The Market Today
Supply-Side Inflation Pressures Continue Building
by Craig Dismuke, Dudley Carter
More Supporting Evidence of Supply-Side Inflation Pressure: Initial jobless claims for the week ending April 14 fell 1k to 232k. The 4-week moving average inched higher to 231k but continues to be very low from an historical perspective. The Philadelphia Fed Business Outlook report showed manufacturing activity in the Fed bank’s region moved higher in April with the index rising from 22.3 to 23.2. The New Orders sub-index slipped from an extremely strong 35.7 reading in March to 18.4 while the Prices Paid sub-index, a measure of production input costs, rose from 42.6 to 56.4, its highest level in 7 years. This is yet another indicator of higher supply side inflation pressure, although businesses have yet to show the ability to pass those higher costs through to consumer prices.
Yesterday – Stocks Took a Breather and the Yield Curve Finally Steepened: After two days of solid gains, U.S. equities leveled off Wednesday. The Nasdaq added 0.2%, the S&P 500 improved a marginal 0.1%, and the Dow dropped 0.2%. Energy companies led the S&P, rallying 1.55% as crude prices surged more than 3% on bullish U.S. inventory data. Despite another week of record output, the EIA reported inventory drawdowns across all product categories. U.S. WTI closed over $68 per barrel and at its highest level since December 2014. The Dow’s total points loss was accounted for more than two times by tumbling shares of IBM, as data away from the better-than-expected bottom line weighed on the company’s performance outlook. The yield curve steepened for just the second time in nine sessions as the 10-year yield’s 4.4 bps gain outpaced the 3.5 bps move by the 2-year yield. The 10-year yield finished at 2.87%, its highest level in almost a month. The 2-year yield, which has risen in eight consecutive sessions and only dropped twice in April, closed at a new cycle-high of 2.43%.
Overnight – Sovereign Yields Climbed as Equities Traded Mixed and Commodity Prices Came into Focus: Global sovereign yields are higher Thursday, tracking yesterday’s rise by the U.S. Treasury curve. Yields in the U.K., which tumbled yesterday after a weak inflation report, are leading the rise. The 10-year Gilt yield was higher by 6.7 bps while the 10-year yields in Germany and France were higher by 3.5 bps. In the U.S., the 2-year yield was essentially flat from Wednesday’s new cycle high but the 10-year yield had inched up another 2.8 bps to 2.90%. After a solid finish across Asia, equity sentiment has tapered off some to drive more modest gains in Europe and small losses in U.S. futures. Commodity prices remain in focus as oil prices added to yesterday’s gains to reach new multi-year highs and metals prices continued to reflect the impact of U.S. sanctions on Russia. Aluminum prices were up 5.5% overnight, are up more than 24% since those sanctions were announced on April 6, and are at their highest levels since 2011. Russia is the second largest world producer of aluminum. Other base metals have also traded higher.
Bullard Believes the Fed Could Cause the Curve to Invert within Six Months: St. Louis Fed President Bullard showed more concern about the shape of the yield curve than the casual caution portrayed by his San Francisco counterpart a day earlier. On Wednesday, Bullard said the Fed should leave the overnight rate where it is or risk inverting the yield curve within six months. This topic, he added, deserves the Fed’s attention and discussion right now. On Tuesday, John Williams had said that an inverted curve is indeed an ominous indicator, but indicated he believes longer rates will move up and keep inversion from becoming a near-term reality. Away from the markets, Bullard’s outlook for the economy was less dire. He summarized the status of the global economy as very good and thinks continued hiring here at home will push the unemployment rate to a 3%-handle.
Beige Book Describes Stable Growth, Trade Concerns, Tight Labor Market, Modest Wage Growth, Moderate Inflation Pressures: The Fed’s Beige Book again described the pace of economic expansion as “modest to moderate” (March and early April) across the 12 Districts. However, business contacts caveated their positive outlook with some consternation towards the “newly imposed and/or proposed tariffs.” The word tariff appeared 36 times throughout the April edition, up from 0 mentions in March. On the Fed’s mandate, “widespread employment growth continued,” but “difficulty finding qualified candidates across a broad array of industries and skill levels” was capping gains. However, “businesses were responding to labor shortages in a variety of ways, from raising pay to enhancing training to increasing their use of overtime and/or automation,” which may help explain why ”upward wage pressures persisted but generally did not escalate; most Districts reported wage growth as only modest.” The Fed did note that “prices increased across all Districts, generally at a moderate pace” and the subsequent discussion was firmer in tone towards the general characterization of inflation pressures.
Dudley Expects Gradual Rate Hikes to Continue: With two months left in his tenure, NY Fed President said gradual rate increases continued to be the appropriate in order to return the Fed Funds rate to neutral and ensure price stability. Dudley disclosed he has the neutral rate pegged near 3% and explained that while “that is higher than the estimates from some models, I have nudged up my estimate because financial conditions are still easy and fiscal policy will likely be quite stimulative in 2018 and 2019, …there is still some distance to go before monetary policy actually gets tight.” But he acknowledged that a gradual path is enough, saying “Even though the unemployment rate is low, inflation remains below our 2 percent objective. As long as that is true, the case for tightening policy more aggressively does not seem compelling.” He said, “The U.S. labor market may have more slack than the 4.1 percent unemployment rate suggests,” and singled out prime-age worker participation as a possible area of slack that could absorb additional hiring without creating undue inflation pressures.