Last week's Treasury market sell-off is a signal to the Fed that monetary policy should take a breather after a 25 BP cut at this week's FOMC Meeting. Parts of the yield curve reversed their inversion (longer-term yields lower than shorter-term yields), suggesting some of the downside risks to the outlook have eased.
News stories suggesting some kind of breakthrough in US/China trade negotiations in October reduce the downside risk to the US economic outlook. And, the ECB rate cut works against the downside risk from the global slowdown. As for other risks, the Saudi shutdown of 50% of its oil output after the drone attack has mixed implications for the US economy and, on balance, should have a small impact.
A 25 BP cut this week is probably still in the cards, despite the optimistic news regarding US/China and higher inflation data for August. It is still not clear whether the negotiations will be concluded. And, the higher August core inflation prints were narrowly based. Historically, the Fed tends to overshoot when either easing or tightening -- possibly a requirement to be effective.
Core inflation may have bottomed, as the Core CPI rose an above-trend 0.3% m/m in the past two months and pushed the y/y up to 2.4%. But, the speedup was not widespread. Large increases were registered in Hospital Services, Health Insurance Premiums and Airfares. Most other components were little changed or lower. And, some important components, like Owners' Equivalent Rent, in fact, slowed. So, the run-up in core inflation may be temporary.
To be sure, Non-Fuel Import Prices were flat in July-August, after falling in 5 of 6 months in H119. So, they may be less of a drag on inflation ahead. Also, Average Hourly Earnings posted a high 0.4% m/m increase in August. But, some of the strength likely reflected calendar considerations that should moderate in September.
The real-side of the economy is rising moderately. It does not justify Fed easing, but does not stand in its way. Q319 Real GDP
Growth, at 1.8% according to the Atlanta Fed model's latest forecast, is
in the range estimated by the Fed to be the economy's long-run
potential growth rate. It is neither too high or too low. While job growth slowed sharply in August, early
evidence points to a speedup in September.
The cutback in Saudi oil production has mixed implications for the US economy. Oil prices are expected to jump by as much as $10/bbl, depending on the length of time of the cutback. This would translate into as much as 23 cents/gallon for gasoline. Along with higher heating costs, consumers will have to pay an additional $35 Bn (annualized) directly with a $10/bbl jump. Total US spending on petroleum products would climb by as much as $75 Bn (0.4% of GDP). But, more than half of this spending would be on domestically-produced oil, which should climb (both production and drilling) in response to the higher prices if they look to be in effect for some time. So, the net effect of the higher oil prices on US GDP should be minor.
The "dots" chart to be released at this week's FOMC Meeting probably loses importance after last week's Treasury market sell-off. The FOMC members' rate projections were done a couple of weeks earlier. So, they might have incorporated concerns about downside risks to the outlook that now look less threatening according to the market (see my last week's blog).
Sunday, September 15, 2019
Sunday, September 8, 2019
Fed Policy After a 25 BP Cut
With a 25 BP rate cut by the Fed at the September 17-18 FOMC Meeting a near-certainty, the markets will be looking for any hint that this is the last easing for awhile. This will be found in the "dots" chart, which will be updated along with the Fed's economic projections at this meeting.
The chart shows what the FOMC participants -- board members and district bank presidents -- expect the funds rate to be in 2019-2022. It is an explicit statement of what officials think the most likely path of the funds rate will be. Nevertheless, the chart is no guarantee of being a correct prediction. For example, at the December 2018 meeting, it showed expectations for an upward path of the funds rate over the next 3 years. The Fed stopped tightening the following month.
Because the Fed is now basing monetary policy on downside risks to the outlook, there is even greater-than-normal uncertainty about the reliability of the dots chart. These risks are difficult to ascertain, as they can be subject to the eyes of the beholder. Powell and other Fed officials have been citing downside risks at the same time as portraying economic growth to be solid. The latter view could seem to undercut the significance of the former. And, he has varied the litany of downside risks over time. So, as the headlines and data shift, the question will be whether the Fed's perception of downside risks have changed enough to affect their policy decision.
The key to answering this question may be the markets' own behavior. Since officials, themselves, are likely unsure how to evaluate the significance of any specific data or event in terms of downside risk, they may continue to rely on the markets' reaction to make policy decisions. If longer-term yields climb and the curve steepens in response to new information, the Fed could pull back from its concerns about downside risks. A breakthrough in the US/China trade talks or new German fiscal stimulus are potential examples where yields could rise (led by European yields in the latter case) and the dollar falls. The extent and persistence of these moves presumably will be important regarding their impact on Fed decision making. But, if such developments do not result in these market moves, then further Fed easing may remain a good possibility. If the markets don't think an event or data significantly affect the risks to the outlook, why should the Fed.
