The Market Today

FOMC Begins Tapering Process, Hedges Outlook for Inflation


by Craig Dismuke, Dudley Carter

TODAY’S CALENDAR

Unemployment Claims Portend Continued Healing in Labor Market: Initial jobless claims for the week ending October 30 fell 14k to 269k, the lowest level of the pandemic. Continuing jobless claims for the week ending October 23 also fell to a new low for the pandemic, down 134k to 2.105m. The decline in continuing claims was fairly broad-based with 35 states reporting lower figures (non-seasonally adjusted.  The unemployment claims data portend continued healing in the labor market, presuming those people go back into the labor market.

Trade Deficit Jumps to New Record High as Exports Languish: As presaged in the goods trade data last week, the September monthly trade deficit jumped from $72.8b to $80.9b, the largest monthly trade deficit on record.  Imports rose $1.7b (0.6%) while exports fell $6.5b (3.0%). The weakness in exports continues to weigh on total output, for now, but is expected to eventually provide a tailwind to growth in the second half of the pandemic recovery.


OTHER ECONOMIC NEWS

FOMC Begins Tapering Process, Hedges Outlook for Inflation: As was widely expected, the Fed voted unanimously to keep its target interest rates unchanged but to begin the process of slowing its monthly asset purchases.  The Fed announced yesterday that it will begin slowing its $120b in monthly purchases by $15b per month beginning this month. Treasury purchases will initially be slowed from $80b to $70b per month and MBS purchases from $40b to $35b.  In December, purchases will be reduced by the same amount.  If conditions permit the Fed to continue tapering at a $15b-per-month pace, purchases will conclude in June 2022 with the balance sheet at $8.8t. The persistence of higher-than-expected inflation led officials to provide a slightly-less-certain inflation assessment in the Official Statement. The Statement was changed from saying, “Inflation is elevated “largely reflecting transitory factors” to saying, “Inflation is elevated, largely reflecting factors that are expected to be transitory” (emphasis added). With the taper process now announced, attention will turn to when the first hike may occur.  Fed Chair Powell indicated in his press conference that policymakers believe they can be patient with rate hikes. The tapering timeline gives officials time to see if the supply-side issues are resolved in the first half of 2022, as they expect, and respond accordingly with interest rate policy. Fed Funds Futures currently project a greater than 50% chance of the first rate hike occurring by mid-2022.

ISM Services Index Shows Constrained Supply Continuing to Face Strong Demand: The ISM’s Services index was surprisingly strong in October, posting its sharpest monthly increase (+4.8) since March and its highest level (66.7) ever recorded. Supply chain issues continued to push the index higher, with the related index rising 6.9 points to its second-highest level on record; the all-time worst supplier delays were registered in April 2020. There was a surfeit of comments from respondents calling attention to the severe supply-chain issues. However, the report was exceptionally strong without the artificial boost to sentiment from supplier delays. The ISM noted “Demand shows no signs of slowing.” Business activity and new orders both climbed sharply to their highest readings in the series’ history. Considering the demand dynamics, a drop in the employment index from 53.0 to 51.6 was likely the result of persistent labor supply issues, not weakening demand. Not surprisingly, considering the aforementioned tensions between supply and demand, work backlogs rose to a new record, inventory indicators fell to near record-low levels, and the prices paid index jumped to its second-highest level in the dataset.

Bank of England Surprises Markets by Keeping Rates Steady: Surprising some, the Bank of England voted 7 to 2 to keep interest rates unchanged. Shorter U.K. yields had risen in recent weeks as rising energy costs and stronger inflation more broadly had prompted the central bank’s Governor to state publicly that officials will “have to act” to keep stronger inflation from becoming imbedded in longer-term inflation expectations. Despite sitting pat at this meeting, the statement said officials believe it “will be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target.” Away from the overnight rate, officials voted 6 to 3 to keep the asset purchase program unchanged. In updated forecasts, growth was revised lower, primarily on supply chain disruptions but also because of rising energy costs and fading fiscal support. Inflation was revised up to show a peak of around 5% in 2Q 2022 but is still “expected to dissipate over time” and be “a little above the 2% target” near the end of 2023.


TRADING ACTIVITY

Treasury Curve Steepened Higher and Stocks Hit Records after Fed Announces Taper Plans: Treasury yields had moved gradually upward after ADP’s estimate of private payroll growth in October topped expectations and climbed strongly to new highs following the release of the surprisingly strong ISM Services Index (more above). An overnight steepening of the curve reversed as shorter Treasury yields overtook the daily increases for longer maturities. Heading into the announcement of the Fed’s decision, the 2-year yield was 2.0 bps higher at 0.47%, the 5-year yield had risen 3.6 bps to 1.18%, and the 10-year yield was up 1.6 bps to 1.57%. While the Nasdaq was marginally higher on the day, the S&P 500 and Dow were trading near session lows after fluctuating in negative territory throughout the morning session. Fifteen minutes after the Fed’s statement was published, the 2-year yield was 2.8 bps higher, the 5-year yield was 5.8 bps higher, and the 10-year yield was 4.8 bps higher. After rising further early in Powell’s press conference, shorter Treasury yields ultimately pared their gains amid the talk of patience. The 2-year yield ended 1.6 bps higher at 0.47% after touching 0.51% intraday. The 5-year yield added 4.0 bps to 1.19%, down from Wednesday’s high of 1.22%. The 10-year yield ended up 5.5 bps at a session peak of 1.60%. Stocks enjoyed a post-Fed rally, with each of the three major indexes climbing sharply in the afternoon to end at records. The Nasdaq led with a 1.0% jump.


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