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Another Day, Another Step Closer to a Tightening Bias
Two important psychological levels are being tested in the US Treasury market right now. The 2-year yield is trading just above 4.00% this evening, May 14 (chart). That's 25bps above the current federal funds rate (FFR) range of 3.50%-3.75%. That implies investors believe the Fed may need to raise the FFR by at least 25 bps in the foreseeable future. The 30-year yield breached 5.00% on May 13, triggered by a $25 billion auction that drew such weak demand that it marked the first time since 2007 that the Treasury has auctioned a 30-year bond with a 5% handle. The 30-year has held above 5.00% since, trading at 5.06% this evening (chart). The 10-year yield is trading just above 4.50%, at 4.51% this evening. The Bond Vigilantes are sending a clear message to the Fed. Drop the easing bias that was in the April FOMC statement. Don't replace it with a neutral stance, but go straight for a tightening bias. Otherwise, the yield curve might start pricing in another Fed policy mistake, i.e., failing to turn hawkish quickly enough to fight inflationary pressures stemming from the Gulf War. Today's economic data fueled these bearish sentiments in the fixed-income markets: (1) Retail Sales. April retail sales rose 0.5% m/m, in line with expectations and the third solid consecutive monthly increase (chart). Excluding autos and gas, sales rose 0.5% m/m, above the expected 0.3%. Nine of 13 categories posted gains. Gas station receipts rose 2.8% m/m as prices at the pump averaged $4.10 per gallon in April. Discretionary spending held up well: food services and drinking places rose 0.6% m/m and sporting goods surged 1.4% m/m (chart). Control group sales, used in calculating GDP, rose a solid 0.5% m/m following a gain of 0.8% in March (chart). (2) GDPNow. The Atlanta Fed's GDPNow model revised its Q2 real GDP growth estimate up from 3.7% to 4.0% saar. The upgrade was driven primarily by the stronger-than-expected control group retail sales reading, which prompted a higher estimate for real personal consumption expenditures growth. At 4.0%, the GDPNow estimate is fully consistent with our view that the US economy remains resilient. While higher inflation eroded real wages in March and April, real consumer spending growth is tracking at 2.7% for Q2 (saar). That's because retiring Baby Boomers are no longer getting paychecks, but they are still spending their retirement nest eggs. (3) Jobless Claims. Initial unemployment claims rose slightly to 211,000 last week, consistent with low layoff activity (chart). The four-week moving average held near its lowest level since January 2024. Continuing claims ticked up slightly to 1,782,000, but the four-week moving average fell further to its lowest level since early 2024, suggesting it is becoming easier for unemployed workers to find new jobs. (4) Import Prices. The BLS import price index rose 4.2% y/y in April, the highest annual pace since October 2022, driven by a 19% surge in petroleum prices. Crucially, even excluding petroleum, the index rose 2.9% y/y, also the highest since October 2022 (chart). This suggests the Strait closure is causing broadening inflationary pressures that are showing up in imports of capital goods and consumer products. Today's data show resilient consumer spending, solid labor market activity, Q2 real GDP tracking at 4.0%, and import price inflation running at its hottest in over three years. If this mix persists, the probability of a Fed shift to a tightening bias will continue to rise. Fed officials can still recall that inflation proved more persistent than they had anticipated in 2022 and 2023. They don't want to fall behind the inflation curve as they did back then. They certainly don't want a repeat of the 1970s Twin Peaks Inflation calamity (chart). Treasury Secretary Scott Bessent appeared on CNBC's Squawk Box earlier today from Beijing, where he is attending the summit between President Donald Trump and President Xi Jinping. Bessent argued that the recent surge in inflation is a "temporary supply shock" driven primarily by energy costs from the conflict with Iran. He stated that while we might see "one or two more hot inflation numbers," he expects substantial disinflation to take hold in the coming months as energy markets normalize and US oil production continues to scale up. We are inclined to agree with Bessent. However, Fed officials need to show the bond market that the latest inflation problem requires a more hawkish stance from them for now.
On Technology, Semiconductors & Fusion
Yes, there’s some froth in this bull market. A few companies have ditched their traditional businesses to jump into AI-related areas. And the market’s performance has certainly narrowed. But the S&P 500 Information Technology sector’s earnings forecast for both this year and next should provide the support this market needs to continue moving higher. … Jackie also looks at the S&P 500 Semiconductors industry, one of the strongest within the Technology sector. Charts of the industry’s amazingly strong earnings and wide margins illustrate why shares have rallied so sharply. … Finally, with the world facing an oil shock, we take a look at some of the recent advancements in fusion energy. Could fusion reactors come online in the next five or so years to solve many of our energy problems?
