Underinflation

CPI (2.1% YoY, 0.0% MoM)was milder than PPI (2.5% YoY, 0.3% MoM), indicating that Businesses are reluctant to pass higher costs onto consumers. This resumes a trend which has persisted for the past decade, having taken a hiatus as fuel prices fell during the past year. This could be a sign that businesses are seeking to grab market share. This makes sense to us as it has been large, dominant, players in various sectors of the economy which have reported the best earnings numbers. Home building has improved, but has been centered among the large homebuilders. Retailing has picked up, but it is the so-called "big box" stores which have reported the most impressive results. The demand pie is smaller so the bigger companies are using economies of scale to garner a bigger slice of the smaller pie. Foreign Purchases of U.S. Securities rose by only $16.7B versus a prior revised $121.3 billion. Purchases of Treasuries increased by $32.5 billion, but corporate bond purchases declined by $24 billion. Judging by rising treasury yields and tighter credit spreads, that trend may be reversing in August. However, August is a poor month to use to judge sea changes. Liquidity is usually poor in August and markets appear to be thinner than usual this August. Empire Manufacturing data indicate that manufacturing in the New York Region contracted in August, after rising a modestly-good 7.39 last month. Slow consumer demand during the first half of the year reduced the need for inventory replenishment. However, June Empire Manufacturing was 2.29 (not much inventory replacement there either). May was the month for inventory replacement with Empire Manufacturing coming in at 17.09. We also believe that the auto plant phenomenon also influenced the July report of 7.39 (pushing it higher than it might have been otherwise). Industrial Production and Capacity Utilization trended higher in July. Auto manufacturer activity influenced the data. Prices of U.S. Treasuries are higher on thin volume. The yield of the 10-year Treasury stands at 1.76%. If we get to 1.80%, sales and shorts could enter the markets. Even if that does not happen at 1.80%, it could happen when the market participants return in September (or following the Fed's Jackson Hole conference.) Meanwhile, credit spreads in the investment grade market and the upper-end of the high yield market continue to grind tighter. To subscribe or receive a free trial go to www.bond-squad.com