One way to get a handle on the likely course of the markets next year is to see what happened after the 1986 tax reform legislation, the previous effort to reform the tax code before this year's. This past episode suggests stocks have more room to climb over the
next few months while Treasury yields risk jumping above 3% this
Spring. Such a scenario would fit with the one I outlined in my
October 29 blog. But, the 1986-87 market behavior suggests there could
be abrupt shifts in the market, which will probably be difficult to
predict.
The earlier tax reform legislation passed in October 1986. It may have helped to boost economic growth from an already strong pace. Real GDP Growth sped up to 4.5% in 1987 from 3.0% in 1986. Inflation also sped up, with the Core CPI rising to 4.2% in 1987 from 3.8% in 1986.
In 1986-87, the S&P 500 Index rallied by 14.2% over the 4 months following the tax reform law (see table below). However, the rally had followed a wobbly market over the prior 4 months, in which there was a 2.8% pt cumulative decline. Some of the post-law rally may have been catch-up.
The current situation has a different start. Stocks rallied a cumulative 5.5% over the 4 months prior to the 2017 legislation. So, there should be less of a catch-up now than in 1986-87. Nevertheless, net of the market behavior prior to the tax law, stocks still have room to climb another 10% through April if they are to be consistent with the post-1986 experience. To be sure, such a gain is unlikely now, given the very high price-earnings ratio for the S&P 500. The P/E Ratio was high relative to the prior few years in 1986-87, as well, but not as high as now.
In the earlier episode, the 10-year Treasury yield fell 37 BPs after the legislation was signed, having backed up 28 BPs in anticipation of the bill. The decline in yield proved temporary, however, with a massive sell-off in the 4th month after the legislation went into effect.
Currently, Treasuries sold off only at the end of the month when it was certain that the legislation would pass. This sell-off also could unwind before resuming, as in 1986-87. But, the unwinding would likely be smaller than in 1986-87, inasmuch as the prior backup in yield was smaller to begin with.
The run-up in yields, along with a market focus on the Trade Deficit and weaker dollar, eventually resulted in the stock market crash of October 1987. This history suggests that significant downside risk to the stock market could develop in the second half of 2018. Moreover, rather than a wider Federal Deficit being the big problem facing the markets, a wider Trade Deficit (and consequently a weaker dollar) could be the main perceived problem as the tax-related boost to spending results in a surge in imports.
Month S&P 500 10-Year Treasury Yield
(m/m % change) (level, percent, monthly avg)
1986-87 2017 1986-87 2017
t-3 -2.1 -0.1 7.30 2.35
t-2 2.0 1.9 7.17 2.36
t-1 -2.7 2.3 7.45 2.20
t 0.0 1.4 7.43 2.39
t+1 3.2 7.25
t+2 1.4 7.11
t+3 6.4 7.08
t+4 6.2 8.02
t+5 -0.8 8.61
t+6 0.7 8.40
t = month tax legislation was passed
Tuesday, December 26, 2017
Sunday, December 17, 2017
Macro Background Positive for Stocks: Q417 Corporate Profits Next
The macroeconomic and policy backgrounds are now very positive for the stock market. As a result, stocks should continue to rally into February.
Even if there is some profit taking after the tax cut is passed and signed into law, the pullback should be short-lived thanks to the other positive fundamentals. Treasuries are likely to remain range bound, as yields are held down by
low inflation.
The economy is strong. The Atlanta and NY Fed models now project 3.3-4.0% for Q417 Real GDP Growth, and the NY Fed model's early call is 3.2% for Q118 GDP. The weather is a big unknown for Q118. But, if GDP is held down by bad winter weather, it should rebound in the Spring.
Fiscal and monetary policy are pro-growth. On the fiscal side, the tax cut should boost the bottom line of corporations, if not the economy, next year. On the monetary side, the Fed is sticking to a gradual pace of rate hikes for 2018, despite having lifted its economic growth forecast for 2018. The next potential Fed rate hike is not until the March FOMC meeting.
The next round of corporate earnings reports, for Q417 and mostly due in January-February, is expected to be strong. Consensus looks for a +10.6% y/y increase in Q417 S&P 500 earnings, up from 8.6% in Q317. Indeed, the macro evidence points to good corporate profits. The weaker dollar and solid foreign economic growth should help the bottom line of corporations with earnings abroad. The oil sector should continue to be boosted by higher oil prices. Overall price and wage inflation do not suggest any significant reduction in profit margins. The only apparent drawback is a difficult comparison with profits in Q416, as the latter were strong according to the GDP measure of corporate profits. That is, the y/y comparison should be more difficult for Q417 than it was for Q317.
Markit
Eurozone Real GDP Oil Prices Trade-Weighted Dollar AHE Core CPI PMI
[ y/y percent change ] (level)
Q316 1.5 -3.4 2.2 2.6 2.2
Q416 1.8 +16.4 3.9 2.7 2.2
Q117 2.0 +65.3 2.3 2.7 2.2 55.6
Q217 2.2 +13.1 3.1 2.5 1.8 56.8
Q317 2.3 +6.0 -1.9 2.5 1.7 57.4
Q417 2.6-2.9 +5.0 -4.1 2.4 1.6 57.2
The economy is strong. The Atlanta and NY Fed models now project 3.3-4.0% for Q417 Real GDP Growth, and the NY Fed model's early call is 3.2% for Q118 GDP. The weather is a big unknown for Q118. But, if GDP is held down by bad winter weather, it should rebound in the Spring.
Fiscal and monetary policy are pro-growth. On the fiscal side, the tax cut should boost the bottom line of corporations, if not the economy, next year. On the monetary side, the Fed is sticking to a gradual pace of rate hikes for 2018, despite having lifted its economic growth forecast for 2018. The next potential Fed rate hike is not until the March FOMC meeting.
The next round of corporate earnings reports, for Q417 and mostly due in January-February, is expected to be strong. Consensus looks for a +10.6% y/y increase in Q417 S&P 500 earnings, up from 8.6% in Q317. Indeed, the macro evidence points to good corporate profits. The weaker dollar and solid foreign economic growth should help the bottom line of corporations with earnings abroad. The oil sector should continue to be boosted by higher oil prices. Overall price and wage inflation do not suggest any significant reduction in profit margins. The only apparent drawback is a difficult comparison with profits in Q416, as the latter were strong according to the GDP measure of corporate profits. That is, the y/y comparison should be more difficult for Q417 than it was for Q317.
Markit
Eurozone Real GDP Oil Prices Trade-Weighted Dollar AHE Core CPI PMI
[ y/y percent change ] (level)
Q316 1.5 -3.4 2.2 2.6 2.2
Q416 1.8 +16.4 3.9 2.7 2.2
Q117 2.0 +65.3 2.3 2.7 2.2 55.6
Q217 2.2 +13.1 3.1 2.5 1.8 56.8
Q317 2.3 +6.0 -1.9 2.5 1.7 57.4
Q417 2.6-2.9 +5.0 -4.1 2.4 1.6 57.2
Sunday, December 10, 2017
December FOMC Meeting: A Negative for Treasuries and Stocks?
Wednesday's FOMC Meeting risks being a negative for Treasuries and, to a lesser extent, stocks. Although a 25 BP rate hike is fully expected, the risk is that the Fed will shift up its expectations for the funds rate in 2018 -- the "dots." The median expectation for the funds rate could shift up to 4-5 hikes from 3.