This week's US economic data are not expected to affect the Fed's concerns about downside risks. Consensus looks for a small 0.1% m/m increase in August Ex Auto Retail Sales, which would be decent after the 1.0% jump in July and the likelihood of some unwinding from "Prime Day" in July. Consensus also looks for a moderate 0.2% m/m increase in the July Core CPI, with the y/y edging up to 2.3% from 2.2%.
US economic data will be important in 3 cases. One, if they show that GDP Growth is well above or below the 1.8-2.0% long-run potential pace for an extended period. Two, if core inflation is very high or low relative to the Fed's 2% target. Three, if Fed officials shift to viewing 3.0% growth as a long-run potential pace rather than their current estimate of 1.8-2.0%. To date, they have not done so.
The chart shows what the FOMC participants -- board members and district bank presidents -- expect the funds rate to be in 2019-2022. It is an explicit statement of what officials think the most likely path of the funds rate will be. Nevertheless, the chart is no guarantee of being a correct prediction. For example, at the December 2018 meeting, it showed expectations for an upward path of the funds rate over the next 3 years. The Fed stopped tightening the following month.
Because the Fed is now basing monetary policy on downside risks to the outlook, there is even greater-than-normal uncertainty about the reliability of the dots chart. These risks are difficult to ascertain, as they can be subject to the eyes of the beholder. Powell and other Fed officials have been citing downside risks at the same time as portraying economic growth to be solid. The latter view could seem to undercut the significance of the former. And, he has varied the litany of downside risks over time. So, as the headlines and data shift, the question will be whether the Fed's perception of downside risks have changed enough to affect their policy decision.
The key to answering this question may be the markets' own behavior. Since officials, themselves, are likely unsure how to evaluate the significance of any specific data or event in terms of downside risk, they may continue to rely on the markets' reaction to make policy decisions. If longer-term yields climb and the curve steepens in response to new information, the Fed could pull back from its concerns about downside risks. A breakthrough in the US/China trade talks or new German fiscal stimulus are potential examples where yields could rise (led by European yields in the latter case) and the dollar falls. The extent and persistence of these moves presumably will be important regarding their impact on Fed decision making. But, if such developments do not result in these market moves, then further Fed easing may remain a good possibility. If the markets don't think an event or data significantly affect the risks to the outlook, why should the Fed.
This week's US economic data are not expected to affect the Fed's concerns about downside risks. Consensus looks for a small 0.1% m/m increase in August Ex Auto Retail Sales, which would be decent after the 1.0% jump in July and the likelihood of some unwinding from "Prime Day" in July. Consensus also looks for a moderate 0.2% m/m increase in the July Core CPI, with the y/y edging up to 2.3% from 2.2%.
US economic data will be important in 3 cases. One, if they show that GDP Growth is well above or below the 1.8-2.0% long-run potential pace for an extended period. Two, if core inflation is very high or low relative to the Fed's 2% target. Three, if Fed officials shift to viewing 3.0% growth as a long-run potential pace rather than their current estimate of 1.8-2.0%. To date, they have not done so.
Friday, September 6, 2019
August Employment Report Shows Business Caution, But...
The August Employment Report shows business hiring caution but has positive elements regarding the outlook. The hiring caution is seen in the Payroll slowdown and jump in part-time workers. The positive elements are the rebound in the Workweek and the further increase in the Labor Force Participation Rate. The Report should not stop the Fed from cutting rates by 25 BPs at the September 17-18 FOMC Meeting.
The +130k m/m increase in Nonfarm Payrolls, with Private Payrolls up only 96k, shows sluggish growth in many industries and continued decline in Retail Jobs. Curiously, manufacturing-related data were better than survey and anecdotal evidence suggested: manufacturing jobs rose 3k (although most industries cut jobs), the workweek rose (including overtime), and temporary jobs rose (viewed as mostly manufacturing jobs). Industrial Production should rise smartly this month. Construction jobs also sped up, with the gains in residential and non-residential. Mining jobs fell, however, possibly as oil drilling activity reacted to the lower oil prices.
Total Hours Worked rose a solid 0.4% m/m, thanks largely to the rebound in the Average Workweek. They stand 1.1% (annualized) above the Q219 average. So, they support estimates of 1.5-2.0% Q319 Real GDP Growth, although the relationship between THW and Real GDP Growth is variable as Productivity Growth can fluctuate.
