The stock market may have put in a bottom last week, after it held a key support level. While there are still potential hurdles before a sustained rally, there is reason to think the worst is over.
The size and speed of the October-December descent was shocking. Here's one explanation. Stock market valuation was based on expectations of 3% sustained GDP Growth, counting on Trump's pro-growth mantra. These expectations were punctured by two events. First, Powell's early-October comment regarding the so-called neutral rate underscored that the Fed did not intend to support such a high trend. Second, Trump's trade war with China showed he was willing to accept a near-term hit to the economy for a long-term gain. Algorithmic trading models caused a very quick and sharp market adjustment to these changed factors.
With at least the bulk of the market adjustment likely over, stocks likely have room to climb as long as GDP is seen growing near the Fed's 1.8-2.0% trend GDP growth and not headed into recession. There still may be a few hurdles before a sustained rally, however. This week's key US economic data -- December Mfg ISM, Payrolls, Unemployment -- risk being on the soft side (see below). But, they may not have a significant or lasting impact on the stock market, which already has adjusted down to low-growth expectations. Moreover, the Treasury market has built in expectations of no Fed hikes in 2019, which shouldn't change as a result of these data. A possibly more important hurdle is the Q418 earnings season, beginning mid-January. The stock market has not done well in the past two reporting periods. Earnings are expected to slow y/y but still be strong; their macroeconomic background has weakened a bit (see my blog on Dec 16).
There are some near-term positives for the market, as well. Internationally, US/China negotiations are set to resume in early January. China is in the process of passing legislation prohibiting forced technical information transfer. And, Trump issued positive tweets about them. Domestically, resolution of the budget impasse in Washington presumably will happen soon.
This Week's Key US Economic Data
Evidence points to a decline in the Mfg ISM (due January 2), consistent with the consensus estimate of 58.0 versus 59.3 in November. Other business surveys weakened this month, including the Chicago PM (correctly predicted m/m direction of Mfg ISM in each of the past 7 months).
The consensus estimate of a speedup in December Nonfarm Payrolls to +180k m/m from +155k in November may be optimistic. The Claims data have softened a bit, as did the jobs components (on balance) in the Conference Board Consumer Confidence Survey.
Consensus looks for a steady 3.7% Unemployment Rate. There is downside risk from rounding analysis. On an unrounded basis, the Rate was 3.67% in November, so a small decline could round the headline down to 3.6% while a large increase is needed to round it up to 3.8%.
Consensus looks for +0.3% m/m in Average Hourly Earnings, which is consistent with calendar considerations. There is downside risk from a composition shift toward lower-paid holiday workers. Consensus looks for a dip in the y/y to 3.0% from 3.1%. The y/y print would fall to 2.9% if the unrounded m/m is 0.26-0.27%.
Sunday, December 30, 2018
Sunday, December 23, 2018
Stock Weakness Not Over Yet, Favorable Macro Economic Background Needed
The stock market will likely continue moving down sharply into early January, despite NY Fed President Williams' attempt to undo Powell's inflexible portrayal of monetary policy after the FOMC meeting. The partial federal government shutdown may not end quickly. Also, the market probably has to overshoot on the downside before a bottom is put in. Moreover, the most significant factor behind the Q418 plunge in stocks -- concern about a global and US economic slowdown -- may not recede until the Spring. And, if it does, another Fed tightening will likely return to the radar screens. So, any rally then may very well be restrained and short-lived. The macro-economic background may have to be just right -- neither too cold nor too hot -- to keep the Fed on hold.
Market fears of a sharp slowdown in US and global economic growth likely need to subside for stocks to stabilize. Both US and non-US economic data need to point away from recession but not be so strong as to flame fears of further central bank tightening. With sales abroad accounting for about 45% of S&P 500 company revenue, foreign economic growth is almost as important as US growth for these stocks.
The macro background has to be just right to stabilize the stock market without stoking fears of Fed tightening. Immediately ahead, Q119 Real GDP Growth has to be seen above 2.0% (q/q, saar), the Unemployment Rate staying near the current 3.7% level, and Core PCE Deflator inflation remaining below 2.0% (y/y). While it will take several months to get a reliable handle on Q119 GDP Growth, the monthly Unemployment Rate will be available. For the year as a whole, Real GDP Growth near the bottom of the 2.3-2.5% Fed Central Tendency and the Unemployment Rate near the top of the Fed's 3.5-3.7% Central Tendency could keep policy on hold.
A very positive development for stocks would be if GDP Growth is above 2% in 2019 and the Unemployment Rate does not fall. This combination would suggest potential economic growth is higher than the Fed's estimate of 1.8-2.0% -- a very big positive for the profits outlook. There is already reason to think this may be the case. The two main determinants of potential growth -- labor force and productivity growth -- have sped up in the past couple of years. Labor Force is now growing 1.4% (y/y) after trending 1.0%, as the participation rate is no longer trending down. Productivity is growing 1.3%, after trending 1.0% in recent years. Fed officials so far apparently have been reluctant to incorporate these higher rates of growth in their estimate of potential economic growth. It would be a major dovish shift on their part if they do.
Another positive development for stocks would be if wage inflation starts to decelerate while the Unemployment Rate is steady at 3.7% or at least does not speed up if the Rate moves lower. This result would imply a tenuous relationship between the Unemployment Rate and inflation, making a further decline in the Rate less problematical for the Fed. There are several reasons why wage inflation may slow down independently of the Unemployment Rate -- /1/ Increased competition from abroad, as worsening labor market slack pushes down wage rates there; /2/ an ending of the push to boost the minimum wage to $15/hour, as the bulk of the increases may have occurred already; /3/ lower overall inflation, thanks to the drop in oil prices, lifting real wages and taking pressure off the need to increase nominal wages.
Market fears of a sharp slowdown in US and global economic growth likely need to subside for stocks to stabilize. Both US and non-US economic data need to point away from recession but not be so strong as to flame fears of further central bank tightening. With sales abroad accounting for about 45% of S&P 500 company revenue, foreign economic growth is almost as important as US growth for these stocks.
The macro background has to be just right to stabilize the stock market without stoking fears of Fed tightening. Immediately ahead, Q119 Real GDP Growth has to be seen above 2.0% (q/q, saar), the Unemployment Rate staying near the current 3.7% level, and Core PCE Deflator inflation remaining below 2.0% (y/y). While it will take several months to get a reliable handle on Q119 GDP Growth, the monthly Unemployment Rate will be available. For the year as a whole, Real GDP Growth near the bottom of the 2.3-2.5% Fed Central Tendency and the Unemployment Rate near the top of the Fed's 3.5-3.7% Central Tendency could keep policy on hold.
A very positive development for stocks would be if GDP Growth is above 2% in 2019 and the Unemployment Rate does not fall. This combination would suggest potential economic growth is higher than the Fed's estimate of 1.8-2.0% -- a very big positive for the profits outlook. There is already reason to think this may be the case. The two main determinants of potential growth -- labor force and productivity growth -- have sped up in the past couple of years. Labor Force is now growing 1.4% (y/y) after trending 1.0%, as the participation rate is no longer trending down. Productivity is growing 1.3%, after trending 1.0% in recent years. Fed officials so far apparently have been reluctant to incorporate these higher rates of growth in their estimate of potential economic growth. It would be a major dovish shift on their part if they do.
Another positive development for stocks would be if wage inflation starts to decelerate while the Unemployment Rate is steady at 3.7% or at least does not speed up if the Rate moves lower. This result would imply a tenuous relationship between the Unemployment Rate and inflation, making a further decline in the Rate less problematical for the Fed. There are several reasons why wage inflation may slow down independently of the Unemployment Rate -- /1/ Increased competition from abroad, as worsening labor market slack pushes down wage rates there; /2/ an ending of the push to boost the minimum wage to $15/hour, as the bulk of the increases may have occurred already; /3/ lower overall inflation, thanks to the drop in oil prices, lifting real wages and taking pressure off the need to increase nominal wages.
Tuesday, December 18, 2018
How the Fed Could Help Stocks
The Fed has to move away from two concepts at tomorrow's post-FOMC briefing if it wants to address the markets' concerns -- forward guidance and neutral funds rate. While both concepts may have helped when the Fed was beginning to normalize policy, sending the message that rates would stay low for a long time, they now appear to lead market participants to believe the Fed is on a predetermined course to raise rates. While Powell may give lip service to them, he should emphasize the Fed will be ready to move in either direction at any FOMC meeting if the data or circumstances require. Opening the door to cutting rates should be a big positive for stocks.
A major problem with forward guidance is that it could be self-fulfilling by reinforcing market expectations. For example, if the Fed lowers its GDP forecast in its Central Tendencies, the bearish economic view in the market would get a boost and hurt stocks. A further drop in stocks would be a negative for the economic outlook. Moreover, a weaker Fed GDP forecast could persuade companies to pull back from investment and hiring. Bernanke and Paulson fell into that trap in September 2008 when they appeared on TV to say the US was heading to the worst recession ever (they were trying to sell TARP to Congress). Massive layoffs occurred right afterwards.
A major problem with the concept of a neutral funds rate is that it is a feature of what economists call a "steady state" long-run path of the economy. The economy is assumed to be growing at a constant rate, with no effect from "exogenous" factors or initial conditions. In the real world, exogenous factors and initial conditions matter. So, by targeting an unobservable, estimated neutral rate, the Fed could be ignoring important information. At the moment, the stock market is focused on the exogenous -- weakening foreign economic growth, government shutdown possibility, and trade negotiations.
A major problem with forward guidance is that it could be self-fulfilling by reinforcing market expectations. For example, if the Fed lowers its GDP forecast in its Central Tendencies, the bearish economic view in the market would get a boost and hurt stocks. A further drop in stocks would be a negative for the economic outlook. Moreover, a weaker Fed GDP forecast could persuade companies to pull back from investment and hiring. Bernanke and Paulson fell into that trap in September 2008 when they appeared on TV to say the US was heading to the worst recession ever (they were trying to sell TARP to Congress). Massive layoffs occurred right afterwards.
A major problem with the concept of a neutral funds rate is that it is a feature of what economists call a "steady state" long-run path of the economy. The economy is assumed to be growing at a constant rate, with no effect from "exogenous" factors or initial conditions. In the real world, exogenous factors and initial conditions matter. So, by targeting an unobservable, estimated neutral rate, the Fed could be ignoring important information. At the moment, the stock market is focused on the exogenous -- weakening foreign economic growth, government shutdown possibility, and trade negotiations.
Sunday, December 16, 2018
December FOMC Meeting and Q418 Corporate Earnings
The stock market has a chance to stabilize into early January if this week's FOMC Meeting's results are viewed as market friendly (see below). The market still will have to contend with concerns about US and global economic growth, headlines regarding US/China trade negotiations, Democratic attacks on Trump, possible government shutdown, and a slowdown in Q418 corporate earnings. So, any rally after the Meeting may be modest and uneven.
FOMC Meeting
This week's FOMC Meeting probably needs the following results to help stabilize the stock market near term:
1. Hike the funds rate by 25 BPs, signaling officials still see solid economic growth.
2. Lower their estimate of the neutral funds rate, citing increased downside economic risks.
3. Cut the projected number of hikes to 2 from 3 in 2019.
4. Project no hikes in 2020 or 2021, implicitly consistent with a 3.0% neutral funds rate.
5. Make no significant change to the economic forecasts laid out in the Fed's Central Tendencies, suggesting still good growth is expected despite the increased downside risks.
If these results do not come out of the Meeting, the market reaction may very well be negative.
Q318 Corporate Earnings
Corporate earnings (mostly due in January) should slow in Q418 from the huge 28.3% y/y gain seen in Q318. Consensus looks for a slowdown to a still strong 16.9%. Domestic fundamentals softened for the most part in the quarter. Oil earnings should have slowed, as did oil prices. And, domestic profit margins should have contracted somewhat, as prices (measured by the Core CPI) did not climb with Average Hourly Earnings. Moreover, earnings from abroad likely weakened, because of the stronger dollar and softer economic activity. However, US Real GDP Growth on a y/y basis was steady at 3.2%, incorporating the 3.0% q/q Atlanta Fed model estimate for Q418.
Markit
Eurozone Real GDP Oil Prices Trade-Weighted Dollar AHE Core CPI PMI
[ y/y percent change ] (level)
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 2.5 +12.7 -4.1 2.5 1.7 59.7
Q118 2.8 +21.5 -6.6 2.7 1.9 59.1
Q218 2.9 +41.0 -1.8 2.7 2.2 55.9
Q318 3.2 +45.4 +5.1 2.8 2.2 54.3
Q418 3.2 +7.6 +6.4 3.0 2.2 51.7
FOMC Meeting
This week's FOMC Meeting probably needs the following results to help stabilize the stock market near term:
1. Hike the funds rate by 25 BPs, signaling officials still see solid economic growth.
2. Lower their estimate of the neutral funds rate, citing increased downside economic risks.
3. Cut the projected number of hikes to 2 from 3 in 2019.
4. Project no hikes in 2020 or 2021, implicitly consistent with a 3.0% neutral funds rate.
5. Make no significant change to the economic forecasts laid out in the Fed's Central Tendencies, suggesting still good growth is expected despite the increased downside risks.
If these results do not come out of the Meeting, the market reaction may very well be negative.
Q318 Corporate Earnings
Corporate earnings (mostly due in January) should slow in Q418 from the huge 28.3% y/y gain seen in Q318. Consensus looks for a slowdown to a still strong 16.9%. Domestic fundamentals softened for the most part in the quarter. Oil earnings should have slowed, as did oil prices. And, domestic profit margins should have contracted somewhat, as prices (measured by the Core CPI) did not climb with Average Hourly Earnings. Moreover, earnings from abroad likely weakened, because of the stronger dollar and softer economic activity. However, US Real GDP Growth on a y/y basis was steady at 3.2%, incorporating the 3.0% q/q Atlanta Fed model estimate for Q418.
