The Market Today

TODAY’S CALENDAR

Consumers and Government Spending Keep Economy Running in 2Q in Strong Report: The economy expanded more than expected in 2Q, growing 2.1% at the headline level.  The year-over-year rate of growth slowed from 2.7% to 2.3%, the weakest pace since 3Q17.  After nine consecutive quarters of acceleration in year-over-year growth, it has now slowed in three consecutive quarters and dropped from a peak of 3.0%.

The details paint a stronger picture than 1Q’s 3.1% report with personal consumption up a sizzling 4.3%, the second best pace since 2014.  The result confirms the consumer rebound from 4Q18 and 1Q19 and proves the consumer’s ability to buoy the economy during all of the trade uncertainty.  Adding to the consumer strength, government spending increased 4.9% on a 15.9% increase in federal non-defense, a 2.8% increase in federal defense, and a 3.2% jump in state and local spending.  This marked the biggest contribution to GDP growth from government spending since 2009.

On the negative side of the ledger, business fixed investment fell 0.6% on a 0.7% increase in equipment, a 4.6% increase in intellectual  property investment, and a 10.6% decline in structures.  That result is particularly discouraging given that still-existing incentives for business investment from 2017’s tax reform.  Residential investment was even more discouraging, dropping 1.6% despite mortgage rates averaging just 4.01% during the quarter (Freddie Mac 30-Year Mortgage Market Survey Rate).  Exports fell 5.2% in 2Q while imports actually ticked up 0.1%, causing the trade deficit to rebound from 1Q’s unusual decline and dragging 0.7% from the final GDP tally. As expected, inventory growth also slowed, up just $71 billion in 2Q versus 1Q’s $116 billion increase, dragging another 0.9% from growth.

Stripping out some of the volatile items, final domestic sales rose 3.5% in 2Q, a very solid quarter and evidence that the U.S. economy is holding up despite the trade uncertainties and global weakness.  The result is unlikely to alter the Fed’s path to a rate cut next week.  But like yesterday’s durable goods orders report showing business investment possibly picking up heading into 3Q, reduces the likelihood of a 50 basis point cut.

TRADING ACTIVITY

Yesterday’s Trading – Mitigated Message from ECB, Strong Durable Goods Report Push Yields Higher: Only one day removed from a new record-high, the S&P 500 saw all eleven sectors fall yesterday as earnings reports were mixed, the ECB prepped investors for a ‘mitigated’ rate cut, and the June durable goods orders report lessened the likelihood of more aggressive Fed easing. Equities were running higher and sovereign yields lower before the U.S. open as the ECB opened the door to a September rate cut and possible re-starting of quantitative easing.  President Draghi, however, was woefully bearish in his press conference highlighting that the outlook is getting “worse and worse” and that a “significant degree of monetary stimulus” is needed.  Confusing the message, he also noted that any rate cut would come with “mitigating measures”, perhaps referencing the need to tier deposit rates so as not to completely erode the liquidity of the banking system.  Moreover, the mere acknowledgement that it will not be as easy as just cutting a key rate raised investors’ fears that central bankers may be pushing on a string this time around.  Also before the open, the June durable goods orders report showed a stronger-than-expected rebound in business investment.  Fed officials have been closely watching business investment as an area of secondary impact from the prolonged trade uncertainty.  The rebound likely removes some of the impetus for anything more than a 25 bps cut.  The 10-year yield had fallen as low as 2.01% after the ECB decision but quickly rose after Draghi’s caveat and the strong durable goods report.  By the end of the day, the yield rose 7 bps to 2.08% while the 2-year yield jumped 6 bps to 1.86%.  Treasury’s were not helped by yet another weak auction, this time a weak 7-year auction with a 1.2 bps tail.  The S&P and DJIA both sank 0.5% to 3,004 and 27,141, respectively.

Overnight Trading – Awaiting the Fed:  Markets were a bit more quiet overnight in the aftermath of the ECB shift, as they look forward to next week’s FOMC meeting and digest a batch of mixed-but-not-so-bad corporate earnings reports. Shortly after yesterday’s close, the House passed a $2.7 trillion budget deal lifting defense and discretionary spending levels for 2020 and 2021.  The deal also suspends the debt ceiling through 2021.  The plan will now go to the Senate which is expected to pass it next week. Eurozone stocks rose 0.4% overnight while S&P futures were up 0.3%.  Treasury yields were fractionally lower heading into the 2Q GDP report.