It’s Mario Draghi’s turn to tell us his inner most thoughts about monetary policy. While the ground has been laid for them to reveal more details about how and when QE will end, I would not be surprised if they punted until the July meeting in making a final decision. After a few days of a rally, European sovereign bonds are selling off ahead of the 8:30am press conference and the euro is higher for a 2nd day.

Whether its related to the possible China tariffs coming tomorrow or just a plain vanilla sell on the news, the US dollar did not trade well after yesterday’s Fed announcement and gold is at a 3 week high and silver is near a 2 month high. I remain bullish on both.

After yesterday’s more bullish take on market sentiment according to II, the AAII index of individual investors is as well. Bulls rose to the highest level since mid February at 44.8 from 38.9 last week. Bears fell to 21.7 from 26.7 and that is one point off the lowest level since mid March. The spread between the two is now the highest since February and purely from a contrarian standpoint, the bull boat is much more full which of course comes with the rally back in stocks and collapse in the VIX.

China reported economic data from May that was weaker than expected across the board. Retail sales grew by 8.5% y/o/y which is a solid number compared to most places but the slowest rate of growth since 2003 and below the forecast of 9.6%. Industrial production and fixed asset investment also missed forecasts with the latter slowing to the weakest pace since at least 1999 when the data set began. This economic slowdown comes coincident with the weaker loan data seen a few days ago and a day before China likely gets hit by Trump’s tariffs. The data weakness could also be why the PBOC did not follow the Fed rate hike with one of its own which they have on the prior ones.

Asian stock markets were red everywhere with the Shanghai comp in particular down by .2% and lower by 8% year to date and the H share index was weaker by .7% and up by 2% year to date. Notwithstanding hopes of bringing North Korea into the 21st century in terms of both international relations and economic progress, the South Korean Kospi fell by 1.8% and is now down on the year.

Maybe due to the recent pick up in wage growth relative to the rate of increase in CPI, UK retail sales ex auto fuel was better than expected in May. They rose by 1.3% m/o/m, above the consensus gain of .3%. Warmer weather and the Royal Wedding (yes, was an economic boost) were the main reasons cited by the ONS. The pound got a boost at 4:30am just as the data was released, along with general dollar weakness. It won’t move the needle though with the BoE and gilt yields are little changed. The BoE meets next week.

The Fed upgraded their outlook on the US economy by referring to economic activity as “rising at a solid rate.” Compare this with “a moderate rate” in May. They repeated the wording on the labor market which they refer to as being strong in terms of growth and the low unemployment rate. They also said “household spending picked up” vs saying it moderated its pace from Q4 in May. They repeated that capital spending remains strong (mixed data on that though). The comments on inflation are pretty much unchanged.

They kept in this: “The stance of monetary policy remains accommodative.” Some thought they would say it is somewhat accommodative as they get closer to their made up version of the ‘neutral rate.’

Importantly, they took this line out of the statement that has been seen for a while: “the fed funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

There were no dissenters.

With respect to their forecasts vs the March projections, they raised their 2018 GDP forecast by one tenth to 2.8% but kept their 2019 estimate at 2.4% and the longer run forecast of 1.8%. Take any forecast in 2019 and on with a grain of salt. With the unemployment rate already at their March forecast of 3.8%, they lowered their year end target to 3.6%. They also acknowledged the rise in inflation and raised their headline PCE forecast by 2 tenths to 2.1% and the core rate by one tenth to 1.9%. They magically think inflation will just about stop here at 2%.

Finally and what markets are most likely responding to, the median “Projected Appropriate Policy Path” for the fed funds rate is at 2.4% (2 more hikes) vs the March median projection of 2.1% (one more).

Bottom line, the reaction in the bond market is all you need to know about the last point as the 2 yr yield is up to 2.58-.59% and the 10 yr is up to 2.98%. Thus, the 2s/10s spread is breaking below 40 bps. I’ll say this though, the December Fed meeting is not for another 6 months and there is zero reason to start trying to predict what they will do then. In the meantime though, they will hike again in 3 months and in two weeks will ramp up QT to $120b per quarter.

Producer price inflation ran hotter than expected in May. The headline gain was .5% m/o/m and 3.1% y/o/y vs the forecast of up .3% and 2.8% respectively. That headline y/o/y print is the highest since December 2011. The core rate was up by .3% m/o/m and 2.4% y/o/y, both one tenth more than expected.

Of note was the 4^th .3% m/o/m increase in goods prices ex food and energy in the past 5 months. Remember, we’ve seen persistent core goods deflation in CPI and it seems inevitable that this price pressure in PPI will eventually spill over into CPI. Combine this with sticky services inflation running around 3% and the Fed can’t rest easy. Goods prices at the headline level rose 1% m/o/m with about half of this contributed by a 10% increase in gasoline prices.