A shifting up of the dots would be in response to a higher central tendency for Real GDP Growth in 2018. The latter conceivably could move up to 2.5-2.8% from 2.0-2.3%, as these forecasts build in the boost from a tax cut and take account of better-than-expected underlying momentum in the economy. The Central Tendency for the Unemployment Rate will likely be lowered, as well. The inflation outlook should be unchanged, but if anything could be raised in response to the higher growth forecasts. The stronger growth expectations should mitigate the impact of higher rate expectations on the stock market. Stocks also could be helped by movements in the Congressional conference committee to eliminate some of the anti-growth elements of the Senate bill, such as the AMT.
Fed's Central Tendencies From September FOMC Meeting
2017 2018
Real GDP 2.2-2.5 2.0-2.3
Unemployment Rate 4.2-4.3 4.0-4.2
PCE Deflator 1.5-1.6 1.8-2.0
Core PCE Deflator 1.5-1.6 1.8-2.0
The economy's strong momentum is showing up in several indicators. Both Initial and Continuing Claims fell below the November average in the latest week (table below). The ECRI Leading Index has moved up to new highs in the past 3 weeks (chart below). And, the NY Fed model's very early projection for Q118 Real GDP Growth is 3.1% after a projection of 3.9% in Q417.
Unemployment Claims (level)
Initial Continuing
Oct Avg 232k 1.893 Mn
Nov Avg 242 1.913
Latest Week 236 1.908
ECRI Leading Index (level)
A shifting up of the dots would be in response to a higher central tendency for Real GDP Growth in 2018. The latter conceivably could move up to 2.5-2.8% from 2.0-2.3%, as these forecasts build in the boost from a tax cut and take account of better-than-expected underlying momentum in the economy. The Central Tendency for the Unemployment Rate will likely be lowered, as well. The inflation outlook should be unchanged, but if anything could be raised in response to the higher growth forecasts. The stronger growth expectations should mitigate the impact of higher rate expectations on the stock market. Stocks also could be helped by movements in the Congressional conference committee to eliminate some of the anti-growth elements of the Senate bill, such as the AMT.
Fed's Central Tendencies From September FOMC Meeting
2017 2018
Real GDP 2.2-2.5 2.0-2.3
Unemployment Rate 4.2-4.3 4.0-4.2
PCE Deflator 1.5-1.6 1.8-2.0
Core PCE Deflator 1.5-1.6 1.8-2.0
The economy's strong momentum is showing up in several indicators. Both Initial and Continuing Claims fell below the November average in the latest week (table below). The ECRI Leading Index has moved up to new highs in the past 3 weeks (chart below). And, the NY Fed model's very early projection for Q118 Real GDP Growth is 3.1% after a projection of 3.9% in Q417.
Unemployment Claims (level)
Initial Continuing
Oct Avg 232k 1.893 Mn
Nov Avg 242 1.913
Latest Week 236 1.908
ECRI Leading Index (level)
Friday, December 8, 2017
November Employment Report Shows Strong Labor Market But Little Inflationary Pressures
The November Employment Report is a positive for stocks and a modest negative for Treasuries, as it showed widespread strength in job creation but little inflationary signs. The report should keep the Fed on course for a 25 BP rate hike next Wednesday and further gradual tightening in 2018.
The +228k m/m increase in November Payrolls was well above the +169k m/m average over the first 10 months of 2017. Some of the strength could be a further rebound from the hurricanes in September. But, some was also reflective of the underlying strength of the economy. In particular, manufacturing jobs in the capital goods industries rose smartly. Even retailers added jobs, despite the shift to shopping on the internet. Besides the job gains, the Average Workweek rose, also signaling strength.
The labor market strength at this point takes some of the wind out of the strong productivity story. Total Hours Worked are up about 2.5% (q/q, saar) so far in Q417. Combined with the q/q surge in self-employed, it points to about 3.5% (q/q, saar) in the aggregate hours figure used to calculate productivity growth. Unless forecasts of Q417 Real GDP Growth move higher than the 3.5-3.9% current range, Productivity Growth should be a modest 0.5% this quarter -- a slowdown from the pace of the prior two quarters. It is too soon to say that Q417 GDP estimates will not climb higher, however.
There is little evidence of inflationary pressures in the November Employment Report. Wage inflation is benign. Average Hourly Earnings rose only 0.2% m/m, with the y/y edging up to 2.5% from 2.4% and staying below the 2.7% Q317 average. The Unemployment Rate edged up to 4.11% from 4.07% in October. (Both rounded to 4.1% in the headlines.) The broadest measure of unemployment, U-6, rose to 8.0% from 7.9% in October, but remained below the 8.5% Q317 average.
The +228k m/m increase in November Payrolls was well above the +169k m/m average over the first 10 months of 2017. Some of the strength could be a further rebound from the hurricanes in September. But, some was also reflective of the underlying strength of the economy. In particular, manufacturing jobs in the capital goods industries rose smartly. Even retailers added jobs, despite the shift to shopping on the internet. Besides the job gains, the Average Workweek rose, also signaling strength.
The labor market strength at this point takes some of the wind out of the strong productivity story. Total Hours Worked are up about 2.5% (q/q, saar) so far in Q417. Combined with the q/q surge in self-employed, it points to about 3.5% (q/q, saar) in the aggregate hours figure used to calculate productivity growth. Unless forecasts of Q417 Real GDP Growth move higher than the 3.5-3.9% current range, Productivity Growth should be a modest 0.5% this quarter -- a slowdown from the pace of the prior two quarters. It is too soon to say that Q417 GDP estimates will not climb higher, however.
There is little evidence of inflationary pressures in the November Employment Report. Wage inflation is benign. Average Hourly Earnings rose only 0.2% m/m, with the y/y edging up to 2.5% from 2.4% and staying below the 2.7% Q317 average. The Unemployment Rate edged up to 4.11% from 4.07% in October. (Both rounded to 4.1% in the headlines.) The broadest measure of unemployment, U-6, rose to 8.0% from 7.9% in October, but remained below the 8.5% Q317 average.
Sunday, December 3, 2017
Washington Developments, the Tax Bills and the November Employment Report
Developments in Washington are likely to keep markets on edge this week, but stock-market positive outcomes are likely. Besides potential for headline shock from the Russian inquiry and presumably the start of a House/Senate conference committee to reconcile the two versions of the tax bill, Congress must pass a Continuing Resolution to keep the government running past December 8. The uncertainty of a Resolution could run to the deadline, which coincides with release of the November Employment Report. The latter should not detract from the strong-growth story, but risks having Payrolls and Unemployment Rate come in softer than consensus. Average Hourly Earnings risks being high.
The November Employment Report could be positive for both stocks and Treasuries, as it should attest to the economy's strength but risks a smaller-than-consensus Payroll print and higher-than-consensus Unemployment Rate. Consensus is +198k m/m Payrolls (well above the +169k average so far this year) and a steady 4.1% Unemployment Rate. Downside risk to Payrolls stems from the possibility of fewer-than-normal holiday workers having been hired by retailers this year as a result of the shift to on-line shopping. The Unemployment Rate risks edging up, after an unusual drop in the Participation Rate (possibly hurricane related) pushed it down in October. The consensus estimate of a high 0.3% m/m Average Hourly Earnings cannot be ruled out, however. While calendar considerations are agnostic between 0.1% and 0.2% m/m, a drop in low-paid holiday workers would add to AHE for composition reasons. The y/y would climb to 2.7% -- near its recent high -- from 2.4% in October, if the m/m turns out to be 0.3%.
The markets' main focus on a reconciled tax bill probably will be whether the corporate tax cut is delayed to 2019 or not. A delay would be viewed as mitigating the economic boost in 2018. While this view would be a negative for stocks and a positive for Treasuries, the reality may be that a delay does not matter in terms of the economic impact. Since business investment decisions are longer-term, a one-year delay may not significantly impact them. Moreover, a delay would lower the odds of an aggressive Fed next year.
