The Market Today

FOMC Barges Ahead Despite the Data

by Craig Dismuke, Dudley Carter

Inflection Point for Monetary Policy?  And Expectations for Interest Rates – Special Webinar Update Today: We will host a special economic update webinar this morning at 10:00 a.m. CT focusing on where the Fed goes from here.  After hiking three times in seven months, the outlook points to a slower pace of rate hikes going forward if the Committee is going to remain data dependent.  As such, we are arguably at an inflection point for policy action.  We will discuss the reasons why this may be an inflection point and the implications for interest rates.  You can click here to register for the short conference call.


FOMC Pushes On Despite Run of Weak Data: The FOMC voted yesterday to hike their target range another 0.25% to 1.00-1.25%, the third hike in seven months.  Overall, the Statement was more hawkish than expected.  The Statement highlighted a labor market that has “continued to strengthen,” economic activity that has been “rising moderately” (a slight upgrade from May’s language saying economic activity had “slowed”), job gains that have been “solid,” household spending that “has picked up,” and business fixed investment which “has continued to expand.”  As it relates to inflation turning lower, the Statement acknowledged the recent weakness but that the FOMC continues to expect it to “stabilize around the Committee’s 2 percent objective over the medium term.”  When pressed on this topic repeatedly in her press conference, Chair Yellen continuously cited the low unemployment rate as evidence that inflation would pick back up – despite the low unemployment rate not yielding a material pick-up in wage growth yet.  The only note of caution in the Statement, seemingly ignoring the run of weak data recently, was the comment that they are “monitoring inflation developments closely.”


Adding to the hawkishness of the announcement, the Fed laid out its balance sheet plans in more detail and stated that they expect to begin the process later this year.  They will begin with a $10 billion per month cap on the amount allowed to roll-off, increasing the cap by $10 billion every 3 months until it reaches a final cap of $50 billion per month.  The final $50 billion per month would include a $30 billion cap on Treasury roll-off and a $20 billion cap on MBS and agency roll-off.  The fact that the Fed has already published these plans and expects to begin this year were a surprise – this was an event most analysts expected to occur in 4Q17 with a start date in 2018.


In the Summary of Economic Projections, FOMC participants left their growth expectations and target rate projections largely unchanged.  Participants still expect to hike one more time this year, three times in 2018, and three additional times in 2019.


Today’s Calendar – Another Day Packed with Data: Import prices for the month of May proved weaker-than-expected, dropping 0.3% MoM and bringing the YoY rate down from 4.1% to 2.1%.  Excluding petroleum, prices of imports were flat.  Initial jobless claims for the week ending June 10 fell 8k to 237k, breaking a recent trend that lasted two weeks of claims being over 240k.  The Philadelphia Fed Business Outlook index fell from 38.8 to 27.6, still a strong report on manufacturing activity in the region, but weaker than expected.  In contrast, the New York Fed index, also covering manufacturing activity in the region, rose strongly from -1.0 to +19.8.  At 8:15 a.m. CT, the Industrial Production and Capacity Utilization reports will be released and are expected to show a weaker pace of manufacturing activity.  The June Homebuilder Confidence index is scheduled for 9:00 a.m. and is expected to remain strong.


Overnight Activity – BoE Split Send Sovereign Yields Higher: Sovereign yields are climbing after a split decision by the Bank of England reinforced an existing overnight bias for higher yields. In a 5-3 decision, the MPC elected to leave its target rate unchanged. The consensus expectation seemed to be that support for holding monetary policy steady would remain at 7-1. In the details of the statement, the surprising dissents appear to be driven by concerns of above-target inflation, given the MPC’s acknowledgment that recent economic data has been weaker. Yields in the U.K. spiked, pressuring yields elsewhere in Europe higher. Equities in the U.K. are at the front of the pack in a race to the downside. In the U.S., equity futures declined sharply; futures on the Dow, S&P, and Nasdaq are off 0.4%, 0.6%, and 1.0%, respectively. The Dollar is leading major global currencies and Treasury yields have clawed back some of yesterday’s decline. The 2-year yield is up 1.6 bps to 1.35% and the 10-year yield added 2.4 bps to 2.15%. Not to be forgotten, oil prices reached a new seven-month low, dropping another 0.5%.


Yesterday’s Trading Activity – Morning Data Sets Disappointing Tone for Wednesday Trading: Early morning disappointment in the May inflation and retail sales data shook markets out of their weekly slumber. Another monthly miss for core inflation and mixed retail sales results sent the 10-year Treasury yield plunging to 2.10% and the 5-year to 1.67%; both new year-to-date lows. The 2-year yield declined more modestly, sliding to 1.28% as markets continued to expect another Fed hike later in the afternoon. The dollar weakened sharply. Equity futures rose as did the current indices when trading opened. Those moves held until the Fed announced its fourth hike of the cycle, wrapped in relatively sanguine packaging, and provided greater detail of its balance sheet normalization policy (more below). Markets differed in their response to the Fed news. The Dollar recovered nearly all of its early losses to end the day unchanged. Yields, however, only edged off their daily lows, finishing well below where they started. The 2-year yield fell 3.2 bps to 1.33%, the 5-year yield settled down 6.6 bps at 1.72%, and the 10-year yield closed 8.5 bps lower at 2.13%. Stocks diverged as the S&P and Nasdaq slipped while the Dow climbed to a new record high. Elsewhere, oil prices fell 3.7% to a seven month low after a surprise build in U.S. gasoline inventories.

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