Wednesday, November 29, 2017

Mid-Week Bond Market Round-Up

Yellen's Congressional Testimony:

Even with a step-up in growth of economic activity and a stronger labor market, inflation has continued to run below the 2 percent rate that the Federal Open Market Committee (FOMC) judges most consistent with our congressional mandate to foster both maximum employment and price stability. Increases in gasoline prices in the aftermath of the hurricanes temporarily pushed up measures of overall consumer price inflation, but inflation for items other than food and energy has remained surprisingly subdued. The total price index for personal consumption expenditures increased 1.6 percent over the 12 months ending in September, while the core price index, which excludes energy and food prices, rose just 1.3 percent over the same period, about 1/2 percentage point slower than a year earlier. In my view, the recent lower readings on inflation likely reflect transitory factors. As these transitory factors fade, I anticipate that inflation will stabilize around 2 percent over the medium term. However, it is also possible that this year's low inflation could reflect something more persistent. Indeed, inflation has been below the Committee's 2 percent objective for most of the past five years. Against this backdrop, the FOMC has indicated that it intends to carefully monitor actual and expected progress toward our inflation goal.

Kashkari: no reason to raise rates right now:

“Because inflation is low, I am seeing no reason to tap the brakes on the economy,” Kashkari said in a Town Hall event at Winona State University in Minnesota and broadcast via the Minneapolis Fed’s website. A rate hike would be expected to slow the economy by reducing incentives for borrowing, investing and hiring.

Dudley thinks inflation will rebound and is therefore in the rate hiking camp:

Dudley, a close ally of Fed Chair Janet Yellen who is set to step down in mid-2018, said that with unemployment having fallen to 4.1% the U.S. central bank thinks the economy has reached “full employment.” Theoretically, that is that unemployment can get without prompting inflation; the Fed’s preferred price measure has drifted down to 1.4% this year, below a 2-% target.

Thus “we have been gradually raising interest rates,” he said, repeating that he expects inflation to rebound along with wage gains.

Are there different reasons for the yield curve flattening?

When the Federal Reserve raises short-term interest rates, the rates on longer-term Treasuries are generally expected to rise. However, even though the Fed has raised short-term interest rates three times since December 2016 and started reducing its asset holdings, Treasury yields have dropped instead. This decoupling of short-term and long-term rates is reminiscent of the “Greenspan conundrum” of 2004–05. This time, however, evidence suggests compelling explanations—a lower “normal” interest rate, the risk of persistently low inflation, and fiscal and geopolitical uncertainty—may account for the yield curve flattening.

Flattening yield curve faces test of its predictive powers (FT)