The Market Today
3Q Economic Growth Tops Expectations; Fed Expected to Cut
by Craig Dismuke, Dudley Carter
FOMC Expected to Cut for Third Time: The FOMC will announce its policy decision at 1:00 p.m. CT today. They are expected to cut rates for a third time bringing the target range down to 1.50-1.75%. With Fed Funds futures contracts still showing expectations for another cut in the coming year, the Fed is likely to push back against that outlook. Chairman Powell will have a press conference at 1:30 p.m. but this meeting will not bring new economic projections. Rather, officials are likely to use the language in the Official Statement to try to shape market expectations.
Economy Expands More Than Expected in 3Q: The economy expanded a better-than-expected 1.9% in 3Q, driven higher by continued strength at the consumer level, the first quarter of positive housing activity in seven, and another gain in federal spending. While the quarter proved better than expected, the growth rate versus year-ago activity has now slowed in four of the past five quarters, now down to 2.0% which is the slowest rate since 4Q16. The perfect storm of factors which were pushing growth above sustainable levels in 2017 and 2018 has clearly faded, although growth has not tanked in the face of so much uncertainty. Real final sales grew 2.0%, slightly below the pre-2017 expansion average.
Strong Consumer: After gaining 4.6% in 2Q, personal consumption rose another 2.9% QoQ highlighting just how strong and resilient the consumer is today.
Housing, Finally: Residential investment rose 5.1%, only the fourth positive quarter since mortgage rates bottomed in 2016 (against ten quarters of contraction). However, even though mortgage rates have now dropped near those 2016 lows, the impact on housing does not appear to be as significant as falling rates were back in 2014 and 2015.
Business Slowdown: As for business investment, it continues to be negatively affected by the slowing global environment and uncertainty from trade. Overall investment fell 3.0%, the second consecutive quarterly decline and the second-worst performance since the recession. Investment in equipment fell 3.8% while structures dropped a disconcerting 15.3%.
Inventory Growth: Inventories rose $69 billion which was a fractionally slower pace of growth than in 2Q leading to a negligible drag on the final GDP tally.
Trade: External trade dragged 0.1% as the deficit grew $5.7 billion. Imports rose 1.2% and exports rose 0.8%
Government Boost: Total government spending rose 2.0% on out-sized gains in federal spending. Federal defense spending rose 2.2% while non-defense jumped 5.2%, cumulatively contributing 0.22% to the GDP tally. This is, however, coming at the expense of the federal deficit. The monthly data from Treasury show a trailing 12-month deficit currently at $984 billion, the largest since 2013.
ADP Tops Estimates Despite Contraction in Goods-Producers’ Payrolls: ADP estimates the private sector added 125k jobs in October, better than the 110k economists had expected. September’s initial estimate of 135k, however, was revised down to just 93k. While firms of all sizes grew their payrolls last month, medium size firms added the most and the gains were concentrated within the services sector. Goods-producing industries dropped 13k jobs while services picked up the slack with a 138k gain. Four of the seven services industries added jobs at a pace better than their 12-month average. The data should calm fears about a surprise disappointment in Friday’s official data, but also confirms a slowing trend. The 3-month average slowed from 132k to 126k while the 12-month average cooled from 172k to 163k.
YESTERDAY’S TRADING ACTIVITY
Mixed Earnings Left Equities Little Changed: U.S. equities and Treasury yields moved very little on balance Tuesday amid mixed corporate earnings as the Fed’s two-day meeting kicked off in Washington. The S&P 500 was led higher by the health care sector in response to solid earnings-related gains from Pfizer and Merck. On the opposite end of the sector ladder, communication services and other tech companies served as offsetting drags following a disappointing quarterly earnings report from Alphabet (Google) a day earlier. Stocks’ sharpest intraday snap lower came at 1 p.m. CT on a Reuters report that the phase one trade deal may not be ready for the U.S. and China to sign at the November APEC Summit in Chile. However, the White House later commented that was still their aim. By the close, the ups and downs had netted the S&P 500 a 0.1% decline.
Treasury Yields Steadied As Investors Await Fed’s Forward Guidance: Treasury yields also ended the day essentially flat in front of this afternoon’s Fed decision. Fed funds futures ended Tuesday pricing in a greater-than-ninety-percent chance of another rate cut this afternoon. President Trump also offered Fed officials some final words of encouragement as they begin their debate, tweeting that “The Fed doesn’t have a clue! We have unlimited potential, only held back by the Federal Reserve.” Although it had limited market impact, the U.K. parliament voted overwhelmingly in favor of allowing Britons a say on December 12th on how to proceed on Brexit.
OVERNIGHT TRADING ACTIVITY
Slow News Flow Leaves Markets Locked on the Fed: Treasury yields inched lower with global stocks overnight with investors anxious to see how much U.S. growth slowed in 3Q and whether the Fed opts to cut rates but signal a pause. Stocks in Asia were mixed but generally weaker across Europe, leaving the Stoxx 600 just below breakeven for the day. While France’s economy grew a better-than-expected 0.3% in 3Q, another soft confidence measure for the Eurozone as a whole served as the latest reminder of the worries around Europe’s economic health. The European Commission’s broadest economic confidence measure fell more than expected in October to its weakest reading since early 2015 as the outlook for the industrial sector continued to weaken.
Solid Morning Data Reverses Yields Higher: Ahead of this morning’s ADP payroll data and first look at 3Q GDP from the BEA, the 2-year Treasury yield was 0.8 bps lower, the 10-year yield had dipped 1.6 bps, and equity futures were essentially flat. Better-than-expected results in both reports reversed yields higher, with the 2-year yield up 0.8 bps and the 10-year yield 0.4 bps higher.
Pending Home Sales Improve Again: Pending home sales perked up more than expected in September and point to a recovery for existing home sales in the months ahead. Data last week showed a larger-than-expected drop in sales of existing home in September. However, pending home sales increased 1.5% in September on gains in the South and Midwest and have now improved in four of the last five months. That recent consistency has helped push sales up 6.3% on an unadjusted basis from a year ago, the strongest year-over-year comparison since 2015. As home price gains have continued to moderate, the steep decline in mortgage rates, from close to 5% last November to around 3.5% in September, has helped aid affordability.
Consumer Confidence Comes Up Short as Worries about the Future Continue to Weigh: Consumer confidence was weaker than expected in October as uncertainty about the future continued to weigh on a relatively solid level of comfort about the current situation. Overall confidence fell unexpectedly from a revised-higher 126.3 to 125.9, a four-month low. The current assessment continued to hold up well, evidenced by the 1.7-point improvement in the present index to the fifth strongest level since 2000. Business conditions were seen to have improved and a key labor indicator recovered to its second best level in almost 19 years. However, there is still some trepidation about the future. Consumers expect business conditions to level off and the labor market to continue slowing, both dragging expectations to the second weakest level since the 2016 election. Income expectations inched up, however, cushioning the drag somewhat. Recent disappointments in the jobs data and retail sales activity has raised scrutiny on the health of the consumer. This latest reading on confidence should stave off worries about an imminent consumer contraction, but is unlikely to settle any debates about the general trajectory of the most important component of the economy.