Winter is Coming, But That's Good For Rates

Winter is coming, both literally and figuratively. While the fallout remains to be seen, financial markets are already reacting.

In the literal sense, colder ambient temperatures are generally correlated with increased covid case counts.  The following chart shows per capita covid hot spots juxtaposed with a low temp map from 2 weeks prior.

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Market participants aren't necessarily epidemiologists, but the correlation is simple enough for the average trader to act upon.  In this sense, the market is pricing in the metaphorical winter of a slower global economy due to covid-related lockdowns (or other measures that inhibit the free flow of business).

The latest example arrived at the end of the week as Austria announced new lockdown measures and vaccine mandates.  Here's how the market reacted:

20211119 nl7.pngTraders can draw their own conclusions, but they're certainly considering the fact that Austria is not alone in its case count surge.

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If it can happen there, it can happen here.  The specifics don't even need to line up.  The bottom line is that "more covid" = "downward pressure on rates," all other things being equal.  That's why we've revisited this chart in recent weeks as declining case counts leveled off and reversed course in the U.S.

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Even if the U.S. remained in better shape than Europe, it's a global economy with interconnected financial markets.  Europe has already helped limit the damage that would have otherwise been seen during the most recent run-up in interest rates.  If EU yields hadn't been declining in November, US yields likely would have had an easier time revisiting October's levels.

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None of the above is to suggest that rates are destined to continue lower.  It's simply to explain their resilience.  After all, there are several important factors that suggest more upward pressure on rates than we've seen in recent weeks.  These include the following, to name a few:

  • Fewer bond purchases from the Fed
  • More inflation 
  • Earlier rate hike expectations from the Fed
  • An absence of runaway covid numbers in the new school year
  • Fiscal policy creating bond market "supply"

In addition, several economic reports have shown faster growth than expected.  This week alone, Retail Sales and the Philadelphia Fed's Business Index both came in at historically high levels (notwithstanding the more significant covid-related distortions from earlier in the pandemic).

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Mortgage rates began the week in apparent trouble, moving higher at the fastest pace in months, but found their footing by Wednesday.  Bond market improvements in the 2nd half of the week help to keep us solidly in the prevailing range, but still well off the summertime lows.

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Thanksgiving week brings several mid-tier economic reports as well as home sales data.  Treasury will also auction 2, 5, and 7yr notes.  The auctions may end up being the biggest sources of volatility if the results are far from expectations.  In general, volatility is a bigger risk than normal due to trading conditions associated with the holiday-shortened week (all of the above will be crammed into the first 3 days).