July 22, 2014Daily Rates & Viewpoints From the Officers & Staff of TIB.

Higher Rates and the Ongoing Stimulus

Federal Reserve Chair Janet Yellen finished her second day of the semi-annual Humphrey Hawkins testimony last Wednesday before the House Services Financial Committee. The commentary focused on the prospect of higher rates and the ongoing stimulus. Essentially her comments were dovish, but she left herself an escape route to change her tune. She is generally regarded as more dovish than the committee as a whole. 

She began her remarks by saying, “The recovery is not yet complete and significant slack remains in the labor markets.” She repeated the line we have heard so many times from the Fed over the past several years, “A high degree of monetary policy accommodation remains appropriate.”   
She went on to say, “The Committee’s decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds target likely would occur sooner and be more rapid than currently envisioned.” 
This quote is almost verbatim from what she said at the end of the June FOMC meeting. So this certainly isn’t ground breaking, but at the next FOMC meeting at the end of July, the Committee will have the advance release of the second quarter GDP (although it will not have employment data). This is significant because of how bad the first quarter GDP turned out. If you remember, it came in at a whoping -2.9%, but the second quarter advance release is predicting a complete turn of +2.9%. However, I wouldn’t expect a change in rhetoric at the next meeting. At the September meeting, the Committee will have two thirds of the quarter’s data and it also coincides with when the Fed updates its' long term forecasts. The following is a direct quote from the prepared statement:
                Although the decline in GDP in the first quarter led to some downgrading of our growth projections for this year, I and other FOMC participants continue to anticipate that economic activity will expand at a moderate pace over the next several years, supported by accommodative monetary policy, a waning drag from fiscal policy, the lagged effects of higher home prices and equity values, and strengthening foreign growth. The Committee sees the projected pace of economic growth as sufficient to support ongoing improvement in the labor market with further job gains, and the unemployment rate is anticipated to continue to decline toward its longer-run sustainable level. Consistent with the anticipated further recovery in the labor market, and given that longer-term inflation expectations appear to be well anchored, we expect inflation to move back toward our 2 percent objective over coming years.
I think it’s reasonable to project second quarter of 2015 as a likely date for the Fed to start the tightening process, but to be clear, there are many things the Fed can do to tighten policy without increasing the Federal Funds rate. The yield curve seems to already be pricing in most of these comments way ahead of time, as it has flattened tremendously over the past 6 months. From August 2011 to August 2013, the two-year note averaged 26 basis points and since then, it has averaged 36 basis points and currently sits at 48 basis points. So the short end has already had a significant move up.
When considering your strategy for employing funds into your bond portfolio, consider the cost of staying in Fed Funds for twelve months.

David Terrell David Terrell
First Vice President, TIB Capital Markets

Market Levels @ 7:21 AM CDT

TIB Fed Funds & MMDA Rates - Previous Day
Agent 0.20% Prin 0.05% MMDA 0.30%
STAR Prin 0.10% STAR MMDA 0.35%
Key Indices/Commodities
1 - Month LIBOR 0.15% Dow Jones 17051.73
3 - Month LIBOR 0.23% NASDAQ 100 4424.70
1-Yr LIBOR 0.55% S&P 500 1973.60
1-Yr CMT 0.11% Spot Gold 1309.00
Prime 3.25% Spot Silver 20.76
3-yr LIBOR Swap/Offer 1.14% Spot Crude Oil 104.98
5-yr LIBOR Swap/Offer 1.81% CRB Index 298.69
3 Mo - Fed Fund Futures 0.1% 6 Mo - Fed Fund Futures 0.12%
US Treasury Yields US Non-Callable Agency Yields
Yield Maturity Yield Spread
0.00% 90 - Days    
0.00% 180 - Days    
0.44% 2 - Year 0.45% 1bp
0.95% 3 - Year 0.92% 3bp
1.66% 5 - Year 1.73% 7bp
2.46% 10 - Year 2.95% 49bp
3.27% 30 - Year    
202 BPs Yield Curve(2's-10's)
Sample 1x Callable Agency Issues
Description Call Date YTC YTM
FNMA 1.05 08/15/17 8/16 1.05% 1.05%
Select MBS Levels
Description Coupon Yield Spread/Duration*
15-Yr FNMA 3.00% 2.26% 44 / 5.03
30-Yr GNMA 3.50% 2.88% 69 / 6.17
*Duration @ 12 month Historical CPR
Morning Commentary: Reed Bateman

Consumer prices increased month-over-month by 0.3% in June, in line with forecasts and down slightly from May.  Excluding food and energy prices, or core CPI, prices increased by 0.1%, which was half as much as forecast and illustrates just how much energy costs are affecting overall prices.  That said, the price of gasoline has fallen since the end of June, from $3.68 to $3.57.  Janet Yellen spoke of recent increases in consumer prices as only being temporary, and this morning’s report would suggest that.  Treasury prices have rallied on the news, but are flat from yesterday’s close as we sold off overnight.  Not that any of us are terribly interested in the long bond at this point, but the 30-year Treasury bond closed yesterday below its 2014 rate low of 3.29%.  Since the beginning of the year, we’ve seen the 2’s to 10’s Treasury spread fall from 265 basis points (very steep) to 200 basis points (125 is long term average), and not surprisingly, we’ve seen the 2’s to 30’s Treasury spread fall even farther, from 360 basis points to 280 basis points today.  The curve will likely continue to flatten until we’re well into the 4th quarter, when QE will likely wind down and we’ll have more GDP and inflation data for the Fed to digest. 

Information contained herein is based on sources we believe to be reliable but its accuracy is not guaranteed. Customers should rely on their own outside counsel or accounting firm for specific circumstances. The securities, yields or levels discussed herein are for illustration purposes and are not guaranteed, not obligations of any bank, thrift or other entity and are not insured by the FDIC.

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