The Market Today

Yield Curve Continues to Flatten as Shorter Yields Continue Higher


by Craig Dismuke, Dudley Carter

TODAY’S CALENDAR

Import Prices Show Rare Month of Weakness: Lower prices of imported foods and energy helped drag the headline import price index down 0.4% MoM in June, its largest monthly decline since February 2016.  The price of imported foods dropped 2.6% and petrol products dropped 0.8%.  Apart from the headline weakness, there was broad-spread weakness in import prices.  The weaker import prices in June helped bring the YoY rate down from 4.5% to 4.3% (exp. 4.6%) offering a small respite from an otherwise-trending-higher inflation indicator.

 

Consumer Confidence, Fed Report to Congress, Bostic:  At 9:00 a.m. CT, the University of Michigan’s preliminary July report on consumer confidence is expected to show confidence remaining high.  The Federal Reserve will release its semi-annual monetary policy report to Congress at 10:00 a.m. in advance of Chairman Powell’s testimony next week.  Atlanta Fed Bank President Bostic is on the tape today speaking at a town hall meeting in Northern Virginia.  He has been one of the more outspoken Fed officials on concerns about how flat the yield curve has become.

 

TRADING ACTIVITY

Yesterday – Stocks Recovered, Curve Flattening Continued; 2-Year Treasury Yield Reached New Cycle High: Stocks recovered Thursday after weakening Wednesday in response to the latest tariffs three between the U.S. and China. Tech companies outperformed other sectors which pushed the Nasdaq up 1.4% to its first record-high close since June 20. Ten of 11 sectors with the S&P 500 gained 0.9% and rose to its highest level since February 1, the day before stocks ripped lower on a strong hourly earnings figure in January’s nonfarm payroll report. The Dow also rose 0.9% and finished at its strongest reading since mid-June. Equity markets have been rocked be various trade announcement as of late, but proven resilient by posting quick recoveries. The bond market has been somewhat of a different story. The most recent episodes of volatility caused by trade have had relatively little impact on the Treasury curve. Longer maturities have been more hesitant to move up as stocks have recovered, with the 10-year yield actually slipping 0.4 bps to 2.85%. The 2-year yield however, rose 0.8 bps to 2.59%, a new high for the cycle. Those fluctuations kept the recent flattening trend on track, with the 2s10s spread dropping to 25.5 bps, a new post-Great Recession low.

 

Overnight – Mixed Signals Friday as Stocks and Sovereigns Both Gain: Markets were sending mixed signals on Friday as global equities and global sovereigns both strengthened. Most Asian markets extended their bounce-back from Wednesday’s sell-off in response to the U.S. plans for tariffs on $200 billion of Chinese goods. Sentiment has recovered over the last several days in the absence of any further escalation. Still, the Chinese yuan continued to weaken towards its lowest level in eleven months and June trade data showed China’s trade surplus with the U.S. at a new all-time record; two facts that could continue to fuel the trade tensions. Chinese stocks closed mixed Friday but the CSI 300 notched its first weekly gain in the last six tries. European stocks were higher by 0.2% and U.S. futures were tilted marginally into positive territory. But other markets aren’t willing yet to signal the all’s-clear. The bond market continued to reflect some concern as the major sovereign yield curves were almost exclusively lower. Ten-year yields in Germany and France were down by more than 2 bps and the same maturity U.S. Treasury 0.9 bps lower.

 

NOTEWORTHY NEWS

Vining Sparks 3Q Economic Outlook Webinar: In our 3Q economic outlook webinar we discussed the economic developments that led the Fed to raise rates in June and project a slightly less gradual pace of tightening in their updated projections. While that has pressured short yields higher, several global forces (e.g. slow patch for global economies, concerns about a trade war) have created some uncertainty and kept longer yields in check. As a result, the yield curve has flattened to levels not seen since the Great Recessions. Most of our time was spent looking at historical examples of environments that accompanied flat and inverted yield curves and the potential implications for the economy and investors today. Click here for a copy of the slides and please reach out to your sales representative for a link to the replay or with any questions you might have.

 

Powell’s Comfortable with the Current Economy, Sees Growing Concerns Around Trade: Fed Chair Powell said Wednesday that “The United States economy is in a good place from a cyclical standpoint close to our maximum employment and stable prices target, …I sleep pretty well on the economy right now.” He went on to say, “Inflation has very gradually moved up and it’s now just touching 2 percent. So we’re really close to our target. I wouldn’t say we’ve fully achieved it yet. We’re not declaring victory there.” Going further, Powell added, “We want inflation to be symmetrically around 2 percent, so just kind of reaching up and touching it once doesn’t fulfill that goal.” On the recent tariff developments, “We are hearing a rising level of concern about the effects of changes in trade policy, …I think this process that is going on now is a new one, …It’s very difficult to predict how it turns out and we’ll just have to see.”

 

Harker’s Open to a Fourth Hike, Says Fed Should Yield to the Yield Curve: Philadelphia Fed President Harker (2020 voter) said his base case is still for three total rate increases but indicated he was open to the possibility of a fourth. The swing factor will be if inflation picks up. On inflation, he highlighted that trends were back near the Fed’s 2% target and, interestingly, said he would be comfortable with inflation moving as high as 2.5% if it wasn’t accelerating through that level. Inflation trends in the services sector will be important to keep an eye on, according to Harker, because “Services are driven by primarily labor, and if we’re starting to see large increases in service inflation, then we’ll start to see those wage increases, as well.” When discussing the flattening yield curve, he noted that if a policy move risks inverting the yield curve, “we should avoid that.”

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