The Market Today
Deluge of Fedspeak Shows High Bar to NOT Hike in December
by Craig Dismuke, Dudley Carter
ADP Portends Another Stronger-than-Expected September Job Report: So much for Hurricane Florence affecting the September labor data, at least according to the ADP Employment report which projected 230k new private nonfarm payrolls for the month. The result beat expectations by 46k and portends another stronger-than-expected BLS report on Friday. While manufacturing and leisure and hospitality jobs were weaker than their 12-month average, there was strength in almost every other sector. The construction sector added 34k payrolls (+12m avg. +17k), and the professional and health services sector added 70k (12m avg. +44k). Despite the ADP report, we continue to believe Hurricane Florence is likely to have affected the BLS payroll tally by 15-20k.
ISM Non-Manufacturing Index: At 9:00 a.m. CT, the ISM Non-Manufacturing index for September is expected to pull back fractionally, but remain very strong. Over the coming months, it will be interesting to see if the index can hold its recently elevated levels or if the index pulls back into the pre-tax reform range – which could be an early indicator that the biggest pop from tax reform was short-lived.
Evans – A Former Dove Who Is Now Satisfied with Inflation and Hiking Rates above 3.0%: Chicago Fed Bank President Charles Evans spoke on CNBC Europe this morning saying the economy is doing “extremely well” and the Fed needs to continue hiking to just above 3.0% to keep growth stable. According to CNBC’s transcript, Evans said, “I spent quite a long time indicating that I think inflation needs to get up to 2 percent, and here we are. … So I think things are going very well, this is something that can be continued for a number of years, in fact I think that by setting the policy rate just a little above neutral, that will continue to keep things going for quite some time.” Evans, once a consistent dove, has turned sharply now that inflation has neared the Fed’s 2% target.
Barkin Appears to Be On-Board with December Hike: Richmond Fed President Barkin, who will have a vote on whether the Fed hikes again in December, sounded upbeat in a speech this morning in West Virginia. He highlighted that “Growth is solid, unemployment is low and inflation is at target. The challenge is not so much today, but rather ensuring that growth continues. … We’ve had fiscal stimulus in the form of tax cuts and the omnibus bill. There’s a sense that we’re in a deregulatory moment. People have jobs, and the markets are strong. Overall, it’s starting to feel like we’ve got some tailwinds rather than headwinds.” He did, however, provide a word of caution that “Trade disputes are making people more nervous than they did a few months ago.”
Harker Could Be Convinced to Support December Hike: Philadelphia Fed President Harker, who votes again in 2020, appeared on Bloomberg after this morning’s ADP numbers were released, saying that the labor market continues to surprise him. And while he expects the unemployment rate will tick down to 3.5% before rising, as was forecast in the September SEP, he expects the pace of improvement to slow and believes the Fed can remain gradual. He mentioned that his base case was for just three hikes in 2018 but said he could talked into raising rates again in December. Harker estimates the neutral rate is around 3% and expects the Fed to arrive there in 2021.
Powell Believes Phillips Curve Tamed by Fed’s Success in Managing Inflation Expectations: Fed Chair Powell spoke yesterday saying that he believes the economy can continue to operate in a “Goldilocks”-type environment, illustrated in the Fed’s Summary of Economic Projections, with an ever-tighter labor market and contained inflation. Powell believes this environment can continue because of changes in the Phillips Curve. The Philips Curve is an academic economic concept holding that inflation rises as the labor market tightens and vice versa. According to the WSJ, “Mr. Powell said improvements in how central banks conduct monetary policy in recent decades, primarily by anchoring consumers’ and businesses’ expectations of future inflation, have ‘greatly reduced, but not eliminated, the effects that tight labor markets have on inflation.’” Given how tight the labor market appears to be and the immediacy of the risk that inflation could ramp up, Powell said the Fed will be paying close attention to inflation expectations, and stood “ready to act with authority if expectations drift materially up or down.”
Kaplan “Comfortable” with December Hike: Dallas Fed President Kaplan said he is “comfortable” with a fourth rate increase this year and sees 2018 growth of 3% thanks to a boost from tax reform. However, he doesn’t believe the Fed has much work left to do. He said his base case is for just two more in 2019. Kaplan told reporters, “We should be moving toward a neutral stance, and at that point we should be assessing where we should go from there.” He said “I’m not advocating a pause,” but “We’ll have to see if it’s appropriate to do more. I’ll make that judgment as we go; I haven’t decided yet.”
More Fedspeak on the Calendar: Fed Governor Lael Brainard is scheduled to speak at 1:00 p.m. CT followed by Cleveland Bank President Mester at 1:15 p.m., and Fed Chair Powell at 3:00 p.m. While Powell’s opinion shouldn’t change too much from his comments yesterday (more below), Brainard is also a key voice on the Fed. Two weeks ago, Brainard said she did not think the Fed should be dissuaded from rate hikes by the flattening yield curve.
Overnight – U.S. Stocks, Yields Rise With Europe on Less Pressure from Italian Politics: Despite a weaker start in Asia, European equities have firmed up and U.S. futures are signaling the Dow could open at a new record high. While several markets remained closed in Asia, including China which is on holiday break for the entire week, Japan’s Nikkei fell 0.66% and several smaller markets weakened. As was the case yesterday in the U.S., autos were one of the larger drags on overall sentiment. However, in context, the tone for Japanese equities is still firm. The Nikkei’s previous close was the highest in nearly 27 years (November 1991). In Europe, the bounce was being led by Italy’s FTSE MIB which rebounded 1.1% after dropping more than 5% over the last five sessions. Reports last Friday that Italian government had agreed to a budget deficit of 2.4% of GDP through 2021 sent Italian yields soaring and the country’s stock market tumbling, setting off a bit of risk-off trade globally. Overnight, a news agency in the country reported the government was discussing reducing the 2020 and 2021 target to 2.2% and 2.0%. The Italian 10-year yield fell 9.9 bps after surging 56 bps over the last three days. German yields rose in response and Treasury yield ticked higher. The 2-year and 10-year Treasury yields were up just under 1 bps ahead of this morning’s U.S. economic data.
Yesterday – Stocks Were Mixed, Adding to Downward Pressure from Europe on U.S. Yields: U.S. stocks closed mixed Tuesday as the Dow rallied 0.46% to a new record close while the Nasdaq sank by an almost-equal 0.47%. The S&P 500 moved between positive and negative territory but ultimately ended unchanged. The defensive utilities and consumer staples sectors were the top performers but offset by losses in the more heavily weighted consumer discretionary group. The latter saw components covering autos, retailers, and household appliances all decline. The Dow also saw its consumer discretionary close in the last spot but those losses were more than neutralized by gains in more heavily-weighted sectors. Industrials, the biggest Dow component, rose 1.2% as investors continued to react to the recent North American trade deal. The Treasury curve ended lower and flatter amid the mixed equity performance and after continued concerns related to Italian politics pushed down core European government bond yields. The 2-year Treasury yield fell 0.8 bps, the 5-year yield settled down 1.0 bps, and the 10-year yield moved down 2.0 bps.