Stocks should be helped this week by tax reform talk from Trump and key US economic data that confirm moderately strong economic growth and low wage/price inflation. The low inflation data should keep open the possibility that the Fed will skip hiking in September, keeping Treasuries little changed.
The Republicans face two objectives with regard to tax reform. They understand that some form of tax reform is important to pass before the 2018 congressional elections. But, they feel constrained by their desire not to blow out the Federal Deficit. A small tax cut, one that is estimated to boost Real GDP Growth by a modest 0.25-0.5% in the first year, might meet both objectives. It also might be the best result for the markets and economy. Stocks would be helped, while Treasury yields would not climb so much as to significantly raise the odds of a recession in 2019 or 2020.
Why is a Small Tax Cut Better Than a Large Cut?
Smaller is better in this case because the economy is operating near full employment. As a result, a large boost to the economy from tax cuts would elicit a sharp rise in longer-term yields and aggressive Fed tightening. However, the fiscal boost would fade over time, while the drag from higher yields would worsen over time. Arguably, then, the larger the tax cut, the higher the risk of recession a year or so from now.
On the corporate side, a cut in the tax rate may be preferable to the full expensing of a capital investment being discussed. (Full expensing allows companies to deduct the cost of an investment from taxable income in the year the investment is made, rather than spreading the cost over a number of years.) To be sure, full expensing should have a larger bang for the buck than a rate cut in terms of stimulating business spending. But, again, a large boost to business demand would likely be quickly offset by higher yields. Moreover, a simple rate cut would eliminate much of the wrangling between capital-intensive and labor-intensive companies that full expensing would likely spark. And, full expensing would be subsidizing companies' actions to cut labor costs, contrary to the Administration's presumed goal.
This Week's US Economic Data
The key data will be released Wednesday through Friday. Consensus estimates are probably in the ball park, although the risk is that the 0.2% m/m estimate for Average Hourly Earnings is too high. The Fed will be faced with the same quandary as before: moderately strong growth with no inflation.
Consensus
Weds ADP Estimate 183k m/m
1st Revision to Q2 Real GDP 2.7% from 2.6%
Thurs Core PCE Deflator 0.1% m/m
Fri Nonfarm Payrolls 184k
Unemployment Rate 4.3%
Avg Hrly Earnings 0.2% m/m
Mfg ISM +0.2 pt to 56.5
Monday, August 28, 2017
Sunday, August 20, 2017
Ahead of Yellen's Jackson Hole Speech
In her speech next Friday at the Kansas City Fed's Jackson Hole Conference, Fed Chair Yellen is not likely to diverge from the Fed's recent mantra of moderately strong US economic growth, gradual tightening, commencement of balance sheet reduction, and dismissal of recent low inflation prints to temporary factors -- if she mentions these issues at all. Her speech is on Financial Stability, and may very well focus solely on arguing against Congressional attempts at weakening the Dodd-Frank law. The speech could be intended more for Congressional ears than the markets.
While the market currently does not assign a high probability to a Fed rate hike at the September FOMC Meeting, the probability would likely rise in coming weeks if real-side data remain strong and the inflation data speed up. Early evidence, however, suggests that while real-side data should remain strong, at least some inflation data should stay soft. The absence of a clear-cut signal from US economic data will likely keep open the possibility the Fed will skip a September rate hike -- unless Fed officials dispel this possibility in their speeches ahead of the meeting.
Concern About Weakening Dodd-Frank
The Fed's attachment of importance to not weakening Dodd-Frank is seen in a full paragraph devoted to the benefits of financial regulation in the July Minutes, shown below. The ideas expressed there probably offer clues to the substance of Yellen's Jackson Hole speech.
"Participants agreed that the regulatory and supervisory tools developed since the financial crisis had played an important role in fostering financial stability. Changes in regulation had likely helped in making the banking system more resilient to major shocks, in promoting more prudent balance sheet management strategies on the part of non-bank financial institutions, and in reducing the degree to which variations in lending to the private sector intensify cycles in output and in asset prices. Participants agreed that it would not be desirable for the current regulatory framework to be changed in ways that allowed a reemergence of the types of risky practices that contributed to the crisis."
Growing Concern at the Fed About Low Inflation?
The July FOMC Minutes showed that more Fed officials were concerned about low inflation than at the June Meeting. But, the growing concern does not appear to be at a significant level that needs addressing through monetary policy.
