While the stock market will focus on several major earnings releases this week, including Apple, Microsoft and Amazon, the more lasting impact may result from the January 29-30 FOMC Meeting and Friday's macroeconomic data. There is a risk the Fed is becoming "too friendly" in the face of strong economic growth. While positive for stocks near term, it could lead to trouble ahead from a Treasury market sell-off.
The markets will likely focus on two items in the FOMC Statement -- /1/ confirmation the Fed intends to keep the funds rate steady for awhile, and /2/ hints that the Fed will pare back its balance sheet reduction.
Regarding the funds rate, the key sentence in the December Statement that would have to change is:
"The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term."
There was no mention of balance sheet reduction in recent FOMC Statements. However, it was discussed extensively at the December meeting. The focus was on the desired amount of excess reserves and the potential volatility of the funds rate as the balance sheet is reduced. The reported discussion concluded with the sentence:
"Participants considered it important to present information on the Federal Reserve’s balance sheet to the public in ways that communicated these facts."
This information is more likely to be presented at Powell's February Semi-Annual Monetary Policy Testimony to Congress in February. But, since the latter is tied to the consensus formed at the January meeting, some mention of it in the Statement is possible.
Meanwhile, US economic growth continues to look strong. Initial Claims fell below 200k in the latest week, and Continuing Claims may have peaked. With the federal government shutdown over at least for the next 3 weeks, a Q418 Real GDP release might be available during this time. The Atlanta Fed model's latest projection is an above-trend 2.7% (q/q, saar). A relatively mild winter may be a factor boosting US economic growth so far in Q119.
Favorable weather could lift January Payrolls (due Friday), as well. (These will reflect benchmark revisions and new seasonal factors.) But, there could be offsets, making it difficult to judge the risks surrounding the +175k consensus estimate. Some of the December Payroll strength looks to have been catch-up from bad weather in November, so should not persist in January. Also, strong holiday-related hiring by retailers in November-December could unwind. And, while federal government workers who were furloughed or worked without pay during the shutdown will be included in Payrolls, there could have been layoffs at companies impacted by the shutdown. To be sure, those government workers who took temporary jobs during their furloughs could add to Payrolls. And, large retailers may have kept workers for delivery purposes as they compete with Amazon.
The government shutdown will not directly impact the Unemployment Rate. But, it will be important to see if the Rate (and the Labor Force Participation Rate) stays at 3.9%, as consensus expects. A still-high Labor Force Participation Rate would suggest trend economic growth is above the 1.8-2.0% seen by the Fed.
The chances are for a slowdown in Average Hourly Earnings in January.
Calendar considerations point to +0.1% m/m. There also could be an unwinding
of the composition shifts that boosted them in December. But, there could be an offset from the end of lower-paid holiday workers. A 0.1-0.2% m/m increase would lower the y/y to 3.0-3.1% from 3.2% in December. Consensus looks high at 0.3%.
The other important US economic release this week, the January Mfg ISM, risks rebounding -- which would be a stronger print than the steady 54.1 consensus estimate. Other surveys -- Markit US Mfg PMI, Phil Fed Mfg and Richmond Fed -- already did so. The Mfg ISM will reflect new seasonal factors.
Sunday, January 27, 2019
Monday, January 21, 2019
Trade Problems Ending?
The stock market risks pulling back this week, in part because it may have overreacted to some of the positive US/China trade headlines last week. The most important headline was China's purported offer to buy $1 Tn in US exports over the next 6 years. While this proposal would be positive for the economy and stock market when it begins, it would likely lead to problems later.
