DIARISE 15 NOVEMBER! For Inflation News

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What if the inflation number comes in once again lower than the Fed expects? The Fed has put a lot of effort and energy trying to get the markets to expect a rate hike in December. The presiding Fed Governors have all been united on the rhetoric that a tightening is coming and most probably in December. The probability of a hike is now about 86%

What if on the 15th of November the inflation remains persistently low and befuddles the Fed’s thinking that low inflation is merely transitory?  After all, there are a number of good reasons why inflation could remain low. Housing has weakened as prices have fallen, rents are falling, and costs of foodstuffs are relatively stable.

Productivity remains persistently weak and wages growth is a mere 2%, hardly a bad omen for wage inflation, and that’s in a marketplace where labour is supposed to be tight. Well at least it is for baristas, shelf stackers, couriers and other low paid jobs. High end jobs remain phoenix-like, still waiting to rise from the ashes.

The inflation read for October is the last read of inflation for the year before the Fed meeting in December. Hence, this number later in the week is a very important number especially since markets have adjusted somewhat to the Fed’s rhetoric and sold off to accommodate a change in interest rates. This could unravel if the inflation number remains weak and a rate hike in December would loom unlikely allowing the bond market to rally.

What the Fed should be measuring is asset price inflation in places such as the equity market. Valuations have soared on relatively small incremental increases in earnings. Where equity assets have risen is more to do with low costs of borrowings.  This allowed companies to fund share buybacks and increased dividends. That’s partly why the pass-through aspect of the proposed budget by the GOP was not so keenly wanted.

Friday was an interesting day. Equities capped the week by finishing the week in red, the first time for some 8 weeks and bonds ended weaker. It is worth noting that the Dow has climbed 19% so far this year and has notched 59 records in the process, the most in a calendar year since 1995.

The change in sentiment was felt in the junk / high yield sector where two high yield deals were pulled. Bowie Resource Partners, a coal company, pulled a $375 mio bond offering. On Thursday, NRG Energy Inc cancelled a refinancing.

There is now concern that the purchases of high yield bonds by the ECB has distorted the European markets, but those purchases have also distorted the U.S. high yield market. Issuer curves are not reliable and make pricing for pending issues difficult.

Meanwhile in Europe on Friday, bond investors continued their sell off from Thursday. The catalyst appears to be concern over increasing issuance, low levels of rates and pessimism over comments from ECB officials. The sell off in Europe continued into the U.S. where bonds also sold off sharply.

Equities sold off on the basis of weaker bond markets and disappointment with the proposed deferral of Tax cuts in the U.S. budget. Mnuchin remains confident but his time frame differs from Paul Ryan’s timeframe. Mnuchin is optimistic that the sign off on the Tax Bill will occur next month not this month.

Recap:

Equities: the S&P 500 was down 0.1%. and the Dow was flat at down 0.17% while the Stoxx 600 fell 0.4%.

Currencies: The euro rose 0.2 % and the pound rose 0.4%.

Bonds: the 2-year rose in yield to close at 1.65%. The U.S. 10-year closed 2.40 % out about 7bp. The 30-year closed at 2.887 %. The curve steepened between 2 and 3 7p depending on the maturities. The 2/10 closed at 74, the 2/30 at 122.2 bp and the 10/30 closed at 48 bp. The European 10-year benchmark closes were, gilts closed at 1.34%, bunds at 0.409% and OAT’s 0.617 %.

Commodities: Gold fell 0.7% and WTI fell 0.6%.  Copper fell 0.4%.

Aussie Market Today.

Bonds are likely to be sold on the day. The trend from offshore is for higher yields and the Aussie bond market will most likely be weaker on the day. Credit looks a little pressured but that’s more in the sub investment grade and weak investment grade sectors.

Geopolitical tensions are still a concern although tensions appear to have been cowed for the moment.
Equities are likely to take the lead from the U.S. and sell down a little.

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