Daily Commentary BY THE CURVE TEAM –

More Cracks Appear

31st of May, 2017

The market is still pricing another hike next month from the FOMC and slightly better than expected data overnight only provided further support. That hasn’t stopped more cracks appearing in the Fed’s resolve. Comments overnight indicate that it isn’t just the Fed’s European counterparts who still have concerns over the outlook for inflation.

Dallas Fed president Robert Kaplan toed the party line, suggesting two more hikes were in train and that the Fed’s balance sheet would be lower than its current $4.5 trillion size. However, one of his colleagues was less certain.

FOMC board member Lael Brainard initially supported the continued removal of monetary support saying that “it would be reasonable to conclude that further removal of accommodation will likely be appropriate soon.” 

She then went on to echo concerns we saw from her European counterparts earlier in the week. “The apparent lack of progress in moving core inflation back to 2 percent is a source of concern” she said, adding “if the tension between the progress on employment and the lack of progress on inflation persists, it may lead me to reassess” the outlook for rate hikes.

While market pricing is close to 100% for a hike next month, bond markets are telling a different story with another rally in longer dates maturities, driving yields lower and leaving the curve flatter. It isn’t just US bond markets on the move either.

The Australian bond markets have outperformed the US. The Australian 10 year yield has now nearly fully unwound the move that followed the US election of Donald Trump. Part of the move in Australia’s bond rates is likely due to souring economic outlook, which has seen the market move to price in a 25% chance of a rate hike by year end.

If next week’s first quarter GDP outcome comes in as weak or weaker than is currently expected, recent trends could gain momentum.

David Flanagan

Director - Interest Rate Markets