Betting Against the House After PPI

This morning, all eyes were fixed firmly on the 8:30 ET release of the August Producer Price Index (PPI) data.  On the surface, at least, the report was no worse, if not better, than expected.  After a closer reading, however, bond traders decided they didn’t like what they saw anyway.  Treasury yields shot up, rising 5-11 basis points across the yield curve, driven by an increasing probability for a September rate hike and a 5% bump in crude oil futures.  The 10-year yield has risen by about 12 basis points since the Treasury announced details of its buyback program yesterday.

10-Year Treasury Yield, 3 Days, with arrow pointing to Treasury buyback announcement

Source: Bloomberg

At first glance, a PPI report that showed an as-expected 0.4% headline gain and a better-than-expected 0.2% core increase should have been greeted in stride, if not welcomed.  Indeed, both are above the Federal Reserve’s 2% inflation target – particularly the headline reading – but in-line reading would typically be “good enough” in a less fraught environment.  Instead, economists and bond traders focused on the portions of the PPI report that also contribute to the Fed’s preferred Core PCE calculation.  Those add to the perception that the FOMC will need to act more quickly to quell rising price pressures.

As a result, we see rising probabilities for a September rate hike today.  Futures are pointing to roughly 70% chance for a 25-basis-point bump next week, up from about 60% yesterday, according to CME FedWatch.  Traders on IBKR Prediction Markets retain a bit more optimism for rate stability, with a 65% “Yes” for the same move. 

But it is not just expectations about timing that are causing the 11-basis-point jump in 2-year yields today.  Futures are now pricing in three full hikes by June, up from two hikes plus a 44% chance for a third yesterday.   Traders seem resigned to a more persistent, deeper hiking cycle than they were for most of the past few weeks.  At the same time, the rise in longer-term rates partially reflects concerns about the Fed’s ability to contain inflation expectations, particularly as energy prices rise.  They also are not immune to the liquidity pressures that are weighing on global rates.  While most of us in the US are transfixed by the seemingly inexorable rise in 10-year yields, long rates in most of the world’s developed economies have been rising as well.

Stocks are once again responding negatively to the rising yields and energy prices, though not as badly as one might expect.  The S&P 500 (SPX) is down by about 0.5%, and the Nasdaq 100 (NDX) is about 0.9% lower.  That’s unpleasant for investors, but not tragic.  Nonetheless, the internals paint an uglier picture.  NYSE decliners are outpacing advancers by about 3:1, and only the defensive Consumer Staples sector is showing a gain.  A lower close today would be the fourth straight for SPX and would take us to the index’s lowest close in over a month. 

Apparently, the bond market is shrugging off the Treasury’s current attempt to guide 10-year yields lower.  As we noted yesterday, $6 billion is a relative pittance compared to the size of the US Treasury market, especially when a combined $58 billion in 10- and 30-year paper was being auctioned yesterday and today.  Although the Treasury Secretary’s comment,  “I am the house now… And you can bet against me if you want,” was specifically in reference to the Japanese yen, many market participants assumed that his haughty sentiment might extend to the Treasury market as well.  As of now, it is fair to question whether it is the market betting against the house, or whether the market itself is indeed the house.