Markit
Eurozone Real GDP Oil Prices Trade-Weighted Dollar AHE Core CPI PMI
[ y/y percent change ] (level)
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 2.5 +12.7 -4.1 2.5 1.7 59.7
Q118 2.8 +21.5 -6.6 2.7 1.9 59.1
Q218 2.9 +41.0 -1.8 2.7 2.2 55.9
Q318 3.2 +45.4 +5.1 2.8 2.2 54.3
Q418 3.2 +7.6 +6.4 3.0 2.2 51.7
Sunday, December 9, 2018
The FOMC Meeting Holds Key to Near-Term Stock Market Stabilization
Some technicians look for the stock market to fall another 20-30% in the coming year. Given the risks of bad outcomes from the US/China trade negotiations and Democratic opposition to Trump in Congress, such a dire prediction cannot be ruled out. However, the outcome of the December 18-19 FOMC Meeting may hold the key to a near-term stabilization of the stock market -- but its message must be just right. The Fed needs to be seen as a steady and judicious hand in a confusing and risky environment. And, the details of the forward guidance cannot be bearish on the economy.
The best result would be if Fed officials stick close to market expectations. They should hike the funds rate by 25 BPs and state that, because of increased uncertainty surrounding the economic outlook, monetary policy will be flexible so as to respond in the appropriate way to how real growth and inflation evolve. And, with all the recent talk by Fed officials of a lower-than-thought neutral funds rate, the Central Tendency for the funds rate should be cut to imply 2 hikes in 2019 and 0 hikes in 2020 and 2021. However, they also should not change their Central Tendency forecasts of the economy or inflation, sending the message that officials still see solid growth and near-2.0% inflation next year.
Fed's September Central Tendencies
2018 2019 2020 2021
Real GDP Growth 3.0-3.2 2.4-2.7 1.8-2.1 1.6-2.0
Unemployment Rate 3.7 3.4-3.6 3.4-3.8 3.5-4.0
PCE Deflator 2.0-2.1 2.0-2.1 2.1-2.2 2.0-2.2
Core PCE Deflator 1.9-2.0 2.0-2.1 2.1-2.2 2.0-2.2
Fed Funds Rate 2.1-2.4 2.9-3.4 3.1-3.6 2.9-3.6
Note: Real GDP Growth and PCE Deflators are Q4/Q4 percent change. Unemployment Rate is Q4 average.
In contrast, if Fed officials downshift their Real GDP growth forecasts or just push rate hikes into the future, the stock market reaction will likely be negative. Lowering the GDP forecast would throw doubt on the wisdom of the 25 BP rate hike at the December meeting. It also would add to market concerns of weaker corporate profits ahead.
The stock market's woes will not necessarily disappear if the FOMC Meeting succeeds in sending a calming message. Besides continuing risks surrounding US/China trade and Congress Versus Trump, the data dependency of Fed policy could impart further market volatility next year, as market participants guess at the policy implications of strong or weak data prints. To be sure, Fed officials will not likely react to any individual data release, but wait to see a trend before acting. There is still a good chance Fed policy will be on hold in H119, as I discussed last week.
This week's US key economic data -- November CPI and Retail Sales -- should have little, if any, influence on the FOMC Meeting's outcome. Consensus estimates of +0.2% m/m Core CPI and (strong) +0.7% m/m Ex Auto Retail Sales would just confirm expectations of a 25 BP hike at the meeting. Weaker prints should not derail a hike.
The best result would be if Fed officials stick close to market expectations. They should hike the funds rate by 25 BPs and state that, because of increased uncertainty surrounding the economic outlook, monetary policy will be flexible so as to respond in the appropriate way to how real growth and inflation evolve. And, with all the recent talk by Fed officials of a lower-than-thought neutral funds rate, the Central Tendency for the funds rate should be cut to imply 2 hikes in 2019 and 0 hikes in 2020 and 2021. However, they also should not change their Central Tendency forecasts of the economy or inflation, sending the message that officials still see solid growth and near-2.0% inflation next year.
Fed's September Central Tendencies
2018 2019 2020 2021
Real GDP Growth 3.0-3.2 2.4-2.7 1.8-2.1 1.6-2.0
Unemployment Rate 3.7 3.4-3.6 3.4-3.8 3.5-4.0
PCE Deflator 2.0-2.1 2.0-2.1 2.1-2.2 2.0-2.2
Core PCE Deflator 1.9-2.0 2.0-2.1 2.1-2.2 2.0-2.2
Fed Funds Rate 2.1-2.4 2.9-3.4 3.1-3.6 2.9-3.6
Note: Real GDP Growth and PCE Deflators are Q4/Q4 percent change. Unemployment Rate is Q4 average.
In contrast, if Fed officials downshift their Real GDP growth forecasts or just push rate hikes into the future, the stock market reaction will likely be negative. Lowering the GDP forecast would throw doubt on the wisdom of the 25 BP rate hike at the December meeting. It also would add to market concerns of weaker corporate profits ahead.
The stock market's woes will not necessarily disappear if the FOMC Meeting succeeds in sending a calming message. Besides continuing risks surrounding US/China trade and Congress Versus Trump, the data dependency of Fed policy could impart further market volatility next year, as market participants guess at the policy implications of strong or weak data prints. To be sure, Fed officials will not likely react to any individual data release, but wait to see a trend before acting. There is still a good chance Fed policy will be on hold in H119, as I discussed last week.
This week's US key economic data -- November CPI and Retail Sales -- should have little, if any, influence on the FOMC Meeting's outcome. Consensus estimates of +0.2% m/m Core CPI and (strong) +0.7% m/m Ex Auto Retail Sales would just confirm expectations of a 25 BP hike at the meeting. Weaker prints should not derail a hike.
Friday, December 7, 2018
November Employment Report Doesn't Change Story for the Fed
The November Employment Report does not change the story for the Fed. Economic growth still looks to be above trend in Q418, while inflation remains contained. The possibility that November is the start of a more significant slowdown cannot be ruled out. A December rate hike still looks highly likely, while forward guidance should reflect some caution -- as yesterday's WSJ report hinted.
Although Nonfarm Payrolls slowed to +155k m/m in November, the pace is still above trend. This can be seen in the Unemployment Rate edging down to 3.67% from 3.74% in October (both rounded to 3.7% in the headlines). To be sure, there was some softening in the "margins" of the labor market, so the broader measure, U-6, rebounded to 7.6% from 7.4% in October. It had been bouncing between 7.4% and 7.5% in the prior few months.
In addition to a slowdown in Payrolls, the Average Workweek slipped to 34.4 hours from a prior trend of 34.5 hours. As a result, Total Hours worked fell 0.2% m/m in November. Nevertheless, THW look to be up 1.3-1.5% (q/q, saar) in Q418 (depending on whether THW is steady or rebounds in December) -- stronger than the +1.1% in Q318.
The 0.2% m/m in Average Hourly Earnings matched the average pace seen over the first 10 months of the year. On an unrounded basis, it was actually slightly below this January-October pace (0.22% versus 0.24%). AHE is the narrowest of the major measures of labor costs. The broadest measure -- Compensation/Hour -- was softer over the first 3 quarters of the year.
Although Nonfarm Payrolls slowed to +155k m/m in November, the pace is still above trend. This can be seen in the Unemployment Rate edging down to 3.67% from 3.74% in October (both rounded to 3.7% in the headlines). To be sure, there was some softening in the "margins" of the labor market, so the broader measure, U-6, rebounded to 7.6% from 7.4% in October. It had been bouncing between 7.4% and 7.5% in the prior few months.
In addition to a slowdown in Payrolls, the Average Workweek slipped to 34.4 hours from a prior trend of 34.5 hours. As a result, Total Hours worked fell 0.2% m/m in November. Nevertheless, THW look to be up 1.3-1.5% (q/q, saar) in Q418 (depending on whether THW is steady or rebounds in December) -- stronger than the +1.1% in Q318.
The 0.2% m/m in Average Hourly Earnings matched the average pace seen over the first 10 months of the year. On an unrounded basis, it was actually slightly below this January-October pace (0.22% versus 0.24%). AHE is the narrowest of the major measures of labor costs. The broadest measure -- Compensation/Hour -- was softer over the first 3 quarters of the year.
Sunday, December 2, 2018
Will A December Fed Rate Hike Be the Last for Awhile?
The US/China trade truce should be only a short-term positive for stocks, with the dispute pushed to the back-burner for the next 2-3 months. The market focus now will be back squarely on the Fed. A December rate hike still looks to be in the cards. But, there may a pause in hiking in H119, as economic growth slows and inflation remains low.
Fed Chair Powell's testimony to the Joint Economic Committee on Wednesday should be a highlight of the week, along with the November Employment Report. It is unlikely he will be specific about a December hike or about the extent of tightening next year. Presumably, he is still constrained by the FOMC's forward guidance presented at the September Meeting.
Nevertheless, a December Fed rate hike now looks highly likely, based on Powell's characterization of the US economy as strong and the November FOMC Minutes. But, there are reasons to think the Fed might refrain from hiking rates in H119. There are hints economic growth may slow in Q119 before picking up again in Q219. If this pattern comes about, sufficient evidence to warrant renewed tightening probably would not be available until late Spring. And, core inflation may stay below 2.0% ahead.
Recent US economic data are beginning to support the downside risks to the outlook. In particular, both Initial and Continuing Unemployment Claims rose notably in the past week or two. They need to stay high or rise further to maintain a bearish clue to the outlook.
Unemployment Insurance Claims (level, 000s)
Initial Continuing
July 214 1745
Aug 212 1720
Sep 206 1663
Oct 214 1635
11/3 wk 214 1670
11/10 216 1660
11/17 224 1710
11/24 234 na
Although the Claims data are not reliable evidence regarding the Employment Report, they suggest the consensus estimate of +200k m/m November Payrolls is too high and steady 3.7% Unemployment Rate too low.
Evidence regarding Monday's November Mfg ISM is mixed. The most reliable predictor -- Richmond Fed Mfg Index (correctly predicting direction in 9 of 10 months this year) -- points to a counter-consensus decline. The Chicago PM Index (correct in 7 of past 10 months) -- points to an increase.
To be sure, Q418 Real GDP Growth remains above trend -- in line with Powell's characterization of a currently strong economy. The Atlanta Fed model projects 2.6% for Q418 Real GDP Growth, with consumer spending climbing faster than 3%. The strength would justify a December rate hike.
Meanwhile, core inflation data have softened notably. The Core PCE Deflator has been flat to up only 0.1% m/m in 3 of the past 5 months. The 3-month annualized rate of change is 1.1%. The Market-Based Core PCE Deflator (which excludes imputed prices) has been flat to up 0.1% in 4 of the past 5 months. Its 3-month annualized rate of change is 0.5%. There are several reasons for the low underlying inflation rate, including a slowdown in Unit Labor Costs, softer import prices (in part, due to stronger dollar), and a moderation in housing rent. A filtering through of the recent drop in oil prices should add to these factors in holding down core inflation in coming months.
Core PCE Deflators (m/m percent change)
Oct Sep Aug Jul Jun May Apr Mar
Core PCE Deflator 0.1 0.2 0.0 0.2 0.1 0.2 0.2 0.2
Market-Based Core PCE Deflator 0.0 0.1 0.0 0.2 0.0 0.2 0.2 0.2
Fed Chair Powell's testimony to the Joint Economic Committee on Wednesday should be a highlight of the week, along with the November Employment Report. It is unlikely he will be specific about a December hike or about the extent of tightening next year. Presumably, he is still constrained by the FOMC's forward guidance presented at the September Meeting.
Nevertheless, a December Fed rate hike now looks highly likely, based on Powell's characterization of the US economy as strong and the November FOMC Minutes. But, there are reasons to think the Fed might refrain from hiking rates in H119. There are hints economic growth may slow in Q119 before picking up again in Q219. If this pattern comes about, sufficient evidence to warrant renewed tightening probably would not be available until late Spring. And, core inflation may stay below 2.0% ahead.
Recent US economic data are beginning to support the downside risks to the outlook. In particular, both Initial and Continuing Unemployment Claims rose notably in the past week or two. They need to stay high or rise further to maintain a bearish clue to the outlook.
Unemployment Insurance Claims (level, 000s)
Initial Continuing
July 214 1745
Aug 212 1720
Sep 206 1663
Oct 214 1635
11/3 wk 214 1670
11/10 216 1660
11/17 224 1710
11/24 234 na
Although the Claims data are not reliable evidence regarding the Employment Report, they suggest the consensus estimate of +200k m/m November Payrolls is too high and steady 3.7% Unemployment Rate too low.
Evidence regarding Monday's November Mfg ISM is mixed. The most reliable predictor -- Richmond Fed Mfg Index (correctly predicting direction in 9 of 10 months this year) -- points to a counter-consensus decline. The Chicago PM Index (correct in 7 of past 10 months) -- points to an increase.
To be sure, Q418 Real GDP Growth remains above trend -- in line with Powell's characterization of a currently strong economy. The Atlanta Fed model projects 2.6% for Q418 Real GDP Growth, with consumer spending climbing faster than 3%. The strength would justify a December rate hike.
Meanwhile, core inflation data have softened notably. The Core PCE Deflator has been flat to up only 0.1% m/m in 3 of the past 5 months. The 3-month annualized rate of change is 1.1%. The Market-Based Core PCE Deflator (which excludes imputed prices) has been flat to up 0.1% in 4 of the past 5 months. Its 3-month annualized rate of change is 0.5%. There are several reasons for the low underlying inflation rate, including a slowdown in Unit Labor Costs, softer import prices (in part, due to stronger dollar), and a moderation in housing rent. A filtering through of the recent drop in oil prices should add to these factors in holding down core inflation in coming months.