The Household Survey data were the most interesting in the Report. Civilian Employment and Labor Force both surged over 500k m/m. More than half of the job growth was in part-time jobs. But, the important point is that the Labor Force Participation Rate continued to climb, raising the possibility that potential trend growth is higher than the Fed's 1.8-2.0% estimate. The increased workforce participation is possibly in response to higher wage rates. While the 0.4% m/m increase in Average Hourly Earnings was probably partly a consequence of calendar considerations, it also could reflect the tight labor market. The headline Unemployment Rate was steady at 3.7%, but unrounded it slipped to 3.69% from 3.71%. The decline was concentrated in African-American, Latino Ethnicity, Teen-Age and Women Unemployment Rates.
The +130k m/m increase in Nonfarm Payrolls, with Private Payrolls up only 96k, shows sluggish growth in many industries and continued decline in Retail Jobs. Curiously, manufacturing-related data were better than survey and anecdotal evidence suggested: manufacturing jobs rose 3k (although most industries cut jobs), the workweek rose (including overtime), and temporary jobs rose (viewed as mostly manufacturing jobs). Industrial Production should rise smartly this month. Construction jobs also sped up, with the gains in residential and non-residential. Mining jobs fell, however, possibly as oil drilling activity reacted to the lower oil prices.
Total Hours Worked rose a solid 0.4% m/m, thanks largely to the rebound in the Average Workweek. They stand 1.1% (annualized) above the Q219 average. So, they support estimates of 1.5-2.0% Q319 Real GDP Growth, although the relationship between THW and Real GDP Growth is variable as Productivity Growth can fluctuate.
The Household Survey data were the most interesting in the Report. Civilian Employment and Labor Force both surged over 500k m/m. More than half of the job growth was in part-time jobs. But, the important point is that the Labor Force Participation Rate continued to climb, raising the possibility that potential trend growth is higher than the Fed's 1.8-2.0% estimate. The increased workforce participation is possibly in response to higher wage rates. While the 0.4% m/m increase in Average Hourly Earnings was probably partly a consequence of calendar considerations, it also could reflect the tight labor market. The headline Unemployment Rate was steady at 3.7%, but unrounded it slipped to 3.69% from 3.71%. The decline was concentrated in African-American, Latino Ethnicity, Teen-Age and Women Unemployment Rates.
Monday, September 2, 2019
Focus on the September FOMC Meeting
Over the next few weeks, the markets are likely to focus on the likelihood of a Fed rate cut at the September 17-18 FOMC Meeting. With Fed officials emphasizing downside risks in their policy decision making, upcoming US and non-US economic data may not be relevant in their decision making. The downside risks will remain even if some data strengthen. And, the evidence suggests the key US economic data risk being mixed, in any case. So, at this point, a 25 BP cut at the Meeting looks probable.
Although some Fed officials have stated recently that more rate cuts are not needed, a decision not to ease at the September meeting was made more difficult by former NY Fed President Bill Dudley's op-ed piece on Bloomberg last week. It argued the Fed should refrain from easing in order to make it difficult for Trump to be re-elected. The piece opens the door for more accusations of political motivation if officials decide not to ease. The Fed is already being attacked by Trump (see last week's blog). And, Dudley's piece gives him ammunition. In principle, Fed officials, current and former, should emphasize that Fed actions always aim to achieve the goals of full employment and low inflation and are not politically motivated.
The evidence is mixed for this week's key US economic data. While an increase in the August Mfg ISM cannot be ruled out, there is some evidence that August Payrolls will slow.
Consensus looks for a dip in the August Mfg ISM to 51.0 from 51.2 in July. But, an increase cannot be ruled out. While none of the other mfg surveys has done a consistent job predicting the m/m direction of the Mfg ISM, they are mixed this month. Markit Mfg PMI and Phil Fed Mfg fell in August, but Richmond Fed and Chicago PM rose. Even a variation of Chicago PM, that had been correct in most prior months, missed the July decline in Mfg ISM, which suggests a reverse miss (and increase) in August.
Consensus looks for a slight slowdown in August Payrolls to +159k m/m from +164k in July. The Claims data show that layoffs remain low, but suggest that hiring has slowed. On balance, they suggest a smaller Payroll gain in August than in July. Calendar considerations point to a consensus-like 0.3% m/m increase in Average Hourly Earnings. But, these considerations underestimated July, so could overestimate in August.
