The Daily Prophet: Remind Us Again Why the Fed Is Raising Rates?

Connecting the dots in global markets.

This bond market sure isn't acting like it's worried about the Federal Reserve raising interest rates for the third time in six months when policy makers meet in a couple of weeks. Fixed-income assets rallied today and are poised to deliver positive returns for the fifth straight month, which hasn't happened at the start of a year since 2003.

Although traders see a rate hike at the Fed's June 13-14 meeting as a sure thing, they are not convinced there will be any more beyond that this year. One big reason that the bond market is so sanguine is that while the labor market is strong, inflation is slipping further below the Fed's 2 percent target. The central bank's preferred price measure rose 1.7 percent in April from a year ago, down from 1.9 percent in March and 2.1 percent in February, Commerce Department figures showed Tuesday. Fed Governor Lael Brainard said soft inflation could cause her to reassess the path forward for monetary policy should it linger.

Beyond the inflation numbers, traders are also having doubts about the usual economic rebound in the second half of the year, with the Trump administration's pro-growth, fiscal stimulus agenda that focused on tax reform and infrastructure spending in tatters. "There is a lot hinging on these tax cuts," said Jason Schenker, the president and founder at Prestige Economics. "Expectations minus reality equals disappointment." As of Monday, the Bloomberg Barclays Global Aggregate Index has gained 1.12 percent for the month and 4.06 percent for the year.  

On a day when equities went nowhere, the big news was that shares of broke above $1,000 on an intraday basis Tuesday, underscoring the continuing divide between technology-related equities and everything else., Facebook, Netflix and Google’s parent Alphabet -- collectively known as the FANG stocks -- along with Apple, account for more than a quarter of the S&P 500’s advance this year. Funds tracked by Bank of America are doubling down, as they now own the highest percentage of technology stocks on record compared to their benchmark, according to Bloomberg News' Dani Burger. Rarely ones to shun the herd, active funds are now 71 percent overweight in the FANG companies after making the biggest move from value to growth since 2008, according to Bank of America. The tech-powered rally has catapulted the sector to a price-to-earnings ratio of 24.4, or 41 percent above the 10-year average. 

The Bloomberg Dollar Spot Index fell again today, and barring a last minute reprieve America's currency will log its third straight monthly decline. That would match its two longest slumps since early 2011. Much like the bond market, the dollar's weakness is attributable to a slowdown in inflation and the rising prospects that the Fed raises rates only one more time this year. Unlike in the bond market, it doesn't appear to be total capitulation just yet. Philip Moffitt, the Asia-Pacific head of fixed income at Goldman Sachs Asset Management, expects the dollar to strengthen about 10 percent against the yen and euro as the Fed raises rates at least two more times this year, according to Bloomberg News' Netty Ismail. "The U.S. is still in very good shape," Moffitt said. An index that Goldman Sachs uses to gauge the impact of financial markets on the economy has fallen this year, and is much weaker than the Fed desires, Moffitt said. "That means that they'll want to see higher rates and a stronger dollar, or some combination of those," he said. "We're betting on both those things."

Oil declined in New York as traders await further proof that OPEC-led production cuts, extended at a meeting last week, are having an effect. West Texas Intermediate futures were down 0.8 percent from Friday's closing price following the U.S. Memorial Day holiday on Monday. OPEC and Russia's deal to extend output limits through March was initially met with a selloff as deeper cuts or a plan for the rest of 2018 weren't proposed, according to Bloomberg News' Jessica Summers and Grant Smith. Saudi Arabia's Energy Minister Khalid Al-Falih said the strategy is working and stockpiles will drop faster in the third quarter. U.S. crude inventories have dropped for seven weeks in a sign the limits may be working, though stockpiles are still above the five-year average. Saudi Arabia plans to reduce exports to the world’s biggest consumer to speed up that decline.

Cocoa prices soared amid signs of tighter supplies in Ivory Coast, the world's top grower, raising prospects that chocolate costs will climb. July futures jumped as much as 6.8 percent, the most ever for the contract. Farmers in West Africa are already locking in more forward sales for next year's crop than traders were expecting, a sign that supplies from the current harvest are beginning to ebb, according to Bloomberg News' Marvin G. Perez. The outlook for tighter supplies marks a shift for the market that’s been suffering from a global surplus. The overhang pushed prices down 32 percent over the past 12 months, helping to lower some retail costs for chocolate. The treats may not stay cheap for long, at least that's what hedge funds are signaling. Money managers have backed away from their bearish cocoa bets for three straight weeks, U.S. government data show.

If the European Central Bank really intends to upgrade its assessment of the economy and, as Reuters reports, drop any reference to downside risks in a statement after the policy makers' June 8 meeting, then they'll want to look past two key pieces of data due Wednesday. First, the spike in euro-area inflation in April is likely to be revealed as transitory when the reading for May is published, according to the economists at Bloomberg Intelligence. Underlying price increases should remain weak and that will prevent the ECB from withdrawing monetary stimulus for a long time -- probably about two years. The median estimate of economists surveyed by Bloomberg News is for a slowdown in headline inflation to a 1.5 percent year-over-year pace in May, from April's 1.9 percent. And while the unemployment rate for April is seen edging lower to 9.4 percent from 9.5 percent, that's still more than double the 4.4 percent rate in the U.S.

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