Thursday March 9

Stocks rose fractionally today as falling oil prices and the increasing possibility weighed on sentiment. The S&P 500 rose 0.1% to 2,364 and the Dow Jones rose 0.01% to 20,858. The KBW Bank index rose 0.2% while the DJ Utility average lost 0.3%. All eyes are on the February NFP report which is set to come out tomorrow, and barring unforeseen circumstances investors and traders expect higher rates next week. The ECB came across as slightly hawkish which sent the euro and bund yields 5bp higher. In the US rates were also higher continuing the trend from recent days. The two year Treasury yield rose 1bp to 1.37%. The ten year Treasury yield rose 4bp to 2.60%. Accordingly 2yr vs 10yr bear steepened once again to 1.23%. Foreign exchange markets were more mixed. USD fell 0.4% against EUR to $1.0582. USD rose 0.5% against JPY to Y114.92. USD fell less than 0.1% against GBP to $1.2175. Oil prices continued to drop after data showed yesterday that supply levels are increasing. WTI fell 1.2% to close at $49.69 and below $50 for the first time this year. Brent lost 1% to $52.57. Gold prices have also dropped 0.6% on higher rate expectations. On the sharp drop in oil prices credit spreads of energy bonds spiked. Credit spreads for high yield bonds have jumped more than 11bp to +437 since Tuesday and are at the highest level since the start of the year. For energy bonds in particular that spread has widened to as much as +645. In spite of this pickup they are still very low compared to their average over the last 12 months.

Investors pay close attention to the inflationary environment in China. That is because since China is a major manufacturer and exporter for goods that are sent all over the world prices in China are closely watched as a leading indicator of inflation around the world. That is because due to China’s position of the global supply chain makes the country an exporter of inflation. There is divergence in inflationary measures in China however. CPI data released for February shows that prices rose just 0.8% which was slower than the month before when prices rose at a 2.5% over the prior year. However PPI data shows prices rising at a much faster pace. PPI data for February showed that prices rose 7.8% over the prior year. As producer prices in China rise that could spur inflation in other economies as Chinese exporters pass along higher costs. The divergence in inflationary measures presents a challenge for China’s central bank. The PBoC has a 3% target for consumer prices but if it lowers interest rates to help revive CPI it risks inciting bubbles across different markets in the country. Already the central bank has been guiding interest rates higher to help reduce excessive speculation in markets.

The ECB met today and the euro appreciated sharply after comments made by Mario Draghi suggest that the central bank believes it has won the battle against inflation. Draghi said that there was little urgency for the ECB to act further and suggested that interest rates are as low as they need to go. That could be the first step towards the ECB positioning itself to reverse course from unprecedented monetary easing. This could be partially as a result of pressure from hawks in Germany who want rates higher sooner rather than later. Following these comments the euro rose 0.7% to $1.0615 and the 10 year bund yield rose to 0.42%. Going forward investors will begin to expect that the ECB may make statements regarding next steps to scaling down its program. Inflation recently rose above the ECB’s target rate which is just under 2% for the first time in four years. Investors are now pricing in a 68% chance that the ECB will raise rates before August of 2018 which compares to 31% last week. The ECB has said that it will only consider raising interest rates after its EUR 60bn per month QE program is wound down. Similar to the United States officials in Europe are still waiting for wages to catch up with economic growth. Monetary doves suggest that since core prices are only up 0.9% and the rest of the increase is due to energy prices that as a result officials can wait. Nevertheless the ECB’s headline inflation forecasts were pushed up to 1.7% from 1.3% last time the forecasts were made.

Traders are already looking beyond next week’s Fed announcement and trying to guess when they might move next. With a 25bp increase to 0.75% to 1.00% nearly certain for next week investors are thinking ahead. Already Jeff Gundlach and David Tepper have already made statements suggesting they believe the Fed may take more of a hawkish stand going forward. That could suggest that investors believe that the Fed has fallen behind the curve of inflation and that quick rate hikes may be needed to prevent inflation from moving too high. A strong report tomorrow could send rates even higher and equities lower since it could prompt future rate hikes sooner than expected. The Fed possible falling behind the curve could be reflected in the spread between the 2 and 10 year Treasury bonds. The ten year has risen more than the 2 year over the last week.

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Thursday March 9

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