Inflation numbers point towards pause in rate hikes; energy prices spike

Banks get downgraded by Moody’s

To start off the week, Moody’s announced that they will downgrade the credit ratings of 10 small to mid-sized banks and put six larger banks on watch. They also changed the outlook of 11 banks from stable to negative. They claimed that this resulted from the higher interest rate environment devaluing their bond holdings and the flight of deposits to accounts with higher interest rates. Moody’s believes that these banks are still vulnerable to a sudden loss of confidence similar to the crisis that rattled the sector earlier this year; companies may consider spreading out trades among a larger pool of counterparties to reduce their exposure.

Inflation and the Fed

Following a 3.0% CPI reading in June, the uptick in CPI by 3.2% caused little concern. The largest driver of the increase is the shelter index, which accounted for over 90 percent of the move according to the BLS. The Core CPI showed a more promising story of control over inflation with a mild decrease to 4.7%. Absent the volatile food and energy indexes, Core CPI is often a better proxy in predicting what the Fed might do, but even FOMC members themselves do not seem to be aligned on that.

Leading up to the next FOMC meeting, inflation readings closer to the Fed's target can further cement the current market view of a likely hold in the policy rate after the next meeting. While the market seems to be generally unified, FOMC members are showing signs that there is uncertainty amongst the committee over the next decision in their respective media appearances last week. Most notably, Federal Reserve Governor Michelle Bowman voiced support for another hike as she sees economic activity continue to expand, while Philadelphia Federal Reserve President Patrick Harker stated that he believes rates are likely at their peak.

Treasury Auctions

The Treasury had its 3-year, 10-year, and 30-year auctions last week after surprising markets by announcing a larger-than-expected issuance. Following the downgrade of U.S. government debt, concerns rose over demand for these securities. After the dust settled, the demand for shorter-term Treasuries proved strong but weak demand at the 30-year bond auction drove 10-year yields 10 bps higher on Thursday.

Energy prices surge

As consumers have noticed an uptick in gas prices, behind the scenes a classic battle between supply and demand is underway with energy prices.

Crude prices have risen consistently over the last month after the announcement of Saudi Arabia’s plan to cut oil production and the U.S. economy proves strong, but that was challenged by data out of China. After easing up on COVID-19 related restrictions, expectations for a rebound in demand were high but have since crumbled with the latest weak trade data and reported deflation. As another large Chinese real estate developer teeters on default after missing interest payments, fears mount over a possible Chinese debt crisis if deflation persists.

Elsewhere, European natural gas prices surged on Wednesday and closed 22% higher week-over-week on Friday as an Australian labor dispute unfolds. A strike could heavily disrupt the supply of natural gas to Asia and Europe where supply is already delicate from the ongoing Russian-Ukrainian war.

Looking ahead

As the dates of predicted economic downfalls come and pass, markets are reluctantly adjusting to the reality of a higher interest rate environment as the yield curve normalizes. While people search for what will be the cause of the “inevitable” recession, long-term rates are continuing to experience higher volatility and short-term rates are anchored by the Fed’s resolve to lower inflation.

This week will start off with the release of U.S. retail sales from the Census Bureau as insight into overall economic activity. On Wednesday, the FOMC meeting minutes and CPI data out of the U.K. will be released. CPI data from the E.U. will cap off the week on Friday.