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  • T-notes react positively as Yellen's inflation confidence wobbles
  • June U.S. PPI expected to ease and provide more evidence of slowing inflation
  • Unemployment claims remain favorable near decade-plus lows
  • 30-year T-note auction to yield near 2.89%

T-notes react positively as Yellen's inflation confidence wobbles -- Fed Chair Yellen in her semi-annual hearings will testify today before the Senate Banking Committee, repeating her prepared remarks from Wednesday but answering different questions.

The market interpreted Ms. Yellen's testimony on Wednesday before the House Financial Services Committee in a mildly dovish light because she sounded a bit less certain about whether the recent softness in the inflation statistics is just transitory.  She did not refer in her written comments to the recent softness being "transitory" and she said, there is "uncertainty about when -- and how much -- inflation will respond to tightening resource utilization."

Ms.  Yellen also made the dovish-sounding comment that rates will "not have to rise all that much further to get to a neutral policy stance."  That comment raised some doubts about whether the Fed really thinks it will raise rates three times per year in 2018 and 2019 as the Fed-dots currently suggest.

Ms. Yellen's comments on Wednesday caused no shift in the federal funds futures contracts for the remainder of 2017, which means that Ms. Yellen's comments did not shift the market odds for rate hikes at the remaining FOMC meetings this year.  The market is still discounting the odds for the next rate hike at 14% at the July 25-26 meeting, 26% at the Sep 19-20 meeting, 28% by the Oct 31/Nov 1 meeting, and 64% by the Dec 12-13 meeting, according to the federal funds futures markets.

However, the federal funds futures curve did turn more dovish by -4 bp for the Dec 2018 federal funds futures contract and by -6 bp for Dec 2019 contract, indicating slightly reduced market expectations for rate hikes in 2018 and 2019.

The 10-year T-note yield has recently tracked the Dec 2018 federal funds futures contract fairly closely.  That illustrates the heavy influence that expectations of Fed tightening over the next 1-1/2 years have had on the movement of the 10-year T-note yield.  Indeed, the 10-year T-note yield on Wednesday again displayed that close correlation.  The 10-year T-note yield on Wednesday fell by -4.3 bp to 2.318%, which was close to the -4 bp decline in the Dec 2018 federal funds futures contract to 1.52% (on a yield basis).

Regarding the balance sheet, Ms. Yellen said that the Fed's balance sheet reduction is something that, "to my mind," should begin "relatively soon."  She said that the Fed expects to start reducing its balance sheet "this year."  We continue to suspect that the Fed will begin its balance sheet draw-down on Oct 1 so that it coincides with calendar quarters considering that the caps adjust every three months.  We suspect the Fed will announce the official start of its balance sheet program at one of the next two FOMC meetings on July 25-26 or Sep 19-20.

 

June U.S. PPI expected to ease and provide more evidence of slowing inflation -- The market consensus is for today's June final-demand PPI report to ease to +1.9% y/y from May's +2.4% and for the June core PPI to ease to +2.0% y/y from May's 5-year high of +2.1%.  The headline PPI in May fell to +2.4% y/y from May's 5-1/4 year high of +2.5% y/y.

The PPI has not fallen nearly as quickly as the CPI and PCE deflator statistics.  The core CPI in May fell to a 2-1/4 year low of +1.7% from the 8-3/4 year high of +2.3% posted in January.  Meanwhile, the core PCE deflator, the Fed's preferred inflation measure, fell to a 1-1/2 year low of +1.4% y/y in May from the 5-year high of +1.8% posted earlier this year in Jan-Feb.  Both the core CPI of +1.7% and the core PCE deflator of +1.4% are comfortably below the Fed's 2.0% inflation target.

The markets are eagerly awaiting Friday's June CPI report, which is expected to ease to +1.7% y/y from May's +1.9%.  However, the June core CPI is expected to be unchanged from May at +1.7% y/y.

Unemployment claims remain favorable near decade-plus lows -- The U.S. unemployment claims data shows that layoffs remain near decade-plus lows, indicating a strong labor market where businesses are holding on to their current employees.  The initial claims series is only +21,000 above the 44-year low of 227,000 posted in February and the continuing claims series is only +57,000 above the 29-year low of 1.899 million posted in May.  The market consensus is for today's initial claims report to show a small -3,000 decline to 245,000 (after last week's +4,000 to 248,000) and for continuing claims to show a -6,000 decline to 1.950 million (after last week's +13,000 increase to 1.956 million).

30-year T-note auction to yield near 2.89% -- The Treasury today will sell $12 billion of 30-year T-notes, concluding this week's $56 billion coupon package.  Today's auction will be the second and final reopening of the 3% T-bond of May 2014 that the Treasury first sold in May.  

Today's 30-year T-bond issue was trading at 2.89% in when-issued trading late Wednesday afternoon.  That translates to an inflation-adjusted yield of 1.01% against the current 30-year breakeven inflation expectations rate of 1.88%.

The 12-auction averages for the 30-year are as follows:  2.29 bid cover ratio, $7 million in non-competitive bids to mostly retail investors, 5.9 bp tail to the median yield, 18.0 bp tail to the low yield, and 53% taken at the high yield.  The 30-year is moderately popular among foreign investors and central banks.  Indirect bidders, a proxy for foreign bidders, have taken an average of 62.8% of the last twelve 30-year T-bond auctions, which is moderately above the average of 60.2% for all recent coupon auctions.

 

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