Even if the corporate tax cut is not delayed, critics of the bill argue that it will have little impact on the economy. Model simulations show only a small lift to GDP growth. Critics, such as Larry Summers, go further and say that a lower corporate tax rate would raise the "user cost of capital" for investments financed with debt -- making it costlier for businesses to invest.
These complaints, however, may not be the full story. The standard model of business equipment spending is based on expectations of demand for output pitted against the cost of capital. The cost of capital is well specified. But, econometric models, such as those used at the Fed and CBO, do not represent expectations well. In particular, they do not incorporate shifts in "animal spirits," an imprecise term that essentially means the degree of aggressiveness in business decision making. Conceivably, the current tax bills have boosted animal spirits. Evidence for the latter is that equipment spending has been rising this year, perhaps in anticipation of lower tax rates, after falling in 2016. Also, measures of business confidence have shot up since last year's presidential election.
The tax bills' critics would likely say that relying on a boost in animal spirits is "voodoo" economics. And, since these spirits are not measurable, they have a point. But, Keynes thought they were important when he wrote his General Theory in the 1930s. Moreover, the standard models likely did not predict the economy's strength so far this year -- missing out on some factor (animal spirits?) that was at work.
The Atlanta Fed and NY Fed models say that the strong 3+% growth is continuing in Q417 -- they are currently estimating 3.5-3.9%, versus 3.3% in Q317. (These models predict the current quarter based on known data and are not the same kind of model used to predict the future impact of a tax cut.) A 3+% GDP for Q417 would almost certainly show strong productivity growth, the 3rd consecutive quarter to do so. It is far from certain that trend productivity growth has ratcheted up, and the standard models used to predict the impact of a tax cut assume it has not. But, a ratcheting up of trend productivity growth would mitigate the longer-run problems of the Federal deficit, Social Security, Medicare, etc.
It is too soon to say whether the proponents of the bills or their critics are right with regard to the economic impact. It is fair to say, however, that the proponents may be ignoring the cost of capital, while the critics are ignoring the bills' potential impact on demand expectations or animal spirits. Both sides' arguments should be viewed cautiously.
Nonetheless, with a tax cut bill passed by both Houses, the stock market impact of headlines from the Russian inquiry may be much more modest than what happened on Friday. Besides Friday's plunge having been precipitated by "fake news" on ABC (subsequently retracted), other information coming out with regard to the Russian connection so far does not seem incriminating. Even if the Administration is "handcuffed" by further revelations, Trump's wish list of additional government projects, such as the Mexican Wall, contains few, if any, with broad economic implications. So, there would be little loss from a market perspective if they were stymied by the Russian inquiry.
The November Employment Report could be positive for both stocks and Treasuries, as it should attest to the economy's strength but risks a smaller-than-consensus Payroll print and higher-than-consensus Unemployment Rate. Consensus is +198k m/m Payrolls (well above the +169k average so far this year) and a steady 4.1% Unemployment Rate. Downside risk to Payrolls stems from the possibility of fewer-than-normal holiday workers having been hired by retailers this year as a result of the shift to on-line shopping. The Unemployment Rate risks edging up, after an unusual drop in the Participation Rate (possibly hurricane related) pushed it down in October. The consensus estimate of a high 0.3% m/m Average Hourly Earnings cannot be ruled out, however. While calendar considerations are agnostic between 0.1% and 0.2% m/m, a drop in low-paid holiday workers would add to AHE for composition reasons. The y/y would climb to 2.7% -- near its recent high -- from 2.4% in October, if the m/m turns out to be 0.3%.
The markets' main focus on a reconciled tax bill probably will be whether the corporate tax cut is delayed to 2019 or not. A delay would be viewed as mitigating the economic boost in 2018. While this view would be a negative for stocks and a positive for Treasuries, the reality may be that a delay does not matter in terms of the economic impact. Since business investment decisions are longer-term, a one-year delay may not significantly impact them. Moreover, a delay would lower the odds of an aggressive Fed next year.
Even if the corporate tax cut is not delayed, critics of the bill argue that it will have little impact on the economy. Model simulations show only a small lift to GDP growth. Critics, such as Larry Summers, go further and say that a lower corporate tax rate would raise the "user cost of capital" for investments financed with debt -- making it costlier for businesses to invest.
These complaints, however, may not be the full story. The standard model of business equipment spending is based on expectations of demand for output pitted against the cost of capital. The cost of capital is well specified. But, econometric models, such as those used at the Fed and CBO, do not represent expectations well. In particular, they do not incorporate shifts in "animal spirits," an imprecise term that essentially means the degree of aggressiveness in business decision making. Conceivably, the current tax bills have boosted animal spirits. Evidence for the latter is that equipment spending has been rising this year, perhaps in anticipation of lower tax rates, after falling in 2016. Also, measures of business confidence have shot up since last year's presidential election.
The tax bills' critics would likely say that relying on a boost in animal spirits is "voodoo" economics. And, since these spirits are not measurable, they have a point. But, Keynes thought they were important when he wrote his General Theory in the 1930s. Moreover, the standard models likely did not predict the economy's strength so far this year -- missing out on some factor (animal spirits?) that was at work.
The Atlanta Fed and NY Fed models say that the strong 3+% growth is continuing in Q417 -- they are currently estimating 3.5-3.9%, versus 3.3% in Q317. (These models predict the current quarter based on known data and are not the same kind of model used to predict the future impact of a tax cut.) A 3+% GDP for Q417 would almost certainly show strong productivity growth, the 3rd consecutive quarter to do so. It is far from certain that trend productivity growth has ratcheted up, and the standard models used to predict the impact of a tax cut assume it has not. But, a ratcheting up of trend productivity growth would mitigate the longer-run problems of the Federal deficit, Social Security, Medicare, etc.
It is too soon to say whether the proponents of the bills or their critics are right with regard to the economic impact. It is fair to say, however, that the proponents may be ignoring the cost of capital, while the critics are ignoring the bills' potential impact on demand expectations or animal spirits. Both sides' arguments should be viewed cautiously.
Nonetheless, with a tax cut bill passed by both Houses, the stock market impact of headlines from the Russian inquiry may be much more modest than what happened on Friday. Besides Friday's plunge having been precipitated by "fake news" on ABC (subsequently retracted), other information coming out with regard to the Russian connection so far does not seem incriminating. Even if the Administration is "handcuffed" by further revelations, Trump's wish list of additional government projects, such as the Mexican Wall, contains few, if any, with broad economic implications. So, there would be little loss from a market perspective if they were stymied by the Russian inquiry.
Sunday, November 26, 2017
The Senate Tax Bill and Other Market Factors This Week
The Senate tax bill and magnitude of holiday shopping will remain the markets' focus this week. Last week, odds of passage improved when the Alaska Senator Murkowski endorsed ending the ObamaCare mandatory insurance provision. But, there is still uncertainty about passage, although scuttlebutt among Washington staffers is that the odds of passage are slightly positive (from what I hear). News headlines should spike on Tuesday, when Trump and Senate Republicans meet and the Senate Budget Committee acts on the legislation ahead of the full Senate vote later in the week.
A tax cut would be a positive for stocks and negative for Treasuries, which should carry into H118. But, these market responses could reverse later next year, when the boost to the economy from the tax cut begins to dissipate while the drag from higher interest rates begins to build. This is the typical "model" prediction of the after-effects of a tax cut. Potentially more important is the possibility that the corporate tax cut will enhance and sustain the recent pickup in productivity growth by encouraging additional investment. A faster trend in productivity growth will help solve long-term problems, such as the solvency of social security and Medicare, as well as improve the US standard of living (see my November 5 blog).
