices were lower than expected on a year-over-year basis, the key measure of retail sales was unexpectedly weak, and existing home sales faded more than estimates. But all-told, no great shakes from the data. Next week we’ll see how new home sales, durable goods and capital expenditures are trending, along with news on consumer sentiment.

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The Baker Group is one of the nation’s largest independently owned securities firms specializing in investment portfolio management for community financial institutions.

Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

*The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc.

For More Information

Jeffrey F. Caughron

Chairman of the Board
The Baker Group LP
jcaughron@GoBaker.com
800.937.2257

INTENDED FOR USE BY INSTITUTIONAL INVESTORS ONLY. Any data provided herein is for informational purposes only and is intended solely for the private use of the reader. Although information contained herein is believed to be from reliable sources, The Baker Group LP does not guarantee its completeness or accuracy. Opinions constitute our judgment and are subject to change without notice. The instruments and strategies discussed here may fluctuate in price or value and may not be suitable for all investors; any doubt should be discussed with a Baker representative. Past performance is not indicative of future results. Changes in rates may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

Baker Market Update – wk220304

Markets have a lot to digest this week, but geopolitics is front and center. It’s hard to know exactly how the situation in Ukraine will play out, but for now it’s extremely dangerous and that fact is being reflected in financial markets behavior. The news last night that Russian invasion forces had attacked and seized Europe’s biggest nuclear power plant sent shockwaves throughout the globe, pushed money into safe haven assets like gold and US Treasuries, and triggered a massive surge in commodities prices. Catastrophe was avoided for now, but the event raises fears of what may come next in the conflict. Meanwhile, Fed Chairman Powell testified to both houses of Congress this week, largely reiterating his intention to stay on task and begin removing stimulus with a liftoff at the end of the month. Powell said he’s inclined to start with a 25bps hike and make several additional moves as the year progresses. In light of the geopolitical situation, he stressed that they would be “nimble” and base their decisions on data and conditions as they develop. Post-testimony, markets anticipate a total of five 25bps rate hikes this year, then possibly two more in 2023. As the price of crude oil soars well above $110 a barrel, consumer prices will remain elevated for longer than previously expected, but the Fed also needs to be mindful of the potential negative impact on the real economy. It’s a real tough situation for Powell and the FOMC. They cannot ignore inflation, but the steadily flattening yield curve is flashing a clear warning to the Fed that if they move too fast, they’ll derail economic growth and potentially risk a recession. Right now, the 10yr T-Note yield sits at 1.74% and the 2yr at 1.45%… a 29bps spread.

This morning the labor department released a stronger than expected jobs report showing a 678K gain in non-farm payrolls, upward revisions to prior months, a larger than expected drop in the unemployment rate to 3.8%, and signs of moderating wage inflation. All of this has to be welcome to the Fed, especially the wage data which showed the annual rate dropping to 5.1% from 5.7%. The composition of payrolls gains was broad based, so most of the deceleration appears to reflect a genuine easing of pay pressures. The labor force participation rate ticked up a bit higher than expected, and survey data suggests that labor shortages may be levelling off. All good news for the Fed. Earlier in the week we got a stream of data including ISM manufacturing, durable goods orders, and capital expenditures, all of which came in largely as expected. Next week we’ll see the latest release of consumer price inflation and consumer sentiment data among other things. The NCAA basketball tournament won’t start for a couple of weeks. Meanwhile, March Madness simply describes a certain Russian dictator.

Crude Oil Futures: 2021 – Today

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The Baker Group is one of the nation’s largest independently owned securities firms specializing in investment portfolio management for community financial institutions.

Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

*The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc.

For More Information

Jeffrey F. Caughron

Chairman of the Board
The Baker Group LP
jcaughron@GoBaker.com
800.937.2257

INTENDED FOR USE BY INSTITUTIONAL INVESTORS ONLY. Any data provided herein is for informational purposes only and is intended solely for the private use of the reader. Although information contained herein is believed to be from reliable sources, The Baker Group LP does not guarantee its completeness or accuracy. Opinions constitute our judgment and are subject to change without notice. The instruments and strategies discussed here may fluctuate in price or value and may not be suitable for all investors; any doubt should be discussed with a Baker representative. Past performance is not indicative of future results. Changes in rates may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

Baker Market Update – wk220225

Financial markets were roiled this week by the Russian invasion of Ukraine. Rather than a limited incursion in the eastern region of the country a broad-based invasion was launched into all of Ukraine, triggering volatile selloffs in risk assets and forcing money into safe havens like US Treasuries and gold. Energy and commodity markets soared, with oil prices briefly surpassing $100 a barrel Thursday. As we approach the weekend Russian troops were threatening the capital, Kyiv.

Treasury prices jumped sharply on the flight to quality, bringing the 10yr T-Note’s intraday yield down to 1.84%, 22bps below the recent high of 2.06% established last week. It has subsequently traded back up toward 2%. Volatility is the word of the week, and there are now legitimate questions about whether and to what degree the Ukrainian mess might change the Fed’s calculus regarding rate hikes and policy stance. Some policymakers like Christopher Waller believe the Fed should remain focused on the data stream rather than geopolitics. He has no problem with a 50bps hike in March if the inflation readings continue to come in hot. Cleveland Fed President Mester acknowledged that the unfolding situation in Ukraine will be a consideration in determining the pace at which to remove accommodation, saying “time will tell whether Ukraine changes the outlook for policy”. But Atlanta bank President Bostic suggested that “we continue with our liftoff plan” if numbers come in close to what’s expected. The inflation situation is compounded by the war-related jump in energy costs which could push headline inflation even higher than its already-elevated levels. Expect the Fed to stay the course and start normalizing policy in March as planned… but a 50bps move is probably less likely now.