The Chinese proposal to buy more than $1 Tn in US exports over the next 6 years would provide a significant boost to US economic growth. Adding about $200 Bn to GDP per year, it would lift US Real GDP by roughly 1% per year, with the boost about half in 2019 if it begins in H219. Everything else unchanged, the Fed's Central Tendency forecast for GDP would be above-trend for the next 3 years at least:
Fed's Central Tendency for Real GDP Growth
(Q4/Q4 percent change)
2019 2020 2021
As of December: 2.3-2.5 1.8-2.0 1.5-2.0
With Chinese Purchases 2.8-3.0 2.8-3.0 2.5-3.0
(everything else unchanged)
Not everything else would be unchanged, however. Market forces and the Fed would move to offset at lease some of the Chinese spending boost. Higher market interest rates and dollar would crowd out domestic spending. And, the Fed would likely have to tighten, as well -- probably by 75-100 BPs. After all is said and done, it is conceivable GDP Growth would be the same as it would have been without the Chinese purchases, but with interest rates and dollar higher the composition would be different. This outcome would be a negative for stocks.
The markets and Fed would have to tighten even more if inflation picks up. The impact on US inflation will likely be the net effect of stronger domestic wage pressures and higher export prices versus softer import prices. Stronger GDP Growth would lower the Unemployment Rate further and put upward pressure on wages. If China boosts purchases of food products, their prices should rise independently of wages. If needed migrant farm workers are not available because of border clampdowns, higher labor costs could boost food prices, too. In contrast, besides the tempering effect of a stronger dollar, foreign price pressures from outside of China could ease if Chinese demand shifts away from them to the US. Moreover, tighter Fed policy would likely put downward pressure on commodity prices.
Elimination of the US/Chinese trade deficit would end the macroeconomic need for deficit spending in the US. When China was grabbing market share of manufacturing by keeping its currency low, some sector of the US economy had to spend more than its income to offset the drag. Moreover, the amount of deficit spending had to expand over time to match the widening trade deficit. The US initially relied on the household sector to do so through the housing market. This channel was not sustainable. Rising Federal deficits took its place. These would no longer be needed. Fiscal initiatives, such as infrastructure/border wall projects, regardless of whether financed by the government or private industry, would just crowd out other spending. In other words, financial market conditions would become even more restrictive.
The Chinese proposal to buy more than $1 Tn in US exports over the next 6 years would provide a significant boost to US economic growth. Adding about $200 Bn to GDP per year, it would lift US Real GDP by roughly 1% per year, with the boost about half in 2019 if it begins in H219. Everything else unchanged, the Fed's Central Tendency forecast for GDP would be above-trend for the next 3 years at least:
Fed's Central Tendency for Real GDP Growth
(Q4/Q4 percent change)
2019 2020 2021
As of December: 2.3-2.5 1.8-2.0 1.5-2.0
With Chinese Purchases 2.8-3.0 2.8-3.0 2.5-3.0
(everything else unchanged)
Not everything else would be unchanged, however. Market forces and the Fed would move to offset at lease some of the Chinese spending boost. Higher market interest rates and dollar would crowd out domestic spending. And, the Fed would likely have to tighten, as well -- probably by 75-100 BPs. After all is said and done, it is conceivable GDP Growth would be the same as it would have been without the Chinese purchases, but with interest rates and dollar higher the composition would be different. This outcome would be a negative for stocks.
The markets and Fed would have to tighten even more if inflation picks up. The impact on US inflation will likely be the net effect of stronger domestic wage pressures and higher export prices versus softer import prices. Stronger GDP Growth would lower the Unemployment Rate further and put upward pressure on wages. If China boosts purchases of food products, their prices should rise independently of wages. If needed migrant farm workers are not available because of border clampdowns, higher labor costs could boost food prices, too. In contrast, besides the tempering effect of a stronger dollar, foreign price pressures from outside of China could ease if Chinese demand shifts away from them to the US. Moreover, tighter Fed policy would likely put downward pressure on commodity prices.
Elimination of the US/Chinese trade deficit would end the macroeconomic need for deficit spending in the US. When China was grabbing market share of manufacturing by keeping its currency low, some sector of the US economy had to spend more than its income to offset the drag. Moreover, the amount of deficit spending had to expand over time to match the widening trade deficit. The US initially relied on the household sector to do so through the housing market. This channel was not sustainable. Rising Federal deficits took its place. These would no longer be needed. Fiscal initiatives, such as infrastructure/border wall projects, regardless of whether financed by the government or private industry, would just crowd out other spending. In other words, financial market conditions would become even more restrictive.
