FOMC minutes are not likely to shift the 100% chance of rate hike at next meeting
Markit U.S. PMIs expected to be steady to higher
U.S. existing home sales expected to remain strong
Treasury continues this week’s auction dump with today’s 5-year auction
Markets still show little concern ahead of Italian election
FOMC minutes are not likely to shift the 100% chance of rate hike at next meeting — The Fed today will release the minutes of the last FOMC meeting on Jan 30-31. The FOMC at that meeting left its policy unchanged, which was fully in line with market expectations since the FOMC had just raised the funds rate by +25 bp at the previous meeting on Dec 12-13.
Looking ahead, the market is still discounting the odds at 100% for a rate hike at the next FOMC meeting in about a month on March 20-21. Fed Chair Powell at the next meeting will deliver his first post-meeting press conference. The markets are still trying to get a sense of whether the FOMC will turn more hawkish with Mr. Powell in charge.
The early-Feb downside correction in the stock market temporarily depressed expectations for Fed rate hikes this year by about 10 bp. However, rate-hike expectations snapped back after the stock market regained its balance and after last week’s report that the headline CPI over the last three months (annualized) rose to a 5-1/4 year high of +4.4% and the core CPI rose to a 6-1/2 high of +2.9%. In addition, inflation expectations are strong with the 10-year breakeven rate at 2.11%, above the Fed’s +2.0% inflation target and just below the recent 3-1/2 year high of 2.14%.
Still, the market is doubting the Fed’s rate-hike resolve. The federal funds futures market is discounting a total of 66.5 bp worth of rate hikes in 2018 (2.7 rate hikes), less than the Fed-dot median forecast for three rate hikes. The market is then discounting only another +39 bp worth of rate hikes in 2019 (1.6 rate hikes), less than the Fed-dot forecast for 56 bp of rate hikes in 2019 (2.2 rate hikes).
We continue to expect the Fed to fulfill its forecasted rate-hike regime in 2018-19, at least until either the stock market or the economy break. The Fed is not only raising interest rates but is also slowly reducing its balance sheet, delivering a double-barreled tightening move. The Fed will have no real way of knowing if it has gone too far on raising interest rates until there is either a stock market plunge or a dip in the economy. The Fed would be incredibly lucky if it could steadily raise interest rates to its intended terminal level of 2.75-3.00% without rocking the stock market and/or the economy.
Markit U.S. PMIs expected to be steady to higher — The market consensus is for today’s Feb Markit U.S. manufacturing PMI to be unchanged at 55.5 following Jan’s modest +0.4 point increase to 55.5. Meanwhile, the Feb Markit U.S. services PMI is expected to show a +0.7 point increase to 54.0, more than recovering from Jan’s -0.4 point decline to 53.3. U.S. business confidence in general remains in solid shape due to (1) the Jan 1 tax cuts, (2) the firm U.S. economy, and (3) the weak dollar and stronger overseas economic growth. Negative factors for business confidence include (1) rising interest rates, (2) the stock market correction, and (3) the Russian investigation and White House trade threats.
U.S. existing home sales expected to remain strong — The market consensus is for today’s Jan existing home sales report to show an increase of +0.9% to 5.62 million, recovering part of Dec’s -3.6% decline to 5.57 million. Existing home sales remain in very strong shape at only -3.6% below the 10-3/4 year high of 5.78 million units posted in Nov 2017. Demand for U.S. homes remains strong despite headwinds from high home prices and rising mortgage rates. The 30-year mortgage rate has risen sharply by 48 bp since November to post a new 3-3/4 year high of 4.38%.
Treasury continues this week’s auction dump with today’s 5-year auction — The Treasury today will sell $15 billion of 2-year floating rate notes and $35 billion of 5-year T-notes, continuing this week’s $107 billion T-note auction package. The Treasury this week raised the size of its 2-year T-note by $2 billion and the size of its 5-year and 7-year auctions by $1 billion a piece in order to help finance the larger U.S. budget deficit.
Today’s 5-year T-note issue was trading at 2.66% in when-issued trading late yesterday afternoon, which translates to an inflation-adjusted yield of 0.60% against the current 5-year breakeven inflation expectations rate of 2.06%. The 5-year T-note yield has moved sharply higher by about 65 bp since last November and posted a new 8-year high of 2.686% yesterday.
The 12-auction averages for the 5-year are as follows: 2.45 bid cover ratio, $55 million in non-competitive bids to mostly retail investors, 4.9 bp tail to the median yield, 15.2 bp tail to the low yield, and 53% taken at the high yield. The 5-year is mildly above average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 64.8% of the last twelve 5-year T-note auctions, which is mildly above the average of 63.4% for all recent Treasury coupon auctions.
Markets still show little concern ahead of Italian election — The markets are still showing little concern ahead of the March 4 Italian election. The Italy-German 10-year bond yield spread closed at 133.3 bp on Tuesday, up by 13 bp from the early-Feb 1-1/2 year low of 120 bp but still well below the 180-200 bp range seen last spring when there was concern that the National Front might win the French national election.
Italy’s center-right coalition has been leading in the polls, but not by enough to ensure that it will be able to form a majority government. The markets have not yet shown much worry about the election even though there is strong chance of a hung parliament and at least a small chance that the anti-EU Five Star Movement might be able to somehow wedge its way into power.