Core PCE Deflators (m/m percent change)
Oct Sep Aug Jul Jun May Apr Mar
Core PCE Deflator 0.1 0.2 0.0 0.2 0.1 0.2 0.2 0.2
Market-Based Core PCE Deflator 0.0 0.1 0.0 0.2 0.0 0.2 0.2 0.2
Sunday, November 25, 2018
Skipping a Fed Hike in December
If the Fed decides not to hike rates at the December 18-19 FOMC Meeting, they have to do so for convincing reasons in order to avoid adverse market reactions. Otherwise, the Treasury market could view the decision as inflationary and sell off -- which could hurt stocks. The decision perhaps has to be based on economic growth and inflation slowing to below the Fed's Central Tendencies.
So far, Q418 Real GDP growth is slowing but not to below the pace implied by the Fed's 2018 Central Tendency. The Atlanta Fed model currently projects 2.5% for Q418 Real GDP Growth, which is above the 2.1% consistent with the low end of the 3.0-3.2% 2018 forecast. It will be important to see if this projection moves down as more data come in ahead of the FOMC Meeting.
Fed officials could rationalize a decision not to hike by tilting US economic risks to the downside, citing softer foreign economic growth and the drop in the stock market. However, not all measures of financial conditions show a tightening. For example, the Chicago Fed's Financial Conditions Index has remained at a low level (implying easy conditions) for the past several weeks. One factor keeping it low could be the plunge in oil prices. The latter should boost consumption of other goods and services and offset the drag from a stock-related wealth effect.
While skipping a hike would boost stocks, there could be some undesirable fall-out in other markets -- unless the skipping is based on solid arguments. The Treasury yield curve could steepen, as longer-term yields build in higher inflation risks. And, the dollar could fall, putting upward pressure on commodity and import prices. All told, the inflation outlook could worsen, raising the odds of more aggressive Fed tightening ahead.
The undesirable fall-out could be mitigated, however, if upcoming US economic data are soft. In particular, a weak November Employment Report and benign October PCE Deflator would make the economic background more compatible for skipping a hike. Also, a reminder by Fed officials that a hike is a "live" possibility at each FOMC Meeting in 2019 could keep market reactions in check.
The evidence is mixed with regard to the November Employment Report, due December 7. The Claims data softened in early November, raising the possibility of a slowdown in Payrolls or an uptick in the Unemployment Rate. Some of the softness, however, could be temporary, related to the California fires having disrupted economic activity there. In contrast, retail jobs could surge if news reports are correct that large retailers hired many people to deliver packages or to assist in store pickups during the holidays. If there is a surge, it risks reversing sharply in January.
Evidence regarding Average Hourly Earnings is mixed. A surge in relatively low-paid retail jobs would hold down AHE for compositional reasons. But, calendar considerations argue for a 0.2-0.3% m/m increase in Average Hourly Earnings, which would put the y/y at 3.1-3.2% versus 3.1% in October.
The October Core PCE Deflator, due November 29, is likely to be benign. It should print 0.2% m/m, based on the CPI. The latter was boosted by a rebound in Used Car Prices, which has a smaller weight in the PCE Deflator. Also, October's flattening in apparel prices is relatively more important and the pickup in Owners' Equivalent Rent relatively less important in the Deflator than in the CPI. The y/y should fall to 1.9% from 2.0% in September.
So far, Q418 Real GDP growth is slowing but not to below the pace implied by the Fed's 2018 Central Tendency. The Atlanta Fed model currently projects 2.5% for Q418 Real GDP Growth, which is above the 2.1% consistent with the low end of the 3.0-3.2% 2018 forecast. It will be important to see if this projection moves down as more data come in ahead of the FOMC Meeting.
Fed officials could rationalize a decision not to hike by tilting US economic risks to the downside, citing softer foreign economic growth and the drop in the stock market. However, not all measures of financial conditions show a tightening. For example, the Chicago Fed's Financial Conditions Index has remained at a low level (implying easy conditions) for the past several weeks. One factor keeping it low could be the plunge in oil prices. The latter should boost consumption of other goods and services and offset the drag from a stock-related wealth effect.
While skipping a hike would boost stocks, there could be some undesirable fall-out in other markets -- unless the skipping is based on solid arguments. The Treasury yield curve could steepen, as longer-term yields build in higher inflation risks. And, the dollar could fall, putting upward pressure on commodity and import prices. All told, the inflation outlook could worsen, raising the odds of more aggressive Fed tightening ahead.
The undesirable fall-out could be mitigated, however, if upcoming US economic data are soft. In particular, a weak November Employment Report and benign October PCE Deflator would make the economic background more compatible for skipping a hike. Also, a reminder by Fed officials that a hike is a "live" possibility at each FOMC Meeting in 2019 could keep market reactions in check.
The evidence is mixed with regard to the November Employment Report, due December 7. The Claims data softened in early November, raising the possibility of a slowdown in Payrolls or an uptick in the Unemployment Rate. Some of the softness, however, could be temporary, related to the California fires having disrupted economic activity there. In contrast, retail jobs could surge if news reports are correct that large retailers hired many people to deliver packages or to assist in store pickups during the holidays. If there is a surge, it risks reversing sharply in January.
Evidence regarding Average Hourly Earnings is mixed. A surge in relatively low-paid retail jobs would hold down AHE for compositional reasons. But, calendar considerations argue for a 0.2-0.3% m/m increase in Average Hourly Earnings, which would put the y/y at 3.1-3.2% versus 3.1% in October.
The October Core PCE Deflator, due November 29, is likely to be benign. It should print 0.2% m/m, based on the CPI. The latter was boosted by a rebound in Used Car Prices, which has a smaller weight in the PCE Deflator. Also, October's flattening in apparel prices is relatively more important and the pickup in Owners' Equivalent Rent relatively less important in the Deflator than in the CPI. The y/y should fall to 1.9% from 2.0% in September.
Sunday, November 18, 2018
The Trump/Xi Jinping and FOMC Meetings -- Reasons to be Cautious?
There are enough uncertainties regarding the two main upcoming events -- the Trump/Xi Jinping meeting on November 29th and the FOMC Meeting on December 18-19 -- to be cautious about the stock market's near-term outlook.
The market should be helped by growing optimism regarding a resolution of the US/China trade dispute as the November 29th meeting approaches -- unless comments out of Washington suggest otherwise. However, after the meeting, this optimism may fade if the meeting just sets goals for an eventual agreement. Stocks would be especially vulnerable if the second leg of tariffs looks like it will be imposed in January.
Since a 25 BP hike at the December FOMC meeting is highly likely, the question is whether the Fed will change its 2019 rate projection of 3 more hikes, cutting it to, say, 2. This possibility was raised in comments by Fed Vice Chair Clarida and Atlanta Fed President Bostic that the neutral funds rate is close -- seeming to reverse the mid-October comment by Fed Chair Powell that the neutral rate is a long way off. A cut in the Fed's projection of the funds rate in 2020, as well as in 2019 (without a change in the economic projections) would signal a lower neutral rate. -- particularly if it puts the 2020 projection near or at the 2019 level.
It is not clear, however, what rationale Powell would offer if forward guidance changes from 3 hikes to 2. And, the rationale could influence market reactions. If he cites weak growth abroad having tilted economic risks to the downside, stocks might find it troubling that the Fed has shifted toward a bearish US economic outlook. This rationale also would raise doubts about the wisdom of the Fed's decision to hike at the meeting. The latter could be viewed as exacerbating the downside risks to the outlook.
Powell's more recent comment reminding the market that each FOMC meeting will be "live" next year -- as Powell will speak to reporters after each meeting -- fits with the Fed taking a more relaxed approach to tightening and could keep the markets in check. Policy can change quickly if needed. For example, if Fed officials think incoming economic data warrant more aggressive tightening, they do not have to wait until a quarter-end meeting to hike rates. The markets would be more sensitive to US economic data and more restrained ahead of all the FOMC meetings than in the past couple of years. This point would probably be made by Powell in his post-meeting press conference.
The market should be helped by growing optimism regarding a resolution of the US/China trade dispute as the November 29th meeting approaches -- unless comments out of Washington suggest otherwise. However, after the meeting, this optimism may fade if the meeting just sets goals for an eventual agreement. Stocks would be especially vulnerable if the second leg of tariffs looks like it will be imposed in January.
Since a 25 BP hike at the December FOMC meeting is highly likely, the question is whether the Fed will change its 2019 rate projection of 3 more hikes, cutting it to, say, 2. This possibility was raised in comments by Fed Vice Chair Clarida and Atlanta Fed President Bostic that the neutral funds rate is close -- seeming to reverse the mid-October comment by Fed Chair Powell that the neutral rate is a long way off. A cut in the Fed's projection of the funds rate in 2020, as well as in 2019 (without a change in the economic projections) would signal a lower neutral rate. -- particularly if it puts the 2020 projection near or at the 2019 level.
It is not clear, however, what rationale Powell would offer if forward guidance changes from 3 hikes to 2. And, the rationale could influence market reactions. If he cites weak growth abroad having tilted economic risks to the downside, stocks might find it troubling that the Fed has shifted toward a bearish US economic outlook. This rationale also would raise doubts about the wisdom of the Fed's decision to hike at the meeting. The latter could be viewed as exacerbating the downside risks to the outlook.
Powell's more recent comment reminding the market that each FOMC meeting will be "live" next year -- as Powell will speak to reporters after each meeting -- fits with the Fed taking a more relaxed approach to tightening and could keep the markets in check. Policy can change quickly if needed. For example, if Fed officials think incoming economic data warrant more aggressive tightening, they do not have to wait until a quarter-end meeting to hike rates. The markets would be more sensitive to US economic data and more restrained ahead of all the FOMC meetings than in the past couple of years. This point would probably be made by Powell in his post-meeting press conference.
Monday, November 12, 2018
Any Macro Help for Stocks This Week?
The stock market may not get much relief from this week's US economic data or other macroeconomic/political developments.
The US economic data are expected to show a still strong economy with contained inflation. A consensus 0.2% m/m increase in the October Core CPI cannot be ruled out. Used car/truck prices may not fall as much as they did in September. Their 3.0% m/m drop was responsible for the Core CPI rounding down to +0.1% m/m that month. Even if the October Core CPI prints a below-consensus +0.1% m/m, it may not be enough to have more than a transitory effect on the market. Fed officials may have to begin emphasizing a below-2.0% core inflation trend before the market reacts strongly to such prints.
So far, market talk regarding inflation has centered on the speedup in Average Hourly Earnings, a narrow measure of labor costs. There has been little, if any, attention to the more subdued trends in the broader Compensation/Hour and Unit Labor Costs. Fed officials understand they are the best measures of labor costs. Their subdued trends could influence the Fed's forward guidance in a market-positive way at the December FOMC Meeting, even if, as is likely, the funds rate is hiked.
Note that while the newswires made much of Friday's high October PPI print, the underlying component -- Core Ex Trade Services -- was in line with its modest trend. Moreover, the plunge in oil prices should lead to lower airfares and prices of other energy-intensive goods and services in coming months. The plunge also frees up about $200 Bn for consumers (some of which could be offset by lower US oil production and exploration).
The split Congress coming out of the mid-term elections is a potential negative for stocks. If Democrats in the House begin investigations aimed at undermining the Administration, they would likely be seen as a negative. If the two sides cooperate with each other, negotiating legislation to address a variety of issues, the efforts would be good for society. But, if they result in new fiscal stimulus, e.g., infrastructure spending or middle-class tax cuts, the financial markets will feel more pressure to move in ways that crowd out other spending.
Headlines regarding the upcoming Trump/Xi Jinping meeting should continue to provide temporary boosts to the stock market. But, at most, the meeting will probably only result in Trump delaying additional tariffs on Chinese goods in return for continuing discussions and negotiations. A resolution of the US/Chinese dispute will likely take a long time to be achieved. So, the dispute would be put on the back burner by the markets after the meeting.
The global economic slowdown, caused in part by the tariffs and higher dollar, remains an issue for the stock market, particularly as it hurts earnings from abroad. But, the slowdown acts as a drag on US exports, which takes pressure off US markets to crowd out other spending. It also acts to hold down global and US domestic prices, which allows the Fed (and markets) to tolerate faster US real economic growth. So, the market's concern may be overdone.
The US economic data are expected to show a still strong economy with contained inflation. A consensus 0.2% m/m increase in the October Core CPI cannot be ruled out. Used car/truck prices may not fall as much as they did in September. Their 3.0% m/m drop was responsible for the Core CPI rounding down to +0.1% m/m that month. Even if the October Core CPI prints a below-consensus +0.1% m/m, it may not be enough to have more than a transitory effect on the market. Fed officials may have to begin emphasizing a below-2.0% core inflation trend before the market reacts strongly to such prints.
So far, market talk regarding inflation has centered on the speedup in Average Hourly Earnings, a narrow measure of labor costs. There has been little, if any, attention to the more subdued trends in the broader Compensation/Hour and Unit Labor Costs. Fed officials understand they are the best measures of labor costs. Their subdued trends could influence the Fed's forward guidance in a market-positive way at the December FOMC Meeting, even if, as is likely, the funds rate is hiked.
Note that while the newswires made much of Friday's high October PPI print, the underlying component -- Core Ex Trade Services -- was in line with its modest trend. Moreover, the plunge in oil prices should lead to lower airfares and prices of other energy-intensive goods and services in coming months. The plunge also frees up about $200 Bn for consumers (some of which could be offset by lower US oil production and exploration).
