The Market Today
Fed Funds Futures Convincingly Pricing in December Hike
by Craig Dismuke, Dudley Carter
Vining Sparks Hosts 4Q Economic Outlook Webinar, Thursday at 10:00 a.m. CT: During the 45-minute presentation, we will 1) discuss the positive attributes of growth today including a quick look at global optimism; 2) highlight a few areas of weakness; 3) discuss the talk of tighter monetary policy but 4) illustrate the challenges evident in broadly weaker inflation; 5) provide a year-end 2017 and year-end 2018 interest rate outlook; and 6) discuss two possible game-changers to our forecast, tax reform and changes at the Federal Reserve. To register for the webinar, please click here.
Today’s Calendar – Industrial Production and Homebuilder Confidence Expected to Be Strong; Import Prices Rise with Dollar Weakness: Import prices for the month of September were slightly firmer than expected, rising 0.7% MoM (2.7% YoY) at the headline level and 0.3% at the core level excluding energy. The weaker Dollar has continued to push import and export prices higher. September’s increase in import prices came primarily from a 1.8% surge in food and beverage prices, specifically agricultural prices. Rising metal prices also pushed industrial supply prices 2.4% higher. While the increase in import prices is moderately inflationary, it is not significant enough at this point to raise concerns. At 8:15 a.m. CT, the September Industrial Production report is expected to show a bounce back in output after Hurricane Harvey was credited with dinging the August data. At 9:00 a.m., October’s homebuilder confidence index is expected to show homebuilder confidence remaining high despite flagging sales.
Overnight Activity – U.K. Assets Respond to Carney’s Call for Rate Hike, Concerns about Brexit: Global markets are mixed heading into Tuesday’s U.S. session. Sovereign yields rose in Asia but European curves have mostly flattened on modestly higher short yields and lower long yields. U.K. gilts were the outlier overnight as yields moved as much as 5bps to 6bps lower across the entire term structure between 2-years and 30-years. Those moves, which have since moderated, came during and despite remarks from the head of the Bank of England reinforcing the view the central bank may hike rates in the coming months. Earlier in the session, U.K. CPI inflation was as expected at a five-and-a-half year high of 3.0%. The Bank of England continues to try and balance the trade-off between weaker economic activity and stronger inflation – both a result of the Brexit vote. The uncertainty surrounding the Brexit process was also discussed by Governor Carney, who said the central bank is working on a contingency plan for a potential “hard exit”, although he said he ultimately expects a transition deal to be reached. Other data from Europe confirmed Eurozone headline and core inflation of 1.5% and 1.1%, respectively, for October and reported weaker expectations for Eurozone economic growth in a survey of financial experts. In U.S. assets, the Dollar is firmer on a weaker Pound (Carney’s comments) and Euro (political uncertainty in Spain, Austria) and equity futures are mixed. Treasury yields moved higher in early trading with the 2-year yield up 0.4 bps and the 10-year yield 0.9 bps higher.
Yesterday’s Trading Activity – Yields Rise on Fed Comments and Reports Trump Liked Taylor: The Treasury curve was led higher Monday by the short-end, flattening the curve to 76 bps between 2s and 10s (flattest since August 2016) but boosting shares of financial companies. The 2-year yield rose 4.5 bps to 1.54% while the 10-year yield finished 3.0 bps higher at 2.30%. The 5-year yield added 5.0 bps to 1.95% while the 30-year yield rose the least, up just 1.8 bps to 2.82%. The spread between 5s and 30s flattened to 87 bps, the least since November 2007. Yields got a boost from weekend comments from Fed officials, including Chair Yellen, that rate hikes were likely to continue at a gradual pace. The biggest move in yields during U.S. trading occurred after lunch on headlines that President Trump was impressed with John Taylor when they met last week to discuss the up-for-grabs role of Fed Chair. It was also reported that the President will meet this week with current Fed Chair Yellen to discuss the position as well. Fed funds futures adjusted, with the implied rate for December 2018 reaching its highest since April. For equities, a recovery in shares of AT&T pushed telecom companies to the top of the S&P but the higher yields helped financial companies finish in the second spot. Higher crude prices benefited energy companies while the higher rates weighed on real estate and utilities. The broader index gained 0.18% and notched another new record-high close. The Dow (+0.37%) and Nasdaq (+0.28%) outperformed the S&P and both reached record highs of their own.
Bloomberg Survey Shows Economists Expect Temporary Disruption in Growth from Hurricanes: The October Bloomberg Survey of Economists shows economists expecting the recent hurricanes to temporarily affect the economic data followed by an equally temporary rebound. Growth is expected to be weaker in 3Q while inflation is expected to be higher and job growth slower. However, those trends are expected to reverse in 4Q and 1Q18. As for the interest rate outlook, economists generally left their interest rate projections unchanged with a slight cut to longer maturity Treasury yields. Economists collectively expect the Fed Funds rate to end 2017 at 1.375% (+25 bps from today’s level) and 2018 at 1.875% (+75 bps), the 2-year Treasury to end 2017 at 1.60% (+7 bps) and 2018 at 2.29% (+76 bps), and the 10-year to end 2017 at 2.44% (+14 bps) and 2018 at 2.95% (+65 bps).