This week's US economic data are expected to show modest pullbacks in new home sales and business surveys, joining the Claims data in suggesting a slight crack opening up in the "strong growth" story. The pullbacks are not enough to derail the story, but should act to keep Treasuries in a range (see table below). The October Core PCE Deflator is expected to edge up to 0.2% m/m and 1.4% y/y (was 0.1% and 1.3% in September). Some of the speedup results from pass-through of the higher oil prices, and the overall story of modest, below-target inflation should remain intact.
(level)
New Home Sales Markit Mfg PMI Chicago PM Mfg ISM
Q117 617k Units 54.2 55.3 57.0
Q2 605 52.5 61.1 55.8
Q3 603 53.0 61.0 58.6
Oct 625 ** 54.6 66.2 58.7
Nov * 53.8 63.0 58.3
* consensus estimate
** consensus estimate, down 6.3% from 667k in September
There are also a number of Fed speakers this week, including Yellen, Fed Governor Powell, NY Fed President Dudley and SF Fed President Williams. They will likely keep open the door for a December rate hike. Last week, Yellen emphasized the apparent decline in long-term inflation expectations in cautioning about raising rates too fast. This would be important except that she is a lame duck. Powell, Trump's appointee for Fed chair, should be more circumspect.
A tax cut would be a positive for stocks and negative for Treasuries, which should carry into H118. But, these market responses could reverse later next year, when the boost to the economy from the tax cut begins to dissipate while the drag from higher interest rates begins to build. This is the typical "model" prediction of the after-effects of a tax cut. Potentially more important is the possibility that the corporate tax cut will enhance and sustain the recent pickup in productivity growth by encouraging additional investment. A faster trend in productivity growth will help solve long-term problems, such as the solvency of social security and Medicare, as well as improve the US standard of living (see my November 5 blog).
This week's US economic data are expected to show modest pullbacks in new home sales and business surveys, joining the Claims data in suggesting a slight crack opening up in the "strong growth" story. The pullbacks are not enough to derail the story, but should act to keep Treasuries in a range (see table below). The October Core PCE Deflator is expected to edge up to 0.2% m/m and 1.4% y/y (was 0.1% and 1.3% in September). Some of the speedup results from pass-through of the higher oil prices, and the overall story of modest, below-target inflation should remain intact.
(level)
New Home Sales Markit Mfg PMI Chicago PM Mfg ISM
Q117 617k Units 54.2 55.3 57.0
Q2 605 52.5 61.1 55.8
Q3 603 53.0 61.0 58.6
Oct 625 ** 54.6 66.2 58.7
Nov * 53.8 63.0 58.3
* consensus estimate
** consensus estimate, down 6.3% from 667k in September
There are also a number of Fed speakers this week, including Yellen, Fed Governor Powell, NY Fed President Dudley and SF Fed President Williams. They will likely keep open the door for a December rate hike. Last week, Yellen emphasized the apparent decline in long-term inflation expectations in cautioning about raising rates too fast. This would be important except that she is a lame duck. Powell, Trump's appointee for Fed chair, should be more circumspect.
Monday, November 20, 2017
This Week's Focus: The Tax Bill, FOMC Minutes and Holiday Spending
The markets will likely remain on edge this week, focused on speculation about the Senate headcount regarding the upcoming tax cut vote. The uncertainty should weigh on stocks but lift Treasuries. Some Senators already have said they will study the bill over the holiday recess before making a decision, so the uncertainty will not likely be resolved until then. If the Senate passes a tax bill, stocks will rally and Treasuries sell off. But, after these initial responses, economic growth and inflation as well as the Fed's reactions to them will once again be the main drivers of the markets.
Besides the Senate tax bill, the markets also will likely focus this week on hints in the November FOMC Minutes (due Friday) on rate hikes in December and 2018, and expectations for Black Friday and Cyber Monday shopping. This week's US economic data are minor, but are expected to be growth-positive.
The November FOMC Minutes will keep open the door for a December rate hike, and the markets' near-certain probability of one should not change. But, there will probably be little new information regarding Fed thinking about the path of monetary policy in 2018. The inflation outlook will probably be the most important information. The question is whether the doves will continue to argue for caution in hiking without clear signs of a speedup in inflation. There also may be some discussion about fiscal policy, but nothing definitive is likely in the absence of the details of a tax cut.
Expectations are high for this year's holiday spending. The National Retail Federation expects holiday sales to climb 3.6-4.0% y/y, among the strongest in recent years. The strength should be particularly noticeable over the Black Friday/Cyber Monday weekend, according to a survey reported by Forbes Magazine. Retailer stocks have already begun to anticipate the start of the holiday season, and should continue to move up in the next couple of weeks if these predictions are correct.
Holiday Spending (y/y percent change)
2017 (est) 3.6-4.0
2016 3.6
2015 3.2
2014 5.0
2013 2.9
2012 2.6
2011 4.6
2010 5.2
2009 0.2
The economy's strength looks like it continued into Q417. Both the Atlanta Fed and NY Fed models boosted their forecasts to 3.4-3.8% (q/q, saar) from 3.2% after incorporating last week's data. These projections show an acceleration from the 3.0% Q317 pace. The Initial Claims data, however, have turned up a bit in the past two weeks, hinting at a crack in the strong growth story. But, so far Continuing Claims have not corroborated the softening, and consensus looks for Initial to fall in next week's report. At this point, these data just should be watched.
Initial Claims Continuing Claims
Aug Avg 237k 1.951 Mn
Sep 274 1.935
Oct 232 1.894
Nov 4 Wk 239 1.860
Nov 11 249 na
The spending strength is not likely to boost inflation, given the stiff competition between internet and brick & mortar retailers. Moreover, there was little in the October CPI report to spark significant concern about a pickup in inflation. The 0.2% m/m Core CPI showed a speedup in rent as its pace returned to trend (some of the speedup, though, could have reflected temporary spikes in hurricane-related areas) and a pass-through of higher oil prices (such as airfares). But, other price movements were mostly benign or down.
Besides the Senate tax bill, the markets also will likely focus this week on hints in the November FOMC Minutes (due Friday) on rate hikes in December and 2018, and expectations for Black Friday and Cyber Monday shopping. This week's US economic data are minor, but are expected to be growth-positive.
The November FOMC Minutes will keep open the door for a December rate hike, and the markets' near-certain probability of one should not change. But, there will probably be little new information regarding Fed thinking about the path of monetary policy in 2018. The inflation outlook will probably be the most important information. The question is whether the doves will continue to argue for caution in hiking without clear signs of a speedup in inflation. There also may be some discussion about fiscal policy, but nothing definitive is likely in the absence of the details of a tax cut.
Expectations are high for this year's holiday spending. The National Retail Federation expects holiday sales to climb 3.6-4.0% y/y, among the strongest in recent years. The strength should be particularly noticeable over the Black Friday/Cyber Monday weekend, according to a survey reported by Forbes Magazine. Retailer stocks have already begun to anticipate the start of the holiday season, and should continue to move up in the next couple of weeks if these predictions are correct.
Holiday Spending (y/y percent change)
2017 (est) 3.6-4.0
2016 3.6
2015 3.2
2014 5.0
2013 2.9
2012 2.6
2011 4.6
2010 5.2
2009 0.2
The economy's strength looks like it continued into Q417. Both the Atlanta Fed and NY Fed models boosted their forecasts to 3.4-3.8% (q/q, saar) from 3.2% after incorporating last week's data. These projections show an acceleration from the 3.0% Q317 pace. The Initial Claims data, however, have turned up a bit in the past two weeks, hinting at a crack in the strong growth story. But, so far Continuing Claims have not corroborated the softening, and consensus looks for Initial to fall in next week's report. At this point, these data just should be watched.
