It was obviously a busy news week. The Trump/Kim meeting garnered a lot of attention early on, and then of course there is the World Cup. But market wise, there were four key items:
- Inflation report
- The Fed meeting
- European Central Bank (ECB) meeting
- Trade Policy
Inflation – Drifting Higher
There was another sign that inflation is percolating this week. The CPI report for May showed that inflation is running at its swiftest pace in six years. The consumer price index rose 2.8% in May from a year ago (chart below), up from 2.5% in April, and 0.1% ahead of the forecast. An 11.7% annualized increase in energy prices played a large part in the spike.
Strip out energy and food, and core inflation edged up to 2.2% from 2.1% the previous month and matched economists’ forecasts.
The Fed’s Hawkish Hike
We touched on the Fed meeting in a previous post . Essentially, the Fed hiked rates by a quarter point as expected, taking the Fed Funds rate to between 1.75% and 2.00%.
More importantly, they signaled that they expect to hike two more times this year (presumably in September and December), ultimately taking rates to between 2.25% and 2.50%. They also expect to hike another three times in 2019 and one more time in 2020, taking rates ultimately to 3.375%.
As BCA notes:
“The outcome of this week’s FOMC meeting was on the hawkish side. The median number of dots in the newly released Summary of Economic Projections now point to four rate hikes this year, up from three hikes in the March projections. In addition, the Fed increased estimates for both growth and core inflation for this year.”
The other big news was that Chairman Powell indicated that a press conference would be held after every meeting starting next year. The market views this as a hawkish move in that it will allow the Fed to move rates more than once every quarter if they feel the need.
Interestingly, the U.S. yield curve flattened this week after the Fed news. The yield on the 10-year bond fell while 2-year yields moved higher, taking the spread down to just 36bps from 44bps at the end of last week, as you can see below.
We talked about the yield curve in a post last week. Read more here.
The ECB – Playing the Dove to the Fed’s Hawk
The ECB also met this week, and as widely expected, they announced an end date for its own quantitative-easing (QE) program. However, unlike the Fed, it said it plans to hold interest rates steady for at least another year. From the Wall Street Journal:
“The European Central Bank is closing a chapter on one controversial policy, government bond purchases, while extending the life of another: negative interest rates. The central bank Thursday laid out plans to wind down its giant bond-buying program by the end of this year, but said it likely would wait ‘at least through the summer of 2019’ before raising its deposit rate, now at minus 0.4%.”
The ECB news had the biggest impact in the currency markets. As you can see below, the euro sold off sharply after the ECB news. Ultimately, the euro lost -1.8% on Thursday, its biggest loss in roughly two years.
Trade Policy – Playing with Fire
Finally, the Trump administration announced the final list of imports from China subject to an additional 25% tariff. There are 1,102 specific product lines being targeted in two separate moves:
- The first tranche will hit 818 product lines worth $34bn and will take effect July 6th.
- The second tranche of 284 proposed tariff lines covering imports worth some $16bn will be the subject of a public comment process and potentially take effect at a later date.
This plan has actually been scaled back in the sense that the second tranche has no specific start date.
Industries targeted include aerospace, information and communication technology, robotics, industrial machinery, new materials, and autos. The list does not include goods commonly purchased by U.S. consumers such as cellphones and TVs.
Beijing quickly announced retaliatory measures that would be of the same scale and strength, although they did not provide a list of targeted products and/or tariffs. Presumably agricultural goods, airplanes, and two of life’s essentials (whisky and motorbikes) will be high on the list.
President Trump, of course, warned the US was prepared to impose yet more tariffs if China chose to go ahead with its promised retaliation against US farm exports such as beef and soybeans. There is reportedly a list of another $100bn in Chinese imports to target for tariffs.
If you want to be an optimist on this, Michael Cembalest at J.P. Morgan is your guy. To quote from his June 6th note:
“…but there’s also enormous economic pressure on China and the US to find common ground. Compared to adversaries of the past 100 years, economic linkages between the US and China are much larger. The chart below is something I’ve been working on for the last few months. The idea is to measure the economic linkages between adversaries of the past and present. To do this, we add the outstanding stock of bilateral foreign direct investment, the amount of bilateral annual trade, and the amount of government bonds owned by the other country’s Central Bank. Compare China/US today to Europe and Asia in the 1930’s, to US/Russia in the 1980’s and to India/Pakistan. I’m not by nature an optimist, but I believe these economic linkages will eventually push the US and China toward compromise and away from a shooting war or a full-blown trade war.”
I hope he’s right.
Have a good weekend.
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