Calm Before Chaos

It’s been quite a tug-of-war of late. After the late-February spike in yields, Treasury bonds seemed to catch some air as stock investors shed some risk.

Last month, the yield on the long-term Treasury hit a high of 3.23%. By last week, yields had fallen to 3.09%. That’s not so surprising, given that stocks fell sharply and investors moved to the relative safety of Treasury bonds.

President Trump seemed to cause last week’s selloff when he announced the imposition of big tariffs on aluminum and steel imports. Internrnational outrage from trading partners and promises of retaliation followed. We’ll see how those countries will ultimately respond, but the market’s reaction in the immediate aftermath was swift and harsh.

There was also significant economic data out last week. The most important to the Federal Reserve were January’s Personal Income and Outlays report and the Institute for Supply Management’s (ISM) Manufacturing Index.

January personal income was up 0.4%, more than the expected 0.3%. Spending was up 0.2%, as expected. The Fed’s preferred inflation gauge, the personal consumption expenditures price index, or the PCE price index, showed a monthly gain of 0.4%, as expected. Excluding food and energy, the core index was up 0.3%, also as expected. The year-over-year change remained at 1.7%, and the core stayed at 1.5%. Other than a surprise income rise, the rest of the data was as expected.

The February ISM Manufacturing Index blew away estimates and came in at 60.8, higher than any analyst estimate. This was the strongest reading in 14 years. New orders and backlogs were also at-14-year highs. Export orders were up sharply to a seven-year high. Capacity, also stressed, is at its own seven-year high. Prices are also up sharply and, again, at a seven-year high. This is also triggering new hiring to keep up pace.

New Fed Chair Jerome Powell testified before Congress last week, and he too shocked the market by saying four more rate hikes were possible this year. He was optimistic about the economy, and his outlook has improved since the December policy meeting. He was encouraged by strong incoming economic data, strength in the labor market, and a pickup in inflation.

So, all of the current data points to a strengthening economy and has the Fed on track to raise rates four more times this year ­– and then yields dropped?

Like I said earlier, Trump’s announcement of protective tariffs sent stocks lower, and money moved into the safety of Treasury bonds. I see it as a temporary move, since my system is still forecasting higher long-term rates in my medium-range outlook.

As I write, stocks are bouncing and yields have steadied. The stock market seemed to have dismissed Trump’s tariff bluster, but yields look a little more cautious. The long-term yield is sitting at 3.14%, up from 3.09% last Thursday, but well below the high of 3.22% two weeks ago.

Looking ahead, February’s jobs report will be out Friday; the market will focus on wage growth. Next week, we’ll get important inflation data. Then, in two weeks, the Fed will decide if interest rates should go up. (Spoiler alert: They will.)

So, is this the calm before all hell breaks loose?

Maybe. And, come hell or high water, the more volatility we see in interest rates, the bigger the gains in Treasury Profits Accelerator.

Lance Gaitan

Editor, Treasury Profits Accelerator