The Market Today
Fed Officials Divided over Timing of Transition, Powell to Testify before House
by Craig Dismuke, Dudley Carter
Existing Home Sales and Regional Fed Report: May’s existing home sales data are expected to show another 2.1% decline at 9:00 a.m. CT. Perhaps more telling will be the non-seasonally adjusted data. Home sales, along with some other categories of economic activity, have followed the reopening trends more so than the normal-year seasonal patterns. As such, the hurdle rate for a positive report appears to be +7% MoM NSA. Also at 9:00 a.m., the Richmond Fed Manufacturing Index will be released.
Fedspeak: Three Fed officials are on the tape today including Cleveland’s Mester (2022 voter), San Francisco’s Daly (current voter), and Fed Chair Powell. Powell will testify before a House subcommittee on the central bank’s reports to the pandemic (1:00 p.m. CT). Prepared remarks show that he intends to anchor his outlook on the belief that inflation will prove transitory (more below).
Powell to Recycle Press-Conference Story to House Committee: The Federal Reserve released the transcript of Fed Chair Powell’s prepared testimony on Monday afternoon, showing the central bank chief will tell members of a House committee later today that “Inflation has increased notably in recent months,” but that “As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.” Sticking close to the story he told at last week’s press conference, Powell will state, “Job gains should pick up in coming months as vaccinations rise, easing some of the pandemic-related factors currently weighing them down.”
24 HOURS OF MARKET ACTIVITY
Two-Year Treasury Yield Sticks Higher after Fed’s Pivot While Stocks and Longer Yields Reverse Sharp Friday Declines: Market volatility has picked up since last Wednesday’s Fed decision showed officials beginning to pivot away from an emergency-policy paradigm in response to an ebbing pandemic and economic reopening boosting activity and inflation more than they had previously expected. St. Louis Fed President Bullard added to the anxieties last Friday when he said the economic situation justified the Fed “tilt[ing] a little bit more hawkish…to contain inflation pressures.” His remarks sent the Dow down more than 500 points and flattened the Treasury curve, with the 10-year yield falling 6.6 bps while the 2-year yield rose 4.4 bps. While the 2-year yield held its Friday shift higher, most other key assets reversed Monday as investors continue to digest and debate the implications of a possible Fed pivot. The 10-year Treasury yield unwound most of Friday’s decline with a 5.1-bp increase while the Dow fully erased its prior-session loss with a 587 point, or 1.8%, gain.
Foreign equities have registered modest gains overnight after Wall Street rallied back to start the week. Asian stocks rose around 0.9%, helped out by Japan’s Nikkei surging back more than 3% following an equally large slump on Monday. Europe’s Stoxx 600 added a more modest 0.2%, with gains for larger European countries partially offset by losses in Spain and Europe. Sovereign yield curves were fluctuating without clear momentum in either direction, with most changes relatively minor. Prior to today’s testimony from Fed Chair Powell, a couple of ECB officials indicated overnight that the economic situation in the EU warrants continued support from policy makers. Yesterday, ECB President Lagarde said the domestic outlook is improving but stressed that the EU and U.S. are in “different situations.” Reuters reported that a weekend retreat of ECB officials yielded no hard decisions related to redefining their price stability goal. Discussing the report, Bloomberg reported, “One source told Reuters there was general consensus that the ECB could tolerate inflation exceeding a new goal of 2% as it has been stuck below that level for most of the past decade.” At 7:30 a.m. CT, U.S. equity futures had risen by between 0.1% and 0.2% and Treasury yields were mixed. The 2-year yield was 2.0 bps lower to 0.23% while the 10-year yield had added 0.5 bps to 1.49%.
A Couple of Fed Hawks Continue to Voice Support for Paring Back Accommodation: After upending markets last Friday, St. Louis Fed President Bullard again said he could easily argue “at any time” that the economy has made the “substantial further progress” necessary under the current forward guidance to begin tapering those monthly bond buys at some point soon. Dallas Fed President Kaplan, repeating a position he has publicly stated for several weeks now, said, “I’ve been more of a fan of doing some things, maybe, to take our foot gently off the accelerator sooner rather than later so that we can manage these risks” and try and “avoid having to press the brakes down the road.” Both Bullard and Kaplan said the Fed needed to seriously consider if the housing market, which has boomed over the last 12 months, actually needs any support from the central bank. The Fed is currently buying $40 billion of mortgage-backed securities each month.
Williams Believes Policy is Appropriate, Expects Stronger Inflation “Mostly” Temporary: New York Fed President Williams said Monday, “It’s clear that the economy is improving at a rapid rate, and the medium-term outlook is very good. But the data and conditions have not progressed enough for the FOMC to shift its monetary policy stance of strong support for the economic recovery.” Importantly, his “view is that the spike in inflation mostly reflects the temporary effects of the surprisingly rapid opening of the economy,” and he believes inflation will cool to around 2% in 2022 and 2023 “once these prices have fully adjusted to the reopened economy.” He pointed to the recent ebbing of costs for used cars and lumber to support his case and reiterated the belief that pre-pandemic disinflationary forces will eventually reassert themselves. Nonetheless, “It goes without saying,” Williams cautioned, “that there is a great deal of uncertainty about the inflation outlook, and I will be watching the data closely.” Citing one particular area of uncertainty, Williams said some bottlenecks in the supply chain will likely last longer than previously expected and potentially into next year.