PCE Slows Rally in Interest Rates

This week has been a great week for interest rates, with rates matching the levels seen at the beginning of May. They have also breached the important 200-day Daily Moving Average (DMA), a technical level that is difficult to pass. Once the level is passed, it bodes well for continued improvement. Federal Reserve (Fed) speakers and poor economic news spurred the rally. Putting a little pause on the rally was the Personal Consumption Expenditure (PCE) inflation report. 

Middle East Conflict Has Little Impact

The week began with market reaction to news of the US’s involvement in attacks on Iran’s nuclear facilities. When it became apparent that the attacks would not escalate and had avoided the important energy infrastructure, the markets continued with barely a shrug.

If market participants were expecting a rate rally due to a flight to safety, they were disappointed. Markets barely acknowledged this historic occurrence in US Middle East policy, which is surprising considering that 20% of the world’s oil flows through this region.

Existing Home Sales Show Pent-Up Demand

Existing home sales rose 0.8% in May to better-than-expected levels of 4.03M annualized sales. 

Year-over-year, sales are down 0.7%, which is definitely slower than normal for this time of the year. This is indicative of pent-up demand. If rates drop, this could unleash these home buyers. 

Inventory rose to 4.6 months from 4.4 months in April. This is an increase in supply, but it now just brings us to what is considered a market equilibriumlevel of 4.6 months, where buyers and sellers are in balance.

Fed Officials Signal July Rate Cuts

One major reason for the better rates this week was that several Fed members seemed to break ranks with the “wait and see” stance of Fed Chairman Powell. Fed Governor Bowman and Chicago Fed President Goolsbee joined Governor Wallace from last week in signaling their willingness to cut rates at the next meeting in July. Markets loved the change in tone and responded with lower rates.

Fed Proposes Reserve Requirement Relief

The first step in Treasury Secretary Bessent’s proposed regulatory reform began this week.

The Fed proposed removing the capital reserve requirements for financial institutions that own US Treasuries. Banks can’t lend and invest 100% of deposited funds, as they need to retain some to cover deposit holder withdrawals and defaults in lending and investments. 

Currently, if a bank owns US Treasuries, it has to hold additional reserves to cover the potential for default. Since US Treasuries are backed by the “Good Faith and Credit” of the US Government, there really is no reason to require additional reserves on these investments. When this regulatory relief is implemented, it may cause treasury yields and interest rates to drop.

Q1 GDP Revised Lower to -0.5%

The final reading of Q1 Gross Domestic Product (GDP) was released this week and was revised lower again after the previous estimates.

The final Q1 GDP was reported as -0.5%, down from -0.2% at the last estimate. Mortgage rates liked the personal spending component as it came in up 0.5%, revised down from 1.2% at last estimate. This could indicate a slowdown in spending and, therefore, less inflation.

PCE Report: Inflation Slightly Hotter

The big report of the week was Friday’s PCE report. Remember that PCE is the Fed’s favorite measure of inflation. This report was relatively good but had one point of weakness.

• Headline inflation came in at +0.1%, as expected.
• Core PCE, which strips out volatile food and energy prices, came in slightly higher than expected at +0.2%, vs +0.1% expected.
• This slightly higher-than-expected number slowed the decline in interest rates, but not by much.

Looking Ahead: All Eyes on PCE

Next week is already jobs week, and it will be another important week for the Fed to review prior to its July meeting and potential rate cuts.

Tuesday, July 1: 

• JOLTS (Job Openings and Labor Turnovers)
• Speech by Fed Chair Powell

Wednesday, July 2:

• ADP Employment Report

Thursday, July 3:

• BLS Jobs Report
• Jobless Claims

Friday, July 4:

• Markets are closed for the Independence Day holiday