The split Congress coming out of the mid-term elections is a potential negative for stocks. If Democrats in the House begin investigations aimed at undermining the Administration, they would likely be seen as a negative. If the two sides cooperate with each other, negotiating legislation to address a variety of issues, the efforts would be good for society. But, if they result in new fiscal stimulus, e.g., infrastructure spending or middle-class tax cuts, the financial markets will feel more pressure to move in ways that crowd out other spending.
Headlines regarding the upcoming Trump/Xi Jinping meeting should continue to provide temporary boosts to the stock market. But, at most, the meeting will probably only result in Trump delaying additional tariffs on Chinese goods in return for continuing discussions and negotiations. A resolution of the US/Chinese dispute will likely take a long time to be achieved. So, the dispute would be put on the back burner by the markets after the meeting.
The global economic slowdown, caused in part by the tariffs and higher dollar, remains an issue for the stock market, particularly as it hurts earnings from abroad. But, the slowdown acts as a drag on US exports, which takes pressure off US markets to crowd out other spending. It also acts to hold down global and US domestic prices, which allows the Fed (and markets) to tolerate faster US real economic growth. So, the market's concern may be overdone.
Sunday, November 4, 2018
This Week's Key Events -- Negative for Stocks?
The stock market may have trouble with the two key events this week -- the midterm elections (Tuesday) and FOMC Meeting (Wednesday-Thursday) -- even if their outcomes match widely-held expectations. While the US economic calendar is light, Monday's October Non-Mfg ISM is likely to fall.
Mid-Term Elections
The conventional view is that a resulting split Congress, with the Democrats controlling the House and Republicans the Senate, would be a mild positive for stocks, based on history. Stocks rallied on a split Congress in the recent past. This past tendency, however, may not play out this time. Two reasons are:
1. A split-Congress was viewed positively by stocks in the past because it would prevent anti-business or re-distribution legislation from being passed. This time, it could prevent passage of pro-business laws. It also could be viewed as hurting Trump's bargaining power in trade negotiations with China and the EU.
2. If the Democrats and Republicans find common ground, such as infrastructure spending as some have reported, this would prompt financial markets to move further to crowd out other spending -- given the economy is operating near full employment. Longer-term yields and dollar would rise and stocks fall.
Even a follow-through of Trump's promise of a post-election executive order to cut middle-income taxes would not likely be a positive for stocks. It also would push the financial markets to crowd out other spending.
FOMC Meeting
There is not likely to be any significant change in the FOMC Statement from what it was in September. It may no longer describe business fixed investment as strong, but that is minor. Nevertheless, the Statement should underscore the Fed's intention to tighten gradually, with no hint of skipping December. Repeating September's language also would accommodate the idea that future rate hikes will be data dependent. With the door still open to the Fed's tightening plans, the markets could be disappointed.
Post Mid-Term Election Rally?
Overall, there may be too much talk of a post mid-term election stock market rally for it to happen as yet. These historical/seasonal patterns have not held in the past 3 months. And, a re-test of the stock market's lows may be needed to dash this talk before a rally is possible. A re-test may happen this week. But, it may be short lived. A low October Core CPI print (due November 14) and firmer positive comments out of the White House regarding the November 29 Trump-Xi Jinping meeting are potential catalysts for a rally.
Mid-Term Elections
The conventional view is that a resulting split Congress, with the Democrats controlling the House and Republicans the Senate, would be a mild positive for stocks, based on history. Stocks rallied on a split Congress in the recent past. This past tendency, however, may not play out this time. Two reasons are:
1. A split-Congress was viewed positively by stocks in the past because it would prevent anti-business or re-distribution legislation from being passed. This time, it could prevent passage of pro-business laws. It also could be viewed as hurting Trump's bargaining power in trade negotiations with China and the EU.
2. If the Democrats and Republicans find common ground, such as infrastructure spending as some have reported, this would prompt financial markets to move further to crowd out other spending -- given the economy is operating near full employment. Longer-term yields and dollar would rise and stocks fall.
Even a follow-through of Trump's promise of a post-election executive order to cut middle-income taxes would not likely be a positive for stocks. It also would push the financial markets to crowd out other spending.
FOMC Meeting
There is not likely to be any significant change in the FOMC Statement from what it was in September. It may no longer describe business fixed investment as strong, but that is minor. Nevertheless, the Statement should underscore the Fed's intention to tighten gradually, with no hint of skipping December. Repeating September's language also would accommodate the idea that future rate hikes will be data dependent. With the door still open to the Fed's tightening plans, the markets could be disappointed.
Post Mid-Term Election Rally?
Overall, there may be too much talk of a post mid-term election stock market rally for it to happen as yet. These historical/seasonal patterns have not held in the past 3 months. And, a re-test of the stock market's lows may be needed to dash this talk before a rally is possible. A re-test may happen this week. But, it may be short lived. A low October Core CPI print (due November 14) and firmer positive comments out of the White House regarding the November 29 Trump-Xi Jinping meeting are potential catalysts for a rally.
Friday, November 2, 2018
October Employment Report Does Not Change the Fed's Issue
The October Employment Report should sustain expectations of a December Fed rate hike. But, the Report does not change the issue faced by the Fed -- economic strength is not translating into significantly higher inflation. Upcoming reports on the October and November CPI remain important with regard to what the Fed does or says at its December FOMC Meeting.
The +250k m/m October Payrolls keeps the 3-month trend in Payrolls above 200k, arguing for additional tightening. But, the jobs strength is pulling people into the labor force, meeting the higher demand for labor and mitigating the pressure on wages. The Labor Force Participation Rate rose in October, keeping the Unemployment Rate steady at 3.7%. Some of the increase could have been sampling noise. Nevertheless, the steadiness in the Participation Rate so far this year runs counter to its demographically-related downtrend -- as Fed Chair Powell keeps pointing out.
The 0.2% m/m increase in October Average Hourly Earnings could have been held down by calendar and composition effects. It is in line with the average m/m pace seen this year. The y/y rose to 3.1% because of base effects -- AHE temporarily fell 0.2% in October 2017. AHE rebounded in November (+0.2%) and December (+0.4%) 2017. But, calendar considerations suggest 0.3% for November and December 2018, which would keep the y/y at 3.1% by year end.
While wage rates have sped up a bit, the broadest measure of labor costs -- Compensation/Hour -- shows a more subdued trend. And, the wage increases may not be inflationary, since a speedup in productivity has slowed Unit Labor Costs.
Labor Cost inflation is slowing, according to its broadest measure. Compensation/Hour has slowed so far this year relative to its 2017 pace. While both years' paces are above the rate of increase in 2016, this year's difference is almost fully offset by stronger productivity. As a result, Unit Labor Costs are up only slightly more than they were in 2016. It is one reason the Core PCE Deflator has risen close to the 2016 pace so far this year. (The Deflator's 2017 slowdown reflected in part a price war in the telephone industry -- margins were cut.)
(percent change over the year)
Compensation/Hour Productivity Unit Labor Costs Core PCE Deflator
2018 * 3.1 1.8 1.2 1.9
2017 3.4 1.1 2.2 1.6
2016 1.1 0.1 0.9 1.8
* over the first 3 quarters, annualized
The +250k m/m October Payrolls keeps the 3-month trend in Payrolls above 200k, arguing for additional tightening. But, the jobs strength is pulling people into the labor force, meeting the higher demand for labor and mitigating the pressure on wages. The Labor Force Participation Rate rose in October, keeping the Unemployment Rate steady at 3.7%. Some of the increase could have been sampling noise. Nevertheless, the steadiness in the Participation Rate so far this year runs counter to its demographically-related downtrend -- as Fed Chair Powell keeps pointing out.
The 0.2% m/m increase in October Average Hourly Earnings could have been held down by calendar and composition effects. It is in line with the average m/m pace seen this year. The y/y rose to 3.1% because of base effects -- AHE temporarily fell 0.2% in October 2017. AHE rebounded in November (+0.2%) and December (+0.4%) 2017. But, calendar considerations suggest 0.3% for November and December 2018, which would keep the y/y at 3.1% by year end.
While wage rates have sped up a bit, the broadest measure of labor costs -- Compensation/Hour -- shows a more subdued trend. And, the wage increases may not be inflationary, since a speedup in productivity has slowed Unit Labor Costs.
Labor Cost inflation is slowing, according to its broadest measure. Compensation/Hour has slowed so far this year relative to its 2017 pace. While both years' paces are above the rate of increase in 2016, this year's difference is almost fully offset by stronger productivity. As a result, Unit Labor Costs are up only slightly more than they were in 2016. It is one reason the Core PCE Deflator has risen close to the 2016 pace so far this year. (The Deflator's 2017 slowdown reflected in part a price war in the telephone industry -- margins were cut.)
(percent change over the year)
Compensation/Hour Productivity Unit Labor Costs Core PCE Deflator
2018 * 3.1 1.8 1.2 1.9
2017 3.4 1.1 2.2 1.6
2016 1.1 0.1 0.9 1.8
* over the first 3 quarters, annualized
Sunday, October 28, 2018
Cracks in the Fed
The stock market correction may not be over until it becomes clear the Fed will hold back from tightening further -- either by skipping a hike in December or suggesting it will be the last for a while. Upcoming inflation data may very well hold the clue. While the risks are for softer-than-consensus wage inflation data this week, the October Core CPI (due November 14) may be more important in influencing market expectations regarding the Fed.
At this point, Fed officials are adhering to their expectation of gradual tightening into 2020, including a December hike and 3 hikes in 2019. However, cracks in their determination are beginning to appear, with the acknowledgement by some that inflation remains subdued and potential economic growth could be stronger than expected. There seems to be growing consensus among officials that future rate decisions will be more data-dependent than in the recent past -- implying not necessarily a 25 BP hike per quarter.
Last week, news stories headlined Fed Vice Chair Clarida reaffirming a commitment for more rate hikes. In fact, most of his speech, academic in nature, focused on reasons not to hike. He emphasized the improvement in productivity growth, the flatness of the Phillips Curve and a lower-than-thought natural rate of unemployment to suggest inflation will remain soft. He argued for further rate hikes based on the idea that keeping the funds rate below r* -- the theoretical and unobservable neutral rate consistent with steady growth and inflation -- would raise the risk of higher inflation in the future.
The problem with r* is that it is a "steady state" concept -- economic growth and inflation are assumed to be independent of initial conditions (e.g., current state of the economy, stringency of bank lending standards) and exogenous factors (e.g., fiscal policy, foreign growth) among other idealistic assumptions. The Fed's econometric model of the US economy has run steady-state simulations, but this required some tinkering and many years of simulation for the model to reach that state. In the real world, initial conditions and exogenous factors matter. Currently, fiscal stimulus would argue that r* should be higher than otherwise, while softer foreign growth would argue for the opposite. Bank lending standards, while easing over the past few quarters, remain tight enough to suggest the funds rate should not be raised further.
In a recent speech, Cleveland Fed President Mester (a hawk) almost admits that forward guidance on the course of the funds rate is no longer relevant. She says with the funds rate now close to its neutral level, rate decisions will be more data dependent than in the recent past.
Similarly, Atlanta Fed President Bostic thinks the Fed is still a few rate hikes away from a neutral level. But, he "intends to weigh the risk of acting too swiftly and choking off the expansion against the risk of having the economy overheat and get into a situation with rising inflation and inflation expectations that would necessitate a muscular policy response. My thinking will be informed by the evolution of the incoming data and from what I'm able to glean from my business contacts."
All the recent Fed speeches have turned cautious because of a recognition that inflation remains subdued despite the strong economic growth and tight labor market. Upcoming wage/price inflation data may very well be the clue to whether the Fed will pull back from its forward guidance on the funds rate at the December FOMC Meeting. This week's inflation data risks underscoring this recognition:
Monday -- Consensus reasonably looks for a soft 0.1% m/m September Core PCE Deflator. The y/y is expected to fall to 1.9% from 2.0%.
Wednesday -- Consensus looks for a speedup in the Q318 Employment Cost Index to 0.7% (q/q) from 0.6% in Q218. This risks being too high. While Average Hourly Earnings (AHE) sped up by 0.1% pt in Q318, it is possible Benefits slowed. For example, news reports made much of Amazon's boosting its minimum wage, but not all mentioned that it cut bonus payments simultaneously. Bonuses impact the ECI's Benefits component but have no impact on AHE.
Thursday -- Consensus looks for +1.2% (q/q, saar) Q318 Unit Labor Costs. This estimate risks being too high. ULC is calculated as the difference between Compensation/Hour and Productivity. Roughly a near-trend 3.0% increase in Compensation/Hour looks reasonable, based on the GDP data. But, Productivity could come in higher than the consensus estimate of an above-trend 2.1%. A flattish ULC would be important for two reasons. First, it is the broadest measure of labor costs. Second, it would show that the pickup in nominal wage inflation just reflects improved productivity and thus is not inflationary. Clarida made a big point about this in his speech.
Friday -- Consensus looks for a high 0.3% m/m in October AHE. Risk is to the downside. Calendar considerations point to 0.1% m/m. Also, composition shifts could have contributed to the high 0.3% September print and could disappear in October.
Next week's real-side data should not be soft enough to convince the Fed to stop tightening, even if they print below consensus.
Wednesday -- ADP Estimate risks printing below the consensus estimate of +189k m/m, as there could be payback for ADP exceeding Payrolls in September. October ADP reversed its September relationship to Payrolls in each of the past 6 years. So, the risk is that whatever prints will underpredict Friday's Nonfarm Payrolls.
Thursday -- Evidence is mixed with regard to the October Mfg ISM, but favors an increase. The Richmond Fed fell, but this might be catch-up to the Mfg ISM after it diverged in direction in September. Also, Richmond Fed could have been impacted by the hurricane. Mfg ISM does not tend to be affected much by weather factors. The Phil Fed Mfg Index (pushed ahead one month) points to an increase. It correctly predicted the direction of Mfg ISM in each of the past 6 months.