Sunday, January 13, 2019
Amidst Potential Downside Risks, the Fed is Now a Positive for Stocks
Although the stock market may trade cautiously into the Q418 earnings season starting this week, the Fed's shift to a wait-and-see approach to monetary policy is a strong positive for the stock market's H119 outlook. Even the hawkish Cleveland Fed President Mester says she now favors not tightening until inflation picks up. While the Claims data so far suggest a modest economic slowdown at most, there is now a "Powell Put" on the economy -- he essentially said the Fed would ease if the economy weakens significantly and inflation remains subdued.
Powell cited two main downside risks in the outlook for the US economy -- a drag from slower growth abroad and a drag from the volatile financial market conditions. He downplayed both. In particular, he believes the recent stimulative fiscal and monetary policies put in place in China will prevent a sharp slowdown there. He recognizes that the Chinese economic slowdown appears to stem from domestic spending rather than from exports.
My guess is that the Chinese anti-corruption policy has put a damper on conspicuous consumption and income growth there. In a sense, what is viewed as corruption -- payoffs to corporate and government officials -- can be interpreted as a way to make administered wages/prices closer to market prices. The payoffs serve to incentivize workers to meet demand. When they are eliminated, people work and spend less. Looking at it this way has relevance to the US regarding ideas now being mentioned by some Democrats regarding income re-distribution and steeply progressive tax rates. They can have disincentive effects.
With political discourse regarding income re-distribution and high top tax rates likely to increase as the 2020 presidential election year approaches, it has to be considered a potential problem for the stock market in H219. Other potential problems are /1/ a speedup in US economic growth and/or inflation this Spring that could convince the Fed to resume tightening in H219 and /2/ Democratic Congressional investigations/impeachment of Trump.
The Claims data so far do not suggest US economic growth is slowing significantly. Initial Claims turned down in the first week of January. Although this is a holiday week, which could impact the data, the w/w decline ran counter to the direction in the first week of January 2018. Better winter weather this year could be holding them down, which also would be a positive for Q119 Real GDP Growth. Continuing Claims are still high, but they turned down in the latest week, as well, and may be just lagging.
Unemployment Claims
Initial Continuing Real GDP Growth
Q118 228k 1.904 Mn 2.2% (q/q, saar)
Q2 223 1.756 4.2
Q3 211 1.709 3.4
Q4 219 1.670 2.8 (e)
Latest Week 216 1.722
Powell cited two main downside risks in the outlook for the US economy -- a drag from slower growth abroad and a drag from the volatile financial market conditions. He downplayed both. In particular, he believes the recent stimulative fiscal and monetary policies put in place in China will prevent a sharp slowdown there. He recognizes that the Chinese economic slowdown appears to stem from domestic spending rather than from exports.
My guess is that the Chinese anti-corruption policy has put a damper on conspicuous consumption and income growth there. In a sense, what is viewed as corruption -- payoffs to corporate and government officials -- can be interpreted as a way to make administered wages/prices closer to market prices. The payoffs serve to incentivize workers to meet demand. When they are eliminated, people work and spend less. Looking at it this way has relevance to the US regarding ideas now being mentioned by some Democrats regarding income re-distribution and steeply progressive tax rates. They can have disincentive effects.
With political discourse regarding income re-distribution and high top tax rates likely to increase as the 2020 presidential election year approaches, it has to be considered a potential problem for the stock market in H219. Other potential problems are /1/ a speedup in US economic growth and/or inflation this Spring that could convince the Fed to resume tightening in H219 and /2/ Democratic Congressional investigations/impeachment of Trump.
