The stock market should continue to rally over the next 2-3 weeks, as corporate earnings releases stay strong and the Fed keeps rates steady and maintains its gradual stance to tightening at next week's FOMC meeting. A cautious pullback in stocks ahead of the Wednesday rate announcement can't be ruled out. But, more significantly, the rally may very well pause when the corporate earnings season ends in late February, as the market focus shifts to the Fed.
The biggest threat to the rally at this point is the weakening US dollar and what it might mean for the Fed -- will it tighten more aggressively, similarly to what happened in 1987 (see my blogs of January 8, 2018 and December 26, 2017). Although it is probably too soon and too orderly a decline so far for the weak dollar to end the stock market rally, developments in the FX market need to be watched carefully.
A major driver of the dollar weakness is probably the widening trade deficit. This trend should
continue, thanks to higher-priced oil imports and increased demand for imports as the tax cuts boost spending. This means that dollar weakness will persist. And, the monthly trade deficit will get increasing attention from the markets.
Dollar weakness will be a serious problem for the stock market if Washington officials -- either the Treasury or Fed -- say it's a problem. Last week's stock market's sharp reactions to Treasury Secretary Mnuchin's negative-dollar comments and Trump's subsequent positive comment illustrate the importance of the official dollar view for stocks.
The Fed will not likely mention the dollar in next Wednesday's FOMC Statement. FX developments are the purview of the Treasury not the Fed. And, the impacts of the dollar weakness on the real economy and inflation, the purview of the Fed, are not yet noticeable enough to warrant comment. Indeed, the Statement should not change its description of the economic outlook significantly, since last week's sub-3.0% Q417 Real GDP means the Fed does not have to change its overall economic outlook. Discussion of the weaker dollar, as well as the related easing in financial market conditions, will probably be seen in the Minutes of next week's FOMC Meeting, due in a few weeks. It could get the market's attention. Note that if dollar weakness eventually becomes serious enough to warrant an official reaction, coordinated FX intervention rather than a rate hike could be an option.
Next week's key US economic data are not likely to have a major impact on the markets. The January Mfg ISM is likely to come off a bit from its high December print, as have most other manufacturing surveys released so far. Consensus looks for a speedup to a near-trend 180k m/m increase in January Payrolls. (Payrolls averaged 171k m/m in 2017.) Evidence is mixed. Some large retailers closed many stores this month, but seasonals look to offset a lot of post-holiday layoffs. Heavy snow in the Northeast could have boosted ski resort jobs. Calendar considerations point to a modest 0.1% m/m increase in Average Hourly Earnings -- and the y/y would fall to 2.4% from 2.5%.
Sunday, January 28, 2018
Sunday, January 21, 2018
Q417 Real GDP -- The Next Important US Economic Data Release
Stocks should continue to rally this week, lifted by strong corporate earnings and the Q417 GDP report (due Friday). The Government shutdown is likely to be a neutral factor at worst, since the main issue of contention -- "dreamers" -- is not market relevant.
A strong GDP report would be a negative for Treasuries, as it would raise the risk of higher inflation ahead. Indeed, last week's survey data on longer-term inflation expectations edged up. The combination of a higher inflation risk and strong economic growth almost guarantees that the Fed will hike 25 BPs at the March FOMC meeting. The Fed is not likely to hike rates at the January 31 FOMC meeting, though, as it remains committed to a gradual approach to tightening and it just tightened in December.
Expectations are for another quarter of GDP growth with a "3" handle. Consensus for Q417 Real GDP Growth is 3.0% (q/q, saar), while Atlanta Fed and NY Fed models project 3.4% and 3.9%, respectively. For the full 2017, the Q4/Q4 growth rate would be between 2.6% and 2.9%, based on these forecasts. It has the potential to be the best growth rate since the recession (see table below).