Friday -- The consensus estimate of +190k m/m October Nonfarm Payrolls risks being too high. While the factors that held down September Payrolls -- an unwinding of summer jobs or drag from the hurricane -- should either fall out or reverse in October, there could be a drag from another hurricane in October. A lot of attention will be placed on the Unemployment Rate, after it fell to 3.7% in September. Unfortunately, there is no reliable evidence regarding the risks surrounding the consensus estimate of a steady 3.7% in October.
At this point, Fed officials are adhering to their expectation of gradual tightening into 2020, including a December hike and 3 hikes in 2019. However, cracks in their determination are beginning to appear, with the acknowledgement by some that inflation remains subdued and potential economic growth could be stronger than expected. There seems to be growing consensus among officials that future rate decisions will be more data-dependent than in the recent past -- implying not necessarily a 25 BP hike per quarter.
Last week, news stories headlined Fed Vice Chair Clarida reaffirming a commitment for more rate hikes. In fact, most of his speech, academic in nature, focused on reasons not to hike. He emphasized the improvement in productivity growth, the flatness of the Phillips Curve and a lower-than-thought natural rate of unemployment to suggest inflation will remain soft. He argued for further rate hikes based on the idea that keeping the funds rate below r* -- the theoretical and unobservable neutral rate consistent with steady growth and inflation -- would raise the risk of higher inflation in the future.
The problem with r* is that it is a "steady state" concept -- economic growth and inflation are assumed to be independent of initial conditions (e.g., current state of the economy, stringency of bank lending standards) and exogenous factors (e.g., fiscal policy, foreign growth) among other idealistic assumptions. The Fed's econometric model of the US economy has run steady-state simulations, but this required some tinkering and many years of simulation for the model to reach that state. In the real world, initial conditions and exogenous factors matter. Currently, fiscal stimulus would argue that r* should be higher than otherwise, while softer foreign growth would argue for the opposite. Bank lending standards, while easing over the past few quarters, remain tight enough to suggest the funds rate should not be raised further.
In a recent speech, Cleveland Fed President Mester (a hawk) almost admits that forward guidance on the course of the funds rate is no longer relevant. She says with the funds rate now close to its neutral level, rate decisions will be more data dependent than in the recent past.
Similarly, Atlanta Fed President Bostic thinks the Fed is still a few rate hikes away from a neutral level. But, he "intends to weigh the risk of acting too swiftly and choking off the expansion against the risk of having the economy overheat and get into a situation with rising inflation and inflation expectations that would necessitate a muscular policy response. My thinking will be informed by the evolution of the incoming data and from what I'm able to glean from my business contacts."
All the recent Fed speeches have turned cautious because of a recognition that inflation remains subdued despite the strong economic growth and tight labor market. Upcoming wage/price inflation data may very well be the clue to whether the Fed will pull back from its forward guidance on the funds rate at the December FOMC Meeting. This week's inflation data risks underscoring this recognition:
Monday -- Consensus reasonably looks for a soft 0.1% m/m September Core PCE Deflator. The y/y is expected to fall to 1.9% from 2.0%.
Wednesday -- Consensus looks for a speedup in the Q318 Employment Cost Index to 0.7% (q/q) from 0.6% in Q218. This risks being too high. While Average Hourly Earnings (AHE) sped up by 0.1% pt in Q318, it is possible Benefits slowed. For example, news reports made much of Amazon's boosting its minimum wage, but not all mentioned that it cut bonus payments simultaneously. Bonuses impact the ECI's Benefits component but have no impact on AHE.
Thursday -- Consensus looks for +1.2% (q/q, saar) Q318 Unit Labor Costs. This estimate risks being too high. ULC is calculated as the difference between Compensation/Hour and Productivity. Roughly a near-trend 3.0% increase in Compensation/Hour looks reasonable, based on the GDP data. But, Productivity could come in higher than the consensus estimate of an above-trend 2.1%. A flattish ULC would be important for two reasons. First, it is the broadest measure of labor costs. Second, it would show that the pickup in nominal wage inflation just reflects improved productivity and thus is not inflationary. Clarida made a big point about this in his speech.
Friday -- Consensus looks for a high 0.3% m/m in October AHE. Risk is to the downside. Calendar considerations point to 0.1% m/m. Also, composition shifts could have contributed to the high 0.3% September print and could disappear in October.
Next week's real-side data should not be soft enough to convince the Fed to stop tightening, even if they print below consensus.
Wednesday -- ADP Estimate risks printing below the consensus estimate of +189k m/m, as there could be payback for ADP exceeding Payrolls in September. October ADP reversed its September relationship to Payrolls in each of the past 6 years. So, the risk is that whatever prints will underpredict Friday's Nonfarm Payrolls.
Thursday -- Evidence is mixed with regard to the October Mfg ISM, but favors an increase. The Richmond Fed fell, but this might be catch-up to the Mfg ISM after it diverged in direction in September. Also, Richmond Fed could have been impacted by the hurricane. Mfg ISM does not tend to be affected much by weather factors. The Phil Fed Mfg Index (pushed ahead one month) points to an increase. It correctly predicted the direction of Mfg ISM in each of the past 6 months.
Friday -- The consensus estimate of +190k m/m October Nonfarm Payrolls risks being too high. While the factors that held down September Payrolls -- an unwinding of summer jobs or drag from the hurricane -- should either fall out or reverse in October, there could be a drag from another hurricane in October. A lot of attention will be placed on the Unemployment Rate, after it fell to 3.7% in September. Unfortunately, there is no reliable evidence regarding the risks surrounding the consensus estimate of a steady 3.7% in October.
Sunday, October 21, 2018
Volatility Masks Market Stabilization, But Not Over Yet
Believe it or not, the stock and Treasury markets stabilized last week, helped by a softening in almost all the US economic data releases. The S&P 500 Index was flat over the week. The 10-year Treasury yield stayed below the 3.23% high of early October. Sharp volatility masked the stabilization, some of it sparked by an incorrect reaction to the FOMC Minutes and by fear of a Chinese economic slowdown. Portfolio Managers' window dressing and program trading may have exacerbated the volatility, as well. Fears of the Fed and global growth, as well as portfolio adjustments, could continue to buffet the markets into November.
A year-end stock market rally, nevertheless, can happen. Two fundamental triggers to watch for are lower y/y Core PCE Deflator inflation that could persuade the Fed to skip a December hike and an easing in the China/US trade war at a meeting of their leaders in late November.
Although the stock and Treasury markets reacted negatively to the September FOMC Meeting Minutes, the latter, in fact, had little, if any, new news in them. The Fed remains committed to a gradual approach to tightening, and whether they diverge from that path is data dependent. The only update is the Fed staff's slight adjustments in their projections of near-term Real GDP Growth in response to the September hurricanes -- slight downward to Q318 and slight upward revision to Q418. Weak data in September need to rebound in October-November to confirm their forecast. This coming week's data are for September, and therefore not important if they are weak.
An economic slowdown outside of the US could hold the clue as to whether the Fed will stop tightening earlier than planned. There are two elements. First, a slowdown in foreign economic growth hurts US exports. Even though the US does not export a lot to China, a slowdown in the latter impacts EM countries that supply materials to it. Their demand for US goods, in turn, would decline. To be sure, a US economic slowdown to under 3% is what the Fed wants. So, unless growth looks like it will slow much more, say to under 2%, a slowdown in Real GDP Growth may not stop the Fed from tightening further.
Second, slower foreign growth holds down US inflation -- and this could be the more important influence on Fed policy. Relatively weak growth abroad helps lift the dollar. It also depresses prices and wages abroad. And, it puts downward pressure on commodity prices. US import prices should fall, not only holding down US inflation directly but also indirectly through competitive pressures on domestic prices and wages. These forces would come on top of a possible slowdown in owners' equivalent rent, as suggested in the September CPI.
A decline in the y/y for the Core PCE Deflator to below the Fed's 2.0% target could persuade officials to stop tightening. The Core PCE Deflator needs to average less than 0.177% m/m from September through December to pull down the y/y to under 2.0%. There is a good chance the next report, for September (due October 29), will meet this requirement. The October and November CPI will be released before the December 18-19 FOMC Meeting.
Further ahead, a meeting between Trump and Chinese President Xi Jinping on November 29 at a G-20 summit in Buenos Aires is reported to be shaping up, according to Politico. This could put a lid on fears of a worsening trade war, helping the stock market to recover even before the meeting.
A year-end stock market rally, nevertheless, can happen. Two fundamental triggers to watch for are lower y/y Core PCE Deflator inflation that could persuade the Fed to skip a December hike and an easing in the China/US trade war at a meeting of their leaders in late November.
Although the stock and Treasury markets reacted negatively to the September FOMC Meeting Minutes, the latter, in fact, had little, if any, new news in them. The Fed remains committed to a gradual approach to tightening, and whether they diverge from that path is data dependent. The only update is the Fed staff's slight adjustments in their projections of near-term Real GDP Growth in response to the September hurricanes -- slight downward to Q318 and slight upward revision to Q418. Weak data in September need to rebound in October-November to confirm their forecast. This coming week's data are for September, and therefore not important if they are weak.
An economic slowdown outside of the US could hold the clue as to whether the Fed will stop tightening earlier than planned. There are two elements. First, a slowdown in foreign economic growth hurts US exports. Even though the US does not export a lot to China, a slowdown in the latter impacts EM countries that supply materials to it. Their demand for US goods, in turn, would decline. To be sure, a US economic slowdown to under 3% is what the Fed wants. So, unless growth looks like it will slow much more, say to under 2%, a slowdown in Real GDP Growth may not stop the Fed from tightening further.
Second, slower foreign growth holds down US inflation -- and this could be the more important influence on Fed policy. Relatively weak growth abroad helps lift the dollar. It also depresses prices and wages abroad. And, it puts downward pressure on commodity prices. US import prices should fall, not only holding down US inflation directly but also indirectly through competitive pressures on domestic prices and wages. These forces would come on top of a possible slowdown in owners' equivalent rent, as suggested in the September CPI.
A decline in the y/y for the Core PCE Deflator to below the Fed's 2.0% target could persuade officials to stop tightening. The Core PCE Deflator needs to average less than 0.177% m/m from September through December to pull down the y/y to under 2.0%. There is a good chance the next report, for September (due October 29), will meet this requirement. The October and November CPI will be released before the December 18-19 FOMC Meeting.
Further ahead, a meeting between Trump and Chinese President Xi Jinping on November 29 at a G-20 summit in Buenos Aires is reported to be shaping up, according to Politico. This could put a lid on fears of a worsening trade war, helping the stock market to recover even before the meeting.
Sunday, October 14, 2018
US Economic Data Need to Confirm a Slowdown to Stablize Markets
Stocks likely need to form a base after bouncing on Friday. So, they will probably remain volatile for the next several weeks, with lower earnings guidance representing downside risk. Whether stocks resume their uptrend could depend on a softening in upcoming US economic data. Along with continuing low inflation, the latter would support the Fed's gradual approach to tightening and stabilize Treasuries.
Upcoming US economic data have to soften enough to confirm the Fed's expectation of a slowdown in Real GDP Growth to under 3% beginning in Q418. Confirmation would reaffirm the Fed's commitment to a gradual tightening path. And, Fed Chair Powell's unintended hint of more aggressive tightening would be left in the past. The Atlanta Fed model's forecast may take on more importance than normal. It typically gets the markets' attention, even though there is not enough data for a reliable forecast until the first month of the subsequent quarter. The model's first estimate of Q418 Real GDP Growth should be released at the start of November. Currently, it projects 4.2% for Q318 Real GDP.
A softening in US economic data needs to pull down the model's estimate to below 3.0% for Q418, but not so much as to raise the risk of a sharp slowdown to under 2%. The latter would lift recession probabilities. Friday's report of a dip in the Mid-October Michigan Consumer Sentiment Index to 99.0 from 100.1 in September was a start in the right direction. In the coming week, the markets may find relief if the data -- covering the consumer, housing and manufacturing sectors -- are weaker than their prior 3-month averages (see table below). Consensus estimates are mixed relative to these averages.
Meanwhile, inflation remains subdued. The Core CPI risks being held down by a slowdown in housing rent, as it was in September. In addition, underlying import prices remain flattish. Friday's report of a 0.5% m/m jump in September Import Prices was misleading with regard to the inflation outlook. Non-Fuel Import Prices were 0.0% and Non-Auto Consumer Goods Prices fell 0.1%. Even more importantly from the Fed's view, the longer-term 5-year Inflation Expectations in the Michigan Consumer Sentiment Survey fell back to a low of 2.3% in mid-October. Moreover, evidence of slower real growth should weigh on commodity prices ahead.
This Week's US Economic Data
Consensus Estimate Prior 3-Month Average
Retail Sales 0.6% m/m 0.16% m/m
Ex Auto Retail Sales 0.4% 0.51%
Ex Auto/Gas Sales na 0.35%
Industrial Production 0.2% 0.46%
Manufacturing Output na 0.47%
Housing Market Index 67 67.3 level
Housing Starts 1.228 Mn 1.211 Mn Units
Housing Permits 1.229 Mn 1.281 Mn Units
Initial Claims 212k level 209.5k 4-wk avg
Continuing Claims 1.665 Mn level 1.656 Mn 4-wk avg
Phil Fed Mfg Index 22.9 20.2 level
Existing Home Sales 533k Units 535k Units
Follow me on Twitter at @cjslyce. I may comment on just-released US economic data or other market developments. Note I commented on the CPI, Claims and Import Prices last week.
