What A Flattening Yield Curve Means – Bond Market Update

The anticipation of Fed rate hikes has gradually raised short-term rates this year, with the demand for longer-term bond maturities increasing. The result has been a flatter yield curve, where short-term rates have risen and long-term yields have dropped. A flattening yield curve implies that longer-term economic growth may be subdued or not expected to be very extensive.

At the end of November, short-term rates such as the 2-year Treasury yield had risen to 1.75% from 1.22% at the beginning of the year. The longer-term 30-year Treasury bond yield fell to 2.77% on November 30th from 3.04% in January.

As promised, the Fed has started to curtail its buying of Mortgage Backed Securities (MBS). Through September, the Fed was buying an estimated 20-25% of the roughly $110 billion of MBS sold each month. In October, the Fed scaled back its purchases by $4 billion and is scheduled to reduce purchases by another $4 billion every quarter. As the Fed buys less and less MBS, the market will need to slowly absorb the additional paper made available by the Fed’s lack of buying. As this occurs, it is expected that MBS prices will gradually fall and yields will gradually rise. (Sources: Federal Reserve, Bloomberg, Treasury Department)

Equity Update – Domestic Stock Markets

The Dow pierced through 24,000 towards the end of November as optimism about tax reform passage intensified. A primary emphasis to reduce both corporate tax rates and small business rates accelerated equity prices higher as optimism grew with the realization of passage.

The relationship between corporate taxes and equity valuations have been significant with the anticipation of a lower corporate rate, which has been elevating stocks ever since the election. The reduction in the corporate rate from 35% to 20% is expected to benefit certain companies more than others as tax rates vary among sectors.

Analysts view the recent decline in the technology sector as a form of market rotation, the exodus of assets from one market sector to another. The anticipation of various tax reform proposals may adversely affect technology companies while benefiting other industry sectors. The passage of tax reform might also prompt a further rotation to companies that may benefit from corporate tax proposals once in effect. (Sources: Dow Jones, S&P, Bloomberg)

The Internet Is Being Deregulated – Government Regulations

The primary growth behind the internet isn’t the number of websites, but the growth of traffic within the invisible freeways it commands. The evolution of technology has enabled nearly every American to have access to the internet, but at a price. As the number of users grew so did the volume of traffic, which like a highway, eventually needs speed limits. These speed limits were imposed during the prior administration with the intent of making the internet equally accessible to all users. Many have complained that the utility-like regulations have hindered competition and limited the entrance of new technology.

Data compiled by Internet Live Stats estimates that there are over 3.7 billion internet users worldwide, with nearly 287 million in the United States. As a percentage of population, the U.S. ranks 40th in internet users internationally, with roughly 88% of Americans having internet access. Scandinavian countries have among the highest percentages of users, with Denmark at 96.9% and Iceland at 100%. Many have argued that unnecessary regulations and minimal competition have limited additional users in the U.S.

The Federal Communications Commission (FCC) voted in November to repeal 1930s era utility style regulation called Title II which has put at risk online investment and innovation since it was enacted in 2015 by the prior administration. The FCC plans to encourage a free and open internet by promoting broadband deployment in rural American towns and new infrastructure investments throughout the nation. The FCC outlines that it will honor and expand on the four “Internet Freedoms” implemented in 2004; freedom to access lawful content, freedom to use applications, freedom to attach personal devices to the network, and freedom to obtain service plan information. (Sources: Internet Live Stats, Federal Communications Commission)

U.S. Oil Gets Less Expensive Internationally – Commodities Update

For decades, the price of domestically produced crude oil, West Texas Intermediate (WTI), closely resembled the price of international crude, Brent. Following production cuts imposed by OPEC on its members and supply constraints in the U.S., the price of both Brent and WTI started to rise over the summer months. Production cuts and supply shifts are a common occurrence in the industry affecting prices, but the rate at which Brent has increased versus WTI is not.

Various factors affecting the price of Brent, such as uncertainty with Saudi Arabia’s leadership and the possibility that the U.S. may resume trade sanctions on Iran, drove overseas oil prices higher. The abundance of U.S. oil production in turn kept domestic prices, WTI, at lower levels.

The advancement of hydraulic fracturing in the United States over the past few years has positioned domestic production as a viable option in the international markets. In addition, the end of the decades old oil export ban lifted in December 2015, has allowed U.S. drilled oil to flow to countries throughout the world.  Some oil analysts see this trend as a validation that the U.S. may now possibly have better price control of domestic production than OPEC has of its multi-member production prices.  (Sources: Department of Energy; EIA)