Investors Keen to See Fed’s Thoughts on Inflation

  • Treasury prices are higher again this morning, and it’s from a similar driver: better news on inflation. Yesterday, it was German CPI coming in under expectations and today it’s French CPI doing the same thing. Investors have been betting for a while now that inflation will ebb faster than the Fed expects. The last several reports on inflation have lent evidence to that bet. We’ll see if the trend continues when December CPI is released a week from tomorrow. Presently, the 10yr is yielding 3.67% up 19/32nds in price while the 2yr is yielding 4.32%, up 2/32nds in price.

 

  • The first week of the month always brings a plethora of releases and the first week of a new year is no exception. The headline report will be the December jobs report due on Friday, but today’s minutes from the December FOMC will get plenty of attention when it’s released at 2pm ET. Investors will be looking for more rationale from the Fed on why they believe inflation will be stickier than previous projections, and despite improving trends in many recent inflation numbers. Is it simply not wanting to revisit errors of the ‘70’s when the Burns Fed had to resume rate hikes after prematurely pausing them?  Or are they worried about other threats that may add fuel to the inflation fire?

 

  • One of those potential threats could be revealed in the December jobs report. While a slight decrease in headline job growth is expected (200k vs. 263k in November) the Fed will be more interested in the wage picture. Expectations are for wages to increase 0.4% MoM vs. 0.6% the prior month, while YoY wages are expected to slip to 5.0% vs. 5.1% in November. The Fed will want to see more slowing in those wage numbers and ideally would like the YoY to dip back to or below 4% before calling it a day with rate hikes.

 

  • Another report of interest to the Fed will be today’s JOLTS Job Openings for November. Expectations are for openings to decline from 10.334 million to 10.050 million. So, moving in the right direction for the Fed but not fast enough as it still signals a tight labor market with twice as many job openings as unemployed.

 

  • Finally, the ISM reports for January will be released this week with the manufacturing series later this morning. It’s expected to slip a little more into contractionary territory (48.5 vs. 49.0) with prices paid also expected to slip a bit which would be another dose of good news on the inflation front. The ISM Services Report is due on Friday with that index expected to slip from 56.5 to 55.0 indicating some softening in activity but still solidly in expansionary territory.

 

  • One of the factors that not often gets mentioned in the inflation story is the growth in the money supply owing from all the stimulus programs that came along with the Covid pandemic.   Milton Friedman once coined the phrase that inflation is once and always a monetary phenomenon, but that economic theory fell on hard times in the last generation. There is, however, no mistaking the dramatic YoY increase in money supply as shown in the graph below and the equally rapid decrease following the expiration of most of the Covid programs. While there were many factors driving inflation, the impetus provided by a rapidly expanding money supply does seem to be one factor that is clearly behind us.

Year-Over-Year Change in M2 Money Supply


 

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 5.20 5.03 4.99 5.00 5.10 5.56
0.50 5.19 5.00 4.93 4.89 4.95 5.45
1.00 5.18 4.97 4.90 4.84 4.86 5.32
2.00 4.96 4.84 4.77 4.75 NA
3.00 4.72 4.68 NA
4.00 4.64 NA
5.00 4.60 NA
10.00 NA

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Published: 01/04/23 Author: Thomas R. Fitzgerald