Initial Claims Continuing Claims
Aug Avg 237k 1.951 Mn
Sep 274 1.935
Oct 232 1.894
Nov 4 Wk 239 1.860
Nov 11 249 na
The spending strength is not likely to boost inflation, given the stiff competition between internet and brick & mortar retailers. Moreover, there was little in the October CPI report to spark significant concern about a pickup in inflation. The 0.2% m/m Core CPI showed a speedup in rent as its pace returned to trend (some of the speedup, though, could have reflected temporary spikes in hurricane-related areas) and a pass-through of higher oil prices (such as airfares). But, other price movements were mostly benign or down.
Sunday, November 12, 2017
Macro Background Should Support Seasonal Strength in Stocks
The macroeconomic background should continue to support the stock market rally during its current seasonally strong period. The stock market tends to climb from around Thanksgiving through the end of the year. A strong stock market should keep upward pressure on Treasury yields, although the latter's Friday sell-off seems excessive and risks unwinding.
The slew of US economic data to be released this coming week, particularly October Retail Sales and CPI on Wednesday, should be stock-market friendly. Consensus-like prints would encourage expectations for good holiday consumer buying amidst modest inflation. Consensus looks for +0.3% m/m Ex Auto Retail Sales and +0.2% Core CPI.
The markets already have built in a near-100% likelihood of a Fed rate hike at the December 12-13 FOMC Meeting. So, this coming's week's strong US real-side economic data should have little effect on this expectation. The odds of a December rate hike could pull back somewhat, however, if the Core CPI comes in below consensus, as discussed in last week's blog.
The probability of a December rate hike also could decline if the November Employment Report, due December 8, softens substantially. But, this is not a slam dunk. A softening in Payroll growth is conceivable as a result of less-than-seasonal holiday hiring by retailers, already announced by some large store chains. And, the Unemployment Rate could rebound, as some of the decline in the labor force in October -- which depressed the Unemployment Rate then -- could have been hurricane related and temporary. Average Hourly Earnings, however, risks printing on the high side. They should rise a modest 0.1-0.2% m/m, based on calendar considerations. But, the risk is for 0.3-0.4% from composition considerations -- average earnings would be boosted by the absence of low-paid holiday workers. In the latter event, the y/y would rebound to 2.7-2.8% from 2.4% in October.
The markets were somewhat unnerved last week with the Senate proposal to delay the corporate tax cut to 2019, versus the House bill's start date of 2018. The market reaction was wrong, according to my analysis of October 29. There, I argued that a tax cut would lead to more aggressive Fed tightening and an increase in Treasury yields that would hit the economy when the boost from the tax cut is abating, thus risking the end of the economic expansion. A delay in the tax cut, or a gradual implementation as is likely in a reconciliation bill, would push back the risk of that scenario.
A potential positive for stocks and negative for Treasuries next year is an easing of the Fed's bank regulations. Both Powell, the nominee for Fed Chair, and Quarles, the new Fed Vice Chair for Supervision, appear to be in favor of doing so. The policy response to the 2008 financial crisis was to clamp down on bank risk taking. This was one reason for the sub-par economic recovery. A relaxation would be a positive for economic growth.
The slew of US economic data to be released this coming week, particularly October Retail Sales and CPI on Wednesday, should be stock-market friendly. Consensus-like prints would encourage expectations for good holiday consumer buying amidst modest inflation. Consensus looks for +0.3% m/m Ex Auto Retail Sales and +0.2% Core CPI.
The markets already have built in a near-100% likelihood of a Fed rate hike at the December 12-13 FOMC Meeting. So, this coming's week's strong US real-side economic data should have little effect on this expectation. The odds of a December rate hike could pull back somewhat, however, if the Core CPI comes in below consensus, as discussed in last week's blog.
The probability of a December rate hike also could decline if the November Employment Report, due December 8, softens substantially. But, this is not a slam dunk. A softening in Payroll growth is conceivable as a result of less-than-seasonal holiday hiring by retailers, already announced by some large store chains. And, the Unemployment Rate could rebound, as some of the decline in the labor force in October -- which depressed the Unemployment Rate then -- could have been hurricane related and temporary. Average Hourly Earnings, however, risks printing on the high side. They should rise a modest 0.1-0.2% m/m, based on calendar considerations. But, the risk is for 0.3-0.4% from composition considerations -- average earnings would be boosted by the absence of low-paid holiday workers. In the latter event, the y/y would rebound to 2.7-2.8% from 2.4% in October.
The markets were somewhat unnerved last week with the Senate proposal to delay the corporate tax cut to 2019, versus the House bill's start date of 2018. The market reaction was wrong, according to my analysis of October 29. There, I argued that a tax cut would lead to more aggressive Fed tightening and an increase in Treasury yields that would hit the economy when the boost from the tax cut is abating, thus risking the end of the economic expansion. A delay in the tax cut, or a gradual implementation as is likely in a reconciliation bill, would push back the risk of that scenario.
A potential positive for stocks and negative for Treasuries next year is an easing of the Fed's bank regulations. Both Powell, the nominee for Fed Chair, and Quarles, the new Fed Vice Chair for Supervision, appear to be in favor of doing so. The policy response to the 2008 financial crisis was to clamp down on bank risk taking. This was one reason for the sub-par economic recovery. A relaxation would be a positive for economic growth.
Sunday, November 5, 2017
Strong GDP Growth: A Positive for Stocks, What About Treasuries?
US economic growth is strong, a clear positive for the stock market. But, a look behind the numbers suggests it is not entirely bad for Treasuries either. Both statements can be supported because a striking feature of the past two quarters of strong GDP gains is a pickup in productivity growth. This feature bodes well for corporate profits -- a positive for stocks. It also keeps price inflation low as nominal wage gains are offset by productivity growth and thus are not inflationary -- a positive for Treasuries. Longer-term yields are likely to stay in a range as the stock market rallies. The resulting improvement in real wages from higher productivity growth lifts workers' standard of living to boot.
Nonfarm Business Productivity has been strong in the past two quarters, rising 1.5% (q/q, saar) in Q217 and 3.0% in Q317. They account for much of the 3.8-3.9% gains in Nonfarm Business Output in these quarters. Together, they are among the strongest two-quarter consecutive gains in productivity outside of the rebounds typically seen after the end of a recession. The expansion of the internet, particularly in the retail space, may help explain the strength of productivity. The retail sector certainly has become more efficient as a result of on-line buying and centralized warehousing. Also, the rebound in domestic oil production is likely a high-productivity industry and helped boost overall productivity growth in the past two quarters as output responded to higher oil prices.
Productivity's strength dampens the inflationary implications of higher wage growth. Thanks to the strength of productivity, Unit Labor Costs (Compensation/Hour divided by Productivity) remained negligible in Q317. To be sure, it's not clear that wage inflation is picking up. While Compensation/Hour -- the broadest measure of labor costs -- sped up in Q317, the speedup may be just an offset to the slowdown in Q217. A similar pattern is seen in the Employment Cost Index -- the labor cost measure least affected by composition shifts between low- and high-paid workers. In both cases, the y/y was little changed in Q317. Average Hourly Earnings shows some sign of speedup, but were impacted by the hurricanes (positively) in Q317 and then negatively in October. It remains to be seen if its trend has moved up.
