Tariff Threat has Treasuries in Rally Mode

May 06, 2019

Trade Developments Back on Front Burner

With a weekend dominated by a pair of presidential tweets threatening increased tariffs on Chinese goods by Friday, the fate of a US/China trade deal is uncertain after a week filled with hopeful chatter. That has stocks in sell mode and Treasuries reaping the benefit in a flight-to-safety trade this morning. Away from trade-related news, we have April inflation readings with PPI on Thursday and CPI on Friday. It looks like the Fed, and the market, are focused solely on price level changes to guide monetary policy given labor market strength hasn’t moved the Fed off its patient pause stance. The Goldilocks scenario of solid growth with low inflation is the default position of the market, but that will get a test on Friday with April CPI. Core CPI is expected to tick up from 2.0% to 2.1% but that should still keep the Fed’s preferred inflation gauge, core PCE, around 1.8% and below the 2.0% target. If the report misses to the high side expect a bearish reaction in bonds. Finally, seven Fed members will be speaking this week headlined by Chair Powell on Thursday morning and that might provide additional Fed thinking after the solid jobs report.

Derivative Market Rates

Brokered Deposit Rates

Treasuries
Treasury Curve	Today	Week Change
3 Month	2.41%	UNCH
6 Month	2.44%	-0.01%
1 Year	2.37%	-0.04%
2 Year	2.29%	-0.01%
3 Year	2.26%	-0.01%
5 Year	2.28%	-0.03%
10 Year	2.49%	-0.04%
30 Year	2.89%	-0.06%

Short-Term Rates
Fed Funds	2.50%
Prime Rate	5.50%
3 Mo LIBOR	2.56%
6 Mo LIBOR	2.62%
12 Mo LIBOR	2.75%
Swap Rates
3 Year	2.337%
5 Year	2.328%
10 Year	2.470%

Economic Calendar
Date	Statistic	For	Briefing Forecast	Market Expects	Prior
May 7	JOLTS Job Openings	Mar	7.350m	7.350m	7.087m
May 7	Consumer Credit	Mar	$17.000b	$16.000b	$15.188b
May 9	PPI YoY	Apr	2.4%	2.3%	2.2%
May 9	PPI Ex-Food & Energy YoY	Apr	2.5%	2.5%	2.4%
May 9	Trade Balance	Mar	-$51.3b	-$50.2b	-$49.4b
May 10	CPI MoM	Apr	0.4%	0.4%	0.4%
May 10	CPI Ex-Food & Energy MoM	Apr	0.2%	0.2%	0.1%
May 10	CPI YoY	Apr	2.1%	2.1%	1.9%
May 10	CPI Ex-Food & Energy YoY	Apr	2.1%	2.1%	2.0%

Top 5 Events for the Week

May 6 - May 10, 2019

1. Trade Developments – All Week
2. April Inflation Readings – Thurs./Friday
3. Fed Speak – All Week
4. March Trade Balance – Thursday
5. March JOLTS Job Openings – Tuesday

1. Trade Developments — All Week

Trade developments lurched back to the front burner after a pair of presidential tweets this weekend that indicated tariffs on $200 billion of Chinese goods would be increased from 10% to 25% this Friday, and an additional $325 billion in goods would get slapped with a 25% tariff “shortly”. There had been chatter in the last week or two that things were progressing on a U.S./China trade deal but now we hear meetings planned for this week have been canceled so something definitely has changed in a short span of time. It could be all part of the U.S.’s negotiating strategy to strike a hard bargain, but right now the weekend developments have sparked a risk-off reaction in stocks and a concomitant flight-to-quality trade in Treasuries. How this issue marinates this week could well determine trading levels despite the presence of first-tier inflation data and its importance to the Fed’s rate reaction function (more on that below).

2. April CPI Report — Friday

While the labor market has continued to impress, inflation readings have failed to show the expected Phillips Curve bump to inflation. It’s with that backdrop that the April CPI release on Friday will be viewed as confirmation that inflation pressures continue to remain modest at best. The market is convinced the Fed is looking almost solely at inflation at this point to guide monetary policy. Even with strong labor market growth, if inflation readings remain tame the Fed is expected to remain in patient pause mode. Expectations are for overall CPI to increase 0.4% matching the gain in March as energy costs continue to rebound. The core rate (ex-food and energy) is expected to increase 0.2% after two straight months of 0.1% gains. On a year-over-year basis, CPI is expected to increase 2/10ths to 2.1% while core CPI YoY is expected to increase one-tenth to 2.1%. The Fed’s preferred inflation measure, core PCE, remains under 2% at 1.6%. The trend for PCE is to run 30bps below CPI so with core CPI expected at 2.1% that implies core PCE increasing to 1.8% but still below the 2.0% target.

Core CPI and PCE YoY

3. Fed Speak — Wednesday

After the FOMC meeting this week we’ll have a full slate of Fed speakers to provide further insight, especially after the solid April jobs report last Friday. After Chair Powell’s post-meeting press conference last Wednesday the market came to the conclusion that the Fed will be almost solely focused on inflation readings to guide rate changes. While many members implied that there will be a greater willingness to allow inflation to drift above the 2% target, Powell appeared reluctant to sign on to that position. His comment that low inflation stems from “transitory” factors implied that he expects inflation to lift again soon. That doesn’t sound like someone too willing to let inflation drift much above 2%. He speaks on Thursday morning.

4. March Trade Balance – Thursday

On Thursday the March Trade Balance will be announced. The March deficit is expected to widen to -$50.2 billion versus -$49.4 billion the prior month. The average over the past year has been -$51.15 billion so a near on average deficit is forecast. The fairly stable deficit is a reflection of the strong dollar and weaker overseas economies. Despite tariffs and threats of tariffs changes to the trade balance continue to be driven more by basic economic fundamentals: namely dollar strength that makes imports cheaper and exports more expensive and the differences in economic activity. With our economy outperforming almost all other developed markets, and with it two-thirds consumption-based, the deficit will continue to persist for some time to come and that will be a slight drag to GDP.

5. March JOLTS Job Openings — Tuesday

The monthly JOLTs reports are always a little dated as they run a month behind the employment report but they do add a few additional details to the state of the labor market. For March, expectations are that job openings will total 7.350 million versus 7.087 million in February. The all-time high reading was 7.626 million back in November. One of the other metrics measured in the JOLTs data is the Quits Rate, or the rate that workers voluntarily quit their jobs. It’s a measure of confidence in finding another job and that rate dipped to 1.9% ( quits to total employed) in February peaking at 2.3% for the prior five months and is the cycle high.