FOMC Revisions

Treasury prices rose on Wednesday’s trading and the recent rally in equities eased over concerns of a slow-down in the U.S. economic recovery. The 2-year note rose 4/32 to yield 0.60% while the 5-year note gained 13/32 to yield 1.81%. Meanwhile, the benchmark 10-year note recovered from 5 consecutive loses to gain 21/32 to yield 3.04%. Finally, the long bond rose 1 12/32 of a point to yield 4.03%. Market participants ramped up demand of U.S. Treasuries as the June 23 FOMC meeting Minutes were released yesterday afternoon with downward revisions to economic forecasts. According to the Minutes, the FOMC is estimating GDP will grow less than previously expected from 3.20% - 3.70%, reported in the April 27-28 FOMC Minutes to 3.00% - 3.50%, reported yesterday. Additionally, the FOMC has narrowed the range of the expected unemployment rate to 9.20% - 9.50%. On the other hand, officials anticipate lower inflationary risk in subsequent years with the range of expected PCE down from 1.00% - 1.50% to 1.00% - 1.10%.

“Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls.” FOMC Minutes Release June 23, 2010

Source: Federal Reserve Website

Treasury prices are reacting to this morning’s economic releases, with both the 5-year and 10-year notes climbing 2/32s to yield 1.79% and 3.03% respectively. Meanwhile, the 30-year Treasury has gained 8/32 to yield 4.01%. On the economic front, the Producer Price Index was released this morning with lower than expected data. Demand for intermediate and long Treasuries, susceptible to inflationary expectations, could increase as a lower than expected PPI indicates lower inflation, decreasing the erosion risk in the value of these maturities. The monthly Producer Price Index (PPI), which measures the change in prices received by domestic producers in all stages of processing (crude, intermediate materials and finished goods), actually declined more than anticipated in June at -0.50%, vs. the expected -0.10%. Meanwhile, Core PPI, which excludes the volatile food and energy sectors, was in line with analysts’ expectations as it showed an increase of only 0.10% for the month. On a year-over-year basis, PPI rose less than expected at 2.80% vs. the anticipated 3.10%. The Core PPI YoY index was also in line with expectations at 1.10%.

Additionally, the Department of Labor released its weekly Initial Jobless Claims report this morning showing that first time claims were lower than expected dropping 29,000 from the previous week to 429,000, beating analysts’ expectation of a milder drop of 445,000. However, continuing claims were higher than expected at 4.681 million versus the expected 4.447 million. The more stable 4-week average number of initial claims was reported to be 455,250 for the period versus 467,800 reported in the previous week. In other economic news, Industrial Production, which measures the change in production of the nation’s factories, mines and utilities, was released with a slightly better than expected result showing a gain of 0.10% in June; analysts were expecting industrial production to contract 0.10% for the period. Additionally, Capacity Utilization, which measures the greatest level of output that a factory can maintain within normal conditions, was in line with expectations at 74.10% in June. As shown in the graph below, historical data shows a direct correlation between the level of capacity utilization and the Fed’s Monetary Policy. Finally, the Philadelphia Fed will be releasing its index at 9:00 am CDT; analysts are expecting an increase in the reading from 8.00 to 10.00 for July.

Source: Bloomberg L.P. compiled by the Fixed Income Strategies Group RBC WM