On the service side, all my readers know I’ve been talking about rising trucking costs for a while. In today’s report ‘truck transportation of freight’ prices rose .8% m/o/m and 6.5% y/o/y. That’s even generous as I’ve heard prices rising 20-40% y/o/y. This helped to drive the rise in services PPI.

Bottom line, price pressures continue to build and it was apparent in the pipeline too. Processed goods jumped 1.5% m/o/m and .8% core and was higher by 2.5% m/o/m for unprocessed goods but little changed at the core rate but only after sharp gains in the two prior months. US Treasuries immediately responded with the 2 yr yield up at a 3 week high at 2.55% and is less than 4 bps from the highest in 10 year. The 10 yr yield is unchanged as I continue to believe that the short end of the curve is reflecting inflation expectations now as it keeps the Fed on its current path. The 2s/10s spread is just above 40 bps now, a fresh 11 yr low.

Here is the chart with truck transportation of freight in PPI in orange and goods prices ex food and energy within CPI

In addition to raising the Fed funds rate by 25 bps today to a range of 1.75-2%, the Fed will also raise the interest paid on excess reserves by just 20 bps for the 2nd meeting in a row in order to get the effective (actual) fed funds rate to the middle part of their range. It has been trending up towards the upper end of the range. They will also likely tweak the wording about how accommodative they are and I’m most interested to hear what they have to say about inflation. Central bankers always want higher inflation but it could also be their worst nightmare if it gets too high as they have to deal with it and it takes away much of their flexibility. Today’s PPI should be noteworthy after yesterday’s 6 yr high in CPI. We will all debate whether the statement and press conference was dovish or hawkish but I think bottom line is the Fed will continue on the path they’ve laid out.

Expect another hike in September and the Fed will play it by ear in December. We’ll also see today whether they change the scheduling of press conferences and plan for having one at every meeting instead of just half of them. It makes sense if they do so they can get out from underneath the scenario of only being able to hike at press conference meetings. Also, we will get another form of tightening in two weeks plus when QT goes to $120b in Q3 from $90b in Q2.

Ahead of this, the 2s/10s spread is down to 41 bps, a fresh 11 year low. What’s it saying?

Along with the persistent rise in the stock market, bullish sentiment is coming along with it. According to II, Bulls rose for a 5th straight week to 55.5 and that is the most since mid March and up from 52.9 last week. Bears were little changed at 17.8 vs 17.7. The spread between the two is the highest since March 21st and those looking for a Correction is at the least since the end of January. Solely looking at the market from the perspective of sentiment, people are now getting giddy. Adding to this, yesterday’s equity put/call ratio closed at the lowest level since January 23rd.

With the rebound in mortgage rates to near a 7 yr high, applications to buy a home fell 1.5% w/o/w and is now unchanged y/o/y. They are lower for the 6th week in the past 7 as higher rates along with record high home prices (or near) has clearly slowed the pace of transactions. Refi’s were down also by 1.5% w/o/w and lower by 34% y/o/y.

The UK reported CPI for May as expected with the headline print up 2.4% y/o/y and up 2.1% at the core level. These are unchanged with April but remain well above where the BoE has their benchmark rate. Producer prices though surprised to the upside with a 9.2% y/o/y jump vs the estimate of up 7.6%. Price pressures are thus fully evident. The BoE has one mandate, controlling inflation and they’ve done nothing to accomplish that because they are afraid of slowing the economy while Brexit negotiations are ongoing. Instead their economy has been a mixed bag because the consumer is being challenged by higher inflation relative to income.

Because the CPI data was in line, the pound is lower as are gilt yields because the BoE will think it buys them more time.

A day before the ECB meets, the eurozone industrial production figure for April fell by .9% m/o/m, two tenths more than expected but March was revised up by a tenth. The y/o/y increase of 1.7% is the least since April 2017 and confirms the moderation in growth we’ve seen in the region over the past few months. Tomorrow’s press conference will be most interesting because the ECB is running out of easing runway.

After the sharp drop in Chinese lending data seen yesterday after their market closed, overnight the Shanghai comp responded with a 1% decline and is now down 8% year to date. The H share index was weaker by 1.4%. ZTE reopened, after months of being halted, with a 42% plunge.

The May CPI rose .2% m/o/m both headline and core as expected. This brings the y/o/y gain to 2.8% and the core rate to 2.2%. That core rate is one tenth from matching a 10 yr high. Energy prices jumped by 12% y/o/y led by gasoline. Food prices were up by 1.2%.

Services inflation ex energy, the persistent push on higher prices, was up .3% m/o/m and 3% y/o/y driven by rents again. Rent of a Primary Residence rose .3% m/o/m and 3.6% y/o/y. Owners Equivalent Rent, 24% of CPI was up by .3% m/o/m and 3.4% y/o/y. Medical care costs grew by .2% m/o/m and 2.4% y/o/y.