The consensus August Payroll estimate and July's print are in line with the +165k H119 average pace. This is the correct comparison, even though both don't take account of the large downward revision in the BLS benchmark estimate. Last week, the BLS released its estimate of the benchmark revision to March 2019 Payrolls. It showed the currently printed level of Payrolls is 501k too high. This benchmark revision will be incorporated into the data in early February 2020 with the January Employment Report. What it means is that the currently reported +165k H119 average is too high, possibly by about 40k. The benchmark revision also could mean that Productivity is higher than currently measured. It will depend on the GDP benchmark revision, due next July.
The best measure of the labor market is the Unemployment Rate. It is independent of Payroll measurement issues. If it falls, then job growth is above trend. In other words, the labor market is strengthening. If the Rate rises, then job growth is below trend and the labor market is weakening. If the Rate is steady, then so are labor market conditions.
July Construction Spending, due Tuesday, will be of interest. Although not typically a market-mover, this report will show whether Public Construction remained weak at the start of Q319 after it dropped in June. A further weak print would work against any rate-induced increase in Residential Construction in terms of boosting Q319 GDP Growth. It could mean that labor or material shortages are holding back construction activity -- suggesting that easier Fed policy will not be particularly effective in stimulating the economy.
Although some Fed officials have stated recently that more rate cuts are not needed, a decision not to ease at the September meeting was made more difficult by former NY Fed President Bill Dudley's op-ed piece on Bloomberg last week. It argued the Fed should refrain from easing in order to make it difficult for Trump to be re-elected. The piece opens the door for more accusations of political motivation if officials decide not to ease. The Fed is already being attacked by Trump (see last week's blog). And, Dudley's piece gives him ammunition. In principle, Fed officials, current and former, should emphasize that Fed actions always aim to achieve the goals of full employment and low inflation and are not politically motivated.
The evidence is mixed for this week's key US economic data. While an increase in the August Mfg ISM cannot be ruled out, there is some evidence that August Payrolls will slow.
Consensus looks for a dip in the August Mfg ISM to 51.0 from 51.2 in July. But, an increase cannot be ruled out. While none of the other mfg surveys has done a consistent job predicting the m/m direction of the Mfg ISM, they are mixed this month. Markit Mfg PMI and Phil Fed Mfg fell in August, but Richmond Fed and Chicago PM rose. Even a variation of Chicago PM, that had been correct in most prior months, missed the July decline in Mfg ISM, which suggests a reverse miss (and increase) in August.
Consensus looks for a slight slowdown in August Payrolls to +159k m/m from +164k in July. The Claims data show that layoffs remain low, but suggest that hiring has slowed. On balance, they suggest a smaller Payroll gain in August than in July. Calendar considerations point to a consensus-like 0.3% m/m increase in Average Hourly Earnings. But, these considerations underestimated July, so could overestimate in August.
The consensus August Payroll estimate and July's print are in line with the +165k H119 average pace. This is the correct comparison, even though both don't take account of the large downward revision in the BLS benchmark estimate. Last week, the BLS released its estimate of the benchmark revision to March 2019 Payrolls. It showed the currently printed level of Payrolls is 501k too high. This benchmark revision will be incorporated into the data in early February 2020 with the January Employment Report. What it means is that the currently reported +165k H119 average is too high, possibly by about 40k. The benchmark revision also could mean that Productivity is higher than currently measured. It will depend on the GDP benchmark revision, due next July.
The best measure of the labor market is the Unemployment Rate. It is independent of Payroll measurement issues. If it falls, then job growth is above trend. In other words, the labor market is strengthening. If the Rate rises, then job growth is below trend and the labor market is weakening. If the Rate is steady, then so are labor market conditions.
July Construction Spending, due Tuesday, will be of interest. Although not typically a market-mover, this report will show whether Public Construction remained weak at the start of Q319 after it dropped in June. A further weak print would work against any rate-induced increase in Residential Construction in terms of boosting Q319 GDP Growth. It could mean that labor or material shortages are holding back construction activity -- suggesting that easier Fed policy will not be particularly effective in stimulating the economy.
Sunday, August 25, 2019
Trump's Beef With the Fed and "Order" Re China
Trump's public beef with the Fed is reprehensible -- political interference with a central bank is bad for the latter's credibility and the economy. Nevertheless, there are a couple of important issues that may have motivated his outbursts. First, is Trump right that more aggressive Fed stimulus (i.e., 50 BP cut) is needed to offset negative fall-out from his fight with China. The trade-off between short-term pain and long-term gain would be mitigated. And, stronger US economic growth could give him more leverage against China by giving him additional time to press his case. Second and more basic, is he right in thinking the Fed is incorrect believing that 3.0% growth would exceed the economy's long-run potential growth rate and be inflationary.