(q/q percent change, saar) (y/y percent change)
ECI Comp/Hr AHE ULC ECI Comp/Hr AHE ULC
Q117 3.2 4.9 2.4 4.8 2.4 1.9 2.7 0.7
Q217 2.0 1.8 2.6 0.3 2.4 1.1 2.6 -0.2
Q317 2.8 3.5 3.0 0.5 2.5 1.4 2.7 -0.1
Oct17 2.4
The economy's current strength is not likely to persuade the Fed to be more aggressive than its stated plan to tighten monetary policy gradually, although the latter likely includes a December rate hike. Last week's November FOMC Statement downplayed the significance of current GDP strength, attributing post-hurricane rebuilding as a reason to expect a temporary jump in growth. (The Atlanta and NY Feds' models now project 3.2-3.3% for Q417 Real GDP growth.) But, the Statement also continued to emphasize that "the Committee is monitoring inflation developments closely." The markets' near-100% probability of a December rate hike might fall if the October Core CPI (due November 15) comes in low. And, if productivity growth remains high into Q417, a low Core CPI may be a good bet.
From a longer perspective, the Fed's estimate of longer-term non-inflationary trend Real GDP Growth would need to be raised from 1.8-2.0% if the recent pickup in productivity growth turns out to be the start of a ratcheting up of trend productivity. The Fed's longer-term projections of the funds rate and longer-term Treasury yields probably would be raised, as well. A pickup in trend productivity growth also would prompt the Congressional Budget Office to lower its longer-term projections of the federal deficit, social security/medicare deficit, etc.
Nonfarm Business Productivity has been strong in the past two quarters, rising 1.5% (q/q, saar) in Q217 and 3.0% in Q317. They account for much of the 3.8-3.9% gains in Nonfarm Business Output in these quarters. Together, they are among the strongest two-quarter consecutive gains in productivity outside of the rebounds typically seen after the end of a recession. The expansion of the internet, particularly in the retail space, may help explain the strength of productivity. The retail sector certainly has become more efficient as a result of on-line buying and centralized warehousing. Also, the rebound in domestic oil production is likely a high-productivity industry and helped boost overall productivity growth in the past two quarters as output responded to higher oil prices.
Productivity's strength dampens the inflationary implications of higher wage growth. Thanks to the strength of productivity, Unit Labor Costs (Compensation/Hour divided by Productivity) remained negligible in Q317. To be sure, it's not clear that wage inflation is picking up. While Compensation/Hour -- the broadest measure of labor costs -- sped up in Q317, the speedup may be just an offset to the slowdown in Q217. A similar pattern is seen in the Employment Cost Index -- the labor cost measure least affected by composition shifts between low- and high-paid workers. In both cases, the y/y was little changed in Q317. Average Hourly Earnings shows some sign of speedup, but were impacted by the hurricanes (positively) in Q317 and then negatively in October. It remains to be seen if its trend has moved up.
(q/q percent change, saar) (y/y percent change)
ECI Comp/Hr AHE ULC ECI Comp/Hr AHE ULC
Q117 3.2 4.9 2.4 4.8 2.4 1.9 2.7 0.7
Q217 2.0 1.8 2.6 0.3 2.4 1.1 2.6 -0.2
Q317 2.8 3.5 3.0 0.5 2.5 1.4 2.7 -0.1
Oct17 2.4
The economy's current strength is not likely to persuade the Fed to be more aggressive than its stated plan to tighten monetary policy gradually, although the latter likely includes a December rate hike. Last week's November FOMC Statement downplayed the significance of current GDP strength, attributing post-hurricane rebuilding as a reason to expect a temporary jump in growth. (The Atlanta and NY Feds' models now project 3.2-3.3% for Q417 Real GDP growth.) But, the Statement also continued to emphasize that "the Committee is monitoring inflation developments closely." The markets' near-100% probability of a December rate hike might fall if the October Core CPI (due November 15) comes in low. And, if productivity growth remains high into Q417, a low Core CPI may be a good bet.
From a longer perspective, the Fed's estimate of longer-term non-inflationary trend Real GDP Growth would need to be raised from 1.8-2.0% if the recent pickup in productivity growth turns out to be the start of a ratcheting up of trend productivity. The Fed's longer-term projections of the funds rate and longer-term Treasury yields probably would be raised, as well. A pickup in trend productivity growth also would prompt the Congressional Budget Office to lower its longer-term projections of the federal deficit, social security/medicare deficit, etc.
Sunday, October 29, 2017
Monetary and Fiscal Policies -- Some Short- and Longer-Term Considerations
The markets now assign a near-100% probability to a Fed rate hike in December, and this is not likely to change as a result of this week's FOMC Meeting or key US economic data. Monday's expected low September Core PCE Deflator will just mimic the low Core CPI released a couple of weeks ago. A number of Fed officials already have dismissed currently low inflation as temporary. Wednesday's FOMC Statement should retain the important elements of the prior one, which kept open the door to gradual tightening. Wednesday's October Mfg ISM should be strong, even if it dips as consensus expects. And, Friday's October Employment will be distorted by a post-hurricane rebound in jobs and slowing in Average Hourly Earnings. Indeed, the risk is that the +315k consensus estimate of Payrolls is too low and +0.2% m/m consensus estimate of AHE too high.
All the markets -- stocks, Treasuries and dollar -- should continue to be impacted by the possibility of a tax cut being passed in December. The latter should help sustain the stock market rally and keep upward pressure on Treasury yields and dollar. While stocks could begin the coming week on a cautious note, ahead of earnings reports and the FOMC Statement, they should bounce back in the second half of the week. Note that Fed Governor Powell, the apparent front-runner for the next Fed Chair, speaks on Thursday. He is not likely to deviate from the official Fed line, namely that the economy is strong, inflation is expected to pick up, and policy is on gradual tightening path.
From a longer perspective, a tax cut ironically could be the biggest threat to the continuation of the US economic expansion. A tax cut would push H118 economic growth above the current, already strong 3% pace. But, this boost would be temporary, as Fed and market actions work against the impact of the tax cut on the economy, particularly if inflation speeds up as a result of the stronger economy. To be sure, stocks should rally in anticipation of and for a while after the tax cut is passed, but the rally would likely stall at some point in H118 on the legitimate fears that the Fed will accelerate its tightening plans. These fears also would drive up the dollar and Treasury yields, with the 10-year yield probably exceeding 3%. The restraint from Fed tightening, higher Treasury yields and stronger dollar will build over time, hitting the economy in H218 or H119, just at the time the thrust from the tax cut begins to abate. While the result may be just a sharp slowdown in US economic growth, the risk is that it could slip into recession.
All the markets -- stocks, Treasuries and dollar -- should continue to be impacted by the possibility of a tax cut being passed in December. The latter should help sustain the stock market rally and keep upward pressure on Treasury yields and dollar. While stocks could begin the coming week on a cautious note, ahead of earnings reports and the FOMC Statement, they should bounce back in the second half of the week. Note that Fed Governor Powell, the apparent front-runner for the next Fed Chair, speaks on Thursday. He is not likely to deviate from the official Fed line, namely that the economy is strong, inflation is expected to pick up, and policy is on gradual tightening path.