The most important fall-out from the GDP report will be whether it pushes the Fed and Street Economists to raise their 2018 GDP forecasts, particularly if they do so to above 3%. Upward revisions would underscore the better profit outlook for stocks. Greater-than-3% full-year forecasts may be expecting too much from forecasters, however, since it is very early in the year. For example, NY Fed President Dudley said in a speech last week that he had raised his 2018 forecast by 0.5 percentage point to 2-1/2 to 2-3/4%. Nevertheless, a Q417 GDP composition that shows strong Final Sales and a decline in or very low Inventory Investment would be viewed as pro-growth and possibly as raising the risk of a "3" handle on 2018 GDP Growth.
The second important fall-out from the GDP report would be if it boosts forecasts of trend productivity growth. A higher trend in productivity growth is a positive for the overall standard of living. It also works toward solving long-term problems in the outlooks for Social Security, Medicare and Federal Deficit, as well as keeping inflation low. The Q417 Productivity data will be released on February 1. At this point, it looks like the Nonfarm Output portion of Q417 GDP needs to be well above 4% to get 1+% productivity growth for the quarter. The higher workweek and surge in self-employed people may have resulted in Total Hours Worked rising 3+%. Productivity Growth is defined as Output Growth less Total Hours Worked Growth.
(Q4/Q4 Growth Rate)
Real GDP Growth Nonfarm Productivity **
2017 2.6-2.9 1.5*
2016 1.9 0.9
2015 2.0 0.7
2014 2.7 0.4
2013 2.7 1.6
2012 1.3 0.1
2011 1.7 0.0
2010 2.7 1.8
2009 -0.2 5.7
* annualized productivity growth over the first 3 quarters of 2017.
** Productivity tends to be strong at the start of a recovery, so the high 5.7% 2009 pace is not indicative of trend. The 0.8% average between 2010 and 2016 is more indicative of the recent trend. It is below the 1.0-1.5% pace that was considered the US longer-term trend prior to the recession.
A strong GDP report would be a negative for Treasuries, as it would raise the risk of higher inflation ahead. Indeed, last week's survey data on longer-term inflation expectations edged up. The combination of a higher inflation risk and strong economic growth almost guarantees that the Fed will hike 25 BPs at the March FOMC meeting. The Fed is not likely to hike rates at the January 31 FOMC meeting, though, as it remains committed to a gradual approach to tightening and it just tightened in December.
Expectations are for another quarter of GDP growth with a "3" handle. Consensus for Q417 Real GDP Growth is 3.0% (q/q, saar), while Atlanta Fed and NY Fed models project 3.4% and 3.9%, respectively. For the full 2017, the Q4/Q4 growth rate would be between 2.6% and 2.9%, based on these forecasts. It has the potential to be the best growth rate since the recession (see table below).
The most important fall-out from the GDP report will be whether it pushes the Fed and Street Economists to raise their 2018 GDP forecasts, particularly if they do so to above 3%. Upward revisions would underscore the better profit outlook for stocks. Greater-than-3% full-year forecasts may be expecting too much from forecasters, however, since it is very early in the year. For example, NY Fed President Dudley said in a speech last week that he had raised his 2018 forecast by 0.5 percentage point to 2-1/2 to 2-3/4%. Nevertheless, a Q417 GDP composition that shows strong Final Sales and a decline in or very low Inventory Investment would be viewed as pro-growth and possibly as raising the risk of a "3" handle on 2018 GDP Growth.
The second important fall-out from the GDP report would be if it boosts forecasts of trend productivity growth. A higher trend in productivity growth is a positive for the overall standard of living. It also works toward solving long-term problems in the outlooks for Social Security, Medicare and Federal Deficit, as well as keeping inflation low. The Q417 Productivity data will be released on February 1. At this point, it looks like the Nonfarm Output portion of Q417 GDP needs to be well above 4% to get 1+% productivity growth for the quarter. The higher workweek and surge in self-employed people may have resulted in Total Hours Worked rising 3+%. Productivity Growth is defined as Output Growth less Total Hours Worked Growth.
