The potential for a trade war, with Trump's "shock treatment" of $60 Bn in tariffs on Chinese goods and appointment of hawks to the Administration, has pushed macroeconomic factors into the background temporarily. How this confrontation evolves will determine the near-term direction of the markets. And, the risk is that the confrontation will worsen before it gets resolved.
To be sure, the rhetoric so far has been restrained and could alleviate some of the fears in the market immediately ahead. US officials, including the new National Security Advisor Bolton, say they are not looking to spark a trade war, but see it as a way to get the Chinese attention and push them to better adhere to existing trade agreements. The Chinese imposition of $3 Bn in tariffs against US goods is modest, but some reports say they were in response to the earlier US steel/aluminum tariffs and not the new tariffs directed at China. So, while recent comments by Chinese officials are cautious, the risk is that they will announce new tariffs at some point -- at least to establish a better bargaining position in the event of negotiations. This would be a negative for the stock market. But, since the US tariffs will not go into effect for at least 45 days (15 days to publish a list of goods and then a 30-day comment period), such an announcement would not be the end of the story. Negotiations and resolution of the issues are still in the mutual interests of both parties. At some point, a stock market sell-off may very well be seen as a buying opportunity.
Upcoming US economic data are not likely to change expectations for a gradual tightening in Fed monetary policy. Next week's calendar is light, with the February Core PCE Deflator on Thursday the most important. The consensus estimate of 0.2% m/m is reasonable, but whether the y/y edges up to 1.6%, as consensus expects, or stays at 1.5% depends on rounding. In the following week, March Payrolls may come in below the early consensus of +200k m/m, if last year's pattern holds. Similarly, a consensus-like dip in the Unemployment Rate to 4.0% from 4.1% would be consistent with what occurred last year. There is no consensus yet on March Average Hourly Earnings, but calendar considerations raise the risk of a high 0.3% m/m. The y/y would rise to 2.7-2.8% from 2.6% in January. Although this would be in line with the (downward-revised) 2.8% in January and 2.7% increase seen over 2017, a high print could spook the stock market as it did in January -- even though both would have been due to technical reasons.
Sunday, March 25, 2018
Wednesday, March 21, 2018
Quick Comment on FOMC "Dots"
The FOMC "dots" are bullish for stocks. They retain the 3 hikes in 2018, implying only 2 more this year after today's 25 BP hike. The FOMC did lift its expected funds rate in 2019 and 2020. But the market pundits are making too much of this, as it so far into the future to make it almost meaningless. More importantly, the more cautious expectation for 2018 means that the Fed is willing to tolerate faster economic growth this year -- a very big positive for the stock market.
If the US economic data turn mixed, as discused in my prior blog, this gradual approach for the year may remain even at the June FOMC Meeting.
If the US economic data turn mixed, as discused in my prior blog, this gradual approach for the year may remain even at the June FOMC Meeting.
Sunday, March 18, 2018
Upside Breakout in Stocks?
The macroeconomic outlook supports the possibility for the stock market to break to the upside near term. Next week's FOMC meeting may very well have a "dovish" outcome. And, Q118 corporate earnings should be strong. Longer-term Treasuries also risk rallying this Spring, as some of the US economic data that have been strong recently are likely to soften in the next few months.
The Fed may very well keep its gradual approach to tightening in place at the FOMC meeting on Tuesday and Wednesday. While tightening the funds rate by 25 BPs, its "dots" should retain expectations for only 2 more rate hikes this year and 3 next year. Real-side US economic data have been mixed: Q118 Real GDP tracking estimates have move down to under 2% but job growth has been strong. Inflation remains low so far this year, once the distortion from the temporary jumps in apparel prices are removed. And, the risks around the real-side and inflation outlooks remain balanced. Although fiscal stimulus has increased, the risk of a trade war works the other way with regard to economic growth. There is no reason for the Fed to lift its expectations for the trajectory of the funds rate. A caveat is that the Fed officials' projections may have been submitted before some of the softer recent data were released.
