The Market Today
Barrage of Fedspeak Shows Some Softening on Additonal Hike This Year
by Craig Dismuke, Dudley Carter
Today’s Calendar – Yellen Goes to the Hill with More Balanced View: In Janet Yellen’s prepared remarks for this morning’s testimony before the House Financial Services Committee, she highlights that the inflation response to the economy is the “key uncertainty” right now. This is the first evidence from Yellen that she may see the weaker run of inflation as something more than transitory. She also affirmed a message from Brainard yesterday that rates do not have to be raised much further to get to neutral (more below). Yellen is still compelled to believe the labor market results will lead to faster wage gains and, thus, more stable inflation. She does believe the FOMC will begin its balance sheet adjustment program later this year. The markets will be dialed in closely to Yellen’s Q&A later this morning to see what else she has to add to these prepared remarks. Our initial take is that she is giving a little more credence to the weaker inflation data.
In Other News Today – Mortgage Apps Fall; Beige Book at 1:00 p.m. CT; Bank of Canada Rate Decision: Mortgage applications for the week ending July 7 fell 7.4% on a 2.5% drop in purchase apps and a 13.0% drop in refi apps. The drop in purchase apps pulled the 4-week moving average (eliminating some of the WoW noise) lower but the trend remains positive. The drop in refi apps pulled its 4-week moving average down 4.9%. However, refi apps remain 18% higher than their low point back in January, albeit at still-low levels. At 1:00 p.m. CT, the Fed will release its Beige Book report of conditions around the country in preparation for its July 26 policy decision.
Also worth noting, at 9:00 a.m. CT, the Bank of Canada will make their July rate decision. While we do not typically follow the BOC’s developments closely, the recent paradigm shift for investors regarding central bank policy, triggered in part by BOC Governor Poloz’s comments June 27th that their first rate hike in seven years might be appropriate, makes this morning’s decision a bit more relevant to U.S. rates.
Overnight Activity – U.K. Unemployment Helps Gilts Break Daily Trend of Lower Rates: Most markets indicated a hint of caution overnight after yesterday’s U.S. news cycle that was focused on a tweet from Donald Trump Jr. (more below) and before Fed Chair Yellen makes her semiannual remarks before Congress. Longer sovereign yields outside of the U.K. fell and the Yen strengthened. Most sovereign curves flattened a touch with Germany’s 2-year Bund down 0.1 bps (-0.62%) while the 10-year Bund fell 1.6 bps (0.60%). Data this morning showing the U.K. unemployment rate fell to a 42-year low (4.5%) in May was enough to help U.K. yields buck the daily trend of lower rates. The report is likely to add to uncertainty about the BoE’s rate outlook that was stirred by what were considered hawkish comments from Governor Carney a couple of weeks ago. Crude prices could be worth watching today after a Tuesday report showed U.S. inventories may have fallen by the most since September. U.S. equity futures are up by 0.4% to 0.6%, the Dollar is down 0.1%, and Treasury yields are lower (2s -3.6 bps, 10s -4.8 bps).
Yesterday’s Trading Activity – Trump Jr.’s Tweet Sets Off Media Whirlwind, Weighs on Market Sentiment: The biggest bout of volatility in Tuesday’s session was sparked by a tweet (and subsequent media storm) from Donald Trump Jr. that included a copy of an email chain between him and others about a pre-election meeting with an attorney allegedly linked to the Russian government. The tweet was time-stamped at 10:00 a.m. CT (and by the market close was “retweeted” 12.1k times and “liked” 20.9k times). At 10:08 a.m CT, stocks moved sharply lower and Treasurys rallied (softly). The S&P 500 moved from almost unchanged to down 0.7% in just 18 minutes. The 10-year Treasury yield moved from +0.5 bp for the day to -1.1 bp over that period. Also responding to the tweet, the Dollar erased its overnight gain and moved lower for the day (and to its weakest level against the Euro since May 2016). For stocks, the tumble was temporary and the major indices spend the rest of the day reclaiming lost ground. The Nasdaq gained 0.3% while the Dow and S&P were almost unchanged by the close. Treasurys and the Dollar didn’t see a similar bounce. Both fell slightly further than their 10:30 a.m. CT levels and finished near their lows of the day. The 2-year yield fell 0.8 bps to 1.38% while the 10-year yield settled 1.3 bps lower at 2.36%.
More Strengths than Weaknesses as May JOLTS Signals Steady Labor Market: The number of open positions fell more than expected in the May JOLTS data and April’s record high was revised down 77k to the second best of the cycle. Also on a less positive note, the number of layoffs ticked higher. However, the layoffs rate was unchanged and the overall level remains healthy in a longer historical context. On the brighter side of the data, the hires rate jumped 0.2% to 3.7% as a result of the strongest monthly hiring since March 2004; total gross hires rose 429k in May. In another positive development, quits accounted for three times the impact of layoffs on total separations. Total quits, seen as a positive indicator of employees confidence in the labor market, rose by the most since December 2015. Click here for the chart.
Yesterday’s Fedspeak – Brainard Watching Inflation before Deciding on Rate Hike, Balance Sheet Soon; Harker Possibly Less Hawkish; Kashkari Waiting for Wages to Stop Dissenting:
Fed Governor Brainard: Fed Governor Brainard was Tuesday’s most anticipated Fedspeaker. In a speech focused on monetary policy and titled “Normalizing Central Banks’ Balance Sheets”, Brainard laid out a case for beginning to normalize the Fed’s balance sheet “soon” if the labor data remains strong and economic activity firms. She said after four hikes, she considers normalization of the overnight rate to be “well under way” – a milestone commonly used by the Fed to mark when phasing out reinvestments can begin. Brainard showed less confidence and little urgency when discussing the overnight rate. Her belief that the neutral (real) rate for fed funds is currently close to zero tells her the Fed doesn’t “have much more additional work to do.” Before she agrees to another rate hike, Brainard said she “will want to monitor inflation developments carefully, and to move cautiously on further increases in the federal funds rate, so as to help guide inflation back up around our symmetric target.”
Philly Fed Bank President Harker: About the time Fed Governor Brainard took the stage, the WSJ published an article detailing comments from an interview with Philadelphia Fed President Patrick Harker. In the interview, Harker supported starting to slow reinvestments later this year but also allowing a period for assessing the market response before determining whether or not to raise rates for a third time this year. Harker noted it’s possible that recent weakness in inflation “could be transitory” but said if it persists “it would give me a little pause in terms of the policy path. …I’m in a wait-and-see mode now…let’s just be pragmatic about it.” The article contrasted Harker’s Tuesday tone with his stance from late June to show a potential change in his outlook, extracting a line from the June speech – “ I still see another rate hike as appropriate for 2017, having already implemented two this year.”
Minneapolis Fed Bank President Kashkari: Certain Fed Officials may point to an unemployment rate of 4.4% and compare it to their projection for a longer-run unemployment rate (NAIRU rate) of 4.6% to justify the additional rate tightening. The relative levels of these two rates is also why some believe certain Fed officials may fear they are behind the (inflation) curve. However, Neel Kashkari, President of the Minneapolis Fed, is in neither group. His remarks on Tuesday indicated he’s honed in on wages in order to gauge when sustainable inflation might arrive. Kashkari noted, “It can’t be that bad to find workers, because if you really were having to compete with other companies to find this scarce talent, we would see wages climbing … I’m looking for that wage growth as an indicator that, OK, maybe the economy is overheating, maybe now we’re going to start seeing inflation, and maybe that’s going to lead us to needing to raise interest rates.”