Good Data=Nervous Bond Markets

The first-week-of-the month data released last week described an economy with good forward momentum–enough momentum to be troublesome to bond market participants.

Both ISM indices stayed well into growth territory, and the key new orders components remained at very healthy levels.  The manufacturing index was especially impressive, and it contained hints of more inflation.  The prices paid index remained elevated and delivery times continued to increase.  Supply chains are apparently becoming strained.  That is consistent with reports that manufacturers are having difficulty expanding output due to labor shortages.  There are also reports of a shortage of trucking capacity.

Sales of new cars and trucks were described as disappointing because they failed to match year-ago levels.  But sales in December 2016 were very strong, and the annual selling rate last month of almost 18 million units was actually very good.

The jobs report last Friday fit the pattern seen most of last year–sufficient employment growth to keep unemployment low.  The 0.3% increase in average hourly earnings and anecdotal reports of labor shortages suggest faster wage growth in 2018.

Together, these data ratify the Fed’s strategy of policy normalization.  Stock prices also support the contention of several FOMC members that financial conditions are no tighter now than they were when the fed funds rate was 1/4%.  Nothing in last week’s data or FOMC minutes argued against a forecast of a much higher fed funds rate by this time next year.

Bond markets might be starting to take that risk more seriously.  A rally after the “weaker-than expected” employment report on Friday could not be sustained.  This week, the CPI report on Friday will be examined closely.  The inflation data are probably now the most important to the markets, because low inflation is the only argument against a steady rise in the funds rate.  Before Friday, Treasury auctions of 10-year notes and 30-year bonds could test the current levels of Treasury yields.

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