The Claims data so far do not suggest US economic growth is slowing significantly. Initial Claims turned down in the first week of January. Although this is a holiday week, which could impact the data, the w/w decline ran counter to the direction in the first week of January 2018. Better winter weather this year could be holding them down, which also would be a positive for Q119 Real GDP Growth. Continuing Claims are still high, but they turned down in the latest week, as well, and may be just lagging.
Unemployment Claims
Initial Continuing Real GDP Growth
Q118 228k 1.904 Mn 2.2% (q/q, saar)
Q2 223 1.756 4.2
Q3 211 1.709 3.4
Q4 219 1.670 2.8 (e)
Latest Week 216 1.722
Sunday, January 6, 2019
Hurdles Not Over Yet
Although Friday's December Employment Report and Powell's comments enabled the stock market to recover from the hurdles it tripped over the day before (the drop in the Mfg ISM and lowered Apple guidance), the coast is not yet clear for a sustained rally. To be sure, stocks should get a lift at the start of this week, hoping for a successful meeting between US and Chinese trade negotiators (January 7-8). But, it is unlikely a full resolution of the dispute is imminent -- considering both sides may want to show how hard they negotiated by waiting to agree until just before the March 1 deadline. And, there could be additional negative surprises as the earnings season gets under way the following week.
Meanwhile, the macroeconomic background will be difficult to ascertain since the Census Bureau will not be releasing its business surveys during the government shutdown. Their absence means that GDP reports will not be released during this period either. Monitoring the economy will rely on Initial Claims data, Employment Reports and private surveys. The CPI presumably will be available to keep track of inflation. The consensus estimate of 0.2% m/m and steady 2.2% y/y for the December Core CPI (due Friday) would be benign prints for the markets.
The window for a sustained rally may become apparent in late February, with the earning season behind and a US-China trade deal looking highly likely. Moreover, the government shutdown could be over by then, allowing the markets to have better clarity about the strength of the economy.
A Q1 slowdown followed by speedup in Q2 and Q3 has been the case in recent years, with a shift from a harsh winter to wet/cold Spring to warm Summer likely responsible. So far, this year's winter doesn't seem bad, suggesting this pattern may not hold. But, other factors could take the weather's place. For example, the government shutdown is causing a delay in tax refunds, which should hurt retail sales in Q119 but then help them when they are finally sent. A cut in government spending would hurt Q119 GDP, as well.
This scenario potentially may have problems for stocks as summer approaches. A bounceback in economic activity this Spring could reignite fears of a Fed tightening. A pickup in inflation would exacerbate these fears. And, higher inflation ahead cannot be ruled out, even though it is currently benign. A further tightening in the labor market could lift wage inflation, although stronger growth need not tighten the labor market if the growth is met by a pickup in labor force participation. Also, a resolution of the trade dispute should weaken the dollar, as an ending of tariffs would raise expectations of a wider trade deficit ahead. A weaker dollar would boost import prices. So, a stock market rally into the Spring may be an opportunity to lighten up.
Meanwhile, the macroeconomic background will be difficult to ascertain since the Census Bureau will not be releasing its business surveys during the government shutdown. Their absence means that GDP reports will not be released during this period either. Monitoring the economy will rely on Initial Claims data, Employment Reports and private surveys. The CPI presumably will be available to keep track of inflation. The consensus estimate of 0.2% m/m and steady 2.2% y/y for the December Core CPI (due Friday) would be benign prints for the markets.
The window for a sustained rally may become apparent in late February, with the earning season behind and a US-China trade deal looking highly likely. Moreover, the government shutdown could be over by then, allowing the markets to have better clarity about the strength of the economy.
A Q1 slowdown followed by speedup in Q2 and Q3 has been the case in recent years, with a shift from a harsh winter to wet/cold Spring to warm Summer likely responsible. So far, this year's winter doesn't seem bad, suggesting this pattern may not hold. But, other factors could take the weather's place. For example, the government shutdown is causing a delay in tax refunds, which should hurt retail sales in Q119 but then help them when they are finally sent. A cut in government spending would hurt Q119 GDP, as well.
