Chance of Fed Rate Hike Shrinking

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Published Date 8/11/2017

July CPI at 8:30 AM EDT this morning softer than expected and in line with the soft PPI yesterday. Overall CPI was thought to be +0.2% as reported up 0.1%; the core (ex-food and energy) expected +0.2%, also up just 0.1%. Yr./yr. CPI +1.7% from +1.8% in June; core yr./yr. +1.7% from +1.8% in June. Inflation isn’t increasing as the Fed, and many others have been betting on for months. Moderation in housing costs remains a major disinflationary force, increasing 0.1% higher for a yearly 2.8%, which is down 2 tenths from June. Wireless services continue to move lower, falling 0.3% on the month for a yearly decline of 13.3%. Auto prices down 0.5% from June. Apparel prices, which had been on a long negative streak, rose 0.3%, though the year-on-year rate remains negative at -0.4%.

The two inflation reports yesterday and this morning should keep the Fed on edge about beginning the tapering of its balance sheet that has been widely believed and another increase in the Federal Funds rate in December is now in question. Yesterday in the Federal Funds futures markets, the trading was only a 33% chance of a Dec increase. It’s a long road though, between now and December, so we don’t want to put too much faith in that now.

On the release this morning, the 10-yr. note rate was unchanged from yesterday at 2.20%. Stock indexes after some selling yesterday were trading higher prior to the 9:30 open.

It's mid-August. Hearing a lot of talk that many believe it will be a quiet month ahead of the key Jackson Hole symposium at the end of the month. Usually, the conference of global central bankers gets news--what Yellen will say--but most of the focus should be on the ECB and what Draghi thinks about beginning to end the QEs and increasing the base rate, which is now negative, as is the base rate in Japan. On one side, there isn’t any inflation creep, and global economies have gained momentum; on the other side, central banks want to increase rates. Fed officials have made it clear they want to increase the Federal Funds rate, reasoning that inflation will increase and it would provide a cushion if a recession were to occur; the Fed would have the room to combat it by lowering again. The problem is, with no inflation and no evidence of wages increasing, the banks can’t move.

The economies of the world have gained momentum, but it isn’t likely to continue at the pace so far this year. The IMF, our own Fed, and now the Bank of England all have lowered GDP growth expectations from the optimistic outlooks a few months ago; not by much, but doesn’t imply a lot of enthusiasm, either.

US vs North Korea got stock markets churned up yesterday; the DJIA -204, NASDAQ -135. Not big moves from a percentage view, and there isn’t any follow-through this morning, with stock indexes opening higher and the 10-yr. note yield slipping back. Trading the VIX (volatility) increased it to 16.04, up from less than 10 earlier this week, this morning, volatility is lower, to 14.89. This morning, Trump increased his rhetoric against North Korea, but the general view being formed is that there won’t be any war unless North Korea makes a move. The consensus is developing that the rogue nation won’t act. The bond and stock markets this morning backing away from the fear that had increased recently.

At the end of trading yesterday, after 4:00 pm the 10-yr. yield increased 2 bps from 4:00 pm and MBS prices declined. Increased volatility now in financial markets. MBS prices declined to give up all the gains that existed at 4:00 pm. Our work is still bullish, but unless safety trades occur the road to lower rates will be bumpy.

Source: TBWS

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