From a longer perspective, a tax cut ironically could be the biggest threat to the continuation of the US economic expansion. A tax cut would push H118 economic growth above the current, already strong 3% pace. But, this boost would be temporary, as Fed and market actions work against the impact of the tax cut on the economy, particularly if inflation speeds up as a result of the stronger economy. To be sure, stocks should rally in anticipation of and for a while after the tax cut is passed, but the rally would likely stall at some point in H118 on the legitimate fears that the Fed will accelerate its tightening plans. These fears also would drive up the dollar and Treasury yields, with the 10-year yield probably exceeding 3%. The restraint from Fed tightening, higher Treasury yields and stronger dollar will build over time, hitting the economy in H218 or H119, just at the time the thrust from the tax cut begins to abate. While the result may be just a sharp slowdown in US economic growth, the risk is that it could slip into recession.
Sunday, October 22, 2017
Three Market Hurdles This Week -- And What They Mean for the Fed
The markets face three important hurdles this week: many corporate earnings, initial report on Q317 US Real GDP, and an ECB announcement regarding the start of tapering its asset purchase program. The stock market rally is likely to be sustained through these events, as corporate earnings so far have proved to be better than expected, Q317 GDP is likely to be above trend, and the ECB announcement arguably risks being benign. The Treasury market should continue to face downward pressure from the first two events, but not necessarily from the third.
These events, as well as a favorable response by the stock market, may very well persuade the Fed to keep a December rate hike in play when the FOMC meets October 31-November 1 -- even as inflation remains low. This realization could give pause to the stock market rally after the meeting.
Corporate Earnings
Many large corporations report this week, including McDonald's, GM, Ford, Microsoft and Google. S&P 500 earnings appear to be up about 5% so far, above the 4.4% consensus estimate. The above-consensus strength seen to date is consistent with the favorable macroeconomic background for corporate profits (see my blog of September 24).
Q317 Real GDP -- due Friday
Consensus expects 2.6% (q/q, saar) Real GDP Growth in Q317, close to the Atlanta Fed model's projection of 2.7% and above the NY Fed model's 1.5% projection. Consensus and the Atlanta Fed are below the 3.1% Q217 pace but above the 2.3% H117 average and the 1.5% estimated longer-run trend. The strength is especially noteworthy inasmuch as the hurricanes are estimated to have shaved up to 1.0% pt from Q317 Real GDP Growth.
The above-trend pace is likely to continue in Q417, boosted by post-hurricane rebuilding as well as favorable fundamentals. The NY Fed model's early projection is 2.6%. Much of the pickup in GDP Growth this year is attributable to strength in exports (reflecting better growth abroad), a rebound in oil production (thanks to higher oil prices), and a speedup in non-oil related business fixed investment (helped by a Trump-related boost in business sentiment?). All three are likely to continue into Q417. The next evidence on business fixed investment will be this week's report on September Durable Goods Orders.
ECB Announcement -- due Thursday
The ECB is expected to announce that it will start tapering but extend the time-frame of its asset purchases in January. The markets are focused on the size of the reduction in monthly purchases and the length of time the program will be extended. According to a Reuters survey, as reported by CNBC, consensus among economists is for a reduction in the monthly purchases to 40 Bn euros from the current 60 Bn pace. The consensus is divided between expecting a 6-month or a 9-month extension. A market neutral announcement would be a reduction to 20 Bn euros for 12 months, to 30 Bn for 9 months or to 40 Bn for 6 months, according to Citi economists. My guess is that the risk is for a more market friendly announcement, since the ECB probably prefers not to boost the Euro further, inflation remains low, and time is on their side.
The Fed
A dovish ECB -- with positive implications for European economic growth -- would provide more reason for Fed officials to believe a rate hike is warranted. Indeed, the US economy's strength is likely to continue to be evident in the following week, with the October Mfg ISM remaining strong and Payrolls rebounding sharply from the hurricanes.
Fed officials continue to downplay current low inflation in the latest speeches:
Yellen: "the economy [is]now operating near maximum employment and inflation [is] expected to rise to the FOMC's 2 percent objective over the next couple of years."
Dudley: "Slightly above-trend growth is gradually tightening the U.S. labor market, which should support a rise in wage growth over time. When combined with a firmer import price trend—partly reflecting recent depreciation of the dollar—and the fading of effects from a number of temporary, idiosyncratic factors, I expect inflation will rise and stabilize around the FOMC’s 2 percent objective over the medium term."
And, they see the need to continue gradual tightening, particularly in light of easier financial market conditions:
Dudley: "even though inflation is currently somewhat below our longer-run objective, I judge that it is still appropriate to continue to remove monetary policy accommodation gradually. This judgment is supported by the fact that financial conditions have eased, rather than tightened, even as the FOMC has raised its short-term interest rate target range by 75 basis points since last December."
Note that Dudley's emphasis on the easing of financial market conditions suggests that a favorable stock market response to this coming week's events will reinforce a somewhat bearish decision at the following week's FOMC meeting. While he views the easing of financial market conditions in the face of Fed tightening as a conundrum, the easier financial conditions can be explained by my "optimal control" approach to understanding market reactions to the Fed (see my blog of September 20). This approach implies that financial market conditions will tighten when the Fed signals that economic growth is too strong -- which, so far, Fed officials have not.
These events, as well as a favorable response by the stock market, may very well persuade the Fed to keep a December rate hike in play when the FOMC meets October 31-November 1 -- even as inflation remains low. This realization could give pause to the stock market rally after the meeting.
Corporate Earnings
Many large corporations report this week, including McDonald's, GM, Ford, Microsoft and Google. S&P 500 earnings appear to be up about 5% so far, above the 4.4% consensus estimate. The above-consensus strength seen to date is consistent with the favorable macroeconomic background for corporate profits (see my blog of September 24).
Q317 Real GDP -- due Friday
Consensus expects 2.6% (q/q, saar) Real GDP Growth in Q317, close to the Atlanta Fed model's projection of 2.7% and above the NY Fed model's 1.5% projection. Consensus and the Atlanta Fed are below the 3.1% Q217 pace but above the 2.3% H117 average and the 1.5% estimated longer-run trend. The strength is especially noteworthy inasmuch as the hurricanes are estimated to have shaved up to 1.0% pt from Q317 Real GDP Growth.
The above-trend pace is likely to continue in Q417, boosted by post-hurricane rebuilding as well as favorable fundamentals. The NY Fed model's early projection is 2.6%. Much of the pickup in GDP Growth this year is attributable to strength in exports (reflecting better growth abroad), a rebound in oil production (thanks to higher oil prices), and a speedup in non-oil related business fixed investment (helped by a Trump-related boost in business sentiment?). All three are likely to continue into Q417. The next evidence on business fixed investment will be this week's report on September Durable Goods Orders.
ECB Announcement -- due Thursday
The ECB is expected to announce that it will start tapering but extend the time-frame of its asset purchases in January. The markets are focused on the size of the reduction in monthly purchases and the length of time the program will be extended. According to a Reuters survey, as reported by CNBC, consensus among economists is for a reduction in the monthly purchases to 40 Bn euros from the current 60 Bn pace. The consensus is divided between expecting a 6-month or a 9-month extension. A market neutral announcement would be a reduction to 20 Bn euros for 12 months, to 30 Bn for 9 months or to 40 Bn for 6 months, according to Citi economists. My guess is that the risk is for a more market friendly announcement, since the ECB probably prefers not to boost the Euro further, inflation remains low, and time is on their side.
The Fed
A dovish ECB -- with positive implications for European economic growth -- would provide more reason for Fed officials to believe a rate hike is warranted. Indeed, the US economy's strength is likely to continue to be evident in the following week, with the October Mfg ISM remaining strong and Payrolls rebounding sharply from the hurricanes.
Fed officials continue to downplay current low inflation in the latest speeches:
Yellen: "the economy [is]now operating near maximum employment and inflation [is] expected to rise to the FOMC's 2 percent objective over the next couple of years."
