Published Date 8/31/2020

Yesterday Jerome Powell made it official. After days of clues and hints, the Fed has changed the way it views unemployment and inflation. It is the death of the Phillips Curve that economists have believed in for years, that as employment increases, so too is the outlook that inflation will follow. It hasn’t been the case in the US since 2012, when the Fed established 2.0% as the pivot. Low unemployment is now not a factor for the Fed in establishing where and when to increase interest rates. The Fed, in hindsight, increased the Fed funds rate in 2015 when employment increased, believing the theory of the Phillips Curve would push inflation higher – it didn’t. Then in the past two years unemployment fell to 3.0% as the economy expanded and no inflation occurred. Now the Fed has put its imprimatur that it wants inflation to move above its previous 2.0% target. That wages are no longer an issue in forecasting inflation as a milestone; for all of the ink and comments about the Fed’s new policy, it won’t change the underlying economic fundamentals that drive growth and/or inflation. All we got was a confirmation from the Fed what markets already understood; the Fed late to formally admit it and make the necessary change.

Powell’s shift provided another tailwind for stocks globally, which are heading for the fifth week of gains as investors monitor progress on vaccine developments for the pandemic. It also helped move the US yield curve to its steepest in two months, a positive that removes concerns that as the curve flattened, the fear of inflation would follow. It very well may increase, but now the Fed is confirming it won’t worry about any increase if inflation were to exceed the “old” 2.0% target that markets would expect the Fed to increase rates.

Yesterday was volatile at the long end of the curve; the 10 yr note started at 0.68%, ran up to 0.75% at the end of the US session. Last night at 8:30 pm ET, the 10 yr climbed more to 0.79%; it won’t show up in the US charts, but there was additional selling of treasuries in the Asian markets. MBS prices were volatile yesterday with wide price swings that dominated the afternoon settling down 21 bps from 9:30 am ET levels.

This morning the 10 yr began US trading down 2 bps at 0.73%, early MBS prices +11 bps. The 10 yr is back within its trading range that has kept any increase in rates under 0.74% since early March.

At 8:30 am ET, July personal income and expenditures: income at +0.4% better than -0.2% expected, expenditures +1.9% (personal spending still accounts for 65% of economic growth) on thoughts of +1.5%. July PCE (personal consumption expenditures) expected +0.4% was +0.3%, yr/yr +1.0% as forecast; core PCE +0.3% better than 0.5% estimates, yr/yr +1.3% as expected.

At 9:30 am ET, the DJIA opened weaker than in the futures trading earlier when the DJIA was +150; at 9:30 am +18, NASDAQ +60, S&P +7. 10 yr note at 9:30 am 0.72% -2 bps. FNMA 2.5 30 yr coupon at 9:30 am +14 bps, compared to 9:30 am yesterday -7 bps.

At 9:45 August Chicago PMI index was expected at 52.0, as released 51.2; still above the pivot at 50 indicating expansion.

At 10:00 am ET, the final U. of Michigan consumer sentiment index, expected at 72.8, as released 74.1.

The 10 yr holding the 0.74% trading level.