U.S. Inflation: Expecting the Best

Mid Week Bond Update

U.S. Inflation: Expecting the Best

The upward move in 30-year yields begs questions about growth, inflation and the Fed's next moves; Brazil's post-election markets all move up; China's bank reserve requirements are moved down.

The past week’s moves in U.S. Treasuries, which brought the 30-year yield to a 4-year high, raise new questions about the pace of inflation, and whether the Fed’s relatively sanguine approach toward rate hikes in 2019 could change.

The long end of the U.S. yield curve saw a rapid uptick in yields, with 30-year Treasuries making a 24 basis-point (bps) jump from 3.205% on October 3 to as high as 3.445% on October 9 before pulling back to 3.368% by the end of trading. That steepened the yield curve slightly, with the 10-30 spread ending at 16.2 bps, a level not seen since 2007, and up from the one-year lows of July 2018. 


10-Year & 30-Year Treasuries, 10-30 Spread

Source: Bloomberg, October 10, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


The usual explanation for upward moves at the long end of the curve involve rising expectations for growth, inflation, or both. Most other measures of inflation expectations, however, remain low, including breakeven inflation rates derived from trading in inflation-linked Treasuries to surveys of consumers.

Taken at face value, that leaves expectations of growth as the least unlikely reason for the spike. That should focus additional attention on the FOMC’s reaction to the September inflation and consumer expectation figures for September, to be released later this week. Reactions to the figures will show up most directly in the futures market for Fed Funds, and its implied expectations for the number of rate hikes over the coming year.  For now, the markets appear split between 2 and 3 hikes for 2019.   But the Fed still scrutinizes all incoming economic data; is this move in the 30-year the first sign of a shift in inflation, and therefore a more hawkish Fed?


On the Rise: Brazil’s bonds, stocks and currency

The first round of Brazil’s election brought right-wing candidate Jair Bolsonaro close to an outright win, with about 46.4% of the popular vote. A runoff election on October 28 will determine the final outcome.   

Financial markets reacted positively, with yields for local-currency 5-year sovereign debt dropping to as low as 9.75% from pre-election 10.53% and U.S. dollar 5-year yield falling from 4.775% to as low as 4.475%. Brazil’s currency rose from 3.84 to 3.714 reais to the dollar, a sizeable 3.34% move. making it the best-performing EM currency for the period against the greenback. Brazil’s Ibovespa stock index rose just over 6% in local currency terms intra-day on the news; in U.S. dollar terms, the rise came to just over 9%.

Brazil has been plagued with economic uncertainty and corruption scandals in recent years. Market reaction could be attributed to the decisive outcome as much as to Mr. Bolsonaro himself; how it responds to the results of the next round will be telling.


On the Slide:  China banks’ required reserve ratio

As China’s Golden Week holiday came to an end, the country’s central bank (People’s Bank of China) announced the fourth cut this year in its required reserve ratio (RRR) for banks by 100 basis points. Effective October 15, that brings the reserve level to 14.5% for larger banks and 12.5% for smaller banks.  The move reduces the amount of cash needed to fund continuing operations. Official estimates are that the moves will effectively inject net 750 billion yuan (about $109 billion) into the banking system.  The PBoC characterized the move as ”…reasonable and moderate, and will not lead to depreciation pressure”. The move comes amid increases in bond issuance by local government authorities to fund a rebound in infrastructure spending and the release of government statistics suggesting that economic growth may have eased.

 

All data Source: Bloomberg, October 11, 2018 unless otherwise indicated.

Definitions:

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Ibovespa Stock Index is a total return index weighted by trading volume and comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

 

 

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