The Market Today
Absent the Energy Effect, Core Inflation Remains Subdued But Retail Sales Rebound
by Craig Dismuke, Dudley Carter
Today’s Calendar – Absent the Energy Effect, Core Inflation Remains Subdued But Retail Sales Rebound: In addition to Wednesday’s Fed Minutes, this morning’s economic calendar rounded out the most important reports of the week. September’s CPI data was 0.1% weaker than expected across each metric while retail sales improved at a pace essentially in line with estimates. Starting with inflation, headline prices rose 0.5% MoM compared with a 0.4% increase in August. The monthly increase lifted the YoY rate 0.3% to 2.2%. Energy prices rose 6.1% MoM as gasoline prices surged 13% in the aftermath of Hurricane Harvey, the biggest monthly increase in more than eight years. Food prices rose a more modest 0.1%. Stripping out these volatile items, core prices rose just 0.1%, a slower pace than August’s 0.2% increase, which left the YoY rate unchanged at 1.7%. The weaker-than-expected core inflation was driven by continued weakness in the prices of goods and a slower pace of increases in the cost of most services. Goods prices declined the most since May; prices for household furnishings, apparel, new and used autos, prescription drugs, and textbooks continued to slide. The drag from goods’ pricing left services to keep inflation buoyant, and the disappointment continued there. Pricing on services involving medical care, transportation, and recreation were all weaker compared with August. But the biggest surprise was the weakness in shelter. Lodging away from home rose again in September but rent prices weakened. Owner’s equivalent rents rose 0.24% in September, the softest since May, while rent of primary residence increased just 0.21%, the smallest monthly increase since February 2014. While inflation pressures remain positive, the subdued core monthly increase will hardly settle the ongoing debate at the Fed.
The retail sales results were more positive, with headline sales up 1.6% MoM at the headline level thanks to a 3.6% gain in auto sales (+0.3% 12-month average) and a 5.8% surge in sales at gasoline stations (+0.9% 12-month average). The jump in auto sales is consistent with the gains we saw in related data elsewhere and shows consumer have begun replacing autos lost in the storm. The big increase in sales at gasoline stations is consistent with this morning’s CPI that showed a surge in gasoline prices; retail sales aren’t inflation adjusted and therefore reflect the higher gasoline prices. However, unlike the August data, the higher gas prices didn’t do much damage to sales at the core level. Stripping out a positive 2.1% sales of building materials (another potential effect of the hurricanes) and a smaller 0.8% increase in consumers’ food purchases, core sales were up 0.4%. The strength at the core level was driven largely by gains in online sales, purchases of apparel, and activity at general merchandiser. Adding to the strength of the retail sales data were positive revisions to activity in August. The 0.2% decline initially reported for August was revised up to 0.0%. The growth story isn’t the concern for the Fed but the rebound in retail sales should give them comfort that the consumer will remain stable into the end of the year.
Overnight Activity – Sources Float Potential ECB Tapering Plan: Ahead of this morning’s important U.S. economic data, U.S. equity futures had tracked global shares higher and reached their daily highs after Bank of America posted better-than-expected revenue and earnings. As was the case with JPMorgan and Citi, however, Bank of America also reported a decline in trading revenue and higher reserves for credit card losses. Friday’s strength in global equities was partly attributed to better-than-expected Chinese trade data released earlier in the day. Both imports and exports improved in September and the gain in imports topped estimates. The Dollar recovered early losses and turned positive after the Euro dropped sharply as local trading opened. The currency’s decline corresponded to the biggest move lower in European yields, with some pointing to media reports on the future of the ECB’s QE program that were released after Thursday’s market close. Those reports said a plan to cut monthly purchases from 60B Euros to 30B Euros with was being considered. The reduced purchases may potentially run through September, with the caveat that they could be extended if needed. European sovereign yields on debt maturing in five years and out were down between 2 bps and 3 bps. Treasury yields drifted up despite the lower yields across Europe. After this morning’s disappointing core inflation data, Treasury yields and the Dollar turned sharply lower to trade at their lows of the day. The 2-year yield is down 1.6 bps to 1.50% and the 10-year yield is 3.0 bps lower at 2.29%.
Yesterday’s Trading Activity – Treasurys Rally on Equity Weakness, Strong 30-Year Auction: The major U.S. equity indices faltered between 0.1% and 0.2% Thursday as Treasury yields closed near their lows of the day and the Dollar rose for the first time in the last five days. The telecom sector was the biggest drag on the S&P, losing more than 3.5%. The sector’s loss was driven primarily by a more-than-6% decline in shares of AT&T. The telecom giant reported a sharp loss in the number of TV subscribers as the industry continues to fight off less expensive options that continue to drive customers to cut the cord. The second worst performing sector was financials after JPMorgan and Citi reported better-than-expected earnings but showed signs of headwinds from depressed trading revenue and increased consumer credit concerns. Citi led the sector’s losses with a 3.4% drop. Treasury yields remained lower during the entire Thursday session and made a notable move down after an auction of 30-year notes received the strongest bid-to-cover since September 2015 and the smallest primary dealer award since March. The 2-year note fell 0.6 bps to 1.51%, the 5-year yield fell 1.8 bps to 1.94%, the 10-year yield dropped 3.0 bps to 2.32%, and the 30-year yield shed 3.6 bps to 2.85%. The outperformance by the Long Bond pushed the spread between 5s and 30s to its lowest level since November 2007.
Thursday’s Central Bank Chatter
Fed Governor Powell: Powell, who is considered one of the current front-runners to be Fed Chair when Yellen’s term is up in February, made remarks on the prospects for emerging market economies. He also addressed the current state of U.S. monetary policy. On the former, Powell said, “Corporate debt represents a moderate degree of vulnerability for EME [emerging market economy] prospects. The situation is not alarming, but risks are significant and bear close watching, especially in China.” He said small market surprises can created larger reactions, especially considering the currently absence of volatility. However, this shouldn’t distract the Fed from “continued pursuit of [the Fed’s] dual mandate.” As a result, he expects gradual policy normalization will continue.
Fed Governor Brainard: Brainard discussed inflation trends in an appearance in Washington, saying that she believed temporary factors were partly to blame for the downturn in inflation in 2017. However, she also believes a “reduction in the underlying trend rate of inflation that’s material,” may have occurred and said “there seems to be a global factor as well.” To Brainard, it’s not as simple as waiting on wages; she noted “It’s not so much that the Phillips Curve isn’t operative, it seems to be that the Phillips Curve is just not very important in the overall inflation process.” After posing the question of what are central banks to do to address lower-trend inflation – she clarified that she was talking about the future policy, not current policy, she discussed the merits of future use of price-level targeting.
ECB Officials: ECB President Draghi appeared on a monetary policy panel in Washington on Thursday, but didn’t tip his hand on what the bank plans to do with its QE program which is set to expire in December. Instead, he defended the use of a negative overnight rate, saying that specific policy had “by and large…been a success.” He also supports a continuation of that policy. The current statement reads that the ECB expects its key policy rates “to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.” Draghi added “the ‘well past’ is very, very important in anchoring rate expectations.” His Chief Economist, Peter Praet, also expects accommodation to continue for now. Praet said, “We are undoubtedly experiencing a solid, broad-based and resilient economic recovery that is contributing to a narrowing of the output and unemployment gaps. But there still appears to be a disconnect between growth and inflation…Crucially, the baseline scenario for future inflation remains contingent on easy financing conditions, which, to a large extent, depend on the support of monetary policy.”