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2019 has easily joined the ranks of those years that are notorious for one, massive, defining theme. It will forever be remembered as the year of the trade war. Granted, we can point to other developments throughout the year that moved the market, but those developments were all informed, mitigated, or complicated by trade war considerations.
Technically, the trade war began in April 2017 when Trump signed executive orders calling for tighter enforcement of certain trade policies and a review of US trade deficits. In August, Trump and Chinese President Xi Jingping failed to make headway in initial trade talks, but that was about it for that year.
2018 was far more active and arguably more important than 2019 in terms of setting stage for trade war drama. This is when when the administration began ramping up tariffs with threats of more to follow. China retaliated in kind. Markets may have paused to to express some uncertainty about all this in the first half of the year, but ultimately moved onward and upward (both in terms of stock prices and bond yields) after tariffs began rolling out without the world imploding.
Things began to change rapidly in October 2018 when a slew of nagging macroeconomic concerns finally got the best of the stock market. October and December went on to become the 2 worst months for stocks since the Great Recession. Although the trade war wasn’t the only headline in play during that time, it increasingly became the center of the conversation.
For instance, a global growth slowdown was a major concern–especially in China–and the trade war only intensified that concern. Additionally, traders were increasingly worried about the end of the economic expansion in the US. The trade war only fueled that fire. The housing market was showing serious weakness and the trade war caused concern about the price of building materials (not to mention the wealth effect taking a hit due to stock losses).
This list could go on, but the bottom line is that massive economic uncertainty surrounding the world’s 2 largest economies is going to spill over to just about everything. Perhaps nowhere else was this as evident as it was in the Fed’s much needed policy shift. After hinting at it in December, the Fed changed its tone in January’s statement, dropping its reference to “balanced” economic risks and additional rate hikes. Then in March, the Fed added “international developments” to its list of concerns. This would go on to serve as a major justification for the Fed to consider actually CUTTING rates after hiking for 3 straight years.
The bond market (aka “rates”) realized the Fed was becoming friendly again and that global economic risks could materialize in such a way as to push rates much lower. The trade war was at the top of the list of underlying justifications. The stock market reaction was a bit different. Stocks lost so much ground at the end of 2018 that a friendlier Fed (and the prospect of lower rates) helped fuel a steady recovery. Beyond that, stocks managed to find support from decent corporate earnings and ongoing strength in the consumer sector.
This led to a situation where stocks consolidated in a triangular pattern for most of the year while rates moved almost exclusively lower through August. Unsurprisingly, the biggest move of the year for rates coincided with the biggest US/China tariff announcement in early August. It was so big, actually, that it forced traders to question the wisdom continuing to buy bonds with rates already close to all-time lows when the global economy could conceivably get a massive and immediate second wind due to a trade deal.
With that, rates have entered an excruciatingly indecisive pattern over the past several months. At first, every little trade-related headline/tweet caused traders to rush to the other end of the field. Trade talks scheduled? Sell bonds! Trade talks fruitless? Buy bonds! Trade deal not likely until such and such date? Buy bonds! Trade deal actually going better than the last headline said? Sell bonds! And so on…
By the end of October and for much of November, rates appeared less and less willing to react to these back-and-forth trade updates, but they seemed to reserve the right to react quite a lot to certain examples. While this may be frustrating and confusing at first glance, it’s actually pretty simple. The market’s reaction to the trade war was never about the headlines themselves, but rather, the actual economic implications of the headlines. Vague, general, qualitative trade war tweets/headlines are less and less likely to move the needle. But if Trump tweets about a new, specific, quantitative change, markets are still very willing to react.
Ultimately though, it will be the ACTUAL impact on the global economy that sets the tone for financial markets. Between now and then, both stocks and bonds can only really guess as to what that will look like. The only safe bet is that dry ink on any meaningful trade agreement will lead traders to guess that rates should be higher than they are right now. Fortunately, most of the market is assuming that some sort of deal will eventually happen (and that’s why rates aren’t well into all-time lows right now), but there is plenty of pain left for confirmation of a deal, when and if it comes.
Perhaps the most insidious aspect of trade war hyper-focus is that it causes markets to question the relevance of other economic data. The few big ticket economic reports that reliably push rates higher and lower are still able to push rates higher and lower, but not as well as they used to. Sometimes we even see markets go in the opposite direction to that suggested by the economic data simply because a trade-related headline had a bigger impact around the same time of day. As frustrating as that may be, it stands to reason. After all, the economic difference between a healthy US/China trade relationship and a nonexistent one is massive.
Does this mean we don’t need to be concerned at all with econ data until after the trade stuff is figured out? Not exactly. Again, it will still have an impact if it’s the right report and if it falls far enough from expectations. Rather, we should simply be prepared to see less of a reaction than normal to traditionally important market movers (such as tomorrow’s jobs report!).
The bottom line for this little 2019 trade war year in review is this: the importance of the trade war–past, present, and future–cannot be overstated. While some headlines may be ignored, the right headlines can still rock the market. More importantly, it’s going to be hard for bonds/rates to go anywhere very quickly without a better idea of how the trade deal is coming together (or not). Just be sure your understanding of “not going anywhere” is on the appropriate scale. To the bond market, half a percentage point over 5 months is a very narrow range, but on the average mortgage, it’s roughly $100 per month.
If we only look at shorter-term market movements (like the chart below with this week’s stock prices and bond yields), we might conclude that neither side of the market knows where it wants to go and that they’re taking turns following each other and/or waiting for bigger inspiration. But that’s actually not an unfair statement.
