June 14 – It’s decision day at the Federal Reserve. Members of the Federal Open Market Committee will conclude two days of debate today, culminating with an updated policy statement at 2 p.m. EDT, followed by a press conference 30 minutes later. Their comments and statements will set the tone going forward. Their path may have been sealed by this morning’s inflation data on the wholesale level. The VIX continues to trade near 15 this morning. The dollar index is trading near 102.9, putting in a fresh three-week low this morning. Yields on 10-year Treasuries are trading near 3.79%, while yields on 2-year Treasuries are trading near 4.61%, after setting fresh three-month highs on Tuesday. Crude oil prices are roughly 1% higher this morning in follow-through buying, while the grain and oilseed sector is mostly lower in early trade.
The producer price index fell 0.3% month-on-month in May, which was more than the 0.1% contraction expected by analysts, and down from 0.2% gains in April. The PPI was up 1.1% year-on-year in May, down from 2.3% in April and below analyst expectations that it would fall to 1.6%. But similar to yesterday, the core PPI told a different story, rising 0.2% month-on-month in May, matching the previous month and matching analyst expectations. The core PPI was up 2.8% year-on-year in May, down from 3.2% in April, and slightly below analyst expectations of 2.9%. Like the CPI data, today’s PPI data shows a lower headline number aided by falling energy prices. That won’t always be the case, but for now it is. Today’s data still shows some stickiness to inflation, but that’s been more the case at the consumer level than at the producer level due to the structure of current inflation, which is largely a lingering problem of wage inflation in the service sector.
The “data” would certainly appear to be showing easing inflation that would justify the market’s expectations of a pivot in policy – and certainly a pause. And that is fully the market’s expectation, with this morning’s Fed fund futures trading 93% odds of no rate hike today, with just one more next month before turning rates lower by the end of the year. But keep in mind that this Fed is paranoid about making the same “mistake” made by its predecessors in 1980 when it pivoted too soon. As such, Fed members have repeatedly stated that they would rather error on the side of too high for too long than to pivot too soon. Inflation for goods is already at the 2% mandated level because consumer sentiment is at historically low levels, reducing buying currently. That’s also seen in the housing sector, which frankly has been in a recession. But M2 money supply remains elevated, meaning there’s still a lot of stimulus still in the system. A pivot that energizes the stock market returns consumer confidence, resulting in a resurgence of buying for goods, and yes for houses. There’s still a shortage of houses in this country. The increase in demand for goods would also reignite demand for workers to produce those goods. As such, the Fed – based on what it has said – will likely remain paranoid about inflation as long as core inflation remains high with M2 money supply remaining elevated. I do not expect a rate hike today, but neither would I be surprised if the Fed shocked everyone with a hike today. The stock market is doing well right now, providing cover for the Fed to bump rates higher if it so chooses to do so, based on the above factors that hold its focus.
China may see more extreme weather this year due to El Nino, according to a warning from its Meteorological Administration. The warning indicated that El Nino could lead to record high temperatures that extend into next year, depending on the intensity of this El Nino event. El Nino events tend to bring more rainfall in the South of China, with higher temperatures across most areas. That means higher chances of a warm growing season for China’s primary corn and soybean growing areas in the northeast of China, and in the North China Plain. Rice production could also be impacted by extreme drought in the Yangtze Rive Valley, according to today’s edition of China Direct. A moderate El Nino in 2009 led to extreme droughts in China’s primary grain producing provinces of Liaoning and Jilin. The three northeast provinces of China produce 50% of its soybeans and more than 40% of its corn.
Yesterday’s rally in the grain and oilseed sector lost momentum late in the day, failing to impress fund managers, resulting in active chart-related selling overnight. Fund managers may not even know what a corn plant looks like, but they do recognize chart signals, and they do understand seasonal price tendencies. Those seasonal tendencies tend to not be a friend of the bulls in the last half of June, unless a compelling story for a weather event is unfolding. Many market analysts continue to make comparisons between this year and 2012, but the fact is, it’s difficult to find a meteorologist who will make the same comparison, and that’s who advises fund managers.
