The Market Today
BOE Less Hawkish than Expected; U.S. Labor Data Sizzling
by Craig Dismuke, Dudley Carter
Today’s Calendar – Labor Data Continues to Show Strength; Dudley Offers No New Insight: Like yesterday’s import price index, the April producer price report showed a touch firmer inflation pressure in the pipeline than expected. Producer prices rose 0.5% MoM and 0.4% when excluding food and energy. The so-called core PPI was expected to rise just 0.2%. Prices of completed goods rose 2.5% YoY, the fastest pace since February 2012, with core goods (excluding food, energy, and trade) up 2.1% YoY. Both readings were firmer than expected. Despite this, the amount of price pressure coming from imports and the production of goods remains relatively low compared to historical periods of faster consumer inflation. However, the increase in PPI is consistent with consumer prices remaining near the 2% growth mark. Also released this morning, initial jobless claims for the week ending May 6 fell from 238k to 236k. Continuing jobless claims plunged 61k to 1.918 million, the lowest level for continuing claims since 1981. For those persons in the labor force, the market continues to tighten. However, there also remains a surfeit of slack from those who have dropped out of the labor force but who could return as the market improves.
New York Fed Bank President Dudley, one of the key voices to listen to on the FOMC, spoke this morning from Mumbai. He did not address the “normalization” of monetary policy in his prepared remarks but did give some insight in his Q&A, albeit comments we have already heard. He expects the FOMC will begin changing the balance sheet reinvestment process later this year or in 2018. He believes they will target reinvestments of both MBS and Treasurys when they do. He continues to expect gradual rate hikes and that the Fed’s balance sheet will not return to its pre-crisis level (approximately $800-$900 billion).
Kansas City Fed Says $675B Reduction in Balance Sheet Would Equate to 25 Basis Point Hike: Dudley also noted that there was much uncertainty over how much quantitative easing depressed interest rates. However, the Kansas City Fed released a paper yesterday concluding that a $675 billion decrease in the size of the balance sheet over a two-year period would equate approximately to a 25 basis point hike.
Overnight Activity – Oil Adds to Gains, Pound Falls on Unchanged BoE Policy: A relatively quiet overnight session left investors focused on continued strength in crude prices, corporate earnings results, and the latest policy decision from the Bank of England. A positive start for Asian equities weakened in Europe with some analysts pointing to mixed corporate earnings as the cause for less optimism. After gaining 3.3% yesterday, U.S. crude added another 1.2% overnight. In the U.K., the BoE left its overnight rate unchanged by a vote of 7-1. The pound fell on the decision. Markets had priced in the chance for more dissents due to recent rhetoric from certain bank officials. The U.K.’s yield curve is steepening ever so slightly with lower shorter yields and higher longer yields. The BoE’s updated forecast predicts marginally stronger growth and slightly slower inflation in 2018 and 2019 under a caveat that its forecast is based on a “smooth” Brexit and a pick-up in wages. The net effect the BoE stated was that, if the forecasts were to play out as predicted, it could create the need for tighter policy than the current yield curve implies. After the BoE decision, U.S. equity futures tracked another move lower in European markets, Treasury yields fluctuated but are essentially unchanged on the day, and the Dollar jumped to its daily high.
Yesterday’s Trading – Stocks Mixed as Oil Rallies, Treasury Yields Rise on Weak 10-Year Auction Results: The S&P clawed its way to another daily gain, besting its previous record high by just 0.25 points. The index was carried by energy companies after crude prices rose 3.3% in their best day since December 1. Official data confirmed crude inventories fell by the most this year and gasoline supplies ticked lower. The Nasdaq rode its recent momentum to another all-time high close. The Dow was not as fortunate, falling 33 points thanks largely to hefty losses by Boeing and Disney. Boeing dragged 26 points from the Dow after announcing it was suspending flights of its 737 MAX jets due to a potential manufacturing issue with the aircraft’s engines. Disney accounted for another 17 points of loss after reporting better-than-expected quarterly bottom line results but a miss on revenues. The Dollar was little changed despite Treasury yields resisting the pull from lower yields in Europe and shifting higher by 1 to 1.5 bps across the curve. Yields had moved lower but jumped after an auction of 10-year notes tailed by 1.8 bps, the bid-to-cover dropped to the lowest since February, and indirect bidders took their lowest share since 2016.