The June Minutes said, "With regard to the outlook for inflation, some participants emphasized downside risks, particularly in light of the recent low readings on inflation along with measures of inflation compensation and some survey measures of inflation expectations that were still low. "
The July Minutes said, "Many participants ... saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside." While the word "many" replaced "some" in describing the number of participants with this dovish view, the Minutes weakened the implication by using the word "might" in describing the possibility that inflation stays low. "Might" is the weakest term in Fedspeak to describe a future possibility.
Moreover, the July Minutes also suggested that Fed officials were not ready to change their overall view on the temporary nature of the recent low inflation prints. The Minutes said, "Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors." And, "most participants indicated that they expected inflation to pick up over the next couple of years from its current low level and to stabilize around the Committee’s 2 percent objective over the medium term."
NY Fed President Dudley -- often representative of the Fed leadership thought process -- still thinks a gradual path of tightening is the right policy, according to comments he made in a recent interview.
Fed Still Sees Real GDP Growing Above Trend
The strength of the economy is what's keeping the Fed on a tightening path. Both the Atlanta and NY Fed models project above-trend Real GDP Growth in Q317, based on data released so far. The Atlanta Fed projects 3.8% (q/q, saar), while the NY Fed model projects 2.1%. Trend is viewed at around 1.5%.
The 12k w/w decline in the latest week's Initial Claims to 232k supports the view of above-trend economic growth continuing in Q317 -- if Claims stay near this level in coming weeks. The latest decline puts them below the 239-244 range seen in the past 4 months.
Upcoming US Economic DataThere is no evidence at this point to expect August Payrolls to slow sharply -- printing, say, under 150k. Indeed, with Initial Claims steady to lower in recent weeks, it would seem that August Payrolls will not slow much from the +180k trend, if at all. The August Employment Report, however, is likely to show a small 0.1% m/m increase in Average Hourly Earnings, based on calendar considerations. The y/y would be steady at 2.5%. There are mixed considerations regarding the August CPI, and it is reasonable to expect the Core to print 0.1% or 0.2% m/m. The y/y would print between 1.5% and 1.7%, versus 1.7% in July.
While the market currently does not assign a high probability to a Fed rate hike at the September FOMC Meeting, the probability would likely rise in coming weeks if real-side data remain strong and the inflation data speed up. Early evidence, however, suggests that while real-side data should remain strong, at least some inflation data should stay soft. The absence of a clear-cut signal from US economic data will likely keep open the possibility the Fed will skip a September rate hike -- unless Fed officials dispel this possibility in their speeches ahead of the meeting.
Concern About Weakening Dodd-Frank
The Fed's attachment of importance to not weakening Dodd-Frank is seen in a full paragraph devoted to the benefits of financial regulation in the July Minutes, shown below. The ideas expressed there probably offer clues to the substance of Yellen's Jackson Hole speech.
"Participants agreed that the regulatory and supervisory tools developed since the financial crisis had played an important role in fostering financial stability. Changes in regulation had likely helped in making the banking system more resilient to major shocks, in promoting more prudent balance sheet management strategies on the part of non-bank financial institutions, and in reducing the degree to which variations in lending to the private sector intensify cycles in output and in asset prices. Participants agreed that it would not be desirable for the current regulatory framework to be changed in ways that allowed a reemergence of the types of risky practices that contributed to the crisis."
Growing Concern at the Fed About Low Inflation?
The July FOMC Minutes showed that more Fed officials were concerned about low inflation than at the June Meeting. But, the growing concern does not appear to be at a significant level that needs addressing through monetary policy.
The June Minutes said, "With regard to the outlook for inflation, some participants emphasized downside risks, particularly in light of the recent low readings on inflation along with measures of inflation compensation and some survey measures of inflation expectations that were still low. "
The July Minutes said, "Many participants ... saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside." While the word "many" replaced "some" in describing the number of participants with this dovish view, the Minutes weakened the implication by using the word "might" in describing the possibility that inflation stays low. "Might" is the weakest term in Fedspeak to describe a future possibility.
Moreover, the July Minutes also suggested that Fed officials were not ready to change their overall view on the temporary nature of the recent low inflation prints. The Minutes said, "Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors." And, "most participants indicated that they expected inflation to pick up over the next couple of years from its current low level and to stabilize around the Committee’s 2 percent objective over the medium term."
