The Market Today
Yields Fall as China Discredits Wednesday Report; Rise After ECB Minutes Seen as Hawkish
by Craig Dismuke, Dudley Carter
Today’s Calendar – Jobless Claims Rise, Producer Prices Fall, Dudley Speaks: Initial jobless claims for the week ending January 6 rose from 250k to 261k, a fourth consecutive weekly increase. Claims tend to be noisy around holidays, and particularly around year-end. However, at 261k, initial claims matched their highest level seen in 2017, save the hurricane-affected September reports.
Producer prices unexpectedly fell in December for the first time since February. Driving the decline was a drop in the prices of services, down 0.2% MoM, while goods prices were unchanged. There were meaningful declines in gasoline station prices, airline services, apparel, televisions, and loan services. Excluding food and energy, prices still fell 0.1% MoM bringing the YoY rate down to 2.3%. The report is yet another indicator that actual inflation remains tame despite all of the indicators pointing to a hot labor market and strengthening economy. Tomorrow’s CPI report will be a key indicator for Fed officials.
At 2:30 p.m. CT, outgoing New York Fed Bank President Dudley will speak at a SIFMA conference in New York. While Dudley has traditionally moved markets with his comments, investors may discount them now given his transition out of the role at New York Fed Bank chief.
Overnight Activity – Yields Fell After China Discredited Wednesday Report, Rose After ECB Minutes Seen as Hawkish: Global equities are mixed Thursday as sentiment remains subdued following an easing of the optimism that drove markets higher to start 2018. But sovereign yield movements were again the story after another bout of intraday volatility. The Wednesday report that indicated China was reconsidering their involvement in U.S. Treasurys and sent yields sharply higher was discredited overnight. China’s State Administration of Foreign Exchange said, “We think the report might have cited wrong sources or may be fake news.” The 10-year Treasury yield dropped from 2.55% to 2.53% in response. But the rally faded around 6:30 a.m. CT after the ECB released the Minutes from its mid-December meeting. While the Minutes showed that “Members widely agreed that the Governing Council needed to remain patient and persistent with its monetary policy,” they also noted that “the Governing Council’s communication would need to evolve gradually, without a change in sequencing, if the economy continued to expand and inflation converged further towards the Governing Council’s aim, …The language pertaining to various dimensions of the monetary-policy stance and forward guidance could be revisited early” this year. The Euro popped on the news and a jump in European yields pressured Treasury yields to their daily highs. After the softer inflation and jobless claims data, the yield curve is hardly changed; 2s -0.4 bps, 5s -0.3 bps, and 10s -0.4 bps.
Yesterday’s Trading Activity – Intraday Volatility Across Various Asset Classes Fades to Leave Most Asset Classes Little Changed: There was interesting price action across assets classes on Wednesday. Starting with stocks, the Dow dropped approximately 130 points in the first half hour, spent most of the day climbing back to up 19 points, but ultimately faded by the close to end down 17 points, or 0.01%. The S&P followed a similar path to a daily decline of 0.11% and the Nasdaq slipped 0.14%. Longer Treasury yields were equally as volatile, with the 10-year yield jumping more than 5 bps overnight on news China was reconsidering holding U.S. Treasurys before rallying back after a solid 10-year auction. Despite the concerns about potentially less demand from China, indirect bidders – which ironically includes foreign central banks such as the PBOC – took down 71% of the auctioned amount, the largest share since August 2016. In other metrics, the bid-to-cover of 2.7x was the strongest since June 2016 and the awarded yield of 2.597% was the highest since July 2014. On the day, however, the dust settled with no part of the curve from the 2-year note and out changing more than 0.5 bp. The Dollar also sold off on the China report but slowly climbed back with the biggest jump following a headline that Canadian officials see a growing chance that the U.S. will pull out of NAFTA. The White House responded by saying the President’s position on NAFTA was unchanged. The Canadian Loonie was Wednesday’s worst performer.
Evans Disagreed with December Hike, Wanted to Wait until Mid-2018: In his remarks on Wednesday, Chicago Fed President Evans explained why he dissented to the December rate hike. Evans said, “I don’t see any evidence of inflation moving up really fast, or even moving up enough,” and therefore he felt “it would be good to sort of put off the increases until about the middle of this year just to make sure the inflationary concerns resolve themselves.” He projects core PCE inflation will end 2018 at 1.7% and doesn’t expect to achieve target-rate price gains until the end of 2019. On the economy, he said he expects the U.S. economy to grow 2.5% in 2018 and noted the global economy is doing extremely well.
Kaplan Sees Three Hikes This Year to Avoid Playing Catch Up: Dallas Fed President Kaplan expects to see a little more wage pressure in 2018 and, despite some headwinds from technology, said cyclical inflation pressures are no doubt building. Kaplan said, “We’re going to have to watch, because we want to avoid a situation where we have such an overheating that we’re playing catch-up. …Cyclical pressures are building substantially, and they will offset some of the structural headwinds. We will have to see.” As to what this means for rates, he added that three hikes this year is still a good base case. On growth, Kaplan noted that the tax cuts could boost business investment but cautioned that possible resultant increases in the national debt are a concern. Ultimately, Kaplan expects any tax-related boost to be fleeting based on his out year GDP forecasts of 2.2% for 2019 and 1.8% in 2020.
Bullard Explained Alternate Policy Frameworks in Wednesday Presentation: Consistent with the growing conversation among economists, including various Fed officials, about the central bank considering different policy frameworks for managing U.S. monetary policy, St. Louis Fed President Bullard gave a presentation Wednesday in his hometown titled “A Primer on Price Level Targeting in the U.S.” While the presentation was obviously focused on introducing alternate policy frameworks the Fed could one day use in place of its current inflation target, Bullard answered a couple of questions on the current situation. He said the U.S. economy looks very good starting 2018 and noted that he doesn’t see a high chance of a recession.
FASB Met to Discuss Financial Reporting Effects of Tax Reform: The Financial Accounting Standards Board (FASB) held a meeting on January 10, 2018 to discuss the financial reporting effects of the Tax Cuts and Jobs Act signed into law on December 22, 2017. Stakeholders in the banking and insurance industries raised financial reporting issues by submitting unsolicited comment letters to the FASB regarding amounts stranded in AOCI as a result of tax reform. The purpose of the Board meeting was to decide whether to add a project to the Board’s agenda on the reclassification of certain tax effects from AOCI to retained earnings (RE) and make technical decisions if the Board decided to add the project to its agenda. Click here to read the related Vining Sparks Strategic Insight.