The combination of weak Real GDP Growth and strong Payroll Growth in Q118 may have resulted from winter weather effects and faulty seasonals. The same combination occurred in Q117. It reversed in Q217 -- with payback for the strong gains in Payrolls showing up in March-May.
Nonfarm Payrolls Real GDP Growth
(m/m change, 000s) (q/q % change, saar)
2018 2017 2018 2017
Jan 239 259
Feb 313 200
Mar 73 1.2
Apr 175
May 155
Jun 239 3.1
The slowdown to a near-trend Real GDP Growth Rate in Q118 is consistent with the steady 4.1% Unemployment Rate seen since October. If last year is a guide, the Rate should begin to fall in March -- even though Payrolls should slow.
Jumps in apparel prices boosted the Core CPI by 0.1% pt in both January and February. Excluding apparel, the Core CPI rose 0.2% m/m in January and 0.1% in February. What may be important in the latter was the slowdown in owners' equivalent rent. If that stays low, inflation is likely to stay dormant. Moreover, apparel prices are likely to slow in the next few months, particularly if some of the January-February jumps resulted from early introduction of higher-priced Spring clothing in stores. Seasonals will look to offset these higher-priced goods in March-April.
Last year, the stock market rose over April-June after a sluggish February-March. The 10-year Treasury yield fell over April May after rising in March.
S&P 500 Index 10-Year Treasury Yield
(% change over month) (level, percent, monthly avg)
2018 2017 2018 2017
Jan 5.6 1.8 2.58 2.43
Feb -3.9 -0.6 2.86 2.42
Mar 1.4 0.0 2.86 * 2.48
Apr 0.9 2.30
May 1.2 2.19
Jun 0.5 2.32
* 2.84% on Friday
The macro evidence supports expectations of strong corporate earnings in Q118, to be reported mostly in April and early May. Domestic activity, as measured by Real GDP, sped up on a y/y basis even with the q/q slowdown in Q118. Oil companies should be helped by the further speedup in oil prices. Companies with earnings abroad will benefit from the weaker dollar and solid foreign economic growth. And, while labor costs appear to have sped up, so did prices, thus maintaining good profit margins. All these factors strengthened in Q118 relative to Q417. So, the corporate tax cut may not be the only reason why S&P 500 earnings are expected to rise faster in Q118 than in Q417 (17% y/y versus 15%).
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 2.7 +20.2 -6.6 2.6-2.7 1.9 59.1
The Fed may very well keep its gradual approach to tightening in place at the FOMC meeting on Tuesday and Wednesday. While tightening the funds rate by 25 BPs, its "dots" should retain expectations for only 2 more rate hikes this year and 3 next year. Real-side US economic data have been mixed: Q118 Real GDP tracking estimates have move down to under 2% but job growth has been strong. Inflation remains low so far this year, once the distortion from the temporary jumps in apparel prices are removed. And, the risks around the real-side and inflation outlooks remain balanced. Although fiscal stimulus has increased, the risk of a trade war works the other way with regard to economic growth. There is no reason for the Fed to lift its expectations for the trajectory of the funds rate. A caveat is that the Fed officials' projections may have been submitted before some of the softer recent data were released.
The combination of weak Real GDP Growth and strong Payroll Growth in Q118 may have resulted from winter weather effects and faulty seasonals. The same combination occurred in Q117. It reversed in Q217 -- with payback for the strong gains in Payrolls showing up in March-May.
Nonfarm Payrolls Real GDP Growth
(m/m change, 000s) (q/q % change, saar)
2018 2017 2018 2017
Jan 239 259
Feb 313 200
Mar 73 1.2
Apr 175
May 155
Jun 239 3.1
The slowdown to a near-trend Real GDP Growth Rate in Q118 is consistent with the steady 4.1% Unemployment Rate seen since October. If last year is a guide, the Rate should begin to fall in March -- even though Payrolls should slow.
