Evans’ comment boosts the market consensus for Sep balance sheet announcement and Dec rate hike
U.S. unemployment claims expected to remain favorable
30-year T-bond auction to yield near 2.83%
U.S. July inflation data kicks off with today’s core PPI expected to match 5-year high — The July inflation data will be critical for the Fed’s near-term outlook since it will provide some indication about whether the recent weakness in the inflation statistics is transitory, or whether it is due to more fundamental disinflationary forces. The Fed generally believes that the inflation softness is transitory due to factors such as price declines in cell phone services and prescription drugs. However, some Fed members are on the fence and are not willing to raise interest rates another notch until it becomes clear that inflation will in fact rise to the Fed’s +2.0% target over the medium term as the Fed assumes.
The recent drop in the inflation statistics has been pronounced for the CPI and the PCE deflator. Specifically, the CPI has fallen sharply by 0.9 points to a 9-month low of +1.6% and the core CPI has fallen by -0.6 points to a 2-1/2 year low of +1.7% y/y. The PCE deflator, the Fed’s preferred inflation measure, has fallen by -0.8 points to a 10-month low of +1.4% y/y and the core PCE deflator has fallen by -0.4 points to a 1-1/2 year low of +1.5% y/y.
Today’s June PPI report is expected to show an uptick in the wholesale inflation data, which would be a factor supporting the Fed’s thesis that the recent inflation softness has been transitory. The consensus is for today’s July final-demand PPI to rise to +2.2% y/y from June’s 5-month low of +2.0%. Meanwhile, the consensus is for June core PPI to rise to +2.1% y/y from June’s +1.9%, thus matching May’s 5-year high of +2.1% y/y.
Evans’ comment boosts the market consensus for Sep balance sheet announcement and Dec rate hike — Chicago Fed President Charles Evans, an FOMC voter and a noted dove, said on Wednesday that it would be appropriate for the Fed at its next meeting on Sep 19-20 to announce a start date for its balance sheet normalization program and wait until December for the next rate hike. That is in line with the current market consensus. The fact that a noted dove made those comments makes a balance sheet announcement at the upcoming meeting and a rate hike in December all the more likely. The market is currently discounting the chances for a Fed rate hike by December at 54%, little changed over the past several weeks, according to the federal funds futures markets.
The only problem with the Evans’ scenario is whether the Fed will be able to start its balance sheet in October with the debt ceiling in play. The Trump administration is pushing for a debt ceiling hike by the end of September, which could actually occur if it is paired with fiscal 2018 spending authority that must be passed to keep the government open past Oct 1. However, a debt ceiling hike is not required until early to mid-October and Congress may wait until the last minute as usual. That could force the Fed to delay the start date for its balance sheet normalization program.
U.S. unemployment claims expected to remain favorable — The initial and continuing unemployment claims series continue to show a strong labor market where businesses are holding on tightly to their employees. The initial claims series is only +13,000 above the 44-year low of 227,000 posted in February. The continuing claims series is only +69,000 above the 29-year low of 1.899 million posted in May.
The market consensus is for today’s initial claims report to be unchanged following last week’s small -5,000 decline to 240,000. The consensus is for today’s continuing claims report to show a -8,000 decline to 1.960 million, more than reversing last week’s small +3,000 increase to 1.968 million.
30-year T-bond auction to yield near 2.83% — The Treasury today will conclude this week’s $62 billion refunding operation by selling $15 billion of 30-year T-bonds. Today’s sale will be of a new issue as opposed to a reopening of an existing issue.
Today’s new 30-year T-bond issue was trading at 2.83% in when-issued trading late Wednesday afternoon. That translates to an inflation-adjusted yield of 0.93% against the current 30-year breakeven rate of 1.90%. The 12-auction averages for the 30-year are as follows: 2.27 bid cover ratio, $7 million of non-competitive bids to mostly retail investors, 6.1 bp tail to the median yield, 20.2 bp tail to the low yield, and 48% taken at the high yield.
The 30-year T-bond is the fifth most popular coupon security among foreign investors and central banks, behind the 10-year TIPS, 30-year TIPS, 7-year T-note, and 10-year T-note. Indirect bidders, a proxy for foreign buyers, have taken an average of 62.2% of the last twelve 30-year T-bond auctions, which is moderately above the average of 60.6% for all recent Treasury coupon auctions.
The market comes into today’s 30-year bond auction on a somewhat weak footing after Wednesday’s 10-year T-note auction saw lackluster demand. The bid cover ratio (bids submitted divided by bids accepted) for the 10-year was weak at 2.23, well below the 12-auction average of 2.42 and the second weakest in the last eight years. In addition, foreign demand was light with indirect bidders taking only 57.9% of the auction versus the 12-auction average of 62.6%.