Drivers, While Marking Time

The main issues for investors have not changed. There are three dominant ones: Trade, growth, and Brexit. Unfortunately, there won’t be any closure in the week ahead, and that may make short-term participants reluctant to turn more aggressive.

The US reported exceptionally poor December retail sales and January industrial output figures. Growth forecasts were adjusted. The Atlanta Fed's GDPNow tracker, for example,cut its estimate to 1.5% from 2.7% the previous week.The NY Fed's Nowcasting estimate for Q4 18 was shaved 0.2% to 2.2%, but Q1 19 estimate was cut in half to 1.1%.Investors also learned ahead of the weekend that although the University of Michigan’s consumer sentiment rose, the long-term inflation expectations slipped to a return to the cyclical low of 2.3% (from 2.6%).

The Fed’s declared patience has clearly signaled no March rate increase. What the Fed decides to do around the middle of the year, when some, like ourselves, see the window for a hike opening up, will not be swayed by the data from the end of 2018 and Q1 2019.

There has been much talk from the commentariat about renewed deflation. Headline CPI in January eased to 1.6% from 1.9%. Yet, digging deeper the situation is not as benign as it may seem. The Fed tends to put weight on core measure because over time, the headline rate converges to the core rate, not the other way around. In turn, many economists see the core rate being driven may wage growth.

Core CPI rose 0.2% for the fourth consecutive month. The year-over-year pace was unchanged at 2.2%. Real average hourly earnings have risen 1.9% year-over-year in January, up from 1.4% in December, and is the fastest pace in more than three years. The real average weekly earnings accelerated from 1.3% to 1.7%, which is also the strongest rise since July 2016. The breakeven of 10-year TIPS has risen 20 bp since January 3 to 1.86%. At his press conference at the end of last month, Fed Chair Powell singled out actual inflation (not expectations) as an important factor in determining the extent of his patience.

Many observers are beginning to look for an opportunity to put on yield curve steepeners. The pessimists see the curve steepening because the two-year yield falls as the market moves to discount a Fed cut. Some optimists see the yield curve steepening as the Fed’s volte-face was premature and its patience means tolerance of the building price pressures and anticipates long-term rates increasing more than short-term rates falling. Recall that the flatness of the US curve makes hedging the dollar for international fixed income investors prohibitively expensive.

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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