Upcoming US economic data have to soften enough to confirm the Fed's expectation of a slowdown in Real GDP Growth to under 3% beginning in Q418. Confirmation would reaffirm the Fed's commitment to a gradual tightening path. And, Fed Chair Powell's unintended hint of more aggressive tightening would be left in the past. The Atlanta Fed model's forecast may take on more importance than normal. It typically gets the markets' attention, even though there is not enough data for a reliable forecast until the first month of the subsequent quarter. The model's first estimate of Q418 Real GDP Growth should be released at the start of November. Currently, it projects 4.2% for Q318 Real GDP.
A softening in US economic data needs to pull down the model's estimate to below 3.0% for Q418, but not so much as to raise the risk of a sharp slowdown to under 2%. The latter would lift recession probabilities. Friday's report of a dip in the Mid-October Michigan Consumer Sentiment Index to 99.0 from 100.1 in September was a start in the right direction. In the coming week, the markets may find relief if the data -- covering the consumer, housing and manufacturing sectors -- are weaker than their prior 3-month averages (see table below). Consensus estimates are mixed relative to these averages.
Meanwhile, inflation remains subdued. The Core CPI risks being held down by a slowdown in housing rent, as it was in September. In addition, underlying import prices remain flattish. Friday's report of a 0.5% m/m jump in September Import Prices was misleading with regard to the inflation outlook. Non-Fuel Import Prices were 0.0% and Non-Auto Consumer Goods Prices fell 0.1%. Even more importantly from the Fed's view, the longer-term 5-year Inflation Expectations in the Michigan Consumer Sentiment Survey fell back to a low of 2.3% in mid-October. Moreover, evidence of slower real growth should weigh on commodity prices ahead.
This Week's US Economic Data
Consensus Estimate Prior 3-Month Average
Retail Sales 0.6% m/m 0.16% m/m
Ex Auto Retail Sales 0.4% 0.51%
Ex Auto/Gas Sales na 0.35%
Industrial Production 0.2% 0.46%
Manufacturing Output na 0.47%
Housing Market Index 67 67.3 level
Housing Starts 1.228 Mn 1.211 Mn Units
Housing Permits 1.229 Mn 1.281 Mn Units
Initial Claims 212k level 209.5k 4-wk avg
Continuing Claims 1.665 Mn level 1.656 Mn 4-wk avg
Phil Fed Mfg Index 22.9 20.2 level
Existing Home Sales 533k Units 535k Units
Follow me on Twitter at @cjslyce. I may comment on just-released US economic data or other market developments. Note I commented on the CPI, Claims and Import Prices last week.
Thursday, October 11, 2018
The Market Crash and Today's US Economic Data
Today's US economic data -- CPI and Claims -- should help stabilize the Treasury and stock market, based on my analysis of what was behind their plunges in the past few days.
Many commentators are trying to figure out why the Treasury and stock markets plunged over the past few days. My view is that both reflected a loss of confidence in the Fed's economic/policy forecast, sparked by Fed Chair Powell's imprecise comment about the level of the "neutral" funds rate last week. The Fed's forecast calls for a slowing in economic growth in response to a gradual tightening of monetary policy over the next couple of years. Fed Chair Powell's comment was taken by the markets to believe Fed officials don't believe their forecast and think a more aggressive tightening will be needed. Ironically, today's low September CPI supports the Fed's view that inflation is tame and will remain so -- in line with my view, as well.
The markets need to see evidence that Real GDP Growth is slowing to regain confidence in the Fed's outlook. In coming weeks, moderate economic data are good, strong data are bad for the stock market. Today's report on Initial Claims was good from this perspective. Initial Claims rebounded to 214k, putting it above the 206k September average. Continuing Claims have stabilized in the past 3 weeks. Claims are the most important high-frequency indicator of the economy and they need to stabilize to suggest economic growth is moderating toward trend.
Many commentators are trying to figure out why the Treasury and stock markets plunged over the past few days. My view is that both reflected a loss of confidence in the Fed's economic/policy forecast, sparked by Fed Chair Powell's imprecise comment about the level of the "neutral" funds rate last week. The Fed's forecast calls for a slowing in economic growth in response to a gradual tightening of monetary policy over the next couple of years. Fed Chair Powell's comment was taken by the markets to believe Fed officials don't believe their forecast and think a more aggressive tightening will be needed. Ironically, today's low September CPI supports the Fed's view that inflation is tame and will remain so -- in line with my view, as well.
The markets need to see evidence that Real GDP Growth is slowing to regain confidence in the Fed's outlook. In coming weeks, moderate economic data are good, strong data are bad for the stock market. Today's report on Initial Claims was good from this perspective. Initial Claims rebounded to 214k, putting it above the 206k September average. Continuing Claims have stabilized in the past 3 weeks. Claims are the most important high-frequency indicator of the economy and they need to stabilize to suggest economic growth is moderating toward trend.
The most important part of low 0.1% m/m Sept Core CPI is the sharp slowdown in owners' equivalent rent. The latter may be catching up to news reports of slowing housing rent. A lower trend in OER will hold down inflation ahead.
Sunday, October 7, 2018
Implications of Last Week's Sell-Offs in Treasuries and Stocks
The unexpected run-up in longer-term Treasury yields and the consequential drop in stocks late last week may have been an overreaction to Fed Chair Powell's comment, but they have put both markets on the defensive immediately ahead. The September CPI (due Thursday) and the Q318 earnings season (begins this week) will be important. The CPI report may very well be in line with consensus, but a possible uptick in the y/y could spark selling in the markets. Corporate earnings risk exceeding consensus again, but forward guidance could be a problem. In the background, uncertainty regarding the mid-term elections and their implications could weigh on stocks over the next few weeks. A year-end rally in stocks is still likely.
Treasury Market Sell-Off
Last week's sell-off in the Treasury market is said to have been sparked by a comment made by Fed Chair Powell in an interview that the funds rate is "a long way from neutral at this point, probably." I believe the market may have overreacted to it for two reasons. First, the comment may have been a "rookie" mistake, since Powell should not have been so specific regarding a concept that he, himself, has admitted is not measurable. Moreover, Fed officials should realize their idea of magnitude may differ from that of the markets and thus refrain from opining on it if they do not state an estimated level. Chicago Fed President Evans puts the neutral funds rate at 3.0-3.2%, for example. Second, the Fed already specified its expectation for the funds rate's path in its Economic Projections and Dot Chart. This is not new news for the markets.
Ironically, the markets' sell-offs could reinforce the Fed's intention to follow a gradual tightening path. Besides not wanting to precipitate even larger sell-offs, Fed officials are not likely to be frustrated that their approach is not having an effect. In contrast, back in 1994, Greenspan became frustrated that his 25-BP measured pace of tightening was not lifting longer-term yields. As a result, he shocked the markets with 50-75 BP hikes -- that had the desired market effects.
The markets' real problem would be any further fiscal stimulus coming out of Washington -- the most likely being a push for infrastructure spending. The latter would likely "require" the markets to move to crowd out other spending, given the labor market is near or at full employment -- yields would rise and stocks fall. This scenario is probably more an issue for next year. But, there could be talk of doing such spending after the elections, possibly a bi-partisan effort in Congress.
September Core CPI
The 0.2% m/m consensus estimate of the September Core CPI looks reasonable. Some of the components, like apparel, that fell in August could decline again, thanks to bi-monthly sampling. The stronger dollar should continue to exert some downward pressure on prices, while it is probably too soon to see any boost from the second round of tariffs on Chinese goods. (The reported problems being experienced by Chinese companies from the tariffs suggest the latter are not being fully passed through.) Further pass-through of higher oil prices, such as in airfares, is possible, however. The y/y of the Core CPI should be 2.2-2.3%, versus 2.2% in August -- depending on rounding. Consensus is 2.3%. An uptick could be a problem for both Treasuries and stocks.
Q318 Corporate Earnings
Corporate earnings should be strong in Q318, possibly exceeding the 21.5% y/y consensus estimate calculated by Thompson Reuters (versus 24.9% in Q318). But, companies may lower future guidance to reflect the impact of tariffs and stronger dollar. Domestic fundamentals remained strong in the quarter. US Real GDP Growth on a y/y basis sped up, incorporating the 4.1% q/q Atlanta Fed model estimate for Q318. Oil earnings should have accelerated. And, domestic profit margins should have been stable, as prices (measured by the Core CPI) kept pace with Average Hourly Earnings. However, earnings from abroad likely weakened, because of the stronger dollar and softer economic activity.
Markit
Eurozone Real GDP Oil Prices Trade-Weighted Dollar AHE Core CPI PMI
[ y/y percent change ] (level)
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 2.5 +12.7 -4.1 2.5 1.7 59.7
Q118 2.8 +21.5 -6.6 2.7 1.9 59.1
Q218 2.9 +41.0 -1.8 2.7 2.2 55.9
Q318 3.2 +45.4 +5.1 2.8 2.3 54.3
Treasury Market Sell-Off
Last week's sell-off in the Treasury market is said to have been sparked by a comment made by Fed Chair Powell in an interview that the funds rate is "a long way from neutral at this point, probably." I believe the market may have overreacted to it for two reasons. First, the comment may have been a "rookie" mistake, since Powell should not have been so specific regarding a concept that he, himself, has admitted is not measurable. Moreover, Fed officials should realize their idea of magnitude may differ from that of the markets and thus refrain from opining on it if they do not state an estimated level. Chicago Fed President Evans puts the neutral funds rate at 3.0-3.2%, for example. Second, the Fed already specified its expectation for the funds rate's path in its Economic Projections and Dot Chart. This is not new news for the markets.
Ironically, the markets' sell-offs could reinforce the Fed's intention to follow a gradual tightening path. Besides not wanting to precipitate even larger sell-offs, Fed officials are not likely to be frustrated that their approach is not having an effect. In contrast, back in 1994, Greenspan became frustrated that his 25-BP measured pace of tightening was not lifting longer-term yields. As a result, he shocked the markets with 50-75 BP hikes -- that had the desired market effects.
The markets' real problem would be any further fiscal stimulus coming out of Washington -- the most likely being a push for infrastructure spending. The latter would likely "require" the markets to move to crowd out other spending, given the labor market is near or at full employment -- yields would rise and stocks fall. This scenario is probably more an issue for next year. But, there could be talk of doing such spending after the elections, possibly a bi-partisan effort in Congress.
September Core CPI
The 0.2% m/m consensus estimate of the September Core CPI looks reasonable. Some of the components, like apparel, that fell in August could decline again, thanks to bi-monthly sampling. The stronger dollar should continue to exert some downward pressure on prices, while it is probably too soon to see any boost from the second round of tariffs on Chinese goods. (The reported problems being experienced by Chinese companies from the tariffs suggest the latter are not being fully passed through.) Further pass-through of higher oil prices, such as in airfares, is possible, however. The y/y of the Core CPI should be 2.2-2.3%, versus 2.2% in August -- depending on rounding. Consensus is 2.3%. An uptick could be a problem for both Treasuries and stocks.
Q318 Corporate Earnings
Corporate earnings should be strong in Q318, possibly exceeding the 21.5% y/y consensus estimate calculated by Thompson Reuters (versus 24.9% in Q318). But, companies may lower future guidance to reflect the impact of tariffs and stronger dollar. Domestic fundamentals remained strong in the quarter. US Real GDP Growth on a y/y basis sped up, incorporating the 4.1% q/q Atlanta Fed model estimate for Q318. Oil earnings should have accelerated. And, domestic profit margins should have been stable, as prices (measured by the Core CPI) kept pace with Average Hourly Earnings. However, earnings from abroad likely weakened, because of the stronger dollar and softer economic activity.
Markit
Eurozone Real GDP Oil Prices Trade-Weighted Dollar AHE Core CPI PMI
[ y/y percent change ] (level)
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 2.5 +12.7 -4.1 2.5 1.7 59.7
Q118 2.8 +21.5 -6.6 2.7 1.9 59.1
Q218 2.9 +41.0 -1.8 2.7 2.2 55.9
Q318 3.2 +45.4 +5.1 2.8 2.3 54.3
Friday, October 5, 2018
September Employment Report Impacted by Some Temporary Factors
The September Employment Report confirms above-trend economic growth -- but some of the components likely reflect temporary factors.
A more-than-seasonal drop in summer jobs may very well have been behind the below-consensus +134k m/m increase in Payrolls. There were declines in Retail and Leisure jobs, possibly as students returned to school. The Household Survey showed a decline in teen-age employment.
A drop in low-paid summer jobs, as well as calendar considerations, likely contributed to the 0.3% m/m increase in Average Hourly Earnings. Unwinding of these effects should help hold down AHE next month. Calendar considerations point to a 0.1% m/m increase in October. However, the y/y would rise to 2.9-3.0% because AHE fell m/m in October 2017.
The drop in the Unemployment Rate to 3.7% from 3.9% in August confirms above-trend growth. A broader measure of labor market utilization, however, rose to 7.5% from 7.4%, suggesting there is still slack in the labor market.
A more-than-seasonal drop in summer jobs may very well have been behind the below-consensus +134k m/m increase in Payrolls. There were declines in Retail and Leisure jobs, possibly as students returned to school. The Household Survey showed a decline in teen-age employment.
A drop in low-paid summer jobs, as well as calendar considerations, likely contributed to the 0.3% m/m increase in Average Hourly Earnings. Unwinding of these effects should help hold down AHE next month. Calendar considerations point to a 0.1% m/m increase in October. However, the y/y would rise to 2.9-3.0% because AHE fell m/m in October 2017.
The drop in the Unemployment Rate to 3.7% from 3.9% in August confirms above-trend growth. A broader measure of labor market utilization, however, rose to 7.5% from 7.4%, suggesting there is still slack in the labor market.
