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Market Update

Inflation readings top expectations

Date:
July 19, 2021
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Prior week summary

The major U.S. equity indices moved lower for the week, snapping a three-week winning streak, as investors turned their attention to a slew of economic data updates and Federal Reserve Chair Powell’s semi-annual testimonies before Congress. After trading in a tight range for the majority of the second quarter, the 10-year Treasury yield has experienced significant volatility over the last month as investors grapple with the incoming reopening data, the length and magnitude of the Fed’s asset purchase program, and the risk of a COVID-19 flare-up from the delta variant. The 10-year Treasury yield remained volatile last week falling roughly six basis points to 1.31%, near the bottom of its recent trading range. Market participants received several key economic updates with all eyes turning to the release of the Consumer Price Index (CPI) on Wednesday. According to the Labor Department, consumer prices rose 0.9% in June and 5.4% over the last year, topping expectations and adding fuel to the already-hot inflation debate. The core CPI measure, which excludes the often-volatile food and energy components, rose 4.5% year over year, the largest yearly increase in nearly 30 years. Used vehicle prices had an outsized impact on the June readings accounting for over a third of the overall gain in the CPI. Prices in travel-related categories also saw sharp increases as the easing of COVID-19 restrictions and depressed COVID-19 case counts around the country improved sentiment and allowed consumers to resume travel in the high-traffic summer months. Notably, the Producer Price Index (PPI) also experienced expectation-beating price movements last month with the June PPI measure increasing 1.0%, far above the 0.6% expectation and May’s 0.8% rise. Federal Reserve Chair Powell was peppered with inflation-related questions from politicians on both sides of the aisle last week as he delivered his scheduled semiannual testimony before the House and the Senate on Wednesday and Thursday, respectively. During the House testimony, Powell admitted that the recent inflation readings were “higher than expected and hoped for” and that the Fed “would absolutely change our policy as appropriate.” Predictably, Powell reiterated the Fed’s current stance that a persistent rise in prices is unlikely and that the most recent inflation readings are a result of a unique combination of robust consumer demand following a pandemic coupled with supply-chain bottlenecks.

While the updated inflation readings and Powell’s testimonies dominated headlines and discussions last week, investors received other key economic updates, including retail sales, industrial production, the Empire Manufacturing Index, and jobless claims. The June retail sales figure defied calls for a 0.3% decline and rose 0.6%. The release continued to highlight the shift in consumer preferences from stay-at-home goods to service-related purchases. Notably, the May retail sales figure was revised downward from -1.3% to -1.7%. Supply chain issues were front and center in the June industrial production report which saw industrial output rise 0.4%. Semiconductor shortages plagued the production of motor vehicles which declined 6.6% in June. The Empire Manufacturing Index soared above expectations posting a record-high 43.0 level for July, reflecting substantial increases in the new orders and shipments segments. Lastly, jobless claims resumed their decline, albeit above expectations, as 360,000 claims were reported for the week of July 10, a pandemic-era low.

Regulatory bodies continue to express support for SOFR as the preferred alternative to LIBOR and last week was no different. The CFTC’s Market Risk Advisory Committee (MRAC) adopted a “SOFR First” practice for consideration by the broader CFTC with the hope that a switch in quoting conventions from LIBOR to SOFR for transactions in the interdealer broker community will facilitate a speedier transition to SOFR. In a statement released announcing the recommendation, the MRAC described the initiative saying, “SOFR First is a phased initiative for switching trading conventions from LIBOR to the Secured Overnight Financing Rate for U.S. Dollar linear interest rate swaps, cross currency swaps, non-linear derivatives and exchange traded derivatives. SOFR First, developed by the MRAC’s Interest Rate Benchmark Reform Subcommittee, is designed to help market participants decrease reliance on USD LIBOR in light of statements from the Financial Stability Board and the International Organization of Securities Commissions on LIBOR transition which reinforce U.S. banking regulator guidance that banks cease entering new contracts that reference USD LIBOR post December 31, 2021.”

The look forward

Market participants are gearing up for yet another busy week of economic data releases with updated figures on housing starts, new and existing home sales, the Chicago Fed National Activity Index, and jobless claims, among others, dotting the economic calendar.

Rates snapshot

Market implied policy path (Overnight indexed swap rates)

Source: Chatham Financial

About the author

  • Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA


Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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