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.
Sunday, October 29, 2017
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.
Sunday, October 8, 2017
Next Week's September CPI and the Fed
While corporate earnings -- likely stock market friendly -- will be the dominant market focus this week, the macro focus should remain on whether the Fed will hike rates in December. The September FOMC Minutes, due Wednesday, will probably keep open the door for a rate hike, but may very well lean dovishly by emphasizing low inflation -- inasmuch as the Fed did not hike rates at that meeting. A speech by the dovish Fed Governor Brainard on Thursday could underscore this tilt. But, the September CPI, due Friday, is the key new information that could impact the odds of a December rate hike. A consensus print would keep these odds high for now, although it would likely be neutral for the markets as a December rate hike already is highly anticipated. Nevertheless, a consensus print will not be the last word on the risk of a December rate hike -- it may not translate into a speedup in the September Core PCE Deflator.
Consensus expects the Total CPI to speed up to 0.6% m/m from 0.4% in August, as the run-up in oil prices filtered through to gasoline and other energy prices. With oil prices having stabilized so far in October, this high print will be viewed as temporary. And, as usual, the Core CPI (total less food and energy) will be the more important inflation measure. Consensus expects a 0.2% m/m increase in the Core, the same gain as in August. Such an increase is enough to lift the y/y to 1.8% from 1.7%. But, the 0.2% m/m increase is likely to translate into a 0.1% m/m increase in the Core PCE Deflator, as it did in August. (The slower Core PCE Deflator is primarily because of differences in weights between the PCE Deflator and CPI.) In this case, the September Core PCE Deflator's y/y may stay at 1.3% -- remaining well below the Fed's 2% target. If so, a dovish view of the Fed could return. The September Core PCE is due October 30.
A consensus 0.2% m/m increase in the September Core CPI cannot be ruled out. Declines could be seen in motor vehicle (given the strength of motor vehicle sales) and apparel prices (as warm weather could have delayed introduction of higher-priced autumn clothes), but hotel rates and owners' equivalent rent could remain robust and airline fares may rebound as fuel costs rose.
From a longer perspective, whether the Core CPI climbs to 2.0% next year, as the Fed expects, could depend on owners' equivalent rent staying at its trend 0.3% m/m. Then, an end of the one-off price drops cited by the Fed would result in the Core CPI trending 0.2%+ m/m. But, if owners' equivalent rent slows to 0.2% m/m and other components continue their low trends, then the Core CPI may not reach the Fed's target next year even if the recent price drops end. So, from a longer perspective, the most important component of the CPI to watch is owners' equivalent rent.
Consensus expects the Total CPI to speed up to 0.6% m/m from 0.4% in August, as the run-up in oil prices filtered through to gasoline and other energy prices. With oil prices having stabilized so far in October, this high print will be viewed as temporary. And, as usual, the Core CPI (total less food and energy) will be the more important inflation measure. Consensus expects a 0.2% m/m increase in the Core, the same gain as in August. Such an increase is enough to lift the y/y to 1.8% from 1.7%. But, the 0.2% m/m increase is likely to translate into a 0.1% m/m increase in the Core PCE Deflator, as it did in August. (The slower Core PCE Deflator is primarily because of differences in weights between the PCE Deflator and CPI.) In this case, the September Core PCE Deflator's y/y may stay at 1.3% -- remaining well below the Fed's 2% target. If so, a dovish view of the Fed could return. The September Core PCE is due October 30.
A consensus 0.2% m/m increase in the September Core CPI cannot be ruled out. Declines could be seen in motor vehicle (given the strength of motor vehicle sales) and apparel prices (as warm weather could have delayed introduction of higher-priced autumn clothes), but hotel rates and owners' equivalent rent could remain robust and airline fares may rebound as fuel costs rose.
From a longer perspective, whether the Core CPI climbs to 2.0% next year, as the Fed expects, could depend on owners' equivalent rent staying at its trend 0.3% m/m. Then, an end of the one-off price drops cited by the Fed would result in the Core CPI trending 0.2%+ m/m. But, if owners' equivalent rent slows to 0.2% m/m and other components continue their low trends, then the Core CPI may not reach the Fed's target next year even if the recent price drops end. So, from a longer perspective, the most important component of the CPI to watch is owners' equivalent rent.
