All eyes turn to inflation data
Prior week summary
In a week packed with high-profile economic data releases, the major U.S. equity indices moved lower with the Dow Jones Industrial Average suffering its worst one-day drop since October as market participants’ concerns of higher-than-expected inflation dominated headlines and outweighed dovish comments from Federal Reserve officials and an improving COVID-19 outlook in the U.S. and abroad.
Much has been said about the rise in inflation expectations in recent months as the 10-year breakeven inflation rate has risen from just under 2% in early January to just over 2.50% as of Friday. Last week, market participants turned their attention not to the expectation of inflation but rather to realized inflation as updates to the Consumer Price Index (CPI) and the Producer Price Index (PPI) were released on Wednesday and Thursday. Both the CPI and PPI readings last week smashed expectations as supply constraints and robust demand drove input and consumer prices higher. The Core CPI, which excludes the volatile food and energy components, rose 0.9% in April, three times higher than the consensus estimate and the highest month over month increase since 1982. Notably, prices in industries hardest hit by the COVID-19 pandemic, such as transportation and travel, experienced the largest gains in the report. Yearly, the CPI rose a staggering 4.2%, but analysts were quick to point out that the large decrease in prices in April 2020 skewed the year-over-year figure. The story was much the same on Thursday when it was reported that the PPI advanced 0.6% in April, twice the consensus expectation. News of the expectation-beating inflation figures drove the yield on the 10-year Treasury over 1.70% mid-week before falling roughly seven basis points between Thursday and Friday to end the week at 1.63%. While the updated inflation readings show that price pressures are firming, retail sales appear to be moderating after March’s historically large advance on the back of stimulus payments made in connection with the American Rescue Plan Act. The Commerce Department reported on Friday that retail sales remained unchanged from March defying expectations for a 1% gain. Digging into the report, eight of the 13 measured categories saw declines in April with restaurants and automotive dealers reporting increases month over month. Lastly, jobless claims continued to show improvement as it was reported that jobless claims for the week of May 8 clocked in at 473,000 claims, a pandemic-era low.
With inflation on many market participants’ minds last week, several Federal Reserve officials commented on the updated figures but signaled that higher inflation is expected and will not lead to a sudden shift in monetary policy. In a speech to the National Association for Business Economics, Federal Reserve Vice Chair Richard Clarida acknowledged he was “surprised” by Wednesday’s CPI release but cautioned against reading too much into what it means for monetary policy saying, “Readings on inflation on a year-over-year basis have recently increased and are likely to rise somewhat further before moderating later this year. I expect inflation to return to, or perhaps run somewhat above, our 2% longer-run goal in 2022 and 2023.” In a nod to continued support for the Fed’s current level of $120 billion in asset purchases per month, Clarida said, “The economy remains a long way from our goals, and it is likely to take some time for substantial further progress to be achieved,” but noted that he expects the U.S. economy to “pick up steam” over the course of the year.
As the U.S. COVID-19 outlook continues to improve with depressed daily case count levels and nearly 60% of the population receiving at least one dose, the Centers for Disease Control and Prevention unexpectedly updated their mask-wearing guidance on Thursday stating that fully vaccinated individuals, those who have received their final dose at least two weeks ago, “no longer need to wear a mask or physically distance in any setting except where required by federal, state, local, tribal, or territorial laws, rules, and regulations, including local business and workplace guidance.” Notably, Walmart and Trader Joe’s updated their guidance to align with the updated CDC guidance.
Swap markets continue to be influenced by the significant amount of excess liquidity in the system, as this week saw the continued decline in spot LIBOR settings to record lows. The benchmark three-month LIBOR setting fell below 16 basis points, while the one-month fixing fell to 0.098%. Similarly, the spread between the swap curve and the equivalent maturity Treasury yield continued to grind tighter, especially at the long-end of the curve. Notably, the 10-year swap spread narrowed to negative six basis points as bank issuers take advantage of friendly markets for debt issuance. The dynamic between these markets bears watching, as many bank portfolios have meaningfully increased their positions in AFS securities hedged with swaps, given the decline in loan demand many have seen recently.
The look forward
Market participants are gearing up for yet another busy week of economic data releases as updated figures on the Empire Manufacturing Index, building permits, housing starts, the Philadelphia Fed Business Outlook Survey, jobless claims, and existing home sales, among others, dot the economic calendar. The Minutes for the FOMC’s April meeting are released on Wednesday.
Market implied policy path (Overnight indexed swap rates)
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