Sunday, September 30, 2018
This Week's US Economic Data Should Help Stocks
The stock market rally should continue for the next few weeks. The Kavanaugh confirmation vote is at least a week off as the FBI conducts its investigation, and, except for possible implications for the midterm elections, is not market relevant in any case. The trade dispute with China is a longer-term issue, which the market correctly quickly discounts after knee-jerk reactions to headlines. Trade agreements with Canada (tonight?) and EU are more likely to be reached sooner than that with China. And, this week's key US economic data should confirm strong growth.
Monday's release of the September Mfg ISM risks a counter-consensus increase, based on the higher Richmond Fed Mfg Index (having correctly predicted the m/m direction of Mfg ISM each month this year). Even the consensus expectations of a dip to 60.3 from 61.3 would keep the Index at a very high level. Consensus also looks for a dip in the Prices component, which would support the Fed's view that inflation will remain in check -- and possibly temper any softening reaction in Treasury prices to the strong real-side data.
An increase in the Mfg ISM would raise the risk of a counter-consensus increase in the September Non-Mfg ISM, due Wednesday. The two moved in the same direction in each of the past 6 months.
The September Employment Report should confirm above-trend economic growth, but hint at some moderation -- not out of line with the Fed's forecast of a slowdown in Q418. The +185k m/m consensus estimate for Payrolls is below the +207k m/m average so far this year. And, there is downside risk coming from the ending of summer jobs for students that exceeds the seasonal expectation. The flooding from Hurricane Florence probably had little, if any, impact on Payrolls, since it hit the Carolinas at the end of the Payroll Survey Week. Consensus also looks for +185k for the ADP Estimate. The ADP Estimate does not show any bias in predicting September Payrolls in the past few years.
The consensus estimate of a decline in the Unemployment Rate to 3.8% from 3.9% in August is reasonable. The Rate was 3.85%, so even a slight dip would round down the headline print to 3.8%. An increase in Labor Force Participation could keep the Rate steady at 3.9%. This possibility gains credence by the strength of the jobs components of the Conference Board's Consumer Confidence Survey -- people could return to the labor force as job opportunities become widely seen. An increase in Labor Force Participation is a positive for both stocks and Treasuries, as it dampens the inflationary implications of strong economic growth.
Consensus looks for a slowdown in Average Hourly Earnings to +0.3% m/m from the high +0.4% in August. A 0.3% print would argue the trend has ratcheted up a bit. AHE averaged 0.24% m/m so far this year, rising 0.3% or more half the time. Calendar considerations point to a 0.3% print for September, although they may not be reliable after missing in August. It is possible the high August print resulted from an ending of relatively low-paid summer jobs. This might be the case in September, as well. If this is the reason, AHE should slow if not in September than in subsequent months. For September, the y/y would dip to 2.8% from 2.9% with a 0.3% m/m print.
Monday's release of the September Mfg ISM risks a counter-consensus increase, based on the higher Richmond Fed Mfg Index (having correctly predicted the m/m direction of Mfg ISM each month this year). Even the consensus expectations of a dip to 60.3 from 61.3 would keep the Index at a very high level. Consensus also looks for a dip in the Prices component, which would support the Fed's view that inflation will remain in check -- and possibly temper any softening reaction in Treasury prices to the strong real-side data.
An increase in the Mfg ISM would raise the risk of a counter-consensus increase in the September Non-Mfg ISM, due Wednesday. The two moved in the same direction in each of the past 6 months.
The September Employment Report should confirm above-trend economic growth, but hint at some moderation -- not out of line with the Fed's forecast of a slowdown in Q418. The +185k m/m consensus estimate for Payrolls is below the +207k m/m average so far this year. And, there is downside risk coming from the ending of summer jobs for students that exceeds the seasonal expectation. The flooding from Hurricane Florence probably had little, if any, impact on Payrolls, since it hit the Carolinas at the end of the Payroll Survey Week. Consensus also looks for +185k for the ADP Estimate. The ADP Estimate does not show any bias in predicting September Payrolls in the past few years.
The consensus estimate of a decline in the Unemployment Rate to 3.8% from 3.9% in August is reasonable. The Rate was 3.85%, so even a slight dip would round down the headline print to 3.8%. An increase in Labor Force Participation could keep the Rate steady at 3.9%. This possibility gains credence by the strength of the jobs components of the Conference Board's Consumer Confidence Survey -- people could return to the labor force as job opportunities become widely seen. An increase in Labor Force Participation is a positive for both stocks and Treasuries, as it dampens the inflationary implications of strong economic growth.
Consensus looks for a slowdown in Average Hourly Earnings to +0.3% m/m from the high +0.4% in August. A 0.3% print would argue the trend has ratcheted up a bit. AHE averaged 0.24% m/m so far this year, rising 0.3% or more half the time. Calendar considerations point to a 0.3% print for September, although they may not be reliable after missing in August. It is possible the high August print resulted from an ending of relatively low-paid summer jobs. This might be the case in September, as well. If this is the reason, AHE should slow if not in September than in subsequent months. For September, the y/y would dip to 2.8% from 2.9% with a 0.3% m/m print.
Wednesday, September 26, 2018
A Cautious Fed Outlook
Stocks and Treasuries should like today's FOMC Statement. The Fed took a cautious approach to the forecast at today's FOMC Meeting, keeping them consistent with a gradual approach to tightening. It looks for GDP Growth to slow sharply from the 4+% pace of Q218 and perhaps Q318, keeping its forecast of growth reverting to the 1.8-2.0% trend over the next two years. Inflation is expected to stay around 2.0% and the Unemployment Rate to stabilize in the 3.4-3.8% range. Their inflation and unemployment forecasts were little changed from the prior set of Central Tendency forecasts.
The upward revision to 2018 Real GDP Growth risks being insufficient, however. It was raised to 3.0-3.2% (was 2.7-3.0%). This implies 1.2-2.0% for Q418 Real GDP Growth, given the 3.2% H118 pace and assuming the Atlanta Fed model's Q318 forecast of 4.4% is correct. The risk is that Q418 Real GDP Growth will be substantially stronger. Next week's key US economic data -- the September Mfg ISM and Employment Report -- are likely to confirm a continuation of strong growth at the end of Q318.
The upward revision to 2018 Real GDP Growth risks being insufficient, however. It was raised to 3.0-3.2% (was 2.7-3.0%). This implies 1.2-2.0% for Q418 Real GDP Growth, given the 3.2% H118 pace and assuming the Atlanta Fed model's Q318 forecast of 4.4% is correct. The risk is that Q418 Real GDP Growth will be substantially stronger. Next week's key US economic data -- the September Mfg ISM and Employment Report -- are likely to confirm a continuation of strong growth at the end of Q318.
Sunday, September 23, 2018
Some Market Hurdles and The FOMC Meeeting
While the Fed's FOMC Meeting on Tuesday and Wednesday should be the highlight this week, the stock market needs to get through two negative headlines -- the Chinese cancellation of trade talks with the US this week and an apparent White House memo regarding anti-trust investigations of social media companies. In addition, the already announced tariffs on Chinese imports go into effect on Monday, but they should exert only a slight drag on US GDP growth (see my September 17 blog).
The negative headlines represent longer-term concerns for the markets, which could be put on the back burner for now. The reported Chinese decision not to hold high-level trade talks with the US this week shows the issues will take a long time to get resolved. At this point, both sides do not appear willing to compromise. The White House memo regarding social media companies underscores the potential of government interference in the industry. But, any anti-trust investigation is in the future, possibly becoming a more significant risk next year.
Stocks should take this week's FOMC Meeting in stride if not positively. At the minimum, the Fed should retain its gradual approach to tightening (including a 25 BP hike at this meeting). The Statement risks changing the description of monetary policy from saying “the stance of monetary policy remains accommodative,” based on the minutes from the August meeting. Instead, it would indicate the funds rate is "moving closer to the range of estimates of its neutral level." The markets could take it to mean the end of the tightening cycle is in sight, although the minutes of the July meeting indicate officials believe neutrality will be reached in 2019.
The Fed's Central Tendencies should show stronger GDP Growth. A Central Tendency Range of 3.0-3.5% is reasonable, given the 3.2% H118 GDP pace and the Atlanta Fed model's 4.4% forecast for Q318. It remains to be seen whether the Fed raises its projection of 2019 and 2020 Real GDP Growth, as well.
There are two important questions. First, does the Fed still see Real GDP Growth converging to trend by 2020? If so, the forecast would imply officials think the very strong growth of 2018-19 is temporary and their gradual approach to tightening will be enough to contain economic growth. Second, did the Fed raise its estimate of trend from 1.8-2.0%. (A higher estimate of trend productivity growth would be the most likely reason for their doing so.) A boost in trend GDP Growth would be a significant positive for the stock market. It would imply that strong GDP Growth does not have to be restrained as much as would be the case were trend in the 1.8-2.0% range -- a positive for the profits outlook.
The Central Tendencies for the Unemployment Rate and inflation should be little changed. Both the Total and Core PCE Deflator have risen an annualized 2.0-2.1% since December 2017.
Fed's Central Tendency Forecasts
(Q4/Q4 percent change)
2018 2019 2020 Trend
Real GDP Growth 2.7-3.0 2.2-2.6 1.8-2.0 1.8-2.0
Unemployment Rate 3.6-3.7 3.4-3.5 3.4-3.7 4.3-4.6
PCE Deflator 2.0-2.1 2.0-2.2 2.1-2.2 2.0
Core PCE Deflator 1.9-2.0 2.0-2.2 2.1-2.2 na
Fed Chair Powell's post-meeting press conference may underscore the Fed's pro-growth focus. He is said to admire Greenspan's restraint from tightening policy in the late 1990's based on his insight that the technological revolution with the internet would hold down inflation. There was a lot of economic and social benefits at the time coming from the Unemployment Rate being allowed to fall to 3.8-4.0%. And, Powell could reiterate the benefits in the current situation, with inflation under control.
.
The negative headlines represent longer-term concerns for the markets, which could be put on the back burner for now. The reported Chinese decision not to hold high-level trade talks with the US this week shows the issues will take a long time to get resolved. At this point, both sides do not appear willing to compromise. The White House memo regarding social media companies underscores the potential of government interference in the industry. But, any anti-trust investigation is in the future, possibly becoming a more significant risk next year.
Stocks should take this week's FOMC Meeting in stride if not positively. At the minimum, the Fed should retain its gradual approach to tightening (including a 25 BP hike at this meeting). The Statement risks changing the description of monetary policy from saying “the stance of monetary policy remains accommodative,” based on the minutes from the August meeting. Instead, it would indicate the funds rate is "moving closer to the range of estimates of its neutral level." The markets could take it to mean the end of the tightening cycle is in sight, although the minutes of the July meeting indicate officials believe neutrality will be reached in 2019.
The Fed's Central Tendencies should show stronger GDP Growth. A Central Tendency Range of 3.0-3.5% is reasonable, given the 3.2% H118 GDP pace and the Atlanta Fed model's 4.4% forecast for Q318. It remains to be seen whether the Fed raises its projection of 2019 and 2020 Real GDP Growth, as well.
There are two important questions. First, does the Fed still see Real GDP Growth converging to trend by 2020? If so, the forecast would imply officials think the very strong growth of 2018-19 is temporary and their gradual approach to tightening will be enough to contain economic growth. Second, did the Fed raise its estimate of trend from 1.8-2.0%. (A higher estimate of trend productivity growth would be the most likely reason for their doing so.) A boost in trend GDP Growth would be a significant positive for the stock market. It would imply that strong GDP Growth does not have to be restrained as much as would be the case were trend in the 1.8-2.0% range -- a positive for the profits outlook.
The Central Tendencies for the Unemployment Rate and inflation should be little changed. Both the Total and Core PCE Deflator have risen an annualized 2.0-2.1% since December 2017.
Fed's Central Tendency Forecasts
(Q4/Q4 percent change)
2018 2019 2020 Trend
Real GDP Growth 2.7-3.0 2.2-2.6 1.8-2.0 1.8-2.0
Unemployment Rate 3.6-3.7 3.4-3.5 3.4-3.7 4.3-4.6
PCE Deflator 2.0-2.1 2.0-2.2 2.1-2.2 2.0
Core PCE Deflator 1.9-2.0 2.0-2.2 2.1-2.2 na
Fed Chair Powell's post-meeting press conference may underscore the Fed's pro-growth focus. He is said to admire Greenspan's restraint from tightening policy in the late 1990's based on his insight that the technological revolution with the internet would hold down inflation. There was a lot of economic and social benefits at the time coming from the Unemployment Rate being allowed to fall to 3.8-4.0%. And, Powell could reiterate the benefits in the current situation, with inflation under control.
Monday, September 17, 2018
Trump's Tariffs Should Have Only A Slight Drag on US GDP Growth
Trump's latest tariffs on Chinese imports -- 10% to year end and then 15% starting January 1 -- should exert only a slight drag on US GDP Growth. I estimate they will subtract about 0.2% pt from annualized GDP Growth in Q418 and 0.3-0.4% in Q119.
The first round of tariffs would represent a $20 Bn tax if they were all passed through to the consumer. If consumption fell by the full amount, it would equal slightly less than 0.1% of the level of GDP -- or 0.4% pt off the annualized quarterly growth rate when they hit. But, not all of the tariffs may be passed through. And, the tariffs could come out of savings rather than spending. Moreover, the dollar should strengthen, offsetting to some extent the impact of the tariffs on import prices -- although a stronger dollar also would hurt US exports. Net, I estimate about half the full effect hurting the US GDP growth rate.
The first round of tariffs would represent a $20 Bn tax if they were all passed through to the consumer. If consumption fell by the full amount, it would equal slightly less than 0.1% of the level of GDP -- or 0.4% pt off the annualized quarterly growth rate when they hit. But, not all of the tariffs may be passed through. And, the tariffs could come out of savings rather than spending. Moreover, the dollar should strengthen, offsetting to some extent the impact of the tariffs on import prices -- although a stronger dollar also would hurt US exports. Net, I estimate about half the full effect hurting the US GDP growth rate.