Friday, October 6, 2017
September Employment Report Raises Odds of a December Fed Rate Hike
The September Employment Report raises the odds of a Fed rate hike in December, despite the hurricane-related temporary decline in Payrolls. The Household Survey appears to have been much less affected by the bad weather and shows a very strong labor market. And, while the hurricane and technical factors were likely behind the jump in Average Hourly Earnings, some factors working to boost AHE may continue in the next few months.
The stock market will likely resume its rally, as it realizes the underlying economy is strong (as seen in the high prints for the Mfg and Non-Mfg ISMs). Expectations for Q317 corporate earnings, in the 6% y/y range, should not change. And, hope for tax reform should remain. Treasury yields and the dollar should stay supported by these considerations, as well.
Although the 33k decline in September Payrolls was clearly caused by the hurricanes, other factors also played a role in the weak job growth. In particular, retail jobs fell for the 2nd month in a row, reflecting the shift to internet shopping from brick-and-mortar stores. Retail jobs are likely to remain weak for the rest of the year -- especially in November and December -- as retailers already have announced less holiday hiring planned for this year than last.
Besides holding down payroll growth, a downshift in relatively low-paid temp help should boost Average Hourly Earnings in the next few months -- a compositional effect. Also, some retailers said they would rely on higher-paid overtime to handle the holiday crowds. This impact from the retail sector should partly offset the unwinding of the hurricane-related boost to AHE in September. The hurricane-related boost was likely responsible for 0.2% pt of the 0.5% jump in AHE, as the largest m/m payroll decline was in relatively low-paid accommodation and food services. Calendar effects are neutral for both October and November.
The Bureau of Labor Statistics stated that that the Household Survey was not significantly affected by the hurricanes, unlike the Payroll Survey. The BLS said, its "analysis suggests that the net effect of these hurricanes was to reduce the estimate of total nonfarm payroll employment for September. There was no discernible effect on the national unemployment rate." There were no changes to survey procedures. The Household Survey counts people as employed even if they miss work for the entire reference period. And, both the Payroll and Household Surveys do not include Puerto Rico or the US Virgin Islands.
The stock market will likely resume its rally, as it realizes the underlying economy is strong (as seen in the high prints for the Mfg and Non-Mfg ISMs). Expectations for Q317 corporate earnings, in the 6% y/y range, should not change. And, hope for tax reform should remain. Treasury yields and the dollar should stay supported by these considerations, as well.
Although the 33k decline in September Payrolls was clearly caused by the hurricanes, other factors also played a role in the weak job growth. In particular, retail jobs fell for the 2nd month in a row, reflecting the shift to internet shopping from brick-and-mortar stores. Retail jobs are likely to remain weak for the rest of the year -- especially in November and December -- as retailers already have announced less holiday hiring planned for this year than last.
Besides holding down payroll growth, a downshift in relatively low-paid temp help should boost Average Hourly Earnings in the next few months -- a compositional effect. Also, some retailers said they would rely on higher-paid overtime to handle the holiday crowds. This impact from the retail sector should partly offset the unwinding of the hurricane-related boost to AHE in September. The hurricane-related boost was likely responsible for 0.2% pt of the 0.5% jump in AHE, as the largest m/m payroll decline was in relatively low-paid accommodation and food services. Calendar effects are neutral for both October and November.
The Bureau of Labor Statistics stated that that the Household Survey was not significantly affected by the hurricanes, unlike the Payroll Survey. The BLS said, its "analysis suggests that the net effect of these hurricanes was to reduce the estimate of total nonfarm payroll employment for September. There was no discernible effect on the national unemployment rate." There were no changes to survey procedures. The Household Survey counts people as employed even if they miss work for the entire reference period. And, both the Payroll and Household Surveys do not include Puerto Rico or the US Virgin Islands.
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