Mel's Blog

The Fed has been saying that upcoming monetary policy will be determined by the incoming data - and this morning's news of weaker than expected Retail Sales and a tame Core Producer Price Index (PPI) keeps the streak alive of tame inflation reports, which suggests that the Fed may indeed be cutting rates later this year.  

Retail Sales slipped in April to - 0.2%, lower than expectations and the worst reading in seven months.  Declines were seen almost across the board, including clothing, restaurants, sporting goods, cars and home products.  Possible reasons?  The price of gasoline has shot back up, and is affecting the middle and lower income classes the most - taking away some of their purchasing power and forcing them to cut back on buying consumer goods.  Additionally, food costs are significantly higher in recent months, due to a variety of factors including crop freezes early in the year, and many corn products being diverted for use as fuel.  Because they are volatile, neither food nor energy costs show up in the important Core inflation numbers, but when it comes to a consumers day-to-day spending habits, these factors will absolutely have an impact.  The weak report is good news for Bonds. 

Wholesale or producer inflation as measured by the Producer Price Index (PPI) rose to a higher than expected level in April, spurred on by a significant increase in energy prices.  However, the more closely watched Core PPI, which strips out those volatile food and energy costs, was reported unchanged from last month, lower than expectations of a 0.2% increase.  In fact, the year-over-year Core PPI is at a lean 1.5% - where just under two years ago sat at a beefy 2.8%, a record high over the previous decade!  

So let's unpack what this tame report means to us.  Up until now, cost pressures seen at the producer level have not been passed along to consumers, as companies have made the decision to “eat" their cost increases, rather than raise their prices to consumers and risk loss of market share in a very competitive global marketplace.  This tame Core Producer inflation data is good news for companies, as it may help take pressure off their costs, and if the trend continues, may eventually allow them to actually lower their prices to the consumer.  This would in turn help consumer inflation moderate - also good news for Bonds.  

In other news, former Fed Chairman Alan Greenspan must miss being in the spotlight and continues to lurk about, seeking headlines, and stating he thinks there is one-third chance the economy will slide into a recession by the end of the year.  During a private presentation at a Merrill Lynch investor forum this morning, the Maestro was quoted as saying, “My arithmetic says if there's a one-third probability of a recession, then there's a two-thirds probability there won't be a recession."  Good arithmetic Alan, you're clearly not losing your edge.  Greenspan’s views differ from those of current Fed Chairman Ben Bernanke, who believes the chances for the economy moving into a recession are more remote.  We’ll see who is most accurate by the end of the year, but we side with Mr. Bernanke on this one. 

At the time, Mortgage Bonds are bouncing higher after trading near strong support at the 200-day Moving Average and have regained the price losses seen after the Fed Meeting on Wednesday afternoon.  We have maintained a Cautiously Floating position in spite of Wednesday's knee jerk reaction lower, because Bonds remain above very strong support at the 200-day MA, and I also felt the incoming data would be Bond friendly, which is turning out just as we expected.  Prices remain in a 32bp range between resistance at the 50-day MA and support at the 200-day MA.