Is Trump right on these two issues? As for the first, aggressive easing offset to the negative fall-out from the trade war is not now needed because Real GDP Growth is still exceeding its estimated long-run potential pace, if the Fed is correct about the latter pace being 1.8-2.0%. Although Powell and the Fed moved toward Trump's demands by citing downside risks in the outlook and cutting the funds rate by 25 BPs in July, the subsequent dissent against further easing by some FOMC members stems from the still strong growth rate. Trump's more basic argument for aggressive Fed easing comes down to a belief that the Fed is too conservative in its 2% view of what is sustainable non-inflationary growth. Whether core inflation picks up or not will determine who is right.
The question of what GDP Growth Rate is sustainable and non-inflationary may take time to get resolved. The latest evidence throws doubt on Trump's belief that the Fed is aiming for too low a growth rate. The Core CPI has risen an above-trend 0.3% m/m in the past two months. And, Compensation/Hour --the broadest measure of labor costs -- sped up sharply in H119. The tight labor market may be finally exerting upward pressure on labor costs, and Powell should not have been so quick to agree that the Phillips Curve is dead in his Semi-Annual Monetary Policy Testimony.
Not all factors point to an inflation speedup ahead, however. The dollar has continues to strengthen, which, along with weaker economic growth abroad, should hold down import prices -- although the tariffs should boost some prices. And, lower oil prices should feed through to items like airline fares. Which factors will dominate should become clearer this Fall.
The next important inflation report is the July Core PCE Deflator this coming Friday. Consensus looks for +0.2% m/m and an increase in the y/y to 1.7% from 1.6%. Both the m/m and y/y risk being 0.1% pt higher. Calendar considerations raise the risk of a high 0.3% m/m increase in August Average Hourly Earnings, due September 6.
This week's US economic data will bear on the risks the Fed sees in the outlook. The consensus estimates argue that the fall-out from the downside risks is limited and overall economic growth still is good. July Durable Goods Orders, on Monday, will show whether the June bounce in Ex Transportation Orders is sustained. Consensus believes that it will, as it looks for +0.1% m/m. The August Consumer Confidence Index, on Tuesday, should reaffirm a strong consumer. Although consensus looks for a decline to 130.0 from 135.7 in July, the level would be high. The Claims data are expected to give back some of the prior week's declines. But, they would remain in their recent range.
Trump's explosive "order" for US companies to rethink their operations in China would appear to reflect frustration that the Chinese are not bending on the fundamental issue in the negotiations, namely for China to play by Western rules. Trump's prior tariff imposition was meant to push China to acquiesce on this issue. China's response by imposing 10% tariffs on some US goods shows it does not want to tackle this fundamental issue. The 10% tariff is minor and a parry in the fight. While Trump's "order" was ridiculed by some, it is in line with what may be the ultimate outcome of this battle -- a separation of two spheres of influence. Or, perhaps fear of such separation could eventually persuade the Chinese to come to grips with more significant changes to their business practices.
Is Trump right on these two issues? As for the first, aggressive easing offset to the negative fall-out from the trade war is not now needed because Real GDP Growth is still exceeding its estimated long-run potential pace, if the Fed is correct about the latter pace being 1.8-2.0%. Although Powell and the Fed moved toward Trump's demands by citing downside risks in the outlook and cutting the funds rate by 25 BPs in July, the subsequent dissent against further easing by some FOMC members stems from the still strong growth rate. Trump's more basic argument for aggressive Fed easing comes down to a belief that the Fed is too conservative in its 2% view of what is sustainable non-inflationary growth. Whether core inflation picks up or not will determine who is right.
The question of what GDP Growth Rate is sustainable and non-inflationary may take time to get resolved. The latest evidence throws doubt on Trump's belief that the Fed is aiming for too low a growth rate. The Core CPI has risen an above-trend 0.3% m/m in the past two months. And, Compensation/Hour --the broadest measure of labor costs -- sped up sharply in H119. The tight labor market may be finally exerting upward pressure on labor costs, and Powell should not have been so quick to agree that the Phillips Curve is dead in his Semi-Annual Monetary Policy Testimony.
Not all factors point to an inflation speedup ahead, however. The dollar has continues to strengthen, which, along with weaker economic growth abroad, should hold down import prices -- although the tariffs should boost some prices. And, lower oil prices should feed through to items like airline fares. Which factors will dominate should become clearer this Fall.