(Q4/Q4 Growth Rate)
Real GDP Growth Nonfarm Productivity **
2017 2.6-2.9 1.5*
2016 1.9 0.9
2015 2.0 0.7
2014 2.7 0.4
2013 2.7 1.6
2012 1.3 0.1
2011 1.7 0.0
2010 2.7 1.8
2009 -0.2 5.7
* annualized productivity growth over the first 3 quarters of 2017.
** Productivity tends to be strong at the start of a recovery, so the high 5.7% 2009 pace is not indicative of trend. The 0.8% average between 2010 and 2016 is more indicative of the recent trend. It is below the 1.0-1.5% pace that was considered the US longer-term trend prior to the recession.
Monday, January 15, 2018
Stocks and the Inflation Outlook
The stock market should continue to rally over the next several weeks, as strong corporate earnings pile in. The S&P 500 is up about 4% so far this year, raising prospects that the outlandish market strength seen in early 1987 is repeated (see my blog of January 8). A more aggressive Fed is still the main risk to the rally, and the inflation outlook may be a key to foreseeing whether it will diverge from its gradual approach to tightening. While the stock market appeared to ignore the high 0.3% m/m December Core CPI reported on Friday, it should have "raised eyebrows" that an aggressive Fed may become more than a risk. I expect fears of the Fed will become more serious after the earnings season is over, in late February or March, and that stocks will trade more cautiously then as a result.
To be sure, the January Core CPI, due February 14, may not significantly change the odds of three Fed rate hikes in 2018 -- the consensus view. The Core is likely to stay in the 0.2-0.3% range in that report, as housing rent stays firm. But, the y/y would be 1.7-1.8%, versus 1.8% in December, so the market may take it in stride. A couple of the components with large gains in November and December (motor vehicles and prescription drugs) may flatten -- as has happened in the past and possibly resulting from bi-monthly sampling, but start-of-year price hikes are typical this month and low post-holiday inventories could lift apparel prices.
The inflation story may become more significant for the markets in the subsequent CPI reports. This is because the Core CPI may remain in the 0.2-0.3% range in the next few months -- which would push the y/y above 2% in March or April (reports due in April and May, respectively). The current run-up in oil prices may begin to filter through to some components in the next few months. Also, the weaker dollar may begin to lift import prices, although there tends to be a tenuous relationship between the two. Note that non-auto consumer or capital goods import prices have not moved up through December.
Wage inflation also is not likely to be of immediate concern, but could develop as a problem ahead. Calendar considerations point to a modest 0.1% m/m increase in January Average Hourly Earnings, due February 2. But, the calendar shifts to suggesting a larger 0.3% m/m increase in the February Report, due March 2. The bonuses and minimum wage hikes announced by some large companies are likely to have a negligible impact on wage data. Bonus payments do not affect AHE. Minimum wage hikes on a national scale never have had a noticeable impact on the Employment Cost Index, because the number of workers who receive the minimum wage is very small. Moreover, since some large companies attributed the bonus and wage hike to "sharing" the corporate tax cut, they presumably would not pass through the higher labor costs to prices.
Inflation may get some attention this coming week with the release of survey data on consumer inflation expectations, The New York Fed releases its December survey on Tuesday. One-year inflation expectations were 2.6% while 3-year expectations were 2.8% in both October and November. The University of Michigan Consumer Inflation Expectations for January come out on Friday. The 5-year inflation expectations was 2.4% in December. Note that the longer-term expectations are more important than the one-year expectation for the Fed. The one-year is likely to be up as a result of higher oil/gasoline prices, which may be temporary.
