U.S. stocks and Treasuries declined yesterday as a group including former Republican government officials, economists and hedge-fund manager Cliff Asness urged Federal Reserve Chairman Ben S. Bernanke to halt his expansion of monetary stimulus, saying it risks an inflation surge. Fed Bank of New York President William Dudley said in an interview with CNBC that the central bank’s bond purchases won’t cause an inflation problem.
The rate markets see the QE as inflationary and are cutting bond holdings in a mass selling run. Interest rates have increased 40 basis points on the bellwether 10 yr note in the last 10 sessions; mortgage rates up about 30 basis points. The Fed continues to speak of its desire to increase the rate of inflation to avoid potential deflation in the economy. Bernanke believes that a small increase in the rate of inflation will stimulate more consumer spending and eliminate a Japanese style long term deflationary economy. All one needs to know is that fixed income investors abhor any move up in the rate of inflation. In this instance with long term rates as low as they continue to be, an increase of just 1.0% in the inflation rate reduces the real rate of return by that amount, leaving investors with a real return of 1.9% and that is not good enough to continue funding the US deficits.
At 8:30 this morning Oct producer price index hit at +0.4%, half of what was widely expected; the ore rate (ex food and energy components) was expected at +0.1% but actually declined 0.6% with the yr/yr core rate of inflation at +1.6%. A positive for the the bond markets but didn't light any additional fires to the skimpy rally earlier.
At 9:15 this morning Oct industrial production was unchanged with markets expecting an increase of 0.3%. Oct factory usage was also unchanged with forecasts of 74.9% it hit at 74.8%, unchanged from Sept that was revised to 74.8% frm 74.7%. No increase in production or factory use; but manufacturing rose 0.5% after a 0.1% increase in September that was previously reported as a 0.2% drop. Total production was little changed by the biggest drop in utility use in six months that was probably caused by unseasonably mild temperatures last month. The headline looked soft but the guts were better with the increase in manufacturing.
The DJIA opened down 80 points at 9:30, the 10 yr note +24/32 at 2.87% -9 bp and mortgage prices +11/32 (.34 bp). Rate markets are momentarily oversold so a rebound is not unexpected. It would take a rather substantial rally now to reverse the bearish outlook. The Fed's easing move has unnerved traders and investors; it is unprecedented leaving markets confused. With interest rates at historic lows any uncertainty will rock markets hard as we have witnessed over the past week. Longer term; we believe the bull market in interest rates is over. Rates have already hit their lows and unlikely will fall back much unless the economy tumbles over, and that appears unlikely now.
At 10:00 the Nov NAHB home index was at 16 as expected, up 1 point from Oct which was revised lower by 1 point. the index is the highest since June but is still in depressed levels. The expectations for buyers over the next six months increased to 25, the highest since last May. No reaction to the report as usual.