Jumps in apparel prices boosted the Core CPI by 0.1% pt in both January and February. Excluding apparel, the Core CPI rose 0.2% m/m in January and 0.1% in February. What may be important in the latter was the slowdown in owners' equivalent rent. If that stays low, inflation is likely to stay dormant. Moreover, apparel prices are likely to slow in the next few months, particularly if some of the January-February jumps resulted from early introduction of higher-priced Spring clothing in stores. Seasonals will look to offset these higher-priced goods in March-April.
Last year, the stock market rose over April-June after a sluggish February-March. The 10-year Treasury yield fell over April May after rising in March.
S&P 500 Index 10-Year Treasury Yield
(% change over month) (level, percent, monthly avg)
2018 2017 2018 2017
Jan 5.6 1.8 2.58 2.43
Feb -3.9 -0.6 2.86 2.42
Mar 1.4 0.0 2.86 * 2.48
Apr 0.9 2.30
May 1.2 2.19
Jun 0.5 2.32
* 2.84% on Friday
The macro evidence supports expectations of strong corporate earnings in Q118, to be reported mostly in April and early May. Domestic activity, as measured by Real GDP, sped up on a y/y basis even with the q/q slowdown in Q118. Oil companies should be helped by the further speedup in oil prices. Companies with earnings abroad will benefit from the weaker dollar and solid foreign economic growth. And, while labor costs appear to have sped up, so did prices, thus maintaining good profit margins. All these factors strengthened in Q118 relative to Q417. So, the corporate tax cut may not be the only reason why S&P 500 earnings are expected to rise faster in Q118 than in Q417 (17% y/y versus 15%).
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 2.7 +20.2 -6.6 2.6-2.7 1.9 59.1
Sunday, March 11, 2018
Upcoming US Economic Data and the Fed's "Dots"
In the next week and a half, the markets will likely focus primarily on the rate expectations embodied in the "dots" at the March 20-21 FOMC meeting -- each dot represents an expectation of the year-end level of the funds rate. The question will be whether the Fed retains its consensus expectation of three 25-BP hikes in 2018 or increases it to four. A 25 BP rate hike at the meeting is an almost foregone conclusion, so
the question is whether there will be 2 or 3 more in the remainder of
the year. To make matters more complicated, if the Fed increases its expectation to 4 hikes this year but lowers it to 2 from 3 hikes in 2019 (thereby keeping the 2.8% year-end 2019 level of the funds rate), the markets could take the decision in stride.
If upcoming US economic data do not raise the probability of 4 rate hikes this year, the stock market is likely to have an upward bias going into the March FOMC Meeting. Conversely, stocks would likely turn down if the data are too strong. Any sell-off in stocks will likely be short-lived, however. This is because expectations for corporate profits remain very strong. S&P 500 corporate earnings are seen rising 17.0% (y/y) in Q118, up from a strong 15.0% in Q417. They are seen strengthening further to 18.9% in Q218 and 20.7% in Q318. So, a sell-off would likely be a buying opportunity ahead of a rally to new highs in April-May.
Upcoming US economic data, particularly Tuesday's February CPI and Wednesday's February Retail Sales, will have significance to the extent they shift the probabilities between 3 or 4 rate hikes in 2018. Consensus-like prints (0.2% m/m Core CPI, keeping the y/y at 1.8%, and 0.3% m/m Ex Auto Retail Sales) would probably not shift the probabilities. Neither is too high to panic Fed officials or too low to remove their concerns regarding future inflation or growth. But, there is more upside than downside risk to the Core CPI.
The upside risk to the February Core CPI comes from apparel prices. To be sure, the 1.7% m/m surge in apparel prices that added a 0.1% pt to the 0.3% m/m January Core CPI should not repeat itself, since at least some of the jump likely resulted from a one-off end of heavy holiday-related discounting. But, apparel prices still could rise notably in February for two reasons. First, their bi-monthly sampling by the Bureau of Labor Statistics means that some of the snapback from holiday discounting will show up in February as well as in January. Second, higher-priced Spring clothing could be captured in February -- with the risk that more will be captured than expected by seasonal factors. So, while a 0.2 m/m rise in the February Core CPI seems reasonable, a 0.3% print can't be ruled out.
