The Market Today

Aggressive ECB and Firm Inflation Complicate Fed Decision


by Craig Dismuke, Dudley Carter

TODAY’S CALENDAR

CPI Inflation Points to Tighter Economic Conditions Right When Fed Is Prepared to Ease: Consumer price inflation was firmer-than-expected in August, up 0.26% MoM at the core level bringing the year-over-year rate up from 2.21% to 2.39%.  This marks the hottest year-over-year core inflation since 2008.  At the headline level, energy prices fell 1.9% in August while food prices were unchanged month-over-month.  Driving core prices higher was the second-largest jump in medical care prices of the cycle, up 0.7% MoM, as hospital-and-related-services prices increased 1.2%.  Medical care inflation, which accounts for over 8% of the core CPI tally, is now up 3.5% year-over-year. Adding to the inflation pressure, used auto prices rose another 1.1% MoM, public transportation prices increase 1.2%, auto repairs increased 0.9%, and shoe prices rose 1.1%.  Across-the-board, with only a few exceptions, prices were firmer in August.  The one notable exception was a weak month for housing inflation, the result of slower gains in rent prices and a 2.1% decline in hotel prices.

Bottom Line – Fed’s Decision Complicated by ECB and CPI: The August CPI inflation report will makes the Fed’s decision next week more challenging, particularly following on the heels of the ECB’s more aggressive policy decision this morning.  Consumer inflation appears to be gaining broad traction with particular heat coming from medical care prices and continued strength in housing inflation.

Jobless Claims Add to Dissonance: Making the Fed’s decision even more difficult, initial jobless claims for the week ending September 7 showed signs of an ever-improving labor market.  Claims fell from 219k to 204k, a level only surpassed by two weekly reports back in April.


YESTERDAY’S TRADING ACTIVITY

Stocks Woke Up Wednesday To End Historically Unique Mismatch In Volatility Across Asset Classes: The U.S. stock market showed some signs of life Wednesday and Treasury yields, which have rocketed higher in recent sessions, finally leveled off. On an absolute value basis, the S&P 500 moved 0.04% cumulatively on Monday and Tuesday while the 10-year Treasury yield changed more than 17 bps, a mismatch of volatility rarely seen historically. Following its least-volatile two-day stretch in three years, the S&P 500 rose steadily throughout the session to close near its high mark for the day. Equities had earlier closed higher across both Asia and Europe on a positive lean in the trade headlines.

China Excluded 16 U.S. Products From Tariffs List: China’s Finance Ministry issued an exemptions list overnight that included 16 products imported from the U.S. that will no longer have tariffs applied to them. A day earlier, a Chinese news outlet had reported the country was considering increased purchases of U.S. agricultural products. Also affecting underlying equity currents was a solid performance for Apple shares a day after the new product launch and a drag from the energy sector on a decline in crude prices. Reports the White House had considered easing sanctions on Iran were the catalysts for the 2.4% decline in U.S. WTI.

Treasury Yields Leveled Off After Sharp Increases To Start The Week: Despite some positive news on the trade front, an exhausted Treasury market held steady. Following a roughly 25-bp shift up over the last five days, Treasury yields closed little change but slightly steeper ahead of the ECB’s decision. The 2-year yield dipped 0.2 bps to 1.67% while the 10-year yield rose 0.7 bps to 1.74%.


OVERNIGHT TRADING ACTIVITY

European Bonds Lead Global Rally After ECB Checks All The Accommodation Boxes: Markets showed a mixed and muted response to news the U.S. would delay the tariff increase on $250B of Chinese goods by two weeks as a “gesture of goodwill”. Just before the ECB’s policy announcement, sovereign yields had inched lower, the Euro had edged up against the Dollar, and U.S. equity futures were firmer while European indices held close to unchanged. At 6:45 a.m. CT, however, the subdued overnight trends were abruptly disrupted after the ECB (1) announced a 0.10% cut of the rate on its deposit facility, (2) changed its forward rate guidance, (3) introduced a tiered system for deposit charges, (3) restarted its QE program on an open-ended basis, and (4) altered its latest TLTRO program to be more accommodative.

ECB Cut Its Deposit Rate: The rate applied to European banks’ overnight deposits was lowered to -0.50% and the forward guidance, previously pledged “through the first half of 2020,” was completely delinked from the calendar and tied solely to the underlying inflation trends. The ECB expects “rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.”

ECB Introduced Tiering System: Paired with the deposit facility rate cut, was the announcement that the rate will be applied on a tiered basis to bank deposits. The “two-tier system for reserve remuneration will be introduced, in which part of the banks’ holdings of excess liquidity will be exempt” from the negative deposit rate. Further details will be released after President Draghi’s press conference.

ECB Announced Open-Ended QE: While the rate cut was a certainty in the mind of the markets, the big question was whether the ECB would get back into the bond buying business. Starting November 1, the ECB will restart net asset purchases at a monthly pace of 20B euros per month. The new net asset purchases will “run for as long as necessary to reinforce the accommodative impact of its policy rates” and will “end shortly before” the ECB decides to raise rates.

ECB Altered TLTRO Stimulus Program: Finally, the TLTRO III program that was announced in June was altered to include a lower-rate and a longer term. The top rate charged on borrowings was lowered by 10 bps and the maturity on any borrowings under the program was lengthened from two years to three.

Yields Rallied Lower On ECB Surprise: While President Draghi’s press conference is still ongoing, and details of the tiering system are yet to be released, markets responded quickly to the changes in a decidedly dovish fashion. The euro tumbled, the Italian 10-year yield sank 20 bps, and the Stoxx Europe 600 moved out of negative territory to up 0.4% on the day. Despite the firmer core U.S. inflation, the 2-year Treasury yield remained 3.4 bps lower while the 10-year yield dropped 5.9 bps.


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