To be sure, the January Core CPI, due February 14, may not significantly change the odds of three Fed rate hikes in 2018 -- the consensus view. The Core is likely to stay in the 0.2-0.3% range in that report, as housing rent stays firm. But, the y/y would be 1.7-1.8%, versus 1.8% in December, so the market may take it in stride. A couple of the components with large gains in November and December (motor vehicles and prescription drugs) may flatten -- as has happened in the past and possibly resulting from bi-monthly sampling, but start-of-year price hikes are typical this month and low post-holiday inventories could lift apparel prices.
The inflation story may become more significant for the markets in the subsequent CPI reports. This is because the Core CPI may remain in the 0.2-0.3% range in the next few months -- which would push the y/y above 2% in March or April (reports due in April and May, respectively). The current run-up in oil prices may begin to filter through to some components in the next few months. Also, the weaker dollar may begin to lift import prices, although there tends to be a tenuous relationship between the two. Note that non-auto consumer or capital goods import prices have not moved up through December.
Wage inflation also is not likely to be of immediate concern, but could develop as a problem ahead. Calendar considerations point to a modest 0.1% m/m increase in January Average Hourly Earnings, due February 2. But, the calendar shifts to suggesting a larger 0.3% m/m increase in the February Report, due March 2. The bonuses and minimum wage hikes announced by some large companies are likely to have a negligible impact on wage data. Bonus payments do not affect AHE. Minimum wage hikes on a national scale never have had a noticeable impact on the Employment Cost Index, because the number of workers who receive the minimum wage is very small. Moreover, since some large companies attributed the bonus and wage hike to "sharing" the corporate tax cut, they presumably would not pass through the higher labor costs to prices.
Inflation may get some attention this coming week with the release of survey data on consumer inflation expectations, The New York Fed releases its December survey on Tuesday. One-year inflation expectations were 2.6% while 3-year expectations were 2.8% in both October and November. The University of Michigan Consumer Inflation Expectations for January come out on Friday. The 5-year inflation expectations was 2.4% in December. Note that the longer-term expectations are more important than the one-year expectation for the Fed. The one-year is likely to be up as a result of higher oil/gasoline prices, which may be temporary.
Wednesday, January 10, 2018
Chinese Pulling Back on Treasury Buying -- Implications for Markets and Fed
The latest significant market development is apparently the Bloomberg report that China is considering pulling back from buying Treasuries. But, even if, as is likely, today's market reactions reflect
exaggerated fears of what the Chinese may do, there are reasons to
think that the markets' reactions should not be extrapolated
Initially, a Chinese pullback in Treasury buying -- or talk of one -- clearly boosts longer-term yields, as attested by this morning's jump, and should be a negative for the dollar and likely stocks. The dollar is hurt by the possibility that Chinese will buy less of the currency. The impact on stocks is mixed. They will be hurt by higher yields -- pulling down discounted profits, but helped by a weaker dollar -- boosting the value of overseas profits.
But, the implications for Treasury yields and stocks would become less negative if the downshift in Chinese buying of Treasuries results in less aggressive Fed tightening -- even if in the short term implications for Fed policy are more market talk than reality.
Talk of a less aggressive Fed would stem from the idea that a pullback in Chinese buying of Treasuries will hurt the US economy. From this perspective, the market moves are mixed. Higher yields will restrain interest-sensitive sectors, like housing. And, softer stocks will weigh on consumer spending. But, the weaker dollar would help net exports.
If economic growth looks to be hurt, the markets should adjust to being net pro-growth if the Fed signals that it still wants economic growth to be at a good pace. Using an "optimal-control" approach to understanding markets, yields will fall back somewhat and stocks would resume climbing if the weaker dollar is viewed as insufficient to achieve the desired economic growth rate.
Initially, a Chinese pullback in Treasury buying -- or talk of one -- clearly boosts longer-term yields, as attested by this morning's jump, and should be a negative for the dollar and likely stocks. The dollar is hurt by the possibility that Chinese will buy less of the currency. The impact on stocks is mixed. They will be hurt by higher yields -- pulling down discounted profits, but helped by a weaker dollar -- boosting the value of overseas profits.