NY Fed President Dudley -- often representative of the Fed leadership thought process -- still thinks a gradual path of tightening is the right policy, according to comments he made in a recent interview.
Fed Still Sees Real GDP Growing Above Trend
The strength of the economy is what's keeping the Fed on a tightening path. Both the Atlanta and NY Fed models project above-trend Real GDP Growth in Q317, based on data released so far. The Atlanta Fed projects 3.8% (q/q, saar), while the NY Fed model projects 2.1%. Trend is viewed at around 1.5%.
The 12k w/w decline in the latest week's Initial Claims to 232k supports the view of above-trend economic growth continuing in Q317 -- if Claims stay near this level in coming weeks. The latest decline puts them below the 239-244 range seen in the past 4 months.
Upcoming US Economic DataThere is no evidence at this point to expect August Payrolls to slow sharply -- printing, say, under 150k. Indeed, with Initial Claims steady to lower in recent weeks, it would seem that August Payrolls will not slow much from the +180k trend, if at all. The August Employment Report, however, is likely to show a small 0.1% m/m increase in Average Hourly Earnings, based on calendar considerations. The y/y would be steady at 2.5%. There are mixed considerations regarding the August CPI, and it is reasonable to expect the Core to print 0.1% or 0.2% m/m. The y/y would print between 1.5% and 1.7%, versus 1.7% in July.
Tuesday, August 15, 2017
Ahead of the July FOMC Minutes
The markets will be examining Wednesday's release of the July FOMC Minutes for hints that Fed officials were becoming more concerned with the risk of low inflation. The markets may be disappointed, however, given that the July FOMC Statement repeated the same sentence regarding inflation risks found in the June FOMC Statement and also given that the latest low inflation readings were released after the July FOMC Meeting.
If there is a hint, it should be seen in a significant change in the key paragraph in the June FOMC Minutes, shown below. An example is if the word "some" is replaced by "many" or "most" in describing the number of members who are concerned about downside inflation risks.
From the June FOMC Minutes:
"With regard to the outlook for inflation, some participants emphasized downside risks, particularly in light of the recent low readings on inflation along with measures of inflation compensation and some survey measures of inflation expectations that were still low. However, a couple of participants expressed concern that a substantial undershooting of the longer-run normal rate of unemployment could pose an appreciable upside risk to inflation or give rise to macroeconomic or financial imbalances that eventually could lead to a significant economic downturn. Participants agreed that the Committee should continue to monitor inflation developments closely."
The next occasion when Fed officials could weigh in on low inflation is the Jackson Hole Conference on August 24-26. Note that ECB President Draghi will speak at this conference and could discuss low inflation as well as the possibility of curtailing policy stimulus in Europe.
Friday, August 11, 2017
Soft July CPI Raises Odds the Fed May Skip A September Rate Hike
The soft July CPI --only +0.1% m/m for Total and Core -- raises the odds that the Fed may hold back from hiking rates in September. The Core now has risen just 0.1% for four straight months. And, at least some of the slow pace cannot be attributed to one-off price changes. Moreover, the chances are that the July Core PCE Deflator (due August 31) will print 0.1% or lower. Its y/y would fall to 1.4% from 1.5% -- further away from the Fed's 2.0% target. The August CPI is scheduled to be released several days before the September FOMC Meeting, however, so today's report is not the final word ahead of the rate decision.
The most notable sign of low underlying inflation is the deceleration in Primary Rent to 0.2% m/m from its recent trend of 0.3%. The slowdown suggests that the pace of rent increases is adjusting down to wage inflation -- as rent presumably cannot outstrip wage gains forever. To be sure, the lower pace would need to persist in coming months to be credible. This slowdown did not show up in Owners' Equivalent Rent, which rose 0.3%. But, OER reflects a smaller sample and is constructed with an energy adjustment that could be lifting it now. While OER has a much larger weight in the CPI than does Primary Rent (reflecting the large percentage of households owning homes), OER has a smaller weight in the PCE Deflator than in the CPI. As a result, it will boost the Core PCE Deflator less than the Core CPI, suggesting the risk of 0.1% or lower in the Fed's more important Core PCE Deflator.
