US bonds fluctuate ahead of Fed update

OVERNIGHT

Asian equity markets are mostly up this morning and seem on course for a second consecutive week of gains. China May price data showed a modest rise in annual CPI inflation to 0.2% from 0.1% in April, while the producer price measure fell 4.6% year on year. That tame inflation environment potentially leaves the way open for further policy measures to stimulate economic growth.

THE DAY AHEAD

Within a very light economics calendar, April Italian industrial production will provide an update on Eurozone economic conditions. Yesterday saw Q1 GDP revised down by more than expected to show a second successive fall of 0.1%. That continues the recent trend of Eurozone data coming in weaker than expected and means that the economy was in recession over the winter using the definition of recession being at least two consecutive quarters of falling output.

Industrial production has lately been weaker than services across most of the Eurozone including Italy and so far there is little sign of that situation changing in Q3. The consensus estimate is that Italian factory output is expected to have risen in April, which would be the first monthly rise this year. However, that would be only a modest counter to signs the sector is struggling. Several smaller Eurozone countries will also report April industrial production results today.

Following on from Wednesday’s unexpected decision by the Bank of Canada to raise interest rates by 25 basis points, markets are now expecting further hikes at the next two policy updates. Consequently, today’s Canadian labour market report will be watched closely for clues on how much more tightening may be required as recent stronger than expected labour market reports are one of the reasons the BoC chose to hike again. However, today’s update is expected to show only a modest slowdown and so may lead to little change in expectations.

The BoC’s decision to resume hiking interest rates after a two-meeting ‘pause’ has boosted speculation about whether similar action by the US Federal Reserve may also prove to be premature. The resultant probability markets put on another hike by the Fed at next week’s policy update has gone up but only to about 30%, which means that a pause is still seen as the most likely outcome. The Fed has been reluctant to surprise markets in the past so if a hike is now on the cards it may signal so through the media beforehand. In the meantime, with the main central banks either already in or close to their pre-meeting silent periods. we are unlikely to hear anything new about the policy outlook today.  

MARKETS

The US Treasury market continued its erratic moves with a sharp fall in bond yields after a larger than expected rise in weekly unemployment claims. UK gilt yields also fell but much more modestly. In currency markets sterling, posted gains against both the euro and the US dollar.