Sunday, September 16, 2018
Good Economic Fundamentals Remain Intact -- History and Policy
Amidst mixed headlines about tariffs and trade negotiations, the good economic fundamentals behind the stock market rally remain intact. Last week's US economic data showed continuing strong growth while inflation remains in check. The Atlanta Fed's model projects 4.4% for Q318 Real GDP Growth, with Friday's Retail Sales report (thanks to upward revisions to June and July) boosting its estimate of consumption. Besides the low August Core CPI, the Mid-September Michigan Consumer Sentiment Survey showed a pullback in the important 5-year inflation expectations to their recent low of 2.4%. This week's data releases are relatively minor.
The past week also saw a couple of well-known economists, Larry Summers and Paul Krugman, address the causes of the last recession and anemic recovery. Summers highlighted a non-conventional specification of expectations to explain the depth of the recession. Krugman blamed the stubborn insistence of Republicans on preventing large enough fiscal stimulus for the slow recovery. I view Summers' idea as another attempt by him to shift the focus away from policy mistakes, as did his earlier promotion of "secular stagnation" to explain the anemic recovery. I agree with Krugman regarding the Republicans, but it is not the full story. The Democrats deserve part of the blame for the weak recovery, as well.
To better understand the role of policy in the 2008-09 recession and aftermath requires starting in 2003 when China began using its currency to grab market share and eviscerate the US manufacturing sector. From a macro perspective, some sector of the US economy had to spend more than it earned to offset the drag on GDP from the Chinese incursion. Policymakers, particularly the Fed, relied on the household sector to do so by allowing people to borrow through credit cards and mortgages. Democratic Senators and Congressmen exacerbated this effort by pushing FNMA and Freddie Mac to buy subprime mortgages. This allowed banks to issue subprime mortgages without keeping them on their balance sheets, which explains why they were not as careful in approving mortgages as they should have been. But, then, many of the banks bought the packaged mortgages or leveraged versions of them -- perhaps thinking that agency bonds would not be allowed to default, taking on excessive risk -- which the Fed did not stop in its supervisory role. The result was that relying on the household sector to overspend was not a sustainable approach to offsetting the macro effects of the Chinese incursion.
The risk to mortgages and its derivatives materialized after the Fed began hiking rates in 2005. This led to a pickup in mortgage defaults over the next couple of years, which led the markets to downgrade the value of the mortgage-related securities. With potentially large losses on the banks' books, interbank lending began to dry up as no one could trust the credit worthiness of its counterparts.
In this situation, Bernanke and the Fed made several major mistakes in 2008. First, they viewed the market problem as a liquidity problem. So, they cut the funds rate aggressively over the year. However, the problem was not illiquidity but a lack of confidence. The main result of the lower rates was to boost commodity prices, particularly oil -- which rose to $140/bbl in the summer. The latter killed the consumer. Second, the Fed and Treasury exacerbated the confidence problem by allowing Lehman Brothers to fail. Third, Bernanke and Treasury Secretary Paulson went on TV in September saying the US economy was headed to the worst recession ever -- in order to convince Congress to pass TARP. This prediction killed business expectations, and massive layoffs followed right afterwards.
The consensus narrative of the recession blames the supposed greed of banks for overdoing it on allowing people to take on debt. However, this story does not recognize that banks were doing what policymakers wanted in order to keep GDP Growth up while China was depressing the US manufacturing sector. This incomplete analysis led to overly tight restrictions on bank lending in the aftermath of the recession. This was one major reason for the subpar recovery. The restrictions could not be fully offset by low interest rates because of the zero bound on the latter.
Obama made things worse by blaming the bankers (and the one percenters) for the recession. FDR had done the same thing in the 1930s, using his speeches to castigate businesses. Official berating may have been more important than generally thought in preventing the US economy from rebounding more strongly than it did from the 1931-32 recession. (The failure of the economy to rebound strongly in the 1930s is, I believe, a conundrum for economic historians.) The same result could have been in play in the more recent recovery. Moreover, many of Obama's regulatory actions had anti-growth implications (regardless of whether you agree or not with their aims).
This way of analyzing the 2008-09 recession and subsequent subpar recovery puts a different light on policy under the Trump administration than how it is frequently portrayed. The Republican's shift to deficit spending is not as wrongheaded as many think if it is viewed as a belated move to offset the drag from Chinese imports. The recent easing up of Dodd-Frank bank regulations is in the right direction. And, Trump's pro-business tendencies and deregulatory actions may be important stimulants for economic growth.
The analysis also helps explain why both establishment Democrats and Republicans have fared poorly in elections. Voters at least implicitly understand that both are to blame for the poor economic performance of the past 10 years.
Follow me on Twitter at @cjslyce. I may comment on just-released US economic data or other market developments.
The past week also saw a couple of well-known economists, Larry Summers and Paul Krugman, address the causes of the last recession and anemic recovery. Summers highlighted a non-conventional specification of expectations to explain the depth of the recession. Krugman blamed the stubborn insistence of Republicans on preventing large enough fiscal stimulus for the slow recovery. I view Summers' idea as another attempt by him to shift the focus away from policy mistakes, as did his earlier promotion of "secular stagnation" to explain the anemic recovery. I agree with Krugman regarding the Republicans, but it is not the full story. The Democrats deserve part of the blame for the weak recovery, as well.
To better understand the role of policy in the 2008-09 recession and aftermath requires starting in 2003 when China began using its currency to grab market share and eviscerate the US manufacturing sector. From a macro perspective, some sector of the US economy had to spend more than it earned to offset the drag on GDP from the Chinese incursion. Policymakers, particularly the Fed, relied on the household sector to do so by allowing people to borrow through credit cards and mortgages. Democratic Senators and Congressmen exacerbated this effort by pushing FNMA and Freddie Mac to buy subprime mortgages. This allowed banks to issue subprime mortgages without keeping them on their balance sheets, which explains why they were not as careful in approving mortgages as they should have been. But, then, many of the banks bought the packaged mortgages or leveraged versions of them -- perhaps thinking that agency bonds would not be allowed to default, taking on excessive risk -- which the Fed did not stop in its supervisory role. The result was that relying on the household sector to overspend was not a sustainable approach to offsetting the macro effects of the Chinese incursion.
The risk to mortgages and its derivatives materialized after the Fed began hiking rates in 2005. This led to a pickup in mortgage defaults over the next couple of years, which led the markets to downgrade the value of the mortgage-related securities. With potentially large losses on the banks' books, interbank lending began to dry up as no one could trust the credit worthiness of its counterparts.
In this situation, Bernanke and the Fed made several major mistakes in 2008. First, they viewed the market problem as a liquidity problem. So, they cut the funds rate aggressively over the year. However, the problem was not illiquidity but a lack of confidence. The main result of the lower rates was to boost commodity prices, particularly oil -- which rose to $140/bbl in the summer. The latter killed the consumer. Second, the Fed and Treasury exacerbated the confidence problem by allowing Lehman Brothers to fail. Third, Bernanke and Treasury Secretary Paulson went on TV in September saying the US economy was headed to the worst recession ever -- in order to convince Congress to pass TARP. This prediction killed business expectations, and massive layoffs followed right afterwards.
The consensus narrative of the recession blames the supposed greed of banks for overdoing it on allowing people to take on debt. However, this story does not recognize that banks were doing what policymakers wanted in order to keep GDP Growth up while China was depressing the US manufacturing sector. This incomplete analysis led to overly tight restrictions on bank lending in the aftermath of the recession. This was one major reason for the subpar recovery. The restrictions could not be fully offset by low interest rates because of the zero bound on the latter.
Obama made things worse by blaming the bankers (and the one percenters) for the recession. FDR had done the same thing in the 1930s, using his speeches to castigate businesses. Official berating may have been more important than generally thought in preventing the US economy from rebounding more strongly than it did from the 1931-32 recession. (The failure of the economy to rebound strongly in the 1930s is, I believe, a conundrum for economic historians.) The same result could have been in play in the more recent recovery. Moreover, many of Obama's regulatory actions had anti-growth implications (regardless of whether you agree or not with their aims).
This way of analyzing the 2008-09 recession and subsequent subpar recovery puts a different light on policy under the Trump administration than how it is frequently portrayed. The Republican's shift to deficit spending is not as wrongheaded as many think if it is viewed as a belated move to offset the drag from Chinese imports. The recent easing up of Dodd-Frank bank regulations is in the right direction. And, Trump's pro-business tendencies and deregulatory actions may be important stimulants for economic growth.
The analysis also helps explain why both establishment Democrats and Republicans have fared poorly in elections. Voters at least implicitly understand that both are to blame for the poor economic performance of the past 10 years.
Follow me on Twitter at @cjslyce. I may comment on just-released US economic data or other market developments.
Sunday, September 9, 2018
Stock Market Hurdles This Week
Stocks could stabilize this week, as they might have already largely adjusted to the risk of additional tariffs on Chinese imports and apprehension of Thursday's August CPI report. Apple's new product event on Wednesday may be a positive.
At this point, Trump seems to believe more pressure on the Chinese leadership is needed to change their policy regarding foreign investments in their country. And, the US economy's strength, as seen in Friday's employment report, could mitigate any concern he might have of an untoward impact from tariffs. So, an announcement of additional tariffs would appear to be a real risk. This would not be the case if a meeting between Trump and Xi Jinping is announced for later in the month. But, this may be a long shot, as Trump has insisted that Xi Jinping be willing to address changing his economic growth policies in order to have the meeting. Although new tariffs would not go into effect immediately, their negative announcement impact on stocks could linger as Street economists lower their US GDP forecasts.
The hit to Real GDP Growth from a 25% tariff on $500 Bn of Chinese imports should be less than 1.0% pt, probably closer to 0.5% pt. If the entire $125 Bn in tariffs is passed through to consumers and reduces spending dollar for dollar, 0.7% pt would be subtracted from y/y Real GDP Growth. The spending reduction is likely to be less than dollar for dollar, though. Some of the tariffs may not be passed through, and, to the extent they are, some could reduce saving rather than consumption.
There would be indirect effects, as well, the net effect is indeterminate. A stronger dollar would hurt US net exports, which, in turn, could depress commodity prices. The latter would be a positive for consumption, but also be a negative for domestic mining and oil production. A stronger dollar and lower commodity prices would hurt emerging market countries, as well. Slower growth could persuade the Fed to slow its path of tightening, a pro-growth positive.
The consensus estimates of +0.3% m/m Total and +0.2% for August Core CPI look reasonable. (Y/Y would dip to 2.7% from 2.9% for Total and be steady at 2.4% for Core.) There still could be further pass-through of the tariffs in Household Appliance and New Vehicle prices and higher oil prices in Airline Fares. Most other prices should be subdued. It is of interest whether news accounts of a weakening in housing rent gets captured in the CPI. Housing rent is calculated as a moving average in the CPI, so their shifts tend to come in gradually.
On Friday, the market reacted to the high 0.4% m/m increase in August Average Hourly Earnings. AHE now has risen 0.3-0.4% m/m in 3 of the past 4 months. And, the calendar favors another high print for September 2018. A similarly sustained high wage inflation pace last occurred over September 2017-January 2018. This pickup in wage inflation may not be fully passed through to prices, however, since productivity growth has sped up, as well.
At this point, Trump seems to believe more pressure on the Chinese leadership is needed to change their policy regarding foreign investments in their country. And, the US economy's strength, as seen in Friday's employment report, could mitigate any concern he might have of an untoward impact from tariffs. So, an announcement of additional tariffs would appear to be a real risk. This would not be the case if a meeting between Trump and Xi Jinping is announced for later in the month. But, this may be a long shot, as Trump has insisted that Xi Jinping be willing to address changing his economic growth policies in order to have the meeting. Although new tariffs would not go into effect immediately, their negative announcement impact on stocks could linger as Street economists lower their US GDP forecasts.
The hit to Real GDP Growth from a 25% tariff on $500 Bn of Chinese imports should be less than 1.0% pt, probably closer to 0.5% pt. If the entire $125 Bn in tariffs is passed through to consumers and reduces spending dollar for dollar, 0.7% pt would be subtracted from y/y Real GDP Growth. The spending reduction is likely to be less than dollar for dollar, though. Some of the tariffs may not be passed through, and, to the extent they are, some could reduce saving rather than consumption.
There would be indirect effects, as well, the net effect is indeterminate. A stronger dollar would hurt US net exports, which, in turn, could depress commodity prices. The latter would be a positive for consumption, but also be a negative for domestic mining and oil production. A stronger dollar and lower commodity prices would hurt emerging market countries, as well. Slower growth could persuade the Fed to slow its path of tightening, a pro-growth positive.
The consensus estimates of +0.3% m/m Total and +0.2% for August Core CPI look reasonable. (Y/Y would dip to 2.7% from 2.9% for Total and be steady at 2.4% for Core.) There still could be further pass-through of the tariffs in Household Appliance and New Vehicle prices and higher oil prices in Airline Fares. Most other prices should be subdued. It is of interest whether news accounts of a weakening in housing rent gets captured in the CPI. Housing rent is calculated as a moving average in the CPI, so their shifts tend to come in gradually.
On Friday, the market reacted to the high 0.4% m/m increase in August Average Hourly Earnings. AHE now has risen 0.3-0.4% m/m in 3 of the past 4 months. And, the calendar favors another high print for September 2018. A similarly sustained high wage inflation pace last occurred over September 2017-January 2018. This pickup in wage inflation may not be fully passed through to prices, however, since productivity growth has sped up, as well.
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