Again weighing on the inflation gain in services is the deflation in goods. Goods prices ex food and energy fell by .1% m/o/m and .3% y/o/y. Used car prices dropped for a 3rd straight month and is down 1.7% y/o/y. We have a large number of cars coming off lease this year that will continue to pressure used car prices which in turn will influence new car sales. New car prices were up m/o/m but down 1.1% y/o/y. Apparel prices saw no change m/o/m but are up 1.4% y/o/y. Moving forward in goods prices overall, I continue to expect the sharp rise in trucking costs (which we’ll see in tomorrow’s PPI) will show up in consumer prices in coming months and quarters as companies do their best to pass it on.

Bottom line, services inflation continues as does the decline in goods prices but I remain on watch that the latter will start to rise in response to the issues in transportation. As the numbers were as expected, there is no response in US Treasuries which remain lower with yields up. Inflation breakevens are also little changed.

We of course hope that yesterday was the first step to ending the nuclear threat of North Korea but maybe it was also a good taste of capitalism for Kim Jong Un as he walked the streets of Singapore. Economic opportunity, private property and freedom of choice after 70 years of repression would be great to see in North Korea. The South Korean Kospi was flat overnight and is also unchanged on the year as it will take time to see what, if any, potential economic integration or business that can be done between the two.

The NFIB small business optimism index for May improved by 3 pts m/o/m to 107.8. Exceeding the February level by a hair puts it at the best level since 1983. The current feel and outlook components all improved, such as those that Expect a Better Economy, Expect Higher Sales and said its a Good Time to Expand. The more concrete Plans to Hire rose 2 pts but after falling by 4 pts in April. Off the highest level in 18 years, Job Openings Hard to Fill fell by 2 pts but wage and price pressures are intensifying. Current Compensation Plans rose 2 pts to 35%, the highest since this question was first asked back in 1984. In order to protect profit margins along with defending against other cost pressures (like trucking), Higher Selling Prices jumped by 5 pts to 19%, the most in 10 years. Optimism that companies can deal with higher costs, Earnings Expectations rose 4 pts to the best level on record dating back to 1973. Capital spending plans rose 1 pt but is still 2 pts below the peak seen last year.

The CEO of the NFIB was ebullient. “Main Street optimism is on a stratospheric trajectory thanks to recent tax cuts and regulatory changes. For years, owners have continuously signaled that when taxes and regulations ease, earnings and employee compensation increase.” Finding qualified workers remains the Single Most Important Business Problem and hence, the rising wage situation. Bottom line, small businesses are feeling great but higher inflation is coming with it and why interest rates will continue higher.

Speaking of inflation, Japan reported a spike in producer prices in May as they grew by 2.7% y/o/y, well more than the estimate of up 2.1%. That matches the quickest pace since December and if only that eventually translates into consumer prices the BoJ will get what it wants. Thanks to a weaker yen and higher energy prices, import prices were up by 8.1% y/o/y. As PPI doesn’t tend to be market moving, JGB yields were only up slightly.

Total loan growth in China in May fell by more than half m/o/m and at 761b yuan was well below expectations. Almost all of the decline was due to a continued shrinkage in lending from the shadow side of the banking system. Bank loan growth of 1.15T was only slightly below the forecast of 1.2T. Also of note, money supply growth (M2) was up by 8.3% y/o/y, just off the lowest level since data was first collected in 1996. Bottom line, Chinese authorities are really cracking down in their attempt to bring most lending onto the full transparent view of bank balance sheets. The balancing act continues as this I believe is a healthy long term development but the slower credit growth that comes along with it of course will slow economic growth that has been dependent on credit.

The news came after the Shanghai comp closed up by .9% but still remains lower by 7% year to date.

We got another economic miss out of Germany but this is considered more ‘soft’ data than ‘hard.’ The ZEW investor measure of the Germany economy fell to -16.1 from -8.2. That is the worst print in 6 years. The Current Conditions component fell almost 7 pts m/o/m to the lowest since April. The ZEW said, “The recent escalation in the trade dispute with the United States as well as fears over the new Italian government pursuing a policy which potentially destabilises the financial markets have left their mark on the economic outlook for Germany. On top of this, German industry has been reporting worse than expected figures for exports, production and incoming orders for April. As a result, the economic outlook for the next six months has worsened considerably.” The euro is little changed as is the DAX. With Italian bond yields down again, German bund yields are higher again. The 10 yr yield is back above .50% for the first time in 3 weeks.

The jobs data out of the UK was better than expected with a gain of 146k for the 3 months ended April, above the forecast of 120k. The unemployment rate held at 4.2% as expected, the lowest since 1975. Wage growth ex bonus’ rose by 2.8% y/o/y, down a tenth but still just off the best in 3 years. After a jump in April, May jobless claims did fall. The pound is up in response and gilt yields are too. The FTSE is lower by about 1/4 of a percent. The BoE wants to hike rates this year but it might just be one and the market is 50-50 on whether it comes by August.