Treasury yields and interest rate swap levels traded in a narrow range this week, ending 2 bps (0.02%) to 5 bps (0.05%) lower in maturities from two to 30 years. One of the few primary economic releases during the week was the set of monthly inflation indices, the Producer Price Index (“PPI”) and the Consumer Price Index (“CPI”), which both showed inflation increases in July continuing in the month of August.
The markets are looking toward next week’s Federal Open Market Committee (“FOMC”) meeting for more clarity on the Fed’s new inflation-based policy and for continued rate guidance.
The ten-year Treasury yield, the benchmark indicator for U.S. rates, has fallen into a range with support at around 63 bps (0.63%), last seen in mid-August, and resistance at 75 bps (0.75%) seen in mid-June and retested a number of times since then over the past few weeks. Only significant changes in the economic outlook will break this yield out of this narrow 12 bps (0.12%) range. An improving economic outlook, perhaps based on positive news regarding progress on a COVID-19 vaccine, could push yields higher. News of deterioration in economic progress could be a catalyst to test the recent 0.63% low.
Producer prices increased more than forecasted
U.S. producers managed to receive higher than expected prices in August, indicating that a rebound in demand from the pandemic-related lockdowns is gradually restoring pricing power.
The PPI increased 0.3% in August, slightly higher than it’s 0.2% forecast, after a 0.6% gain in July, Labor Department figures showed Thursday. Excluding the volatile food and energy components, the “core PPI” rose 0.4% in August over July’s levels. The median forecast called for a 0.2% increase in this core measurement.
These figures signal producers are becoming slightly more successful in passing along higher raw materials costs to their customers. Recent data has shown an acceleration in consumer prices as well, but there is still room for both wholesale and retail prices to grow in order to hit the Federal Reserve’s new 2% “average” annualized inflation target under their recently announced new policy.
The index for final demand services increased 0.5% for a second month. The Labor Department said that two-thirds of this advance was due to a 1.2% rise in margins received by wholesalers and retailers, another sign of the strengthening ability to price up these final services.
Used car costs drive consumer prices higher
U.S. consumer prices rose for a third month in August, driven by the sharpest gain in used car prices since 1969 and consistent with the gradual pickup in inflation as seen in the PPI results. The CPI rose 0.4% in August, following a 0.6% gain in July, Labor Department figures showed Friday. The median forecast in a survey of economists called for a 0.3% increase.
Viewed as a more reliable gauge of consumer price trends by excluding volatile food and fuel costs, the “core CPI” increased 0.4% from the prior month after a 0.6% jump in July that was the largest in almost three decades. A 5.4% surge in the cost of used cars and trucks accounted for more than 40% of the gain in the core index. The cost of new vehicles remained unchanged. Airfares climbed another 1.2% after posting the biggest monthly gain in 21 years in July, though prices remain 23.2% below year-earlier levels with passenger counts still depressed.
On an annual basis, core inflation has been 1.7%, a slight uptick from this same annual measure in July of 1.6%. The gain in consumer prices reflects the steady advance in demand for goods and services, suggesting inflation is gradually returning to it’s pre-crisis pace.
On a surprising note, especially for anyone with children in college, education costs showed the first drop in records going back to 1993. Specifically, college tuition and fees (which ones?) fell 0.7%, the most since 1978, as many schools transitioned to remote learning because of the pandemic.
The results of the CPI and the PPI reports will be key to the new Fed policy that will have no problem tolerating inflation in excess of 2% annually to compensate for past low inflation results. Inflation expectations will remain a key determinant of future policy action.
Weekly new jobless claims failed to decline
New applications for state unemployment insurance benefits failed to decline as expected last week, a sign that extensive job losses are persisting.
Initial jobless claims in regular state insurance programs were unchanged at 884,000 for the week ended September 5th, Labor Department data showed Thursday. Due to a change in the methodology for seasonal adjustments earlier this month, this figure is directly comparable only to the prior week. Continuing claims, or the total number of Americans claiming ongoing unemployment assistance, rose 93,000 to 13.4 million for the week ended August 29th.
The unexpectedly high levels of claims underscore the uneven nature of the labor market’s recovery. Many businesses are hiring or bringing back workers, yet millions remain unemployed and others are on the chopping block as more companies announce job cuts and small-business aid runs dry.