From Cuts to Hikes: The Fed's Shifting Calculus
The April FOMC statement contained an easing bias, signaling that the Fed remained likely to cut the federal funds rate (FFR) over the rest of the year. That bias is becoming increasingly difficult to defend. Three voting members on the FOMC (Hammack, Kashkari, and Logan) already dissented against retaining it at the April meeting of the monetary policy committee. Boston Fed President Susan Collins has since added her voice to those calling for its removal. The consensus on Wall Street has coalesced around June 16-17 as the next FOMC meeting at which the easing bias will be dropped. The question is whether the easing bias will be replaced with a tightening bias. The US Treasury market is pushing for that outcome. The 2-year Treasury yield is currently trading above the effective federal funds rate (chart). When 2-year yields trade significantly above the policy rate, the market is signaling that the current FFR is too low to curb inflation and may have to be hiked–and certainly not cut. A simple removal of the easing bias may not be enough. After five consecutive years of above-target inflation, the Fed may need to signal a willingness to hike (chart). The data support such a pivot. Consider the following: (1) PPI Inflation Was Hotter Than Expected. April's PPI report delivered a significant upside shock. The PPI final demand rose 1.4% m/m and 6.0% y/y, the fastest annual pace since December 2022 and well above the consensus forecasts of 0.5% m/m and 4.8% y/y. The core PPI (excluding energy and food) rose 1.0% m/m and 5.2% y/y, the highest reading in more than three years, against consensus expectations of 0.3% m/m and 4.3% y/y (chart). The surge was broad-based across both goods and services (chart). Service costs rose 1.2% m/m, the largest increase in four years (chart). Energy prices soared 7.8% m/m. Transportation and warehousing costs rose 5.1% m/m (chart). The spike in transportation and warehousing costs was driven by an 8.1% surge in truck freight costs, the largest increase since 2009 (chart). Inflation is reaccelerating in a broad-based fashion according to April's PPI report. The Fed's easing bias is history and may need to be replaced with a tightening bias if incoming data confirm that the economy is in good shape, as we expect. (2) Labor Market Looking Better and Better. While upside risks to inflation have increased meaningfully, downside risks to the labor market have moderated. The latest ADP NER Pulse, a weekly survey of employment, shows private industry employers adding an average of 33,000 jobs per week in the four weeks ending April 25, a slight uptick from the prior moving average and consistent with a monthly pace of around 132,000, close to April's ADP print of 109,000 (chart). Bloomberg Economics' Labor Market Surprise Index is at its highest level in two years, suggesting stabilization at the very least and possibly an improvement in labor demand. (3) April Retail Sales Likely to Surprise to the Upside. Tomorrow's April retail sales release carries a consensus estimate of a 0.5% m/m rise, a slowdown from the 1.7% m/m jump in March, which was heavily distorted by a 15.5% spike in gas station sales. We expect the report to surprise to the upside. The Redbook same-store retail sales index rose 9.6% y/y in the week ending May 9 and has averaged a robust 7.3% y/y through April, well above the 2025 full-year average of 5.8% (chart). A strong retail sales print would push the FOMC committee in an even more hawkish direction. A better-than-expected retail sales report would boost the Citigroup Economic Surprise Index, which remains highly correlated with the 13-week change in the 10-year Treasury bond yield (chart). (4) No cuts, but hikes are becoming more likely. Where does this leave the Fed? A rate cut in 2026 is essentially off the table. Reaccelerating inflation, five consecutive years above the 2% target, the inflationary impact of the AI build-out phase, and a stabilizing/improving labor market all make the bar insurmountable. Notwithstanding all of the above, we remain in the none-and-done camp for the rest of the year. Disinflationary forces are still at work: productivity growth is containing unit labor costs, inflationary tariff effects are fading, wage inflation is moderating, and market rents are pointing to further shelter disinflation. Additionally, long-term inflation expectations remain anchored, and the risk of a wage-price spiral remains low. Nevertheless, the probability of a hike is rising. Market measures of inflationary expectations are moving higher (chart). Additionally, labor demand is showing signs of improvement, which could accelerate wage growth, and the combination of economic resilience and another energy supply shock is a scenario in which the Fed could plausibly be forced to tighten. The bond market is pricing in exactly this risk. (chart). The 10-year Treasury yield is likely to move up to 4.60% in coming days.
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