U.S./China officials meet in Alaska; treasury yields continue to climb higher

Prior week summary

In an eventful week for market participants, the major U.S. equity indices moved lower against a backdrop of weak economic data, rising treasury yields, and contentious U.S./China talks. Bond prices continued to decline last week sending the 10-year treasury yield roughly 10 basis points higher over the week to levels not seen in over a year as market participants continued to price in the expectation of a strong U.S. economic recovery and a firm increase in inflationary pressures. Inflation expectations marched higher with the 10-year breakeven inflation rate, the market’s expectation of inflation over the next 10 years and calculated as the difference in the yield on the 10-year treasury and the 10-year TIPS, topping 2.31%, a level not reached since January 2014. While many market participants expect a strong U.S. recovery in the second quarter of this year and beyond, the economic data updates released this week largely pointed to a struggling U.S. recovery. The outlook for the manufacturing industry looks mixed based on last week’s data releases. The Empire Manufacturing topped expectations posting a 17.4 level for March, above the consensus estimate of 15.0, and well above the 12.1 level seen in February, driven by continued improvement in the activity and outlook sections of the survey. Similarly, the Philadelphia Fed Business Outlook Survey smashed expectations on Thursday calling for a 23.3 reading and clocked in at a staggering 51.8 level, the survey’s best level since the first quarter of 1973. Notably, both the orders and shipments sections increased substantially, while the price of materials jumped to a 41-year high, suggesting a firming of inflationary pressures. Industrial production figures for February, released on Tuesday, did not fare as well as the surveys, falling 2.2% month over month, well-below analyst calls for a 0.3% increase and the 0.9% increase seen in January. The retail sales figure for February fell 3% month over month, as winter weather wreaked havoc on much of the U.S. and the figure offered some level of payback from the substantial 5.3% increase seen in January, which was revised to 7.6% in this month’s release. While the pullback in retail sales was far more than the consensus estimate, many analysts have suggested that retail sales may move higher over the coming months as stimulus payments, part of the $1.9 trillion relief package passed earlier this month, make their way into bank accounts and subsequently into the U.S. economy. The harsh February weather looks to have stalled some momentum seen in the housing sector. After housing starts reached levels not seen since September 2006 in January’s reading, February housing starts fell to 1.42 million, a 10% decline. Building permits also pulled back in February as 1.68 million permits were reported, down from the 1.88 million permits seen in January and below the consensus estimate of 1.75 million permits. Finally, jobless claims for the week ended March 13 clocked in at 770 thousand claims, snapping a two-week streak of declines and posting the highest level of claims seen since mid-February.

All eyes turned to the FOMC and Fed Chair Powell mid-week as investors looked for clues on the timing and direction of the Fed’s monetary policy following the FOMC’s two-day policy meeting. As expected, the FOMC opted to leave the target range unchanged at 0% - 0.25%. Furthermore, the Fed reiterated its commitment to supporting the U.S. economy through the pandemic and asserted that it will continue its asset purchase program of $120 billion per month until, “substantial further progress has been made toward the Committee’s maximum employment and price stability goals.” While treasury yields have moved considerably higher since the last FOMC meeting, Chair Powell indicated that the rise in yields was not worrisome and the Federal Reserve would look for actual increases in prices rather than forecasts before changing course saying, “The fundamental change in our framework is that we’re not going to act pre-emptively based on forecasts for the most part and we’re going to wait to see actual data. I think it will take people time to adjust to that and to adjust to that new practice, and the only way we can really build the credibility of that is by doing it,” but noted that a tightening in financial conditions would grab the attention of policy-makers stating, “I would be concerned by disorderly conditions in markets or by a persistent tightening of financial conditions that threaten the achievement of our goals.”

On the geopolitical front, senior U.S. and Chinese officials met in Anchorage, Alaska for the first high-level talks since President Biden was inaugurated as the 46th U.S. President. Secretary of State Antony Blinken and National Security Advisor Jake Sullivan pressed China on a variety of concerns over the two-day meeting ranging from Beijing’s increasing control over Hong Kong to the treatment of Uighurs in Xinjiang. The talks amounted to a contentious affair with little to show as no major announcements resulted from the meeting. Speaking to reporters at the conclusion of the meeting, Sullivan said, “We expected to have tough and direct talks on a wide range of issues, and that’s exactly what we had. We were clear-eyed coming in, we’re clear-eyed coming out, and we will go back to Washington to take stock of where we are.”

The look forward

Market participants are looking forward to another busy week of economic data releases as updated figures on new and existing home sales, durable goods orders, the third estimate of fourth-quarter GDP, jobless claims, consumer spending, and the Fed-preferred measure of inflation, core PCE, dot the economic calendar. Federal Reserve Chair Powell and U.S. Treasury Secretary Yellen will appear before the House Financial Services Committee on Tuesday and the Senate Banking Committee on Wednesday.

Rates snapshot

Market implied policy path (Overnight indexed swap rates)