The Market Today
ECB and Fed Shift Communications; Stocks Roar, Bonds Diverge
by Craig Dismuke, Dudley Carter
New York Fed Manufacturing Index Improves but Weakness Still Evident: The Empire Fed Manufacturing Index improved more-than-expected, rising from -8.6 to +4.3 in July. However, beneath the headline index the sub-indices remained discouraging, just less discouraging. The ever-critical new orders sub-index rose from -12.0 to -1.5, improvement but still negative. The number of employees sub-index fell from -3.5 to -9.6. The inventories sub-index fell from -5.3 to -10.9. And perhaps the most positive of the sub-indices, it is now taking manufacturers longer to deliver products. The delivery times sub-index rose from -4.5 to +4.4. However, in context, it does not appear that this increase was related to capacity constraints.
Busy Week of Fedspeak Kicks off with Williams Today: This week’s flurry of Fedspeak begins this morning with comments from New York Fed Bank President Williams. Williams is a voting member of the FOMC. He spoke last week and really echoed the same policy posture that Powell displayed in his congressional testimony.
ICYMI – Stocks Hit All-Time Highs as Longer Yields Rose on Synchronized Shift in Monetary Policy Posture and Firmer U.S. Inflation Report: The NASDAQ, S&P 500 and Dow Jones Industrial Average all hit new record-highs last week (Dow broke through 27,000 for the first time while the S&P broke the 3,000 barrier) as stock investors welcomed signs that central bankers are collectively warming up to the idea of easing policy. Specifically, officials at the ECB and Fed, who were engaged in wholly opposite strategies this time last year, communicated to markets growing support for easing policy. The ECB did so via their June Meeting Minutes which stated that there was “broad agreement” that the heightened uncertainty was “likely to extend … into the future” and they needed to be “ready and prepared to ease the monetary policy stance.” For the Fed’s part, the Minutes from their June Meeting noted that “uncertainties and downside risks … had increased significantly.” As a result, “many … judged additional monetary policy accommodation would be warranted in the near term” if those uncertainties continued to weigh on the outlook. While the Minutes were six-week-old news, Fed Chair Powell testified before Congress last week noting that those uncertainties do, in fact, “continue to weigh on the outlook.” Several other comments revealed a firming belief that accommodation would soon be appropriate.
Markets began to price in more than just a temporary shift in monetary policy stance. Investors responded to the communications by continuing to price in short-term rate cuts and the 2-year Treasury yield fell 2 bps to 1.84 during the week. However, It also appears that investors interpreted the Fed shift as evidence that the central bank may actually let inflation run hotter in future years as they try to re-establish their credibility around a symmetric, 2% inflation target. A growing expectation for higher, future inflation would imply higher longer-maturity yields. Sure enough, the 10-year yield rose 9 bps to 2.12% as 10-year TIPs implied inflation rose 8 bps to 1.77%.
Ironically, just as the two largest central banks shifted their messaging, the BLS reported that June saw the second-hottest month for core consumer price gains dating back to 2006. The strength of the report was fairly broad with only a few unsustainable aspects (used car prices up 1.6% MoM and apparel prices up 1.1%).