A 0.3% m/m increase in February Ex Auto Retail Sales, with no significant upward revisions to December or January, would not likely change GDP forecasts. The Atlanta Fed's model is now projecting 2.5% (q/q, saar) growth for Q118 Real GDP, while the NY Fed model is now 2.8%. Both are in line with the 2.2-2.6% Fed's Central Tendency for 2018. So, along with the steady 4.1% February Unemployment Rate reported on Friday, there would be no compelling reason from the real-side of the economy for the Fed to change its expectation for 3 hikes in 2018.
If upcoming US economic data do not raise the probability of 4 rate hikes this year, the stock market is likely to have an upward bias going into the March FOMC Meeting. Conversely, stocks would likely turn down if the data are too strong. Any sell-off in stocks will likely be short-lived, however. This is because expectations for corporate profits remain very strong. S&P 500 corporate earnings are seen rising 17.0% (y/y) in Q118, up from a strong 15.0% in Q417. They are seen strengthening further to 18.9% in Q218 and 20.7% in Q318. So, a sell-off would likely be a buying opportunity ahead of a rally to new highs in April-May.
Upcoming US economic data, particularly Tuesday's February CPI and Wednesday's February Retail Sales, will have significance to the extent they shift the probabilities between 3 or 4 rate hikes in 2018. Consensus-like prints (0.2% m/m Core CPI, keeping the y/y at 1.8%, and 0.3% m/m Ex Auto Retail Sales) would probably not shift the probabilities. Neither is too high to panic Fed officials or too low to remove their concerns regarding future inflation or growth. But, there is more upside than downside risk to the Core CPI.
The upside risk to the February Core CPI comes from apparel prices. To be sure, the 1.7% m/m surge in apparel prices that added a 0.1% pt to the 0.3% m/m January Core CPI should not repeat itself, since at least some of the jump likely resulted from a one-off end of heavy holiday-related discounting. But, apparel prices still could rise notably in February for two reasons. First, their bi-monthly sampling by the Bureau of Labor Statistics means that some of the snapback from holiday discounting will show up in February as well as in January. Second, higher-priced Spring clothing could be captured in February -- with the risk that more will be captured than expected by seasonal factors. So, while a 0.2 m/m rise in the February Core CPI seems reasonable, a 0.3% print can't be ruled out.
A 0.3% m/m increase in February Ex Auto Retail Sales, with no significant upward revisions to December or January, would not likely change GDP forecasts. The Atlanta Fed's model is now projecting 2.5% (q/q, saar) growth for Q118 Real GDP, while the NY Fed model is now 2.8%. Both are in line with the 2.2-2.6% Fed's Central Tendency for 2018. So, along with the steady 4.1% February Unemployment Rate reported on Friday, there would be no compelling reason from the real-side of the economy for the Fed to change its expectation for 3 hikes in 2018.
Friday, March 9, 2018
The Most Important Part of the February Employment Report
The February Employment Report is a positive for both stocks and Treasuries because it raises the possibility of strong economic growth without inflation. While Payrolls were very strong, a jump in the Labor Force Participation Rate means that faster growth can be accommodated without undue stress on the supply side. This is seen in the steady 4.1% Unemployment Rate.
The most important part of the Report is the jump in the Participation Rate -- but it has to stay at this level if not rise further to be meaningful. The Rate jumped to 63.0% from 62.7%, only the 3rd time in more than 3 years that it hit that level. As a result, the Labor Force sped up to 1.5% (y/y) from 0.9% in January and is about 0.5% pt above what had been trend. If this is the new trend in labor force growth, the US economy could surprise the Fed and other mainstream economists by being able to grow 3.0% on a trend basis.
