Aug 14 ( ) - Even though we're slipping inexorably into the summer holiday doldrums on world markets, bond anxiety was once again a theme of the early part of this week, threatening to spoil the party for stock markets basking in the glow of bumper, AI-infused second-quarter earnings. All's well that ends well, however - at least for this week. Two less-than-scary updates on U.S. consumer and producer price inflation for last month appeared to be enough to take the sting from jumping Treasury yields.
The largely expected tick lower in both annual inflation gauges offers Federal Reserve officials some cover if they want to avoid an interest rate rise as soon as next month. The Fed futures market scaled back chances of a hike in September to just one-in-three from what was a coin toss before the price reports. Encouraged also by decent demand at new debt auctions of some $125 billion this week, Treasury yields unwound most of their recent rise, with the two-year yield hitting its lowest in a month.
For a start, Treasury was forced to sell new 10-year notes at their highest rate at auction in 19 years this week and 30-year bonds at their highest rate in 25 years on Thursday. Meanwhile, the average 30-year fixed mortgage rate is running as high as 6.7%. Hopes that July's high oil and energy costs would quickly dissipate on moves to end the Iran war have run aground again this month.
Brent crude prices probed $90 per barrel this week - and average U.S. retail gas prices are still above $4 per gallon - as it became increasingly clear that the two sides in the war are still far apart. Iran continues to assert control over the Hormuz strait and sporadic attacks continue in the Gulf and Red Sea, while the U.S. said on Thursday it could maintain a blockade on Iran's ports indefinitely. Importantly, transits through Hormuz fell this week and less crude may be escaping the Gulf than the U.S. believes.
If that were the only issue aggravating inflation, it may be tempting to look through it. But after the week's relatively well-behaved inflation reports, the Fed now has to look to the personal consumption expenditures (PCE) price measure that it explicitly targets. With key components from this week's data mapped into that, the Cleveland Fed's inflation "nowcaster" still has PCE inflation running at 3.7% for both July and August - with core PCE running at 3.3%.
So, not only have these PCE measures been above the Fed's 2% target for almost six years, they have both been above 3% for all of this year so far. The doves cling to hopes that tariff-related goods price rises are about to fall out of inflation indexes, downward PCE data revisions are on the way, the labor market is softening and AI promises productivity miracles. The hawks see overly loose financial conditions that suggest the Fed is no longer restricting activity, rising corporate leverage, tech sector product tightness, a falling jobless rate and - above all - fraying credibility in the Fed's willingness to get inflation back to its target.
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