- Markets remain convinced there will be no rate hike for four years as FOMC meets
- U.S. manufacturing production expected to rise for fourth consecutive month
- 20-year T-bond auction to yield near 1.20%
Markets remain convinced there will be no rate hike for four years as FOMC meets — The market is unanimously expecting the FOMC at its 2-day meeting that begins today to leave its main policy variables unchanged, although there is a chance that the FOMC may issue more specific interest rate guidance. The FOMC at this week’s meeting is expected to leave its funds rate target range unchanged at 0.00%/0.25% and its QE program unchanged at $120 billion per month.
Fed Chair Powell recently announced at the Jackson Hole virtual conference that the FOMC, as part of its long-term structural policy review, adopted an average inflation target. That means that the FOMC will specifically encourage the inflation rate to move above 2% when inflation has been below the target for an extended period, thus producing a long-term average inflation rate that is closer to the 2% target. Inflation has persistently undershot the Fed’s inflation target. Since the Fed set its +2% inflation target in 2012, the core PCE deflator has averaged only +1.6%.
The FOMC on Wednesday will release updated macroeconomic forecasts. The FOMC will also release a new Fed-dot forecast for the funds rate that adds forecasts for 2023. The FOMC’s last Fed-dot forecast, released in June, showed a median forecast for the funds rate to remain unchanged from its current level of 0.00%/0.25% through the end of the forecast period in 2022.
However, there were two FOMC members in June that forecast a rise in the funds rate in 2022, one predicting a +25 bp rate hike and one predicting a full one percentage point hike to 1.00%/1.25%. The addition of a new forecasting year in 2023 is likely to mean that there will be more forecasts for rising rates by 2023.
The federal funds futures market is forecasting no rate hikes at least through July 2023. The longest-dated federal funds futures contract is the July 2023 contract. That July 2023 contract is currently trading at a yield of 0.00%, which is actually 9 bp below the current effective federal funds rate of 0.09%.
The Eurodollar futures market, which has contracts that trade out much farther than the federal funds futures market, is forecasting the first +25 bp rate hike by mid-2024 and an overall +100 bp rate hike to 2028. The expected funds rate hike of +100 bp by 2028 means that the funds rate would remain far below the funds rate target of 2.25%/2.50% that existed in early 2019 before the economy started fading later in 2019 and was then crushed by the pandemic in early 2020. That shows that the market currently expects the negative effects of the pandemic to linger and hurt the economy for at least the next decade.
Meanwhile, there is no end in sight for the Fed’s QE program, which is currently running at $120 billion per month. The Fed has boosted its balance sheet by $2.85 trillion (+69%) to $7.01 trillion from the pre-pandemic level in February of $4.16 trillion. The Fed’s balance sheet has ballooned to 32.5% of GDP from just 19.3% of GDP before the pandemic.
U.S. manufacturing production expected to rise for fourth consecutive month — The consensus is for today’s Aug manufacturing production report to show a +1.3% m/m increase, adding to July’s +3.4% increase. Meanwhile, today’s Aug industrial production report is expected to show a +1.0% m/m rise, adding to July’s +3.0% increase.
Today’s expected +1.3% increase in manufacturing production would be the fourth consecutive monthly increase, and would leave the index up by a total of +17% from the 23-year low of 83.8 posted in April. However, the index would have to rise by another +7% to reach the pre-pandemic index level of 104.9 seen in February.
The U.S. manufacturing sector was already in a recession when the pandemic hit in early 2020. Manufacturing production in December 2019 was already down -1.2% y/y and then fell to -19.7% y/y in April at the depth of the pandemic recession. Manufacturing production in July was still down -7.7% on a year-on-year basis.
The good news, however, is that manufacturing confidence has surged as the economy recovers from the pandemic closures. The ISM manufacturing index in August rose to a 1-3/4 year high of 56.0, and the new-orders sub-index in August rose to a 16-year high of 67.6.
20-year T-bond auction to yield near 1.20% — The Treasury today will auction $22 billion of 20-year T-bonds in the first reopening of the 1-1/8% 20-year bond of August 2040 that the Treasury first sold in August. The $22 billion size of today’s auction is up sharply from the $17 billion size seen in the June and July reopenings.
Today’s 20-year T-bond issue was trading at 1.20% in when-issued trading late yesterday afternoon. The 20-year T-bond yield is near the middle of its narrow trading range of 0.93% to 1.53% seen since May when the Treasury first started selling 20-year T-bonds again.
The 4-auction averages for the 20-year are as follows: 2.26 bid cover ratio, $2 million in non-competitive bids, 5.8 bp tail to the median yield, 31.8 bp tail to the low yield, and 25% taken at the high yield. The 20-year is slightly below average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 63.0% of the last four 20-year bond auctions, which is slightly below the median of 63.6% for all recent Treasury coupon auctions.
