The Week Ahead: Inflation, Treasury Auctions, MBS Settlement

The monthly Employment Situation Report was expected to be the market's main focus last week, instead plunging commodities prices stole the show and put the sensitive state of the domestic economic recovery back in the spotlight.

The NYMEX light crude oil contract last week fell from a high of $114.83 all the way down to $94.63 amidst growing concerns that rising food and energy prices would slow the overall economic recovery and force the Fed to leave overnight interest rates near zero for longer than originally anticipated. Benchmark interest rates illustrated that sentiment as a forced bond rally (short covering) flattened the yield curve and pushed mortgage rates to their lowest levels since early December. SEE CHART. READ MORE: MBS Ledge: Shift in Production Coupon Potentially in Progress

The 10yr note went out under 3.15% and the FNCL 4.5 MBS coupon finished Friday's session +1/32 at 103-16. Benchmarks 10s begin the week slightly higher but most of last week's gains remain in tact. 10s are currently -4/32 at 103-27 yielding 3.164% and the FNCL 4.5 is -1/32 at 103-15.

Key events this week include retail sales, $72 billion in Treasury coupon auctions, two inflation reports, and the first look at May consumer sentiment. Economists at Citigroup believe the run-up in fuel prices will dominate each of those reports, but say "the recent collapse in crude oil prices will dramatically alter interpretations of the results."

Key Events This Week:

Monday:

No economic data.

Treasury Auctions:
11:30 - 3-Month Bills
11:30 - 6-Month Bills

Tuesday:

10:00 - The Wholesale Trade report is anticipated to post continued growth in March. In February, inventories jumped 1% on a monthly basis and were up 12.7% from the prior year. Consensus forecasts weren't available for this report, but in its Q1 GDP report, the BEA assumed a growth rate of 0.9% in March.

"Wholesale inventories have increased since the start of 2010 and we expect them to follow their current positive trend," said economists at BBVA, predicting a monthly pickup of 1.1%.

Economists at Nomura Global Economics added: "Wholesalers' inventories likely increased at a solid pace in March, led by stock building as well as higher gasoline prices.

10:00 - Tim Geithner, Treasury Secretary, holds a press conference following US-China Strategic and Economic Dialogue in Washington.

12:45 - Jeffrey Lacker, Richmond Fed President. speaks on the economic outlook in Virginia.

Treasury Auctions:
11:30 - 4-Week Bills
1:00 - 3-Year Notes

It's Class A MBS roll day! Fannie Mae and Freddie Mac 30-year coupons move  to June delivery as the monthly settlement process begins for May trades.

Wednesday:

8:30 - Rising petroleum prices are expected to widen the monthly Trade Deficit in March. Economists look for a $47.7 billion trade gap, up from $45.8 billion a month before. Both imports and exports are anticipated to pick up, but the pace of imports should rise faster due to oil costs. The expected widening follows a 1.7% narrowing in February.

"Petroleum imports probably increased sharply on both higher price and increased volume," said analysts at Citigroup. "Given the further price rise in April, we expect that this is not the last big increase in the oil bill." 
Economists at IHS Global Insight said trade "was close to neutral for growth in the first quarter," but they see exports carrying a little more momentum in the second quarter, while import growth slows.

2:00 - The gap in April's Budget Statement from the Treasury is anticipated to be roughly one-third of the previous month, but April is usually a time of surplus so it's not much to get excited about. Economists look for a $65 billion deficit, with estimates ranging from $16 to $75 billion. That looks relatively good next to March's $188 billion gap, or April 2010's $82.7 billion deficit. But in the first six months this fiscal year, the deficit already adds to $829.4 billion - about 15% worse than last year. 

"A strong increase in April tax receipts likely improved the budget balance," said economists at Nomura Global Economics. "We expect the budget deficit to be $42.0 billion in April, compared with a deficit of $82.7 billion for April of last year."

12:00 - Narayana Kocherlakota, Minneapolis Fed President, speaks on contingent planning for monetary policy in New York.

12:20 -Dennis Lockhart, Atlanta Fed President, speaks on the economic outlook in Atlanta.

1:00 - Sandra Pianalto, Cleveland Fed President, speaks on the economic outlook and monetary policy in Cincinnati.

Treasury Auctions:
1:00 - 10-Year Notes

Thursday:

8:30 - Headline inflation is expected to remain worrisome due to soaring energy prices but core costs should be contained in the Producer Price Index. April's report is expected to produce a 0.6% headline climb in the month, following a 0.7% advance in March and a 1.6% gain in February. Nine consecutive advances have brought the annual rate to 5.8% (as gas prices have jumped nearly one-third).

