The Market Today
10-Year Treasury Hits 3.10%
by Craig Dismuke, Dudley Carter
Another Day of Strong Economic Reports: Initial jobless claims for the week ending May 12 rose from 211k to 222k. Claims remain very low and point to a continuation of the inexplicably tight labor market.
The Philadelphia Fed’s Business Outlook index, a regional measure of manufacturing activity, confirmed the New York Fed’s report earlier in the week, beating expectations rising from 23.2 to 34.4. The new orders subcomponent rocketed higher from 18.4 to 40.6. In fact, every subcomponent of the index showed a stronger manufacturing sector including the number of employees and average workweek. The two regional Fed reports (New York and Philadelphia) now point to the May ISM Manufacturing index rising to 59.5 in May which would be the second-highest level since 2004.
The April Leading Indicators Index is expected to rise 0.4% at 9:00 a.m. CT. Minneapolis Fed Bank President Kashkari and Dallas Bank President Kaplan are both on the tape today.
Gasoline Prices Are Higher but the Impact Should Be Minimal at This Point: Oil prices continue to move higher, creating some concerns for the strength of the consumer given the resulting increase in gasoline prices. In 2017, gasoline prices averaged $2.39 per gallon including $2.33 per gallon through May 16. Through May 16 of this year, prices have averaged $2.62, 12.4% higher than the comparable time period last year. Based on constant usage rates, this increase would have theoretically cut $15 billion from consumers’ pocketbooks. This is only a small fraction of the total savings taxpayers are expected to receive this year from the 2017 tax cut. Moreover, given the larger role the U.S. is playing in global oil production, higher oil prices are not just a drag on the U.S. consumer any longer. The negative effect on the consumer is now partially offset by the expected increase in U.S. energy companies’ revenues, investment, hiring, and possibly higher wages.
Yesterday – Stocks Undeterred by Another Day of Rising Rates: U.S. equities strengthened Wednesday despite Treasury yields extending their weekly rise to set new multi-year highs across most of the curve. The Russell 2000, a popular index tracking performance of U.S. small caps, gained 1.0% and reached a new all-time high. Looking at the larger companies, the materials sector led the S&P’s 0.4% gain but nine of 11 sectors finished in the black in a signal of the widespread strength. The two groups that finished lower, real estate and utility companies, are those generally negatively correlated to higher interest rates. Rates rose for a third straight session and the curve steepened for a fourth day. That matched the longest stretch of curve steepening since a five-day run in early February. The 2-year yield added 1.1 bps to 2.59%, a new high for the cycle, and hasn’t declined since May 3. The 5-year yield was up 2.1 bps to 2.94%, also a new high for the cycle, but the 10-year yield again led the way. The 10-year yield rose 2.4 bps to 3.10% and was up 13 bps on the week. Despite another day of a stronger Dollar, oil prices rose after the EIA reported a drawdown of inventories.
Overnight – U.S. Yields Mostly Hold Weekly Rise as Brent Crude Crosses $80: U.S. yields, oil prices, and Italian politics remained a major focus in the overnight session. After attempting to extend this week’s rise during Asian trading, Treasury yields had pulled back and were less than 1 bp changed from Wednesday’s close. After ticking up to 2.60%, the 2-year yield was back down to 2.58%. The 10-year yield had reached as high 3.12% but retreated to yesterday’s close of 3.10%. Oil prices, however, held their overnight gains that pushed Brent crude above $80 a barrel for the first time since November 2014. U.S. crude was trading at $72 per barrel, its highest since December 2014. Italian government bond yields were volatile again Thursday although off the highs of the day following reports that the League and Five Star were approaching a final coalition agenda. A draft of that program, which includes corporate and individual tax cuts, citizen’s income for the poor, lowering the retirement age for pensions, and stiffer rules on immigration among other things, does not include the debt write-off proposal that roiled Italian assets on Wednesday. U.S. equity futures were weaker against a mixed day of trading globally.
Industrial Production Remained Steady in April as Manufacturing Picked Up to Offset Lower Utilities Output: Industrial production rose 0.1% more than expected in April but activity in the prior two months was revised down on net thanks to a steep decline in February. All three major industry groups improved on the month and the gains were more evenly distributed. Utilities output slowed from +6.1% MoM to +1.9%, but manufacturing rose 0.5% after an unchanged March and mining gained 1.1% to after an 0.8% improvement.
Bostic Took Ownership of Shaping the Curve: Atlanta Fed President Bostic again credited an expected boost from fiscal stimulus for his recently revised 2018 rate hike expectations for two more increases (three total for the year) by the end of December. He said simulative fiscal policies “means we can be a little more rapid” in returning to a neutral stance but “not so fast as to be disruptive.” He also said the Fed is discussing the shape of the curve, noting “We are aware of [the flattening yield curve]. So it is my job to make sure that doesn’t happen.”
John Williams Said the Fed May Hike Two or Three More Times in 2018: Soon-to-be head of the New York Fed John Williams continues to believe two or three more hikes this year will be warranted with inflation near target and unemployment further below the Fed’s longer-term expected rate. However, he isn’t concerned about inflation “being on the cusp of an outburst” and doesn’t see much left to do based on his estimate that a neutral setting for the overnight is around 2.50%. He also commented on the Fed’s use of forward guidance, saying that each step towards neutral will further necessitate tweaks to the language used in the official Statement.
Bullard Believes the Fed Shouldn’t Be Forecasting Rate Hikes So Far Out: St. Louis Fed President Bullard again showed a lack of concern about the economy overheating. He’s still positive on the economy but said “I don’t think we have to scramble to get to some higher level of rates in order to contain inflation.” He too discussed his opinion of the dot plot, saying “The whole idea that you’re naming the number of rate hikes way out into the future when you don’t know what the data are going to be is something we should get out of the business of doing. … We should be more Greenspanian in the policy where you say, ‘we think we have the rate about where is needs to be today and we’re going to monitor developments and we’ll reach to what happens in the future.”