The yield curve has flattened even further in the wake of Ukraine. The yield spread between 2s and 10s is now inside of 38bps, the lowest level since April 2020 when the COVID pandemic was just getting started. Persistent curve flattening will be on the Fed’s radar as an indicator of slower growth coming down the pipe and raising the specter of stagflation if price increases don’t settle down.

Lost in the shuffle of war news was the drumbeat of positive economic data. The Case Shiller home price index rose 18.5% YoY, the purchasing manager’s index for both manufacturing and services beat expectations along with consumer confidence, personal spending, durable goods, and capital expenditures. The Fed’s preferred measure of inflation came in at 5.2% as expected. That level is the highest it’s been since Ronald Reagan was President and Vladimir Putin was a young KGB agent in training.

US 10yr vs 2yr T-Note Yield Spread

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The Baker Group is one of the nation’s largest independently owned securities firms specializing in investment portfolio management for community financial institutions.

Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

*The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc.

For More Information

Jeffrey F. Caughron

Chairman of the Board
The Baker Group LP
jcaughron@GoBaker.com
800.937.2257

INTENDED FOR USE BY INSTITUTIONAL INVESTORS ONLY. Any data provided herein is for informational purposes only and is intended solely for the private use of the reader. Although information contained herein is believed to be from reliable sources, The Baker Group LP does not guarantee its completeness or accuracy. Opinions constitute our judgment and are subject to change without notice. The instruments and strategies discussed here may fluctuate in price or value and may not be suitable for all investors; any doubt should be discussed with a Baker representative. Past performance is not indicative of future results. Changes in rates may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

Baker Market Update – wk220204

If you thought the transition into 2022 was volatile for the bond market, hold on to your hat because the hits keep coming. The sustained upside inflation data from supply shocks, which was well noted last month by the newly aggressive Fed, has now been bolstered by a stunning upside surprise from the January employment report. The US economy created 467K new non-farm payrolls when the consensus estimate was for just 125K. Participation in the labor force jumped unexpectedly by three-tenths of a percent, so the unemployment rate ticked back up to 4.0%… as we now have a larger denominator (size of the labor force) in the equation. This is all good news for the jobs market. Notably, average hourly earnings popped up a healthy annualized rate of 5.7% which is a .8% higher than the prior month. There were also some stunning revisions to prior month levels of job creation. The outsized magnitude of those revisions (November job growth, for example, was revised from 249K to 647K) was partly a function of the annual baseline and benchmark revisions done by the Bureau of Labor Statistics. This year, the benchmark revisions were substantial due to pandemic related noise. Either way, the jobs report was an upside stunner which gives the Fed a green light for tapering, rate hikes, and quantitative tightening as they see fit. It also fuels talk of a 50bps move to put an exclamation point on the Fed’s seriousness. But let’s not get carried away. This is one report pulled from a statistical morass of data with huge COVID-related revisions.

The yield on the 10yr T-Note is now above 1.90% for the first time since the pre-pandemic days of 2019. The 2yr yield is now around 1.30%, pushing the 2s / 10s spread to 60bps… almost 100bps tighter than last March. This flattening of the yield curve will be closely watched by the Fed. If it continues to flatten and/or starts to threaten inversion later this year, that could give the Fed pause as it typically portends economic weakness coming down the pipe. Right now, the forward yield curve is calculating that one year from today we’ll see a 2yr Treasury yield of 1.87% and a 10yr yield of 2.11%. But that’s just based on the math of today’s price action. It can and will change with every new development.

To be sure, there was other economic data this week. The ISM manufacturing report came in mostly as expected but the price component was a little hot. The JOLTS labor turnover report continued the pandemic trend of more openings vs fewer hires, and durable goods and capital expenditures were largely as expected. A healthy increase in labor force productivity kept unit labor costs in check… which is good news on the inflation front. Next week we’ll see a heavy calendar of Treasury auctions along with data on retail sales, housing and producer prices among other things. Hopefully the frozen parts of the country will thaw out, and Team USA will do us proud in the Olympics.

US 10yr Treasury Yield: Jan 28 – Today

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The Baker Group is one of the nation’s largest independently owned securities firms specializing in investment portfolio management for community financial institutions.

Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

*The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc.

For More Information

Jeffrey F. Caughron

Chairman of the Board
The Baker Group LP
jcaughron@GoBaker.com
800.937.2257

INTENDED FOR USE BY INSTITUTIONAL INVESTORS ONLY. Any data provided herein is for informational purposes only and is intended solely for the private use of the reader. Although information contained herein is believed to be from reliable sources, The Baker Group LP does not guarantee its completeness or accuracy. Opinions constitute our judgment and are subject to change without notice. The instruments and strategies discussed here may fluctuate in price or value and may not be suitable for all investors; any doubt should be discussed with a Baker representative. Past performance is not indicative of future results. Changes in rates may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.