The more closely-watched core index - which strips out volatile energy and food prices - is expected to inch forward just 0.2% in April, following a more-than-forecast 0.3% uptick. Core prices are currently up 1.9% for the year - the fastest pace since August 2009.

"Producer prices probably jumped again in April, on sharply higher energy prices, especially gasoline," said economists at Citigroup, who noted that gas prices surged 25% in the past two months but that rise has been muted by seasonal adjustments. "Rising seasonal factors have held the two-month increase in gasoline prices to just 11%. Seasonal adjustment will dampen May gasoline prices as well. Those factors, combined with the sudden drop in oil prices this week, could produce a sharp turn in PPI next month."

Energy costs make up one-fifth of the headline index, according to economists at Janney Montgomery Scott. 

8:30 - Retail Sales have posted average monthly gains of 0.8% in the last three quarters, so the Street's +0.6% forecast for April is a bit below trend even if it's higher than March's 0.4% gain. Some of the gain also reflects high gas prices, so gains may not be widespread. But economists are impressed with how the consumer has held up despite rising energy costs. 

Analysts at Citigroup, for instance, note that motor vehicle sales were roughly unchanged and large retail chains reported healthy gains.
"The extra household income from an improving labor market and the temporary payroll tax cut has been helping consumers cope with higher gasoline and food prices," said economists at IHS Global Insight, who note that in April there was a strong increase in private payrolls and an uptick in average hourly earnings.

8:30 - Economists at Deutsche Bank said the weekly Initial Jobless Claims report would be "the most important labor market indicator between now and the next employment report." The reasoning is simple: the nonfarm payrolls survey suggested 268k private jobs were created last month - the strongest month since February 2006. But reaction to the report was appropriately mixed, as unemployment rose to 9% and the previous day's jobless claims report jumped 43k to 474k, its highest weekly reading since August. 
Economists believe the first week of May could provide some much-needed correction. The last report also suggested temporary distortions that could have driven the claims figure higher. Still, the median forecast of 430k is far from inspiring; nor is the range of forecasts: from 415k to 465k. 
"We expect that the surge in New York and Oregon filings, which added nearly 28,000 to unadjusted claims in the previous week, will reverse," said economists at Citibank, who anticipate a weekly decline of 60k. "However, shutdowns among certain auto manufactures may place some upward pressure on the figure. We also note that storm- related filings may be more apparent during the reference period, introducing the risk that claims could exceed our estimate." 

8:30 - Charles Plosser, Philadelphia Fed President, speaks on the economic outlook in Florida.

10:00 - Few comments were available for March's Business Inventories. The consensus expects a 0.8% increase following a 0.5% uptick a month before, but economists said little beyond that inventories would post increases in line with previous reports. 

"The March business inventory report will reveal how much retailers added to stocks in March," said analysts at Nomura. "If the pace of stockpiling topped the BEA's assumptions (+0.6% for March), the report would add a few tenths to our Q1 GDP tracking estimate."

Treasury Auctions:
1:00 - 30-Year Bonds

Friday:

8:30 - The Consumer Price Index should report similar trends to the Producer Price Index, but more people watch this one because it reflects how rising costs are being passed onto the average spender. Total inflation is set to jump 0.4% in April following a 0.5% uptick in March, but if energy and food costs are stripped out than the gain should be a less-than-alarming 0.1%, economists predict. Even if the monthly headline figure comes in higher than expected, the market will likely be comforted by last week's collapse in energy costs.

"On the core side, we continue to see very low risk of passthrough, particularly now that energy prices have rapidly reversed course," said economists at Janney Capital Markets. "Shelter costs remain the biggest single anchor to the CPI, comprising nearly a third of the total index, and with home prices still on an evident down trend and rental vacancies elevated in many markets, we see limited risk of reversal. For the intermediate term, the normalization of consumer demand in a post-recessionary environment should allow inflation rates to stabilize in the 1.5% - 2.0% range, even accounting for $100 oil."

9:55 - A strong payrolls report and the death of Osama bin Laden aren't enough to change the spirits of the American consumer, economists say. The U of Michigan Consumer Sentiment report is expected to move forth just 0.2 points to 70 in May, as climbing fuel prices continue to hurt discretionary spending. 

"If the recent large decline in crude oil prices persists, it should remove a major roadblock to consumer confidence in the months ahead," said economists at Citigroup.

"Recent news has been a mixed bag," added analysts at IHS Global Insight. "April's payrolls and average hourly earnings improved, but there was an uptick in the unemployment rate to 9.0%. The first week in May was eventful with a volatile stock market and falling world oil prices on the economic front, and the killing of Osama Bin Laden. Stock market volatility is not a good thing for consumer mood and household net worth - especially with falling real estate prices. However, falling world oil prices can have a positive impact on consumer sentiment as long as it translates into cheaper prices at the pump."