The Market Today

Cool Inflation Remains Enigmatic, Keeps Fed on Gradual Pace


by Craig Dismuke, Dudley Carter

TODAY’S CALENDAR

Hot Labor Data Continues: Initial jobless claims for the week ending May 5 remained at their extremely low 211k from the previous week.  Claims, like Tuesday’s JOLTs report, continue to point to a very tight labor market.

 

Cooler Inflation in April than Expected: In arguably the biggest report of the week for the bond market, April’s CPI inflation report showed slightly softer inflation than expected.  Headline CPI rose 0.2% MoM (exp. +0.3%) while core rose 0.1% (exp. +0.2%).  At the headline level, energy prices rose 1.5% MoM as oil prices continue to grind higher and food and beverage prices were a bit firmer than they have been over the past year, up 0.3% MoM, but not an alarmingly fast pace.  At the core level, housing inflation was meaningfully stronger, up 0.35% MoM versus a 12-month run rate of +0.25%.  When excluding household fuel/utilities, housing inflation was equally strong, rising 0.36% MoM versus a 12-month run rate of +0.25%.  On the weak side, medical care prices rose just 0.09% MoM, half their 12-month run rate.  Driving the weakness was a 0.21% drop in medical care commodities (including non-prescription drugs and medical care supplies) while prescription drugs and medical care services rose a more normal 0.16%.  Auto prices were also weak with new car prices down 0.5% MoM and used car prices falling 1.59%, the biggest monthly drop since 2009.  Likewise, airfares fell 2.7% MoM, their biggest drop since 2014.

 

Bottom line: The April CPI report shows housing price gains reasserting themselves as a driving force of core inflation, but weakness across most other categories of core consumer prices.  The report takes a little steam out of the rapidly ascending inflation fears and will help the Fed remain on its “gradual” path. 

 

TRADING ACTIVITY

Yesterday – Crude Prices Boosted Stocks Even As Treasury Yields Rose: It was a big day for investors holding long positions in oil and energy stocks and broader sentiment proved resilient in the face of the 10-year yield reclaiming the 3.00% level. Both U.S. WTI and Brent crude rallied more than 3% and closed at their highest levels since late 2014. That boosted interest in energy companies and helped the sector move up more than 2% and lead the S&P 500. The broader index gained 1.0%, matching the Nasdaq’s improvement and outperforming the Dow’s 0.8% increase. While energy companies outperformed, the strength was broad-based with four other sectors adding more than 1%. Financials finished in the second spot as the Treasury curve finished higher and slightly steeper. The 2-year yield rose 2.1 bps to 2.53%, another new cycle-high finish. The 5-year yield rose 2.6 bps to 2.84% and the 10-year yield closed up 2.8 bps at 3.00%.

 

Overnight – Bank of England Elected to Wait and See: Equities were mixed overnight and yields moved mostly lower in anticipation of the latest policy announcement from the Bank of England (BoE) and an inflation update in the U.S. There had been some speculation that the BoE could raise rates at this meeting. However, the central bank elected to hold as they downgraded their 2018 growth estimate and forecasted inflation to move back down to 2% more quickly (two years) as the currency impact fades faster than expected. While the longer-term outlook was little changed and there continued to be multiple references to disappearing economic slack, activity in the U.K. has softened as of late and core inflation dropped unexpectedly in the last report despite unemployment at a 43-year low. As a result, the BoE decided that “the costs to waiting for additional information were likely to be modest, given the need for only limited tightening over the forecast period to return inflation sustainably to the target.” Eliciting a bigger response from U.S. assets was the weaker-than-expected April inflation data. Immediately following that report, the Treasury curve moved lower with fed funds futures and the Dollar.

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