The next important inflation report is the July Core PCE Deflator this coming Friday. Consensus looks for +0.2% m/m and an increase in the y/y to 1.7% from 1.6%. Both the m/m and y/y risk being 0.1% pt higher. Calendar considerations raise the risk of a high 0.3% m/m increase in August Average Hourly Earnings, due September 6.
This week's US economic data will bear on the risks the Fed sees in the outlook. The consensus estimates argue that the fall-out from the downside risks is limited and overall economic growth still is good. July Durable Goods Orders, on Monday, will show whether the June bounce in Ex Transportation Orders is sustained. Consensus believes that it will, as it looks for +0.1% m/m. The August Consumer Confidence Index, on Tuesday, should reaffirm a strong consumer. Although consensus looks for a decline to 130.0 from 135.7 in July, the level would be high. The Claims data are expected to give back some of the prior week's declines. But, they would remain in their recent range.
Trump's explosive "order" for US companies to rethink their operations in China would appear to reflect frustration that the Chinese are not bending on the fundamental issue in the negotiations, namely for China to play by Western rules. Trump's prior tariff imposition was meant to push China to acquiesce on this issue. China's response by imposing 10% tariffs on some US goods shows it does not want to tackle this fundamental issue. The 10% tariff is minor and a parry in the fight. While Trump's "order" was ridiculed by some, it is in line with what may be the ultimate outcome of this battle -- a separation of two spheres of influence. Or, perhaps fear of such separation could eventually persuade the Chinese to come to grips with more significant changes to their business practices.
Sunday, August 18, 2019
Focus Back on the Fed
This week's market focus will be primarily on the July FOMC Minutes (due Wednesday) and Fed Chair Powell's speech at the Jackson Hole Conference (Friday). Neither should diverge from Powell's message at the post-FOMC meeting news conference -- economy is strong, Fed sees some downside risks, it has moved in response to these risks, and stands ready to do so again if needed. Now that the markets are less concerned about a near-term recession, a reiteration of this message should be a positive for the stock market, in contrast to the sell-off following Powell's comments at the press conference.
Last week, the markets had some solace over the US economic outlook from the strong July Retail Sales report. July Housing Starts also showed underlying strength, even though Total Starts fell. (The apparent responsiveness of 1-Family Permits and Starts to lower mortgage rates argues against those analysts who say easing monetary policy won't work to boost the economy under current circumstances.) The Atlanta Fed model's Q219 forecast moved up to 2.2% from 1.9% after these reports. The forecast now exceeds the Fed's 1.8-2.0% estimate of the long-run potential growth rate.
Ironically, the markets ignored some softer data. Unemployment Claims bounced toward their recent highs in the latest week, after they had been signaling economic strength through the recession-fear moves in the stock and Treasury markets, In addition, Manufacturing Output Excluding Motor Vehicles unwound their June bounce, showing that this sector remains under pressure from global economic weakness. The bright spot in manufacturing is now Motor Vehicles, which appear to be past their Spring inventory correction. Assemblies rose further in July, the 3rd consecutive monthly increase.
In total, last week's real-side data underscored the Fed's perception of the US economy. Growth remains acceptable, but downside risks from weak global growth are showing up in some areas. This narrow area of softness in economic activity for now justifies the Fed's cautious approach to easing.
Another justification is the risk that inflation finally may be beginning to move up. The Core CPI rose 0.3% m/m in the past 2 months. Labor Compensation/Hour (the broadest measure of labor costs) surged over H119, according to revised data. The 4.3% y/y in Q219 is a post-recession high and well above the near-3% range seen in other labor cost measures. This is high even taking account of strong productivity gains. Unit Labor Costs are up to 2.5% (y/y) in Q219, well above the 1.0% in Q418. The Phillips Curve may not be dead after all.
To be sure, global real-side data are expected to remain soft, as well. Consensus looks for dips in the Markit European "Flash" Purchasing Managers Indexes (PMIs), due Thursday. However, soft European PMIs could have a neutral to positive impact on stocks and the euro if they bolster expectations for German fiscal stimulus, as was suggested in a report on Friday. The prospect that European fiscal policy will finally act to counter economic weakness there also takes pressure off the Fed to ease in response to downside global risks. It is a negative for Treasuries.
