U.S. CPI report poses risk for T-notes
U.S. Dec retail sales expected to show a solid gain
Washington has yet to resolve immigration issues to prevent a government shutdown next week
Chinese 10-year bond yield rises to 6-week high
U.S. CPI report poses risk for T-notes — The market consensus is for today’s Dec CPI report to ease slightly to +2.1% y/y from Nov’s +2.2%. The Dec core CPI is expected to be unchanged from Nov’s +1.7% y/y. Nov’s CPI report of +2.2% y/y matched an 8-month high and was just moderately below the 6-year high of +2.7% posted in Feb 2017. Meanwhile, the core CPI has been moving sideways in the narrow range of 1.7%-1.8% for the last seven months.
While the CPI statistics have been contained in recent months, the market’s fear of inflation has risen significantly in the wake of the surge in oil prices to a 3-year high and Congressional passage in late December of the tax-cut bill. The markets are also expecting some upward pressure on inflation in 2018 from the tight labor market and the higher minimum-wage laws that took effect in 18 states and 20 cities on Jan 1, which will encourage businesses to raise prices to cover higher wage costs.
The 48% rally in WTI crude oil prices seen since mid-2016 to a 3-year high of $64.77 on Thursday is putting upward pressure on the headline inflation statistics as well as on inflation expectations. The size of the rally means that the higher crude oil prices are likely to creep even into the core inflation statistics by boosting the prices of petroleum-related products such as plastics and by increasing the price of various types of transportation and services.
In fact, the 10-year breakeven inflation expectations rate has risen by +19 bp in the past five weeks and posted a 10-1/4 month high of 2.05% on Wednesday, then falling back a bit to close at 2.02% on Thursday.
The rise in inflation expectations has directly undercut T-note prices and has also hurt T-notes by increasing the pressure on the Fed to raise short-term interest rates. The 10-year T-note yield on Wednesday rose to a new 10-month high of 5.595% but then fell back on Thursday by -2.0 bp to close the day at 2.537%. The 10-year yield on Wednesday’s high was just 4.5 bp shy of the 3-1/4 year high of 2.64% posted in Dec 2016 in the wake of the Nov-2016 election.
A stronger-than-expected CPI report today could grease the skids for renewed T-note losses considering all the bearish news for T-notes that has been seen this week. That bearish news includes the rally in crude oil prices to a new 3-year high, supply overhang from this week’s Treasury auctions, and Wednesday’s Bloomberg report that Chinese foreign-reserve authorities may be considering cutting back or even halting their Treasury purchases.
U.S. Dec retail sales expected to show a solid gain — The market consensus is for today’s Dec retail sales report to show solid gains of +0.5% and +0.4% ex-autos, adding to November’s very strong report of +0.8% m/m and +1.0% ex-autos. Vehicles sales for December have already been reported at +2.1% m/m to 17.76 million units, which was stronger than the 12-month trend average of 17.3 million units.
While the December holiday retail sales figures are expected to be strong, the key will be whether the Jan-1 tax cuts cause a new surge in retail sales in early 2018. Those tax cuts will put more cash into the pockets of many consumers. A significant amount of that cash is likely to be spent on retail goods, as opposed to being solely used for savings or debt paydown.
However, the tax cut may take a while to show up in the spending data. It will take at least a month for tax withholding to be cut and produce higher after-tax paychecks since the tax cut was passed just several weeks ago and since there is a new system for determining tax withholding that must be ironed out and implemented by payroll administrators.
Washington has yet to resolve immigration issues to prevent a government shutdown next week — A bipartisan group of six Senators on Thursday agreed on an immigration proposal but it was rejected by the White House and by hawkish Republican Senators who said that the Democrats had to make more concessions. Nevertheless, the proposal represented progress and at least inched the negotiations forward.
Meanwhile, House Minority Leader Pelosi on Thursday again essentially threatened a government shutdown by saying that there is “no point” in doing another continuing resolution if there is no agreement on DACA and immigration. Democrats have essentially refused to negotiate the spending levels that are necessary for a spending bill until the DACA issue is resolved to their satisfaction. The U.S. government will shut down next Friday night (Jan 19) at midnight if Congress does not pass new spending authority to replace the expiring CR.
Chinese 10-year bond yield rises to 6-week high — The 10-year Chinese government bond yield on Thursday rose by +1.1 bp to post a new 6-week high of 3.956%. The bond yield has risen above the 6-week consolidation range, but so far remains below the 3-1/4 year high of 4.035% posted on Nov 22.
The rise in the Chinese 10-year bond yield to a 6-week high was driven mainly by this week’s sharp +5.7 bp increase in the U.S. T-note yield to 5.533%. The German 10-year bund yield has show an even larger gain this week and is up +14.2 bp at 0.581%. The German bund yield was pushed higher on Thursday by the ECB minutes saying that that ECB members need to revise their guidance in early 2018 to adjust to improving macroeconomic conditions.