Dudley: "Slightly above-trend growth is gradually tightening the U.S. labor market, which should support a rise in wage growth over time. When combined with a firmer import price trend—partly reflecting recent depreciation of the dollar—and the fading of effects from a number of temporary, idiosyncratic factors, I expect inflation will rise and stabilize around the FOMC’s 2 percent objective over the medium term."
And, they see the need to continue gradual tightening, particularly in light of easier financial market conditions:
Dudley: "even though inflation is currently somewhat below our longer-run objective, I judge that it is still appropriate to continue to remove monetary policy accommodation gradually. This judgment is supported by the fact that financial conditions have eased, rather than tightened, even as the FOMC has raised its short-term interest rate target range by 75 basis points since last December."
Note that Dudley's emphasis on the easing of financial market conditions suggests that a favorable stock market response to this coming week's events will reinforce a somewhat bearish decision at the following week's FOMC meeting. While he views the easing of financial market conditions in the face of Fed tightening as a conundrum, the easier financial conditions can be explained by my "optimal control" approach to understanding market reactions to the Fed (see my blog of September 20). This approach implies that financial market conditions will tighten when the Fed signals that economic growth is too strong -- which, so far, Fed officials have not.
Sunday, October 15, 2017
Ideal Macro-Economic Background for Stocks
The stock market is facing an ideal macro-economic backdrop of strong growth and low inflation, with the latter holding down the markets' probability of a December Fed rate hike to 33%. So, the market's rally is likely to continue, helped as well by good Q317 corporate earnings. The Treasury market may have room to further unwind the risk of near-term Fed tightening, but this week's Fed speakers could impact the odds one way or the other. The curve could steepen, as the absence of a December Fed rate hike would raise the probability of higher inflation in the future.
Fed speakers could be this week's highlights, impacting the odds of a December rate hike. If they focus on the latest low reading of the Core CPI, the probability of a hike could fall even more. But, if, as more likely, they adhere to the Fed's position that inflation is expected to pick up ahead, the probability could climb a bit. The most important speakers will be NY Fed President Dudley on Wednesday and Cleveland Fed President Meister (hawk) and Yellen on Friday.
The Claims data have best indicated the economy's strength among US economic data. Although Initial Claims spiked after the hurricanes struck, they have been coming down quickly and were close to their lows in the latest report. Remarkably, Continuing Claims were impacted for only one week. They fell steadily since, making new lows in the latest report. They suggest very temporary job losses from the hurricanes and strong demand for labor. Note that an Initial Claim is filed when a person is newly unemployed. A Continuing Claims is filed in each subsequent week that the person is still unemployed.
The Fed's models continue to project above-trend Q317 GDP growth. The NY Fed model is tracking 1.7% (q/q, saar), while the Atlanta Fed model is at 2.7%. Trend is viewed about 1.5%.
Initial Claims Continuing Claims
July Avg 243k 1.963 Mn
Aug Avg 237 1.951
8/26 Week 236 1.951
9/2 298 1.936
9/9 282 1.979
9/16 259 1.936
9/23 272 1.921
9/30 260 1.886
10/7 243 na
Fed speakers could be this week's highlights, impacting the odds of a December rate hike. If they focus on the latest low reading of the Core CPI, the probability of a hike could fall even more. But, if, as more likely, they adhere to the Fed's position that inflation is expected to pick up ahead, the probability could climb a bit. The most important speakers will be NY Fed President Dudley on Wednesday and Cleveland Fed President Meister (hawk) and Yellen on Friday.
The Claims data have best indicated the economy's strength among US economic data. Although Initial Claims spiked after the hurricanes struck, they have been coming down quickly and were close to their lows in the latest report. Remarkably, Continuing Claims were impacted for only one week. They fell steadily since, making new lows in the latest report. They suggest very temporary job losses from the hurricanes and strong demand for labor. Note that an Initial Claim is filed when a person is newly unemployed. A Continuing Claims is filed in each subsequent week that the person is still unemployed.
The Fed's models continue to project above-trend Q317 GDP growth. The NY Fed model is tracking 1.7% (q/q, saar), while the Atlanta Fed model is at 2.7%. Trend is viewed about 1.5%.
Initial Claims Continuing Claims
July Avg 243k 1.963 Mn
Aug Avg 237 1.951
8/26 Week 236 1.951
9/2 298 1.936
9/9 282 1.979
9/16 259 1.936
9/23 272 1.921
9/30 260 1.886
10/7 243 na
Wednesday, October 11, 2017
September FOMC Minutes and CPI
The September FOMC Minutes, as expected, kept open the door for a December rate hike, but still emphasized some officials' concerns of low inflation:
1. "Members ... expected that economic conditions would evolve in a manner that would warrant gradual increases in the federal funds rate."
2. "In their review of the recent data and the outlook for inflation, participants discussed a number of factors that could be contributing to the low readings on consumer prices this year and weighed the extent to which those factors might be transitory or could prove more persistent."
There appeared to be general agreement that a decision to hike would depend on upcoming economic data. The problem for doing so in the next few months, however, is the likelihood that the hurricanes distorted a wide range of data -- making it difficult to draw conclusions about the underlying trends. This possibility was acknowledged in the Minutes. They said, "Higher prices for gasoline and some other items in the aftermath of the hurricanes would likely boost inflation temporarily...."
This coming Friday's release of the September CPI could be a case in point. News headlines have highlighted that Houston rents jumped as people were forced out of their homes by the storms. This should have some temporary impact on the CPI, possibly affecting owners' equivalent rent -- which in normal circumstances is viewed as an important element in underlying inflation. In principle, the Fed should not put much weight on the report if OER and Core CPI jumps.
But, the Minutes said that, despite the acknowledgement of a hurricane effect, "Some members emphasized that, in considering the timing of further adjustments in the federal funds rate, they would be evaluating incoming information to assess the likelihood that recent low readings on inflation were transitory and that inflation was again on a trajectory consistent with achieving the Committee’s 2 percent objective over the medium term." This emphasis raises the question whether the hawks on the Committee will dismiss a high print for the September CPI. Whether they do or don't could be an important market focus in subsequent Fed speeches.
1. "Members ... expected that economic conditions would evolve in a manner that would warrant gradual increases in the federal funds rate."
2. "In their review of the recent data and the outlook for inflation, participants discussed a number of factors that could be contributing to the low readings on consumer prices this year and weighed the extent to which those factors might be transitory or could prove more persistent."
There appeared to be general agreement that a decision to hike would depend on upcoming economic data. The problem for doing so in the next few months, however, is the likelihood that the hurricanes distorted a wide range of data -- making it difficult to draw conclusions about the underlying trends. This possibility was acknowledged in the Minutes. They said, "Higher prices for gasoline and some other items in the aftermath of the hurricanes would likely boost inflation temporarily...."
This coming Friday's release of the September CPI could be a case in point. News headlines have highlighted that Houston rents jumped as people were forced out of their homes by the storms. This should have some temporary impact on the CPI, possibly affecting owners' equivalent rent -- which in normal circumstances is viewed as an important element in underlying inflation. In principle, the Fed should not put much weight on the report if OER and Core CPI jumps.
But, the Minutes said that, despite the acknowledgement of a hurricane effect, "Some members emphasized that, in considering the timing of further adjustments in the federal funds rate, they would be evaluating incoming information to assess the likelihood that recent low readings on inflation were transitory and that inflation was again on a trajectory consistent with achieving the Committee’s 2 percent objective over the medium term." This emphasis raises the question whether the hawks on the Committee will dismiss a high print for the September CPI. Whether they do or don't could be an important market focus in subsequent Fed speeches.
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