2019 has been a big year for both stocks and bonds. Both have moved to very strong levels (high stock prices and low bond yields) and have covered a lot of ground to get there. The uncertain fate of the trade deal was a major factor helping rates move lower and preventing stocks from breaking to all-time highs earlier this year. But now that a “phase 1” deal is at least being discussed as a possibility, stocks have moved higher while rates have reconsidered the long-term lows seen in early September. With this in mind, the divergent performance between stocks and bonds in the bigger picture makes more sense.
Notably though, rates aren’t panicking, and have actually managed a modest but noticeable winning streak over the past 2 weeks. In terms of mortgage rates, this translates to average 30yr fixed rates improving by an eighth of a percentage point to the lowest levels since October 31st.
As far as rate rallies go, that qualifies as just a bit longer than average and just a bit better than average, but it’s good to keep in mind that it comes at the expense of a more significant move toward higher rates that lasted nearly the entire month of October.
In the bigger picture, however, rates are staggeringly lower than they were this time last year. Despite having risen from multi-year lows in September, we’re still in a very solid ball park.
The impressive drop in mortgage rates seen in the chart above has done wonders to help the housing market get back on track. There were multiple housing-related reports out this week and everywhere we look, there are reasons to be excited.
Existing Home Sales didn’t quite break their recent highs, but they’re back in line with the highest levels since before the housing crisis.
Unsurprisingly, low rates and strong sales have had a positive impact on builder confidence as seen in this week’s Housing Market Index from the National Association of Homebuilders.
In this week’s New Residential Construction report, building permits surged to their highest levels in more than 12 years.
And on a mortgage-specific note, application activity has remained undeterred by rising rates. Granted, refinance demand has leveled-off, but it remains in territory that’s 150% better than the same time last year. Purchase applications are winning in a different way. While they’re only up about 14% year over year, that’s the highest growth rate since 2016.
The extent to which the good times will keep rolling depends heavily on global economic momentum. And global economic momentum depends heavily on the outcome of the US/China trade negotiation. It’s anyone’s guess as to how long that will take and how it will ultimately look, but no one is expecting a sweeping conclusion to happen in the next few weeks. That’s precisely why we’ve seen rates level-off and push back, but NOT in a panicked way.
Be warned though, if progress materializes in trade negotiations and especially if economic data can manage to improve even before a trade deal is shored up, rates are ready and willing to move higher at a quicker pace. Bottom line: take advantage of what we have today or at the very least, be ready to act if it looks like the rate landscape is shifting.
In both cases, breaking news about the US/China trade deal was at the scene of several of the biggest swings. That was especially apparent in wee hours of Thursday morning when China’s Commerce Ministry claimed both sides had agreed to cancel a certain amount of existing tariffs as a part of the deal and that both sides had been in close communication.
The reaction in stocks and bonds was obvious. As we should expect, news that improves the outlook for US/China trade relations (or that simply speaks to tariffs going away) pushes stock prices and bond yields (aka “rates”) higher. Notably though, rates continued drifting higher even as stocks flattened out.
The divergence between stocks and bonds in the chart above can be hard to see. The following two charts examine specific pockets of time on November 7th where it was most obvious.
If we know the trade news was the motivation for the initial volatility and we know stocks and bonds are equally likely to react to it, we’re forced to conclude that the additional movement in bonds is due to something else.
While the trade deal is definitely the spark behind Thursday’s drama, other considerations have acted as dry powder for interest rates. By far the biggest of those considerations is the bigger-picture trend in the bond market. The way it works is surprisingly basic.
In general, bonds/rates have been doing so well for so long that they risk bouncing simply because we’re running out of past precedent that suggests the good times can continue to roll. If that doesn’t sound like an actual justification for trading momentum, it absolutely is! I you’ve ever heard the terms ‘overbought’ or ‘oversold,’ those are fancy ways to refer to the same phenomenon. Traders refer to such motivations as “technical.”
Technical motivation can play out differently depending on the market in question. Unlike the stock market, which has proven itself capable of rallying for more than 2 years without major incident (most recently from April 2016 until the end of 2018), the bond market rarely strings together more than a year of strong momentum without some sort of reset–especially when the year in question has covered as much ground as this one.
The chart below shows these ebbs and flows. The green numbers list the length of time (in months) that a rally trend has lasted and the amount of ground it has covered in terms of 10yr Treasury yields. Vice versa for the red numbers. Mortgage rate movement has been a bit different than Treasury yields, but the latter is what sets the tone for these bigger picture shifts.
If you were hoping to see rates continue lower in 2019, this chart should scare you. The peak to trough improvement already matches the best example from the past decade (2011) and the length of time is certainly on the higher end of the spectrum. Granted, we can count the bounce in rates that’s already taken place over the past 2 months, but even then, we’d still have another 0.1% to go before matching even the gentlest example from the past.
Does this mean rising rates are a sure thing and a done deal? No one will ever be able to tell you such things with certainty. Past precedent is great until it’s not anymore. The best bet is to prepare for the worst and hope you don’t see it. At the very least, people with loans in progress, or those who are on the verge of buying or refinancing, should probably try to get that done sooner than later.
On a final note, if you read other news this week that suggested mortgage rates were LOWER and are wondering why I’m telling you they’re higher, that’s because they’re wrong and I’m right. And it’s all just a big misunderstanding.
Look closely at those articles claiming lower rates and you’ll see they are citing Freddie Mac’s weekly rate survey. There’s nothing wrong with Freddie’s data if you’re only looking for a rough overview of rate trends over super long-term time horizons. For day to day moves, however, their methodology can create a lot of confusion.
Freddie’s survey only accepts responses through Wednesday morning, but our vast experience comparing Freddie’s numbers to actual rate sheets suggest the survey is mostly measuring rates that were available from Friday afternoon through Monday afternoon. As such, the more things move on Tuesday through Friday morning, the farther from reality the survey can be by the time it’s released on Thursday morning. Simply put, rates moved up to 3-month highs this week, NOT back down to 3-week lows.