May 11, 2018
The U.S. Yield Curve Is the Flattest Since August 2007
The Treasury yield curve from 5 to 30 years flattened Thursday to the lowest level since August 2007, as a combination of weaker-than-expected U.S. inflation and solid demand for a record bond auction bolstered investor confidence in owning long-dated securities. The spread narrowed by more than 4 basis points, the most since February, dropping through a previous intraday low from April to 27.7 basis points. The gap between 2- and 10-year Treasuries also shrank in a bull flattening move. U.S. inflation took a breather in April from its acceleration in recent months, with the core consumer price index up by a weaker-than-anticipated 0.1 percent from March and just 2.1 percent on an annual basis. Perhaps in part because of the data, the Treasury saw good demand for its $17 billion auction of 30-year bonds, the largest-ever sale of the maturity. “Bull flattening of the yield curve signals that inflation is not a problem,” Scott Minerd, chief investment officer at Guggenheim Partners, said Thursday on Twitter. “But that won’t stop the Fed from staying on course for three more rate hikes this year.” Though the flattening has been relentless, it may still have room to go. BMO Capital Markets strategists said in a report Thursday that a closing level below 30 basis points signals “a clear path” for the yield curve from 5 to 30 years to fall to 20-25 basis points. Investors and Federal Reserve officials alike have been on guard for the curve flattening toward inversion, which has historically preceded recessions. Yet bond traders are still pricing in more than two additional quarter-point rate hikes by year-end, betting policy makers will stick to their tightening path.
Fed Study Shows U.S. Hikes Hit High-CPI Emerging Markets Hardest
Emerging markets with the weakest financial metrics, especially those with high inflation, tend to be the worst affected by U.S. interest-rate shocks, according to a study by Federal Reserve Board economists. “Both the bright and the dark side of foreign responses to U.S. interest rate increases” are highlighted by the discussion paper, wrote the authors, Matteo Iacoviello and Gaston Navarro. “On the dark side, these responses seem to be large, to the point that they suggest that foreign economies — especially vulnerable, emerging economies — may react to U.S. monetary shocks more so than the U.S. economy itself.” The duo constructed a “vulnerability index” to measure how financial fragility might explain differing negative impacts across countries’ gross domestic products in the wake of Fed rate-hike shocks. Included in the index. “In emerging economies all four indicators — inflation in particular — have explanatory power in enhancing the response of GDP to a U.S. shock,” Iacoviello and Navarro wrote in the April 23 paper. While the Fed economists didn’t address this year’s market volatility as the U.S. continues with its monetary tightening, the two worst-performing emerging market currencies in 2018 so far are Argentina’s peso and Turkey’s lira. Both countries have double-digit inflation rates. Using data from 1965 to 2016, the study found a 1 percentage-point “policy-induced” rise in U.S. rates lowers emerging-nations’ GDP by about 0.8 percent, a little more than the 0.7 percent reduction seen in the U.S. For emerging nations with high vulnerability-index readings, the impact is more than double, the economists said.
Clouds Linger as U.K. Economy Sours in April: Brexit Barometer
The Bloomberg Brexit Barometer last month had its largest drop since August 2017 as the U.K. jobs picture and market uncertainty took their toll. The decline came as the country’s policy makers, businesses and citizens grappled with what exactly a post-Brexit trading relationship with the European Union will look like. The barometer, which includes data for growth, labor market, inflation and other key economic indicators, fell to 22.7 in April from a revised 33.2 in March, marking the third consecutive month of “cloudy” weather. It was the largest drop since August 2017. The one bright spot in the barometer was a pickup in business sentiment in the industrial and construction sectors. Driving the decrease was falling consumer confidence in the state of the overall economy and household finances, as well as weakening employment expectations in manufacturing.
U.K. Construction Slumped in March as Snow Stalled Projects
U.K. construction output plunged in March after heavy snow brought swathes of the country to a standstill. Work volumes in the building industry declined 2.3 percent from February, rounding off the weakest quarter in almost six years, the Office for National Statistics said Thursday. Separate figures showed manufacturing output declined 0.1 percent in March, a second month of contraction, though the ONS said there is no anecdotal evidence from factories that the weather played a role. Overall industrial production climbed 0.1 percent, as freezing temperatures boosted demand for energy. The figures come as the Bank of England prepares to announce its latest policy decision. Economists and investors, who until recently saw an interest-rate increase today as near-guaranteed, now expect no change after the economy barely grew in the opening months of the year. Disruptions caused by the Beast from the East snowstorm affected the construction industry across the board in March, with infrastructure and housing the worst hit. It left the sector down 4.9 percent from a year earlier, the steepest drop since January 2013.
Asia’s Worst-Performing Stock Market May Need a Rate Hike
Asia’s worst performing equity index this year may get a break should the Philippine central bank carry out its first rate hike since 2014 on Thursday. “While the impact of a rate increase on inflation will take time, this will put a floor on the peso’s weakness against the dollar, helping pacify investors who are worried the selloff in equities will continue if the currency depreciation isn’t arrested,” said Jonathan Ravelas, chief market strategist at BDO Unibank Inc. Since its Jan. 29 peak, the Philippine Stock Exchange Index has plunged more than 16 percent as overseas investors dumped shares and the peso slid.