Bond Outlook August 16th

The US PPI data showing only a modest increase in producer prices (0.1% July) took almost everyone, including us, by surprise. Can inflation really have been brought under control? Is this the end of Fed hikes? A fortnight ago we argued that powerful inflationary forces, mostly “cost-push”, remained. We therefore incline to a double “no” as answers to these key questions, while recognising that financial markets, for the moment at least, are leaning more towards a double “yes”. Examination of historical values of the Fed rate suggests that typical Fed behaviour is to hike, pause, and then hike again before reaching the turning point of the rate cycle. Obviously much depends on the CPI, which rose by 0.4% in July, partly, but inconclusively, reflecting the move in the PPI. Are these declines in the inflation rate a trend, or a short-lived aberration reflecting the willingness and ability to absorb higher input costs by companies which have been enjoying big profit margins, with the squeeze being on labour costs?

In the light of market perceptions, a modest adjustment in maturities seems appropriate: we have provisionally suspended barbelling in USD but re-introduced it for the EUR.