Yields Surge on First Quarter GDP Revision, Softer Unemployment Claims: Jun. 29, 2023

Just one day after Federal Reserve Chairman Jerome Powell said restrictive policy will be needed in the medium-term as he forecasted 2025 as the year in which the Fed reaches its 2% inflation goal, this morning’s surprisingly big uptick revision in GDP and decline in initial unemployment claims are reinforcing the likelihood that the central bank will remain considerably more hawkish than investors anticipate. This morning’s strong data are causing bond yields to soar on the eve of tomorrow’s Personal Consumption Expenditures release, a pivotal event in assessing inflation’s trajectory and momentum.

Powell Cautions Investors Once Again

Investors expecting the Federal Reserve to cut interest rates this year or early next year based on expectations that inflation will decline quickly may not want to uncork the champagne just yet. Contrary to many investors’ expectations for the central bank to turn dovish in the coming months, the Fed is likely to keep the fed funds rate elevated and policy restrictive for an extended period and doesn’t expect core inflation, which has been declining at a painfully slow pace, to hit the central bank’s target anytime soon, according to Powell, who spoke yesterday at the European Central Bank’s Forum in Sintra, Portugal. Additionally, he anticipates keeping the fed funds rate elevated even once inflation hits the 2% level to prevent a resurgence of inflation, he explained.

Headline inflation has fallen because energy and commodities prices that had peaked due to the Russian invasion of Ukraine have declined, but core inflation has been stubbornly high, a result of persistently strong services spending that is supporting a tighter-than-expected job market.

Powell said the Fed is likely to raise the fed funds rate two more times this year, which is consistent with the majority of Fed members based on the Summary of Economic Projections, or Dot-Plot, from the organization’s June 14 meeting when policymakers decided to skip a rate hike after increasing the rate during ten consecutive meetings. An anticipated July 25-basis point (bp) increase would set the rate at 5.38%, its highest rate in 17 years. The Fed has raised rates quickly—it increased the rate a minimum of 50 bps during each of its last six meetings in 2022 and then proceeded with 25-bps increases during its first three meetings of this year. It’s too soon to assess the impact of the rate changes to see the full effect of the tightening because of the rapid nature at which the increases were made, Powell explained. The Fed may decide to make increases at every other meeting to give monetary policy more time to impact the economy between rate changes, but making increases at consecutive meetings hasn’t been ruled out.

GDP Surprises to the Upside

On the economic data front, this morning’s final revision to first-quarter real GDP—an upward revision to 2% on an annualized quarter-over-quarter percent basis—was a scorcher. It climbed from the latest revision of 1.3% and is almost double the initial estimate of 1.1%. Better-than-expected consumer spending and exports drove most of the increase. Still, GDP growth slowed from the 2.6% rate in fourth quarter 2022. 

A Tight Labor Market Drives Decline in Unemployment Claims

Initial unemployment claims also fueled optimism of a stronger and more resilient economy than previously thought. After spiking for three consecutive weeks to over 260,000, the highest levels since October 2021, claims declined sharply during the week ended June 24. Initial claims totaled 239,000, much better than the feared consensus expectation of 265,000. However, seasonal adjustments related to the recently established Juneteenth holiday may have contributed to a lower number partially due to the lack of historical precedents. Continuing unemployment claims continued their cooperative trend, signaling that laid off workers can find new jobs pretty quickly. Continuing unemployment claims declined to 1.742 million during the week ended June 17, much better than expectations calling for 1.765 million and declining from the previous week’s 1.761 million.

Debt Investors Push Up Yields

Yields are surging today following upbeat economic data fueling expectations of stronger consumer spending and inflation in the coming months. With broad-based participation across the U.S. Treasury curve, the 2- and 10-year maturities are up a staggering 13 and 12 bps to 4.85% and 3.83%. While the 2-year is the highest it’s been since immediately prior to the regional bank debacle in March, the 10-year briefly reached the threshold at 3.868% but strong resistance at 3.85% pulled it down amidst fierce buying at the level. Stronger economic data following hawkish central bankers in Sintra, Portugal, are pushing up the Dollar Index as well. It’s up 22 bps to 103.20. Equities are higher also and are seeking to build on recent momentum despite negative developments regarding economic growth, consumer spending and central banks. Cyclical sectors are leading while interest rate sensitive sectors are taking a break, climbing only modestly. The Dow Jones Industrial Average is up 0.57% while the Nasdaq Composite is up 0.1%. The S&P 500 Index is up 0.3%, with mixed participation among sectors. Crude oil is continuing its progress from yesterday due to a larger-than-expected decline in U.S. inventories while investors keep further rate hikes in mind. WTI crude oil is up 0.2% to $69.70 per barrel.