A Busy Week of Bank Earnings, Inflation Reactions and Bond Yields

Ed Mertiri |

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Inverted Bond Yield Curve Extends

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Reaction to the June CPI Report

 

Yet another scorching CPI report for June. The report was higher than expectations with increases in every major category. Markets were calmed after Federal Reserve officials indicated that they wouldn’t be raising rates above 75bps at the next meeting despite the record report.

One area of hope for declining inflation is lower raw material prices and even further declines in the commodities futures market. Prices for future delivery are significantly lower than current spot prices for most commodities, a phenomenon called “backwardation” in commodity traders’ parlance. Among others, Cotton and Crude oil have notable steeply backwardated futures curves (see charts above).

Higher recession risk is indicated in the fixed income markets. Last week the yield curve inversion extended through 1-year to 10-year treasuries. The 2-year Treasury yield is about 20 basis points, 1/5 of 1 percent higher, than the 10-year. This kind of inversion, where several series of short-term bonds are at higher yields than long-term, hasn’t been seen since the 2007 financial crisis. While the bond markets indicate a recession is more likely, it is not certain. There is a strong employment environment and a persistent consumer willingness to pay more, which continues to add inflationary pressure. There are still approximately 11 million job openings, about two job postings for every unemployed person. The FOMC still has some room to slow down the economy without increasing unemployment to unhealthy levels.

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