While Fed officials could point to some components with likely one-off drops, there are others that appear to be one-off jumps, as well. Some of this reflects volatility, with sharp moves following similarly sharp moves but in the opposite direction in the prior month. Some recent price declines could reflect the pass-through of lower oil prices, which has ended for now. For example, airfares fell sharply in May and June, but edged up in July. Airfares in the PCE Deflator, however, are based more on the PPI's measure than the CPI's. And, airfares fell in the July PPI. So, this is another reason why the Core PCE Deflator will print low.
In general, the mixture of increases and declines among components -- which in part could reflect relative price changes -- nets out to a conclusion that overall inflation remains low.
The most notable sign of low underlying inflation is the deceleration in Primary Rent to 0.2% m/m from its recent trend of 0.3%. The slowdown suggests that the pace of rent increases is adjusting down to wage inflation -- as rent presumably cannot outstrip wage gains forever. To be sure, the lower pace would need to persist in coming months to be credible. This slowdown did not show up in Owners' Equivalent Rent, which rose 0.3%. But, OER reflects a smaller sample and is constructed with an energy adjustment that could be lifting it now. While OER has a much larger weight in the CPI than does Primary Rent (reflecting the large percentage of households owning homes), OER has a smaller weight in the PCE Deflator than in the CPI. As a result, it will boost the Core PCE Deflator less than the Core CPI, suggesting the risk of 0.1% or lower in the Fed's more important Core PCE Deflator.
While Fed officials could point to some components with likely one-off drops, there are others that appear to be one-off jumps, as well. Some of this reflects volatility, with sharp moves following similarly sharp moves but in the opposite direction in the prior month. Some recent price declines could reflect the pass-through of lower oil prices, which has ended for now. For example, airfares fell sharply in May and June, but edged up in July. Airfares in the PCE Deflator, however, are based more on the PPI's measure than the CPI's. And, airfares fell in the July PPI. So, this is another reason why the Core PCE Deflator will print low.
In general, the mixture of increases and declines among components -- which in part could reflect relative price changes -- nets out to a conclusion that overall inflation remains low.
Friday, August 4, 2017
Solid July Employment Report
The solid July Employment Report keeps open the door for the Fed to hike the funds rate and begin balance sheet reduction in September. It shows above-trend job growth for the second month in a row as well as a dip in the Unemployment Rate. Wage inflation, however, remains constrained. The economy's strength should keep the stock market rally in place, even with the likelihood of Fed tightening in September. The hit to the long-end of the Treasury curve should be modest, as inflationary pressures remain muted.
The +209k m/m increase in July Payrolls, after +231k in June, exceeded the +184k monthly average so far this year. The July gain was widespread, occurring in the cyclical manufacturing and construction sectors as well as in services. Even department stores added employees this month. The +16k m/m in increase in manufacturing jobs also was noteworthy, as motor vehicle jobs rose despite plants shut down temporarily for an inventory correction.
Total Hours Worked rose 0.2% m/m in July. Their level is is 1.9% (saar) above the Q217 average, raising the odds of 2+% (q/q, saar) Q317 Real GDP Growth -- arguing against a slowdown in economic growth in Q317. Above-trend growth is also suggested by the dip in the Unemployment Rate to 4.3%, which put it below the 4.4% Q217 average.
The 0.3% m/m increase in Average Hourly Earnings was in line with the upward bias from the calendar. More importantly, the y/y was steady at 2.5% -- keeping it at the moderate pace seen in other labor cost measures and signaling no pickup in wage inflation.
The +209k m/m increase in July Payrolls, after +231k in June, exceeded the +184k monthly average so far this year. The July gain was widespread, occurring in the cyclical manufacturing and construction sectors as well as in services. Even department stores added employees this month. The +16k m/m in increase in manufacturing jobs also was noteworthy, as motor vehicle jobs rose despite plants shut down temporarily for an inventory correction.
Total Hours Worked rose 0.2% m/m in July. Their level is is 1.9% (saar) above the Q217 average, raising the odds of 2+% (q/q, saar) Q317 Real GDP Growth -- arguing against a slowdown in economic growth in Q317. Above-trend growth is also suggested by the dip in the Unemployment Rate to 4.3%, which put it below the 4.4% Q217 average.
The 0.3% m/m increase in Average Hourly Earnings was in line with the upward bias from the calendar. More importantly, the y/y was steady at 2.5% -- keeping it at the moderate pace seen in other labor cost measures and signaling no pickup in wage inflation.
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