The Market Today
Fed Divided on Inflation Outlook; President Loses Business Support
by Craig Dismuke, Dudley Carter
Today’s Calendar – No Cooling of Labor Data: Initial jobless claims for the week ending August 12 fell from 244k to 232k, the lowest reading since February and continued evidence of a hot labor market. The Philadelphia Fed’s Business Outlook Index fell fractionally from 19.5 to 18.9, beating expectations and remaining in reasonably solid territory. At 8:15 a.m. CT, July’s Industrial Production report will be released, including the important reading on manufacturing output. Dallas Fed Bank President Kaplan continues his speaking blitz today, speaking in Lubbock at noon CT. Speaking yesterday, Cleveland Fed Bank President Mester said that she still favors another rate hike this year and that the Fed should look through the recent inflation data to the broader economic trends. She also said there is an equal chance that the Committee will need to hasten the pace of tightening as slowing it. Mester has been on the more hawkish side of the Fed over the past few years but has certainly not been the most hawkish.
Overnight Activity – ECB Disappointed by Inflation, Concerned about Currency Strength: Global stocks and sovereign yields are lower Thursday after similar shifts in the U.S. Wednesday. After recovering in the first two and a half days of trading this week, sentiment soured halfway through Wednesday’s U.S. trading session on another round of turmoil in U.S. politics (more below). Lower sovereign yields have been the response to the July Fed Minutes that depicted a divided and cautious Fed assessment of the U.S. inflation outlook (more below). Daily strength in the Yen weighed on Japanese stocks but the benefit of the YoY weakness was reflected in the July trade data. Exports topped estimates and rose for an eighth consecutive month. In Europe, France’s unemployment rate fell to its lowest level since 2009 and U.K. retail sales were better than expected. However, markets were more focused on the ECB Minutes from its July meeting. The Minutes initially sent yields and the Euro lower but both have since recovered. The main takeaways from the Minutes were the ECB’s continued focus on disappointing inflation and an acknowledgment of some concerns surrounding the Euro’s recent strength. As to U.S. markets, the 2-year Treasury yield is up 0.8 bps and the 10-year yield is 1.8 bps higher. Stocks futures are notably lower and the Dollar has recovered on the Euro weakness.
Yesterday’s Trading – Washington Weighs on Markets…Again, Fed Fractured on Inflation Outlook: Turmoil in Washington stirred markets even before the Fed released the Minutes from its July meeting. The announcement of additional resignations from the President’s Manufacturing Council preceded an announcement that the entire Council, along with the Strategic and Policy Forum, would be disbanded. Members had begun to distance themselves from the President in response to his handling of last weekend’s events in Charlottesville. The President tweeted that it was his decision to disband the two groups while separate reports indicated that the members had made the decision. Regardless of the cause, the effect was a swift market response around lunch. The Dollar dropped as stocks and Treasury yields moved to their daily lows. After the Fed released the cautious July Minutes (more below), these moves strengthened further. On the day, the 2-year yield fell 2.0 bps with the 10-year yield closing down 5.1 bps. Stocks managed to recover from their lows to close positive for the day but the Dollar ended near its daily low.
Fed Divided on Inflation Raises Bar for Incoming Reports: The July Fed Minutes described a Committee that is comfortable with the notion that the labor market is nearing, if not at, full employment. However, in the two paragraphs dedicated to inflation, there is a notable split. On the more hawkish side, “Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors.” In contrast, “Many participants, however, saw some likelihood that inflation might remain below 2 percent for longer than they currently expected,” and “several indicated that the risks to the inflation outlook could be tilted to the downside.” Those that were more concerned about inflation believe the recent weakness will allow the Committee to be more patient with the policy rate. On the other hand, there are those that believe the current and expected strength of the labor market warrant further gradual tightening to avoid an inflation overshoot. On the balance sheet, there continues to be consensus support for beginning normalization “relatively soon”; a likely indication for a September announcement. Bottom Line: The timing of future rate hikes will depend on future inflation data. With the Committee evenly divided on the nature of inflation weakness in 2017, the bar has been raised for the incoming inflation reports to show the trend moving towards the Fed’s 2% target.