Last week, the markets had some solace over the US economic outlook from the strong July Retail Sales report. July Housing Starts also showed underlying strength, even though Total Starts fell. (The apparent responsiveness of 1-Family Permits and Starts to lower mortgage rates argues against those analysts who say easing monetary policy won't work to boost the economy under current circumstances.) The Atlanta Fed model's Q219 forecast moved up to 2.2% from 1.9% after these reports. The forecast now exceeds the Fed's 1.8-2.0% estimate of the long-run potential growth rate.
Ironically, the markets ignored some softer data. Unemployment Claims bounced toward their recent highs in the latest week, after they had been signaling economic strength through the recession-fear moves in the stock and Treasury markets, In addition, Manufacturing Output Excluding Motor Vehicles unwound their June bounce, showing that this sector remains under pressure from global economic weakness. The bright spot in manufacturing is now Motor Vehicles, which appear to be past their Spring inventory correction. Assemblies rose further in July, the 3rd consecutive monthly increase.
In total, last week's real-side data underscored the Fed's perception of the US economy. Growth remains acceptable, but downside risks from weak global growth are showing up in some areas. This narrow area of softness in economic activity for now justifies the Fed's cautious approach to easing.
Another justification is the risk that inflation finally may be beginning to move up. The Core CPI rose 0.3% m/m in the past 2 months. Labor Compensation/Hour (the broadest measure of labor costs) surged over H119, according to revised data. The 4.3% y/y in Q219 is a post-recession high and well above the near-3% range seen in other labor cost measures. This is high even taking account of strong productivity gains. Unit Labor Costs are up to 2.5% (y/y) in Q219, well above the 1.0% in Q418. The Phillips Curve may not be dead after all.
To be sure, global real-side data are expected to remain soft, as well. Consensus looks for dips in the Markit European "Flash" Purchasing Managers Indexes (PMIs), due Thursday. However, soft European PMIs could have a neutral to positive impact on stocks and the euro if they bolster expectations for German fiscal stimulus, as was suggested in a report on Friday. The prospect that European fiscal policy will finally act to counter economic weakness there also takes pressure off the Fed to ease in response to downside global risks. It is a negative for Treasuries.
Sunday, August 11, 2019
US/China Battle and This Week's US Economic Data
The markets are once again primarily focused on the battle between the US and China. The concern is that the battle will lead to a global recession. This week's US economic data could influence this concern, as real-side data are likely to be soft.
There are two aspects of the battle that should be kept in mind: /1/ The battle will not be resolved quickly. The US wants China to conform to the rules of the global trading system. China wants to follow its own rules of conduct. At issue is which country will dominate world trade. Since neither country seem willing to concede, the markets are likely to face continued headline risks for an extended period. To be sure, there could be positive surprises, such as the North Korean president's letter to Trump raising the possibility of ending missile testing and resuming talks. /2/ The Trump Administration is not entirely correct in blaming the recent dollar strength on Chinese FX intervention. US tariffs have the effect of boosting the dollar because they lower the expected trade deficit. And, bond arbitrage between Europe and the US also serves to lift the dollar.
US economic data will remain important for two reasons. First, they influence the probabilities of a negative fall-out from the US/China battle. Second, they influence the probabilities of another Fed rate cut. Weak data would not be stock-market friendly because of the first reason. But, the market impact would be mitigated because of the second.
At this point, there is evidence that caution is creeping into private economic decision making. The July Employment Report showed a dip in the Average Workweek, suggesting firms are pulling back on hours worked without cutting jobs significantly. The Claims data show companies are not in the aggregate firing workers in response to economic uncertainties. Initial Claims fell to 209k in the latest week, putting them below the 212k July average and the 218k Q219 average. But, hiring may have slowed, as suggested by Continuing Claims staying high. Continuing Claims fell to 1.684 Mn in the latest week, putting them slightly below the 1.687 Mn July average. But they remain just above the 1.680 Mn Q219 average. The low point was April. Continuing Claims need to fall further to suggest hiring has picked up.
The Atlanta Fed model's latest forecast is 1.9% for Q219 Real GDP Growth. This is in line with the longer-run potential growth rate as estimated by the Fed. But, there is not enough available data for the model's forecast to be reliable now.
This week's US real-side economic data risk being soft. /1/ The consensus estimate of +0.4% m/m July Retail Sales may be overly optimistic. Some of the gain may reflect higher-priced gasoline. If so, the more important Ex Auto/Ex Gasoline Retail Sales would be softer. Also, a pause after several months of strong gains in Ex Auto/Ex Gasoline would be typical. /2/ The consensus estimate of +0.1% m/m in July Industrial Production, with Manufacturing Output -0.1%, is not out of line with the flattish Total Hours Worked in Manufacturing Production Workers seen in the Employment Report. Such prints would underscore sluggish activity in that sector. /3/ Consensus looks for a decline in the August Phil Fed Mfg Index to 10 after it jumped to 21.8 in July. But, the latter missed the declines seen in the Mfg ISM and Markit Mfg PMI that month. So, it would be just catch-up.
