Yields Push Higher Ahead of Fed Meeting

Inflation pressures were expected to ease heading into the second quarter of the year and ease more aggressively heading into the second half of the year as economies opened back up and attempted to reestablish some derivative of?“normal.”?For many economies, COVID restrictions have come to an end as countries find a way to live with the virus. China, meanwhile, has maintained a?"zero-COVID"?strategy, continuing to impose strict lockdowns and containment measures.

According to reports, China just placed the 17.5M residents of Shenzhen into lockdown for at least a week, coupled with three rounds of city-wide testing. All bus and subway systems are closed, and businesses – except those deemed essential services – have been shuttered. Similar measures are impacting Hong Kong, Shanghai and other regions amid a rise in coronavirus infections.

Ongoing restrictions have analysts concerned about further inflationary pressures as well as disruptions to the global supply chain, particularly in technology as already some key suppliers have announced a – temporary – production halt.?

Overseas, equities were impacted both by the longer-term threat of further dislocations and higher costs, and the more recent reports from U.S. officials that Russia asked China for military assistance for its war in Ukraine.

The Hang Seng Index plunged 5% overnight to close at 19,531.66.

In the U.S., inflationary fears are boosting Treasury rates ahead of this week’s Fed meeting. The 10-year yield climbed 10bps overnight to 2.10%, the highest level since July 2019. This morning, the 10-year is steady at 2.10% as of 10:02 a.m. ET.

The market is betting on a more aggressive, or a more hawkish approach to policy as inflation pushes to the highest level since 1982.

Recall last week, the latest read on consumer prices showed that the CPI rose 0.8% in February, following a 0.6% gain in January. Year-over-year, consumer prices jumped 7.9%, up from the 7.5% pace reported the month prior and the fastest rate since January 1982. Food prices rose 1.0% and energy prices increased 3.5% in February, following a 0.9% gain in January. Excluding food and energy costs, the core CPI rose 0.5% in February, following a 0.6% gain in January. Year-over-year, the core CPI increased 6.4%, the largest annual increase since August 1982.

As a result, the Fed is hyper-focused on reining in what some have described as?“out of control”?prices. Of course, as we have written extensively, raising the cost of capital via a higher target on the federal funds rate will do little to address cost increases stemming from supply-side limitations in the aftermath of COVID-19, or as China continues to implement lockdowns, or as war rages on in Ukraine.?

That being said, this week the Fed is expected to lift the target rate off of crisis levels, raising the target 25bps to 0.25-0.50%. We also anticipate the famed dot plot will shift to some extent and show at least some members expect more hikes in 2022, along with a higher inflation forecast in the Summary of Economic Projections (SEP).?

Broadly speaking, however, the pathway for policy remains extremely complicated; given the number of uncertainties, Federal Reserve Chairman Jerome Powell is likely to reiterate a need for policy makers to remain?“nimble.”?Thus,?the press conference is likely to focus on key questions: How does the Russian war impact the Fed’s policy outlook? Is the Fed willing to tighten into recession, or said differently, is getting inflation under control the Fed's primary goal no matter the costs? And, is there a fear – or rising fear – of recession or stagflation?

On the economic calendar, on Friday, the University of Michigan Consumer Sentiment Index sunk from 62.8 to 59.7 in March, more than the expected decline to 61.0 according to?Bloomberg?and the lowest since 2011. In the details of the report, a gauge of current conditions fell from 68.2 to 67.8 in March, the lowest level since 2009, and consumer expectations dropped to 54.4, the weakest since 2011. Inflation expectations over the next 5-10 years held steady at 3%.

This morning, the economic calendar is empty.

Tomorrow, the PPI is expected to rise 0.9% in February and 10.0% over the past 12 months, up from the 9.7% gain in January. The core PPI is expected to rise 0.6% in February and 8.7% year-over-year, up from the 8.3% gain reported in January. Also, the Empire Manufacturing Index is expected to rise from 3.1 to 6.5 in March, a three-month high.

Later this week, on Wednesday, retail sales are expected to rise 0.4% in February, down from the 3.8% increase reported in January. Also, import prices are expected to increase 1.6% in February, following a 2.0% gain in January, business inventories are expected to rise 1.1% in January, and the NAHB Housing Market Index is expected to fall from 82 to 81 in March.

On Thursday, housing starts are expected to rise 3.8% in February, while building permits are expected to decline 2.4%. Also, initial jobless claims are expected to decline from 227k to 220k in the week ending March 12.

Finally on Friday, existing home sales are expected to drop 6.2% from 6.50m to 6.10m in February. Also, the Leading Index is expected to rise 0.3% in February, offsetting the 0.3% decline in January.

-Lindsey Piegza, Ph.D., Chief Economist