But, the implications for Treasury yields and stocks would become less negative if the downshift in Chinese buying of Treasuries results in less aggressive Fed tightening -- even if in the short term implications for Fed policy are more market talk than reality.
Talk of a less aggressive Fed would stem from the idea that a pullback in Chinese buying of Treasuries will hurt the US economy. From this perspective, the market moves are mixed. Higher yields will restrain interest-sensitive sectors, like housing. And, softer stocks will weigh on consumer spending. But, the weaker dollar would help net exports.
If economic growth looks to be hurt, the markets should adjust to being net pro-growth if the Fed signals that it still wants economic growth to be at a good pace. Using an "optimal-control" approach to understanding markets, yields will fall back somewhat and stocks would resume climbing if the weaker dollar is viewed as insufficient to achieve the desired economic growth rate.
Monday, January 8, 2018
The Stock Market and Monetary Policy
Last week's large stock market rally was a vote against the technical arguments for a significant market correction immediately ahead. Stocks should continue to rally into February. First, strong US/global economic growth, tax reform, and expectations of solid corporate earnings to be reported over the next several weeks should continue to underpin market gains. Second, market pundits are well aware of the "rule of thumb" that gains in the first two days of January tend to be associated with a gain for the month, and a gain in January tends to be associated with a gain for the year. So, any market pullback for the rest of January is likely to be minor, as no one will want to "buck" this "rule."
The biggest threat to the stock market rally is monetary policy. If the Fed becomes more aggressive than its expectation of three 25 BP hikes this year, stocks will likely correct. But, this is not yet a high probability. Indeed, Friday's soft December Payroll increase -- with a steady Unemployment Rate -- argues against such a policy shift. And, a consensus 0.2% m/m print for next Friday's December Core CPI should not change this argument, as the y/y would be steady at 2.5%. But, further market gains on top of a strong economy will likely prompt talk of more aggressive Fed policy as we approach the March 20-21 FOMC meeting -- the first meeting when Powell presides as chairman. So, some market caution may assert itself in late February or March.
The importance of monetary policy for the stock market is seen in 1987, the year after the previous tax reform legislation. A massive stock market rally in the first 3 months of the year was stopped by a 75 BP hike in the funds rate over April and May. The market rally resumed when the Fed pulled back from tightening in early July, but was cut short by large hikes in the funds rate in August and September. Note that even with the October crash, the Dow Jones Industrial Average ended the year above its year-end level in 1986 -- consistent with the January rule of thumb.
Monetary Policy and Stock Market in 1987
Fed Funds Rate Target DJIA
(level, percent) (month-end to month-end % change)
Jan 1 5.875 Jan 13.8
Jan 5 6.00 Feb 3.1
April 30 6.50 Mar 3.6
May 22 6.75 Apr -0.8
July 2 6.25 May 0.2
Aug 27 6.75 Jun 5.5
Sep 4 7.25 Jul 6.3
Sep 24 7.3125 Aug 3.5 -- peak Aug 17
Sep -2.5
Oct -23.2
The biggest threat to the stock market rally is monetary policy. If the Fed becomes more aggressive than its expectation of three 25 BP hikes this year, stocks will likely correct. But, this is not yet a high probability. Indeed, Friday's soft December Payroll increase -- with a steady Unemployment Rate -- argues against such a policy shift. And, a consensus 0.2% m/m print for next Friday's December Core CPI should not change this argument, as the y/y would be steady at 2.5%. But, further market gains on top of a strong economy will likely prompt talk of more aggressive Fed policy as we approach the March 20-21 FOMC meeting -- the first meeting when Powell presides as chairman. So, some market caution may assert itself in late February or March.
The importance of monetary policy for the stock market is seen in 1987, the year after the previous tax reform legislation. A massive stock market rally in the first 3 months of the year was stopped by a 75 BP hike in the funds rate over April and May. The market rally resumed when the Fed pulled back from tightening in early July, but was cut short by large hikes in the funds rate in August and September. Note that even with the October crash, the Dow Jones Industrial Average ended the year above its year-end level in 1986 -- consistent with the January rule of thumb.
