Weak inflation may lead to Fed reassessing rate hikes

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Published Date 5/31/2017

Good day yesterday--the yield on the 10-year declined 4 bps to 2.21% where we have some technical resistance, and MBS prices increased 17 bps. This morning, no follow-through, but not unexpected after the improvements yesterday. Yesterday some minor selling in equity markets dropped the DJIA 50 points. This morning in pre-open trading, the indexes traded a little better. The 10 at 8:00 am EDT 2.22% +1 bp, FNMA 3.5 30 yr. coupon -5 bps from yesterday’s close.

Weekly MBA mortgage applications released this morning were down 3.4% overall after increasing 4.4% the week before; purchase apps -1.0% the second week in a row; purchase apps down 1.0% from the previous week. Refinance apps -6.0% after increasing 11% the prior week.

Around the world: The US successfully launched an anti-missile yesterday, a test that was scheduled but added more interest after N. Korea continued to advance its missile launches and touted their recent successes. The situation isn’t being ignored by some bond buyers these days. On June 8th, UK prime minister May has a vote in parliament to try and gain control before Brexit negotiations begin; Reuters this morning writing that the polls suggest she might lose, raising the prospect of political deadlock. Trump has decided to pull out of the Paris climate accord. The decision will put the United States in league with Syria and Nicaragua as the world's only non-participants in the Paris Climate Agreement. The accord, agreed on by nearly 200 countries in Paris in 2015, according to Trump is flawed, and he has always said he didn’t believe the depth of the data. The debate is that carbon dioxide emissions should be cut back. No one argues that, but is the geological clock too much to counter? Global warming, according to those opposed to the expense of trying to stop it by attempting to eliminate carbon dioxide is inevitable and escalating, and won’t change the path of warming. They claim it will increase costs on everything.

Inflation in the eurozone reported is less than forecasts; +0.9%, well off the 2.0% Draghi wants (as does our Fed). Europe’s economies are improving but no inflation in sight, confirming Draghi’s comments recently that he isn’t in any hurry to withdraw EU stimulus and negative interest rates.

More Fed official’s comments: yesterday Fed Gov. Lael Brainard added her voice to increasing the federal funds rate likely in two weeks. “And if the economy evolves in line with the SEP median path, the federal funds rate will likely approach the point at which normalization can be considered well underway before too long when it will be appropriate to adjust balance sheet policy. I support an approach that retains the federal funds rate as the primary tool for adjusting monetary policy, sets the balance sheet to shrink in a gradual and predictable way for both Treasury securities and MBS, and avoids spikes in redemptions.” Brainard is a Fed dove: “If the soft inflation data persist, that would be concerning and, ultimately, could lead me to reassess the appropriate path of policy.”

At 9:45 May Chicago purchasing mgrs. index expected at 57.5 from 58.3 in April; as released 55.2; still above 50 and over the last four months has held relatively well with little wild swings as is customary with the regional report. Tomorrow, the national ISM manufacturing index is expected at 54.7 from 54.8 in April. There was no noticeable reaction to the lower index.

At 10:00, NAR April pending home sales, expected +0.8% after declining 0.8% in March; sales were down 1.3% and March revised to -0.9%. Low inventories are blamed. Pending sales are contracts that are signed but have yet to close. Recent reports on housing have not met expectations. The bond and mortgage markets saw a slight improvement when the data was released and after opening better, US stock indexes moving lower.

This afternoon, the Fed Beige Book will be released. Don’t expect anything significant; details from each of the Fed districts is interesting but usually not a factor in trading.

Crude oil continuing under pressure as we continue to expect; traders concerned OPEC may not be able to hold the cuts for much longer, as the US and Canada increase oil output at around $50.00/barrel. One more read on the outlook for inflation lessening at the moment.

The long end of the yield curve is holding well as investors and traders continue to see less inflation ahead than the Fed or equity investors. Technicals remain bullish. With employment data coming on Friday we are not looking for any significant changes until the details are reported. Two weeks from today, the FOMC policy statement and Janet Yellen’s press conference; we as well as most of the markets expect the Fed will increase the federal funds rate but as inflation reads wane a little the possible Sept increase is now in question.

Source: TBWS

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