The benchmark 10-year Treasury yield yesterday remained at its lowest level since late 2012, according to daily data published by Treasury.gov through June 14. For the second consecutive day, this widely followed rate held at 1.62% - more than 60 basis points below the level at the start of the year. The implication: the bond market is expecting that the Federal Reserve will leave interest rates unchanged in today's FOMC meeting, and perhaps for months to come.
The 2-year yield, which is said to be the most sensitive spot on the yield curve for rate expectations, has been a bit firmer. The 0.74% rate as of yesterday reflects a middling value relative to recent history, suggesting that this maturity is on the fence with regard to rate hike prospects.
Note, however, that the stock market and the Treasury market's inflation expectations are again falling simultaneously. Earlier this month, I noted the divergence between a rising stock market and the sliding inflation outlook. The S&P 500 (NYSEARCA:SPY) appeared to be breaking free of the tight connection it's exhibited with inflation expectations in recent years. But thanks to the recent slide in equity prices, the two markets are again moving in tandem - to the downside. The dual tumbles offer another clue for thinking that the Fed will be hard-pressed to raise interest rates today.
Veteran Fed watcher Tim Day wrote earlier this week that "it makes no sense to show concern with the possibility of unanchored inflation expectations to the downside while at the same time stating that you anticipate the next policy action will be a hike." The Oregon University economics professor notes that "if inflation expectations are no longer stable, then any rational central banker must act accordingly, and in this case that means easing policy."
Perhaps, then, it's no surprise that Fed funds futures markets are projecting that the central bank is unlikely to raise rates today. CME data shows an implied 98% probability that the current 0.25-0.50% target range for Fed funds will prevail when the dust clears from today's policy meeting.
Another factor to consider is this morning's monthly update on industrial production, which is expected to show a monthly decline of 0.1% for May, according to Econoday.com's consensus forecast. That translates into another year-over-year decline. In short, industrial activity's annual pace is set to post a decrease for the ninth month in a row - the longest stretch of contraction since the last recession.
And let's not forget that a few weeks ago, the government reported that employment growth posted a dramatic slowdown in May. Perhaps that's just noise? Maybe, But the Fed's Labor Market Conditions Index (LMCI), which tracks a spectrum of indicators, looks weak too, which suggests that job growth is stumbling. Note, however, that Fed Chair Janet Yellen is ignoring this metric. Maybe there's a reason why LMCI isn't ringing the alarm bells at the Fed. As Bloomberg notes, there are questions about the indicator's reliability. And as Barry Ritholtz points out, tax data via the Treasury Dept. implies that job growth is strengthening.
Hawks argue that the solid gains in retail spending in April and May offer a brighter profile of economic conditions, and one that leaves the door open for squeezing monetary policy sooner rather than later. But as I discussed yesterday, the annual trend in retail spending appears to be downshifting, albeit slowly.
There may be a case for raising rates, but there's much support for doing so via the data. In fact, some analysts think the central bank may be forced to reverse itself in due course. "I'm not convinced the Fed will hike at all; in fact their next move might be a rate cut rather than a hike," Nicholas Ferres, investment director of global asset allocation at Eastspring Investments, told CNBC earlier this week.
Judging by the 10-year Treasury yield, the bond market appears inclined to agree.