Cooling Inflation

WEEK ENDING 7/12/2024

• June’s cooling CPI makes the case for lower inflation.
• Probability of a Fed September rate cut of 25 basis point is currently at 95%.
• Former President Trump attacked at a rally.

A CITY DIFFERENT TAKE

June CPI showed further-softening inflation with headline CPI falling by 0.06% and core CPI slightly up by 0.006%. A drop in energy prices aided headline CPI. Meanwhile, the tenants’ and owners’ equivalent rent continues to be stubborn, increasing by 0.26% and 0.28% respectively.

The narrative seems to be shifting from “higher for longer” to “when is the next rate cut.” That decision really rests on three key areas: the labor market, inflation, and supply shock.

• We saw the June employment report show some labor market slack with unemployment rate marginally ticking up to 4.1% and average hourly earnings growth softening to 3.9% compared to a year ago.
• Inflation numbers have lived up to expectations. Spending has moderated in 2024. In June, inflation fell for the first time in four years. May and June reversed the increase in CPI we saw from January to March.
• These factors caused the real economy to slow. Now, the Fed must balance between inflation and employment for a soft landing.

 The probability of the first rate cut happening in September is gaining momentum. Currently, the market has priced 25 basis points with almost 95% probability. The Wall Street Journal teased the reason for a September rate cut as “mostly procedural, not economic.” The Fed meets at the end of July, but that doesn’t leave much time to communicate a rate cut. With no meetings set in August, September does seem the most probable time for a rate cut.

CHANGES IN RATES

Treasury yields were lower over the week. The markets' implied probability of a September rate cut jumped from 74.5% on July 5 to 94.5% as of July 12. Tamer inflation readings from both the CPI and PPI reports were the main drivers of the rates move.

The Treasury curve steepened again last week from -0.32% on July 5 to -0.27% on July 12. Last week, we mentioned that the insurance cost to avoid the “cash trap” (using a 3-month T-bill and a 2-year Treasury note as proxies) had increased over the last year from -0.30% yield to -0.62% yield. Well, this week, that cost increased again to -0.74%. Given the talk of potential Fed rate cuts in September and the following rate decreases in money fund rates, there is the potential for many disappointed money market investors.

Municipal yields were lower last week. In addition, the yield curve steepened a good bit. The yield spread for a 1-year AAA Municipal GO bond went from -0.32% on July 5 to -0.18% on July 12. Out with the new normal and in with the old normal!

The short end of the municipal market (maturities of 1 to 5 years) outperformed their Treasury equivalents, and ratios decreased. Meanwhile, the long end of the municipal market lagged its Treasury equivalents (ratios increased for maturities 10 years and longer).

Corporate yields were lower over the week, in line with the Treasury and muni markets.

THIS WEEK IN WASHINGTON

In an assassination attempt, shots were fired at former President Trump at a rally in Pennsylvania over the weekend. Trump was wounded in the right ear but survived the attack. Another attendee, Corey Comperatore, a 50-year-old former fire chief attending the rally, was shot and killed while protecting his family. Two other victims are in stable condition. The FBI identified the assailant as 20-year-old Thomas Matthew Crooks of Bethel Park, Pennsylvania. Crooks was killed by Secret Service counter-snipers.

This was to be the final campaign rally for Trump before the Republican National Convention in Milwaukee this week where he will be nominated as the Republican candidate for president. Trump still plans to attend the convention where he is expected to speak and announce a running mate. Trump voters are rallying behind their candidate after the attack with increased support and donations.

On the other side of the presidential election, President Biden’s candidacy gets some reprieve as the nation’s attention turns to the attack on Trump. Biden addressed the nation on Sunday, calling on Americans to “stand together” and “lower the temperature in our politics.”

WHAT, ME WORRY ABOUT INFLATION?

The 5-year Breakeven Inflation Rate finished the week of July 12 at 2.33%, which was lower by one basis point from the close of July 5. The 10-year breakeven inflation rate also finished the week at 2.24%, which is three basis points lower than the close of July 5.

MUNICIPAL CREDIT

As of July 12, 10-year quality spreads (AAA vs. BBB) were 1.08%, two basis points wider than the July 5 reading (based on our calculations). The long-term average is 1.70%.

Quality spreads in the taxable market are not attractive. They ended the week two basis points higher at 0.72%. High-yield quality spreads were higher at 3.15%.

WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?

Money Market Flows (millions of dollars)

Money market funds saw drops in cash flow over the week. The cost of “cash trap” insurance is getting richer.

Mutual Fund Flows (millions of dollars)

Bond fund categories saw mostly positive cash flows.

ETF Fund Flows (millions of dollars)

ETF asset classes experienced a drop in cash flows overall.

SUPPLY OF NEW ISSUE MUNICIPAL BONDS

The supply of new issues is expected to be about $11 billion this week, continuing the heavy tax-exempt supply. A note here on the July reinvestment capital of roughly $7 billion. Between June and August of this year we will see nearly $110 billion up for reinvestment.

CONCLUSION

Cooler June CPI is giving the market confidence for a September rate cut. The muni market is going through its technical of July reinvestment but with a big calendar on the supply side. And the nation is still in shock over Saturday’s attack on former President Trump.

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