With lawmakers at a stalemate over additional jobless benefits and President Donald Trump’s stopgap aid through executive order nearing it’s end, unemployed Americans face even tougher challenges than before. Funding for the Lost Wages Assistance program, which authorized an extra $300 a week from the federal government to most jobless benefit recipients, will not extend beyond the benefit week ending September 5th, according to statements by government officials.
Trump authorized the Federal Emergency Management Agency to spend up to $44 billion from the Disaster Relief Fund for the payments. States also had the option to supplement the $300 weekly federal grant with an extra $100.
While the program authorizes eligible claimants to receive the supplemental payments starting with the week ended August 1st, logistical hurdles led to a delay in unemployed Americans receiving this bonus money. Some states have not yet even started distributing these funds.
Millions of Americans are also heading for long-term unemployment, or unemployment lasting 27 weeks or more. Most states offer 26 weeks of jobless benefits, but many of the workers who have been without a job since late March will hit that mark this month.
Positive data last Friday showed U.S. employers added 1.37 million jobs in August, and the unemployment rate fell almost two percentage points to 8.4%, the second largest one-month improvement in this measure on record. If continuing jobless claims fail to show further declines, this will mark a break in labor-market progress since the depths of the pandemic crisis.
U.S. debt grows but continues to get cheaper
The U.S. government is paying less as it borrows more. It is not just a question of how much debt is outstanding, but what is the cost to service the debt.
Interest payments in the federal budget declined about 10% in the first 11 months of this fiscal year, when America was running up its biggest deficit since World War II. Over the next few years, servicing the national debt will be cheaper than any time in the past half-century when measured against the size of the economy, according to the Congressional Budget Office (“CBO”).
That’s because yields in the $20 trillion U.S. Treasury market plunged to record lows early in the economic collapse, and they have risen only slightly since then, even though the supply of debt has surged to record levels.
The Treasury’s borrowing probably won’t always be this cheap, but, for now, the U.S. government is far from running up against any financial limits. Concerns that the country cannot afford much more spending have been voiced by both government officials and from leading economists.
The CBO predicts a deficit of about $3.7 trillion this year, or 16% of GDP, more than triple the amount from one year ago. Bonds issued to fund the shortfall have pushed the U.S. public debt past $20 trillion, more than the U.S. economy’s annual output.
Yet the average yield on the debt has dropped to 1.70%, from 2.40% in December, and it is set to fall further.
Even after a few recent Treasury auctions that saw signs of faltering demand, the government can currently borrow for 30 years at below 1.50%. The Treasury has shifted sales toward longer-term securities, helping lock in historically low rates. The latest 30-year bond auction on Thursday drew solid demand.
Fed purchases of Treasury securities has accounted for about $1.8 trillion of government debt since March, while the Treasury was issuing some $3 trillion of new notes and bonds to fund the CARES Act fiscal relief package. The Federal Reserve is the second largest holder of U.S. Treasury debt:
The U.S. central bank is currently purchasing about $80 billion of Treasuries a month.
There are many market pundits that argue that the low interest bills America currently pays on its growing debt are just short-term benefits, like teaser rates on mortgages, that will eventually create a financial burden that may become unsustainable.
Fed has become less predictable
The FOMC meets next week, September 15th-16th, and market investors will be looking for several key signals.
Investors are eager for more detail from the Fed after Federal Reserve Chairman Jerome Powell unveiled on August 27th a new strategy for achieving the central bank’s goals of maximum employment and price stability. Powell said the Fed will sometimes allow price increases to run a bit higher than its 2% target in pursuit of inflation that averages that level “over time.”
Federal Reserve officials will link interest rate increases to inflation outcomes when they provide more guidance on the future path of monetary policy. But no one is sure when that guidance will be forthcoming as the Fed is seen as balking at providing fresh interest rate guidance.
The only recent hint came from Fed Vice Chairman Richard Clarida who left the door open to a policy of capping Treasury yields at some point, though he indicated it is not imminent. This led expectations for the Fed to apply yield caps to Treasury securities, a policy known as “yield curve control”, to continue to fade.
The Fed has so far not made clear how the new inflation-based strategy will influence their near-term policy decisions as it tries to help lift the U.S. economy out of the recession and support higher employment. This has made Fed policy less predictable for market observers, making them uneasy and adding to the potential for increased volatility.
Until the Fed defines the time frame for determining the average inflation rate, monetary policy will become even more discretionary.