The July CPI could be problematic for the markets. Consensus looks for the Core CPI to return to 0.2% m/m after +0.3% in June. Friday's release of the July PPI supports the idea of an easing of inflation pressures: the underlying PPI -- PPI Ex Food/Energy/Trade Services -- was -0.1% m/m in July after 0.0% in June. But, there are upside risk to the Core CPI from other sources. Apparel Prices could be up again, after +0.8% m/m in June -- as a result of bi-monthly sampling for this component. And, Owners' Equivalent Rent risk continuing to print 0.3% m/m or even 0.4%. A 0.2% m/m print for the Core CPI would keep the y/y steady at 2.1%. A high print for the Core CPI would temper expectations of a Fed rate cut, making it less of a mitigating factor regarding the US/China battle.
There are two aspects of the battle that should be kept in mind: /1/ The battle will not be resolved quickly. The US wants China to conform to the rules of the global trading system. China wants to follow its own rules of conduct. At issue is which country will dominate world trade. Since neither country seem willing to concede, the markets are likely to face continued headline risks for an extended period. To be sure, there could be positive surprises, such as the North Korean president's letter to Trump raising the possibility of ending missile testing and resuming talks. /2/ The Trump Administration is not entirely correct in blaming the recent dollar strength on Chinese FX intervention. US tariffs have the effect of boosting the dollar because they lower the expected trade deficit. And, bond arbitrage between Europe and the US also serves to lift the dollar.
US economic data will remain important for two reasons. First, they influence the probabilities of a negative fall-out from the US/China battle. Second, they influence the probabilities of another Fed rate cut. Weak data would not be stock-market friendly because of the first reason. But, the market impact would be mitigated because of the second.
At this point, there is evidence that caution is creeping into private economic decision making. The July Employment Report showed a dip in the Average Workweek, suggesting firms are pulling back on hours worked without cutting jobs significantly. The Claims data show companies are not in the aggregate firing workers in response to economic uncertainties. Initial Claims fell to 209k in the latest week, putting them below the 212k July average and the 218k Q219 average. But, hiring may have slowed, as suggested by Continuing Claims staying high. Continuing Claims fell to 1.684 Mn in the latest week, putting them slightly below the 1.687 Mn July average. But they remain just above the 1.680 Mn Q219 average. The low point was April. Continuing Claims need to fall further to suggest hiring has picked up.
The Atlanta Fed model's latest forecast is 1.9% for Q219 Real GDP Growth. This is in line with the longer-run potential growth rate as estimated by the Fed. But, there is not enough available data for the model's forecast to be reliable now.
This week's US real-side economic data risk being soft. /1/ The consensus estimate of +0.4% m/m July Retail Sales may be overly optimistic. Some of the gain may reflect higher-priced gasoline. If so, the more important Ex Auto/Ex Gasoline Retail Sales would be softer. Also, a pause after several months of strong gains in Ex Auto/Ex Gasoline would be typical. /2/ The consensus estimate of +0.1% m/m in July Industrial Production, with Manufacturing Output -0.1%, is not out of line with the flattish Total Hours Worked in Manufacturing Production Workers seen in the Employment Report. Such prints would underscore sluggish activity in that sector. /3/ Consensus looks for a decline in the August Phil Fed Mfg Index to 10 after it jumped to 21.8 in July. But, the latter missed the declines seen in the Mfg ISM and Markit Mfg PMI that month. So, it would be just catch-up.
The July CPI could be problematic for the markets. Consensus looks for the Core CPI to return to 0.2% m/m after +0.3% in June. Friday's release of the July PPI supports the idea of an easing of inflation pressures: the underlying PPI -- PPI Ex Food/Energy/Trade Services -- was -0.1% m/m in July after 0.0% in June. But, there are upside risk to the Core CPI from other sources. Apparel Prices could be up again, after +0.8% m/m in June -- as a result of bi-monthly sampling for this component. And, Owners' Equivalent Rent risk continuing to print 0.3% m/m or even 0.4%. A 0.2% m/m print for the Core CPI would keep the y/y steady at 2.1%. A high print for the Core CPI would temper expectations of a Fed rate cut, making it less of a mitigating factor regarding the US/China battle.
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