Stocks to Rally Into Mid-October?

The stock market rally is likely to persist into mid-October, helped in part by expectations of a good earnings season.   Moreover, there is a chance the September 25-26 FOMC Meeting will result in a Statement that sparks market talk of the Fed skipping a December rate hike.  This would be a catalyst for another leg up in stocks.

The possibility of a significant change in the FOMC Statement was highlighted at the end of the July Minutes, released last week.  In a long paragraph, a large number of FOMC participants was said to agree the funds rate would soon be reaching a level that should not be described as "accommodative."  The market could interpret a dropping of that description as signaling a near-term end of the tightening cycle or at least a pause.

The paragraph read:

 "Many participants noted that it would likely be appropriate in the not-too-distant future to revise the Committee’s characterization of the stance of monetary policy in its postmeeting statement.  They agreed that the statement’s language that “the stance of monetary policy remains accommodative” would, at some point fairly soon, no longer be appropriate.  Participants noted that the federal funds rate was moving closer to the range of estimates of its neutral level.  A number of participants emphasized the considerable uncertainty in estimates of the neutral rate of interest, stemming from sources such as fiscal policy and large-scale asset purchase programs.   Against this background, continuing to provide explicit assessment of the federal funds rate relative to its neutral level could convey a false sense of precision." [highlights mine]

This week's US economic data are minor, with consensus looking for small pullbacks in many of them.  A run of softer data into the September meeting could encourage Fed officials to change the Statement.

Follow me on Twitter at @cjslyce.   I may comment on just-released US economic data or other market developments.   Note that I pointed out the significance of the July Minutes in a tweet last week.


 

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Fears of a Trade War Ending? What About the Fed?

The market effects of the trade war may be about to reverse.  With negotiations between the US and Canada/Mexico scheduled for early this week and China later in the week, headlines are likely to turn hopeful for an end to the trade wars.  Moreover, any weakness in US manufacturing data may very well have just a fleeting effect on the markets, as it is seen as tariff-induced and temporary.

Stocks should be helped by an abatement of trade war fears, although the boost could be tempered in this seasonally soft period for the market.  In contrast, the dollar has likely peaked.  As I've been arguing, somewhat counter-consensus, the imposition of tariffs by the US caused the dollar to appreciate on the expectation of a future narrowing in the trade deficit.  Conversely, eliminating the tariffs should lower the dollar.  A weaker dollar and an ending of the fears of a trade-induced slowdown in the US economy point to higher Treasury yields. 

The markets' focus will shift back to the Fed this week -- the minutes of the July meeting will be released on Wednesday and Powell will speak on "Monetary Policy in a Changing Economy" at the Jackson Hole Conference on Friday.  Neither will likely increase the odds of a pullback from the Fed's path of gradual tightening.  It is too early to say with any certainty whether economic growth is slowing appreciably because of the trade war turmoil.  And, any negative impact from the tariffs could reverse quickly if, as is likely, the trade disputes get resolved.  Meanwhile, inflation remains in check and near the Fed's target.  Importantly, last Friday's release of the University of Michigan Consumer Sentiment Survey showed little change in long-run inflation expectations, displaying no significant impact from the tariffs that have been applied so far.


Follow me on Twitter at @cjslyce.   I may comment on just-released US economic data or other market developments.
 

Turkish Crisis and US Economic Data

 The Turkish Crisis has taken center stage, but good US economic data could limit the damage to stocks.

The Turkish crisis is reminiscent of the 1997-98 Asian crisis.  In both cases, a weakening currency raised default risk on debt denominated in foreign currency.  This, in turn, created problems for European and US banks that had made the loans or held the foreign debt.  It is questionable whether banks are as vulnerable now as in the past episode.  Presumably, their balance sheet strengthening and successful stress tests mean they can withstand the impact of the Turkish debt problem.  There is also a possibility this problem could affect the Fed's rate decisions.  In September 1998, the Fed surprised the markets with a 25 BP rate cut (after the effects of the crisis had hit the Long-Term Capital Market fund).   If the Turkish crisis worsens and spreads, the Fed could skip a rate hike.

The most interesting economic data this week will be Productivity/Labor Costs (due Wednesday).   This will be the first read for Q218, but more interesting will be the impact of the GDP benchmark revisions on Productivity and Unit Labor Costs in the past 3 years.  Productivity Growth could be revised up about 0.5% pt per year from the latest figures (see table).  If so, it should lift market estimates of long-run potential Real GDP growth to the 2.0-2.5% range from the 1.5-2.0% range -- a positive for the profits outlook.  Stronger potential GDP Growth would argue for a higher Fed funds end-point in the Fed's tightening cycle, but it also allow for a longer time to get there when the economy is growing 3.0% and not at full employment.