Trump's goal of 3% GDP Growth would only be possible (without inflation) if labor force or productivity growth picked up from their prior sluggish paces. The greater Participation Rate raises the possibility that the pro-growth Administration policies are encouraging people to re-enter the labor force. Fed Chair Powell in his testimony said he thought the prior flat level of the Participation Rate was a good sign, given the demographically-related downward pressure on the Rate. A pickup in Productivity Growth is still uncertain.
The 0.1% m/m Average Hourly Earnings shows that the January jump in AHE was just a composition-related fluke. The fall-back in the y/y to 2.6% from 2.8% (revised down from 2.9%) brings it back in line with the trends in other labor cost measures. It shows no speedup in wage inflation.
The most important part of the Report is the jump in the Participation Rate -- but it has to stay at this level if not rise further to be meaningful. The Rate jumped to 63.0% from 62.7%, only the 3rd time in more than 3 years that it hit that level. As a result, the Labor Force sped up to 1.5% (y/y) from 0.9% in January and is about 0.5% pt above what had been trend. If this is the new trend in labor force growth, the US economy could surprise the Fed and other mainstream economists by being able to grow 3.0% on a trend basis.
Trump's goal of 3% GDP Growth would only be possible (without inflation) if labor force or productivity growth picked up from their prior sluggish paces. The greater Participation Rate raises the possibility that the pro-growth Administration policies are encouraging people to re-enter the labor force. Fed Chair Powell in his testimony said he thought the prior flat level of the Participation Rate was a good sign, given the demographically-related downward pressure on the Rate. A pickup in Productivity Growth is still uncertain.
The 0.1% m/m Average Hourly Earnings shows that the January jump in AHE was just a composition-related fluke. The fall-back in the y/y to 2.6% from 2.8% (revised down from 2.9%) brings it back in line with the trends in other labor cost measures. It shows no speedup in wage inflation.
Monday, March 5, 2018
An Irony of Tariffs -- With Market Implications
Ironically, Trump's imposing a tariff on a particular good, like steel or aluminum, has FX implications that could undermine any benefit to overall US economic activity. This is because the tariff should result in an appreciation of the dollar, reflecting the smaller trade deficit. A stronger dollar would make other imports more competitive. Domestic industries other than those being protected by the tariff would be hurt. Conversely, from this perspective, a country that bears the brunt of a tariff should not retaliate as its other exports will benefit from a weaker currency.
At the same time, the world price of the protected good should fall, reflecting higher US production of it. Other countries that had formerly exported the good to the US would dump their output on the rest of the world market. The lower world price would partly offset the benefit of the tariff to the protected industry.
On balance, these price effects could be a negative for the US economy. Even though the tariff is larger than the price effects of a stronger dollar, there are many more commodities/services that would be impacted by the latter than those protected by the tariff.
The dollar should appreciate most against the countries that are the main suppliers of those goods, since the bi-lateral trade deficits would fall the most. The latest strength of the dollar against Canada, the biggest exporter of steel to the US, is a case in point. But, the dollar could appreciate against other countries, as well. US demand for their exports should shift toward the countries whose currency depreciated the most. There would be some sort of balancing out of the FX fall-out from the tariff.
At the same time, the world price of the protected good should fall, reflecting higher US production of it. Other countries that had formerly exported the good to the US would dump their output on the rest of the world market. The lower world price would partly offset the benefit of the tariff to the protected industry.
On balance, these price effects could be a negative for the US economy. Even though the tariff is larger than the price effects of a stronger dollar, there are many more commodities/services that would be impacted by the latter than those protected by the tariff.
The dollar should appreciate most against the countries that are the main suppliers of those goods, since the bi-lateral trade deficits would fall the most. The latest strength of the dollar against Canada, the biggest exporter of steel to the US, is a case in point. But, the dollar could appreciate against other countries, as well. US demand for their exports should shift toward the countries whose currency depreciated the most. There would be some sort of balancing out of the FX fall-out from the tariff.