This scenario potentially may have problems for stocks as summer approaches. A bounceback in economic activity this Spring could reignite fears of a Fed tightening. A pickup in inflation would exacerbate these fears. And, higher inflation ahead cannot be ruled out, even though it is currently benign. A further tightening in the labor market could lift wage inflation, although stronger growth need not tighten the labor market if the growth is met by a pickup in labor force participation. Also, a resolution of the trade dispute should weaken the dollar, as an ending of tariffs would raise expectations of a wider trade deficit ahead. A weaker dollar would boost import prices. So, a stock market rally into the Spring may be an opportunity to lighten up.
Friday, January 4, 2019
December Employment Report Reflects Volatility and Strength, But...
The December Employment Report should keep the Fed on its plan to hike two more times in 2019, even though some of the jobs strength is probably make-up for November weakness and both months might have been impacted by weather (negatively in November, positively in December). The 2-month jobs pace is still strong, but the Report leaves open the door to the possibility that strong job growth is sustainable as a result of faster labor force growth.
The 312k m/m Payroll jump in December followed a below-trend +175k increase in November. About 1/3, if not somewhat more, of the jump were in sectors that had been weak in November. For example, Construction Jobs rose 38k after being flat in November. Some of the monthly volatility could be measurement problems. The opposite volatility is seen in the Household Survey's Civilian Employment, which measures number of people with jobs rather than number of jobs. Civilian Employment rose 142k in December after +221k in November.
Job growth is still strong after the m/m volatility is smoothed out. The 2-month average of Payrolls is +243k m/m, above the +223k 3-month average ending October.
Strong job growth is putting upward pressure on wages. While compositional and calendar factors likely contributed to the above-trend 0.4% m/m increase in Average Hourly Earnings, the y/y has moved up -- hitting 3.15% in December. But the increase in the y/y is modest. and could stay so. Better job opportunities and wage rates appear to be pulling people back in the labor force. The Labor Force Participation Rate jumped last month and boosted the Unemployment Rate to 3.9% -- back to the level that prevailed between April and July. A continuation of strong or rising labor force participation would temper further wage increases and allow for stronger non-inflationary economic growth than the Fed currently estimates to be the case.
The chances are for a slowdown in Average Hourly Earnings in January. Calendar considerations point to +0.1% m/m. There could be an unwinding of the composition shifts that boosted them in December. But, there also could be an offset from the end of lower-paid holiday workers.
The 312k m/m Payroll jump in December followed a below-trend +175k increase in November. About 1/3, if not somewhat more, of the jump were in sectors that had been weak in November. For example, Construction Jobs rose 38k after being flat in November. Some of the monthly volatility could be measurement problems. The opposite volatility is seen in the Household Survey's Civilian Employment, which measures number of people with jobs rather than number of jobs. Civilian Employment rose 142k in December after +221k in November.
Job growth is still strong after the m/m volatility is smoothed out. The 2-month average of Payrolls is +243k m/m, above the +223k 3-month average ending October.
Strong job growth is putting upward pressure on wages. While compositional and calendar factors likely contributed to the above-trend 0.4% m/m increase in Average Hourly Earnings, the y/y has moved up -- hitting 3.15% in December. But the increase in the y/y is modest. and could stay so. Better job opportunities and wage rates appear to be pulling people back in the labor force. The Labor Force Participation Rate jumped last month and boosted the Unemployment Rate to 3.9% -- back to the level that prevailed between April and July. A continuation of strong or rising labor force participation would temper further wage increases and allow for stronger non-inflationary economic growth than the Fed currently estimates to be the case.
The chances are for a slowdown in Average Hourly Earnings in January. Calendar considerations point to +0.1% m/m. There could be an unwinding of the composition shifts that boosted them in December. But, there also could be an offset from the end of lower-paid holiday workers.
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