                                                   (Q4/Q4 Percent Change)
                                        Productivity                Unit Labor Costs
            2017                          1.2                                  1.8
            2016                          0.9                                 -1.2
            2015                          0.7                                   2.4       

Some of last week's US economic data are worth mention:

The 0.2% m/m July Core CPI showed inflation remains subdued. The short-term impacts of tariffs and higher oil prices were noticeable, with jumps in household appliances and airfares and a further increase in vehicle prices. These are relative price changes, not inflation.

The Claims data were mixed -- with Initial down but Continuing up a bit.  They hint at another sub-200k Payroll print for August.


Follow me on Twitter at @cjslyce.   I may comment on just-released US economic data or other market developments.
 

Fundamentals Look Good For Stocks in Rest of August, Treasuries Too?

The fundamentals look stock-market friendly for the rest of August -- which could limit if not offset the market's seasonal weakness this month.   US economic data should ratify moderately strong growth.   A 0.2% m/m consensus print for the July Core CPI, due Friday, looks reasonable, while a lower print cannot be ruled out.  Even if the Core CPI prints above consensus, it could be attributable to temporary boosts from tariffs or higher oil prices.  None of the data should persuade the Fed to depart from its gradual approach to tightening.  And, the trade disputes with Mexico, Canada and the EU may become tailwinds, as their resolutions look more and more likely.  The next steps in the trade dispute with China are known and won't be put into effect until September at the earliest.

The 0.2% consensus estimate for the July Core CPI looks reasonable.  But a lower print cannot be ruled out, as the impact of tariffs may have peaked.   Motor vehicle prices already rose sharply in May and June.   And, household appliance prices slowed sharply in June after a couple of months of large increases.  

Treasuries could be helped over the month by a ratcheting down in the Atlanta Fed model's projection of Q318 Real GDP Growth.   After last Friday's July Employment Report, the model's forecast was cut to 4.4% (q/q, saar) from 5.0%,.  But, it still looks too high relative to Payrolls and Total Hours Worked that month.  So, the risk is that the forecast will be trimmed further to under 4.0% as more data come in.

Some Street economists have been warning that the huge Federal Deficit will steepen the Treasury curve in H18.   I'm not so sure.  The last piece of research I had done at the New York Fed (in 1985), together with another economist, expanded the Fed model's term structure equation to include the Federal Deficit.  We found that it was the expected Deficit over the following 4 quarters, as projected by the CBO, that mattered.  If this is correct, the impact of the higher Deficit into 2019 already should be embodied in longer-term yields.  The fact that yields have not risen much probably reflects offsets from other factors, such as the stronger dollar. 

The risk to Treasuries may very well be a weaker dollar in H218.   The resolution of the trade disputes could be the catalyst behind a decline in the dollar.   This would be the case if its recent strength reflected expectations of a smaller trade deficit resulting from US tariffs.




 Follow me on Twitter at @cjslyce.   I may comment on just-released US economic data or other market developments.

July Employment Report Shows Above-Trend Growth With Little Inflation

The July Employment Report shows above-trend growth continuing with little inflation pressures in Q318.  But, it suggests GDP Growth may come in below 4.0% (q/q, saar).

Payrolls slowed to +157k and the workweek dipped from its June high.  Total Hours Worked in July are 0.9% (annualized) above the Q218 average.   While a good start to the quarter, it will be difficult to match the 3.0% (q/q, saar) increase in Q218.  Productivity growth would need to jump to get GDP Growth above 4.0% in Q318.

The most interesting components of Payrolls were gains in manufacturing, construction and retail.  These are cyclical components and are strong.

Despite the slowdown in overall job growth, Q318 GDP Growth should be well above trend.  This is most clearly seen in the decline in the Unemployment Rate to 3.87%, below the 3.91% Q218 average.  Some of the decline could be a lagged effect of the very strong economic growth in Q218, but it likely reflects above-trend growth in Q318, as well.
 
Average Hourly Earnings rounded up to 0.3% m/m (0.259%), with the y/y steady at 2.7%.  The increase is slightly above the pace suggested by calendar considerations.  But, the m/m and y/y increases are in line with recent history.