Sunday, March 4, 2018
Tariff Fears, the Fed and the February Employment Report
Fears of a trade war upended any post-Powell relief rally in stocks late last week. But, since it is unclear whether Trump will actually follow through with the proposal as presented, these fears may abate somewhat for now. Besides last week's stock market reaction, it is most likely that many of the companies that would be hurt by the tariffs have been pushing back through Congressional and Administration officials. The threat of tariffs may devolve into trade negotiations with other countries, just as the battle of words between Trump and the North Korean president appears to be moving toward talks. To be sure, if this scenario for tariffs does not materialize, stocks will likely drop again.
Note that the Chinese Trade Balance for February will be released on Thursday night. Consensus looks for a deficit, which may ease international trade fears although it probably reflects the timing of the Chinese New Year.
The markets' focus could quickly turn back to the Fed, with Friday's February Employment Report the next key piece of evidence. Consensus-like prints for Nonfarm Payrolls (+204k m/m), the Unemployment Rate (-0.1% pt to 4.0%), and Average Hourly Earnings (+0.3% m/m) would keep alive fears of the "dots" showing 4 expected hikes this year, up from 3. But, softer-than-consensus prints cannot be ruled out:
a. Payrolls may very well slow from January's 200k pace, perhaps to below the 192k 3-month average, as retail jobs resume their downtrend after seasonals likely overly boosted them in January. Other Payroll components were trend-like in January.
b. The Unemployment Rate may not fall from 4.1%, because of rounding. It was 4.148% in January, so a decline of less than 0.1% pt would round up to 4.1%.
c. AHE risks slowing to 0.1-0.2% m/m, after composition shifts may have boosted it to 0.3% in January. The y/y would fall to 2.7-2.8% from 2.9%.
A Fed rate hike at the March 20-21 FOMC Meeting is highly likely even if the Employment Report is somewhat softer than consensus. But, it is not certain that the "dots" will be boosted. Current-quarter GDP forecasts could come down. And, there is always the possibility the economy may moderate later in the year as the boost from the tax cut dissipates. Ironically, the negative fall-out of tariffs throws some doubt into forecasts of continuing strength for the rest of the year. It would seem the Fed could stick with its expectation of 3 hikes this year and wait a few months to decide whether another hike this year will be needed.
Note that the Chinese Trade Balance for February will be released on Thursday night. Consensus looks for a deficit, which may ease international trade fears although it probably reflects the timing of the Chinese New Year.
The markets' focus could quickly turn back to the Fed, with Friday's February Employment Report the next key piece of evidence. Consensus-like prints for Nonfarm Payrolls (+204k m/m), the Unemployment Rate (-0.1% pt to 4.0%), and Average Hourly Earnings (+0.3% m/m) would keep alive fears of the "dots" showing 4 expected hikes this year, up from 3. But, softer-than-consensus prints cannot be ruled out:
a. Payrolls may very well slow from January's 200k pace, perhaps to below the 192k 3-month average, as retail jobs resume their downtrend after seasonals likely overly boosted them in January. Other Payroll components were trend-like in January.
b. The Unemployment Rate may not fall from 4.1%, because of rounding. It was 4.148% in January, so a decline of less than 0.1% pt would round up to 4.1%.
c. AHE risks slowing to 0.1-0.2% m/m, after composition shifts may have boosted it to 0.3% in January. The y/y would fall to 2.7-2.8% from 2.9%.
A Fed rate hike at the March 20-21 FOMC Meeting is highly likely even if the Employment Report is somewhat softer than consensus. But, it is not certain that the "dots" will be boosted. Current-quarter GDP forecasts could come down. And, there is always the possibility the economy may moderate later in the year as the boost from the tax cut dissipates. Ironically, the negative fall-out of tariffs throws some doubt into forecasts of continuing strength for the rest of the year. It would seem the Fed could stick with its expectation of 3 hikes this year and wait a few months to decide whether another hike this year will be needed.
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