Dog Wagging the Tail, or Tail Wagging The Dog?

This morning saw the release on the US inflation report, and it came in under expectations. US inflation edged up .2% month over month, and 3.4% YOY, both missing market expectations by.1%.

Ironically, it was 1 week ago today we had the BOC announce, at about this time they were cutting rates by 25 bps. What I find super interesting is that Canadian 5 year yields are down more this morning on the US inflation report than they were last week after the BOC actually cut rates.

This should tell us a lot about how markets work. Markets are more concerned with forward thinking, and forward guidance then they are what happens today. Markets didn’t care as much about ACTUAL rate drops, as they do about inflation easing in another country. This is because stock markets, bond markets, currency markets are all forward looking indicators.

No matter the reason, 5 year government bond yields are down around 12 to 13 bps, so it is a win for borrowers. Lets hope this will force a few lenders to cut fixed rates. If we see the bond close out on the high end of todays range ( lower yield ) then it could pave the way for some small drops in the coming days and weeks. If however we see the bond price hit a high, and head lower ( yield up ) then it could throw some cold water on that.

Sometimes what the market giveth the market takes back right away, and this morning was no different. While inflation readings came out a touch on the cool side, the crude oil market sprang back to life after the Department of Energy announced they see an increase in global oil demand, and projected a supply deficit. Of course oil prices trucked higher on the news, and while prices have been a bit subdued as of late, they suddenly have some life in them. After hitting around $73.25 USD a barrel in early June, prices are now bouncing around $79.25. Let’s remember that oil plays a large roll in inflation, and inflationary expectations.

However, higher oil is generally good for the CAD and this morning between the lower inflation print in the US, suggesting the Fed will cut sooner than thought, and oil prices gaining, the CAD is up about half a cent on the USD. Before the release of both reports, the CAD was down about .10% on the USD, so these 2 different reports have lifted the currency.

I personally don’t think either of these reports will convince Mr. Powell to cut rates at todays meeting, however if inflation does remain subdued in the coming months, we could see new language from the Fed and new forward guidance. Around the 2 pm release of the Fed minutes today there is likely to be some volatility in stocks, bonds, commodities, currencies and yields. Don’t panic if you see the yield nose diving or climbing. Simply make a cup of coffee, and check back in 30 minutes. It will likely be a completely different chart. There is trillions of dollars hedged in USD to Fed meetings, and so if there is any language change, any expectations change, etc. you will see traders re allocate, re hedge, and move positions. This creates a lot of volatility for a short period of time.