Monetary Policy and Stock Market in 1987
Fed Funds Rate Target DJIA
(level, percent) (month-end to month-end % change)
Jan 1 5.875 Jan 13.8
Jan 5 6.00 Feb 3.1
April 30 6.50 Mar 3.6
May 22 6.75 Apr -0.8
July 2 6.25 May 0.2
Aug 27 6.75 Jun 5.5
Sep 4 7.25 Jul 6.3
Sep 24 7.3125 Aug 3.5 -- peak Aug 17
Sep -2.5
Oct -23.2
Tuesday, January 2, 2018
Are Strong Fundamentals Fully Priced in Stocks?
The economic fundamentals look strong, as I’ve been pointing out in my blog. But, stocks appear to be fully or more than fully priced for the strength, according to technicals and historical p/e ratios. Since seasonal market strength and expectations of strong Q417 corporate earnings argue for stocks to rally into February, a flat market for the next few weeks would support the idea that stocks are fully priced. A lightening up of positions would be warranted if this turns out to be the case. Even so, there is a good possibility that stocks will not correct significantly or may even rally further once the earnings season ends in late February, as consensus may be underestimating the economy's momentum.
The US economic data should remain strong in this first week of the new year. In particular, the December Mfg ISM, due Wednesday, risks printing above the flat but still high 58.2 consensus estimate. Most other manufacturing surveys rose this month, although the m/m direction of any of them is not well correlated with that of the Mfg ISM. As for Friday's December Employment Report, consensus looks for +189k Payrolls, which would keep the pace above the 174k monthly average between January and November. The consensus estimate of an above-trend +0.3% m/m for Average Hourly Earnings fits with calendar considerations, and the y/y would stay moderate at 2.5%. AHE averaged a tad under 0.2% m/m so far this year.
The most important economic report very well may be Q417 Real GDP, due January 26. Another quarter with a "3" handle on the growth rate could prompt Street economists and the media to lift their 2018 forecasts from the low-to-mid 2% range. A ratcheting up of economic growth expectations could sustain the stock market rally into the Spring (in line with the 1987 experience, see my prior blog). At this point, the Atlanta Fed model is projecting 2.8% (as of December 23) for Q417 Real GDP Growth, while the NY Fed model is projecting 3.9% (as well as 3.2% for Q118 GDP). The Atlanta Fed model seems to me to be underestimating Consumption Growth. I would not be surprised if its GDP forecast is lifted as we get more data.
The US economic data should remain strong in this first week of the new year. In particular, the December Mfg ISM, due Wednesday, risks printing above the flat but still high 58.2 consensus estimate. Most other manufacturing surveys rose this month, although the m/m direction of any of them is not well correlated with that of the Mfg ISM. As for Friday's December Employment Report, consensus looks for +189k Payrolls, which would keep the pace above the 174k monthly average between January and November. The consensus estimate of an above-trend +0.3% m/m for Average Hourly Earnings fits with calendar considerations, and the y/y would stay moderate at 2.5%. AHE averaged a tad under 0.2% m/m so far this year.
The most important economic report very well may be Q417 Real GDP, due January 26. Another quarter with a "3" handle on the growth rate could prompt Street economists and the media to lift their 2018 forecasts from the low-to-mid 2% range. A ratcheting up of economic growth expectations could sustain the stock market rally into the Spring (in line with the 1987 experience, see my prior blog). At this point, the Atlanta Fed model is projecting 2.8% (as of December 23) for Q417 Real GDP Growth, while the NY Fed model is projecting 3.9% (as well as 3.2% for Q118 GDP). The Atlanta Fed model seems to me to be underestimating Consumption Growth. I would not be surprised if its GDP forecast is lifted as we get more data.
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