Higher inflation expectations should be seen on the 10-year yield

Outlook

Bloomberg reports the dollar could come under pressure this morning as new data supports the Fed’s dovish stance. The Markit flash manufacturing PMI is likely 56 from 56.4, still well over the boom-bust line of 50 but a decline all the same. Existing home sales probably rose a mere 1.6% in May (Reuters has 1.4%) after 1.3% in April. The WSJ has May existing home sales expected at an annual pace of 4.75 million units, up 2.2% vs. 1.13% in April. We have too many estimates and they are too far apart.

Bloomberg also says the revision of Q1 GDP, due Wednesday, will be 1.8% (from 1% reported May 29). Bloomberg bases the anti-dollar bias on surveys and interviews, but we say the Markit PMI has strong competition from other cor-ners, including the Institute for Supply Management (up to 55.4 in May with all components higher). Q1 was a long time ago, in the perspective of the financial world, and we know GDP was bad, so tell us Q2, please. It’s true that existing home sales today and new home sales tomorrow could point in a bad direction. But still, we are not so sure the data is high enough in the pecking order of data to influence bulls into becoming bears.

We had another feint on Friday when Bloomberg asserted that some see inflation accelerating faster than the Fed thinks and the Fed seeming behind the curve. One analyst said some inflation talk was dollar-supportive and behind the rise in 10-year yields. The influential Hans Redeker at Morgan Stanley sees the causality going the other way, saying “The Fed meeting’s impact on the bond market is already disappearing. Higher U.S. bond yields have positive impact on volatili-ties,” supporting the dollar.

Well, maybe. But we have other data coming, tons of it, including the Chicago Fed today, the FHAA and Case-Shiller house price index tomorrow, plus consumer confidence and the Richmond Fed on Wednesday. Thursday brings the usual jobless claims, personal income and spending, and the Kansas City Fed. This week we also get durables, the oil invento-ry report, and later in the week, the EC’s economic sentiment index and UK GDP. Speaking of other countries’ data, we get IFO tomorrow and a slew of data from Japan later in the week (retail sales and CPI being the biggies after the sales tax hike).

If we are going to get higher inflation expectations and this expectations of the Fed becoming less dovish, we should see it in the 10-year yield—but it isn’t there, at least not yet. Bond traders may be talking about it, but they are not acting on it, and that is the essence of chart-reading. Watch what they do, not what they say. You can bet the Fed would be less complacent if they saw yields rising to 2.75-3.00% again. We say it’s premature to expect the Fed to give up “lower for longer” and besides, there is some kind of liquidity issue that is vexing NY Fed Pres Dudley. The Fed has to walk on tip-toes.

It’s hard to speak of “the dollar” when so many individual currencies have their own factors driving valuations, includ-ing sterling and the CAD/AUD/NZD. Many analysts are discouraged by the Fed’s dovishness in the face of oil-induced inflation, and yet it’s probably realistic to consider that the Fed is seeing two glasses and not just one. The half-full glass is the recovery in manufacturing, catching up to services, which is why we want to watch the Markit PMI, the ISM data and the regional Fed reports as well. These indicators have employment as a component, and it’s employment that has influence on housing, where the glass is increasingly seen as half empty. Whatever the new and existing sales data turns out to be, it’s pretty clear the housing sector is flagging and lagging. We can blame flat and stifled wage growth but we can’t blame rising mortgage costs, thanks to the Fed.

In a way, the Fed is in a race to get GDP on a decent growth track before inflation becomes so noisy it must act. This is familiar territory. We have CPI at 2% but the PCE deflator, which accompanies personal income and spending on Thurs-day, is expected at only 1.5%. This is a tiny gain from 1.4% in April and no cause for alarm. In fact, unless and until the public gets a bug up its nose about inflation, the Fed is safe from inflation expectations becoming an issue, except among the chattering press. And we can, perhaps, look to durables as an offset to housing. Durables leads capital spending, if with a lag and in a fairly ragged way, depending on inventories. So maybe the US economy is not so bad, after all.

The important point is “not so bad” in comparison to what? The eurozone, aside from Germany, is struggling. Some countries have deflation (Spain, Greece) and naming it something else (“lowflation”) is silly. We haven’t heard much about the ECB engaging in QE lately, but we bet the staff is working day and night behind the scenes to figure out how to do it and with what securities and how to keep the BBK off the ECB’s back. The big picture of US rates up/European rates down remains in place—it’s just very blurry around the edges. We fear that we will get a high-volatility congestion out of it. Buy on dips will alternate with sell on rallies. Oh, dear.