Inflation readings top expectations
- July 19, 2021
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.
Market implied policy path (Overnight indexed swap rates)
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