The Market Today
Curve Flattens as Inflation Expectations Drop; Bullard Kicks off Taper Communications
by Craig Dismuke, Dudley Carter
Bullard Plays the Heavy Kicking off Taper Communications – Raises Idea to Data-Dependent Rate of Taper This Time: St. Louis Fed Bank President Bullard appeared on CNBC this morning, the first official to speak publicly following the Fed’s policy-posture pivot on Wednesday. There is a wave of Fedspeak scheduled for next week. Bullard justified the Fed’s transition, highlighting that the recovery has been stronger than expected and inflation has turned hotter than expected. He noted that future taper discussions involve many moving pieces: the starting date, the pace of taper, MBS versus Treasurys, and the data dependency. He believes it will take several meetings to get through all of the discussions He is leaning toward the idea that the Fed might not need to be in MBS during a booming housing market. Very notably, he highlighted that it might have been a mistake to put the taper on autopilot coming out of the Financial Crisis. It appears that the upcoming taper process may have some data- or stage-dependency. He also outed himself as one of the seven dots expecting a rate hike in 2022, notable because Bullard is a voting member next year.
24 HOURS OF MARKET ACTIVITY
Treasury Curve Flattens as Longer Yields Retreat with Inflation Expectations Checking Up on Fed’s Projection of Faster Lift-Off: The S&P 500’s imperceptible 0.04% drop obscured the true volatility that played out Thursday as investors continued to digest the Fed’s Wednesday decision. The index flipped between a gain and loss more than ten times Thursday, losing as much as 0.7% midday before gaining as much as 0.2% shortly before the close. The intraday low coincided with the daily bottom for the 10-year Treasury yield. Thursday’s nadir of 1.4702%, a 10.5-bps drop, represented a full unwind of the post-Fed spike that had sent the benchmark from 1.48% to 1.575% Wednesday afternoon. The Fed’s pulling forward of two rate hikes into their projections for 2023 had elicited that sharp sell-off on Wednesday. Recovering a bit higher before the close, the 10-year yield ended Thursday down 7.1 bps at 1.504%, with a drop in inflation expectations accounting for less than 3 bps of the decline. Over the last two days, however, 10-year inflation expectations have softened by 9.3 bps, a move consistent with the potential for a faster lift-off for fed funds, which would mitigate the risk of uncontrolled inflation, as well as the Fed’s belief that stronger inflation will be transitory. This dynamic was even more pronounced for 30-year bonds, which fell 11.5 bps to 2.09%, the biggest drop and lowest yield since February. Despite declines on the long end, shorter maturities continued to reprice to the steeper dots. Fed funds futures adjusted higher again, supporting a 0.4-bp increase for the 2-year Treasury yield. The 5-year Treasury, which was hardest hit by Wednesday’s Fed events, slipped 1.5 bps.
Longer Treasury yields had retreated further early Friday but failed to give support to U.S. equity index futures. The 10-year Treasury was 1.5 bps lower at 7 a.m. CT while S&P 500 futures contracts had slid 0.4%. Shorter yields, however, extended their push higher sending the 2-year yield up 0.8 bps to 0.218%, a high since June 8 of last year. Although the U.S. calendar is empty today, the global economic schedule included a couple of notable events. The Bank of Japan left policy unchanged, as expected, and extended its COVID-19 emergency financing support program for firms by six months through March 2022. Reflecting the global nature of the current inflation dynamics, Germany’s Producer Price Index (PPI) inflation rose 1.5% in May, more than the 0.7% gain expected, and 7.2% YoY, the strongest since 2008. At 7:30 a.m., the Treasury curve had moved up notably from previously mentioned levels following the remarks from Fed President Bullard. The 10-year yield was 1.3 bps higher and the 2-year yield had climbed 2.5 bps to 0.234%, a high since April 2020.
CORONAVIRUS UPDATE Vining Sparks Coronavirus Chartbook
The U.K. announced earlier this week that it was extending England’s nationwide lockdown by one month to the middle of July, primarily because of concerns related to India’s Delta variant of COVID-19. On Thursday, the U.K. reported 11k new cases, the most in a single day since February 19. The U.S. Surgeon General discussed the Delta variant publicly on Thursday, calling it “significantly more transmissible” and “more dangerous” than other variants.