The Market Today
Disappointing ISM Report; Slower Global Trade but Smaller U.S. Deficit
by Craig Dismuke, Dudley Carter
Mortgage Applications Slowing After Strong Start to 2019: Mortgage applications for the week ending February 1 fell 2.5% on a 4.6% decline in purchase applications and a 2.6% increase in refis. After two strong reports to start the year, the last three reports on new mortgage applications have been negative, keeping the focus on weak housing activity. On a positive note, the 4-week average for new purchase applications remains 19% higher than the November trough.
November Trade Balance Shows Slower Global Trade, Smaller U.S. Deficit: The November trade deficit shrunk sharply more-than-expected, dropping from $55.7 billion to $49.3 billion. After October’s $55.7 billion deficit, the largest monthly deficit since 2008, it appeared trade might drag 0.5% from 4Q GDP. However, November’s data points to trade possibly being a non-event in the 4Q tally. A potentially negative outworking of trade uncertainty and weaker global growth, imports and exports of non-petroleum items both fell in November. By country, the bilateral deficits fell with China (-$5.2 billion), the EU (-$2.5 billion), Canada (-$1.3 billion), and Mexico (-$0.5 billion).
Fedspeak Unlikely to Make Headlines: At 5:05 p.m. CT, Fed Vice Chair Quarles is scheduled to speak on bank stress testing in New York. At 6:00 p.m., Fed Chair Powell is slated to speak at an educators’ town hall meeting in Washington. The venue is unlikely to lend to monetary policy pronouncements.
State of the Union – President Trump Describes “Unprecedented Economic Boom”: The president delivered a rhetorically soaring State of the Union Address last night that was long on vision, but short on market-moving details. President Trump described economic activity over the last two years as an “unprecedented economic boom,” spending several minutes discussing historic labor market metrics. He mentioned the administration’s focus on deregulation and highlighted that for the first time in decades the U.S. became a net exporter of energy. He segued into his remarks on border security by highlighting areas (i.e. Farm Bill, VA reform, criminal justice reform) that Democrats and Republicans have successfully agreed on bipartisan bills. After a plea for Congress to pass his “commonsense proposal” as part of a longer-term spending deal, he said “I’ll get it built” with reference to a wall he wants “deployed in the area identified by border agents as having the greatest need.” As the president reminded Congress, there are 10 days left on the current short-term funding bill. He discussed the progress with China on trade but reiterated any agreement “must include real, structural change to end unfair trade practices, reduce our chronic trade deficit, and protect American jobs.” He said, “Both parties should be able to unite for a great rebuilding of America’s crumbling infrastructure,” and said he was “eager to work” with Congress on such a deal.
Yesterday – Treasury Yields Pulled Back Despite Stocks Extending Positive Run: U.S. stocks rose Tuesday to take the S&P 500 index higher for a fifth consecutive session, matching the longest stretch since February 2018. Consumer discretionary stocks were the top performer while those closely tied to the tech space finished in a close second and third. Financials slipped 0.1% and led three of eleven sectors lower on the day. Stocks gave up early gains and flirted with negative territory around the lunch hour, but the S&P 500 recovered to finish 0.5% higher and near its daily peak. Despite upbeat sentiment across the equity space, Treasury yields fell across the curve. After sliding rather precipitously between 7:30 and 10:30 a.m. CT, yields moved sideways in the afternoon to close down between 1.4 bps and 2.5 bps on the day. While a weaker-than-expected non-manufacturing PMI (more below) and strong auction of 3-year notes (first stop through in 11 auctions), the downtrend was well entrenched prior to both events. The 2-year yield closed down 1.4 bps at 2.52% while the 10-year yield dropped 2.5 bps to 2.70%, flattening the curve between the two for the first time since before the Fed’s policy pivot last Wednesday.
Overnight – Another Quiet Session with Most of Asia Still Closed: Major markets are little changed Wednesday with several larger Asian market still closed for the Lunar New Year and little in the way of a catalyst to get investors excited. Japan’s Nikkei rose 0.1% while Europe’s Stoxx 600 moved above and below Thursday’s level and was most recently marginally higher for the day. A positive close Wednesday would give the index its first seven-day stretch of gains for the first time since October 2017. German equities, Wednesday’s downside outlier, could play the role of spoiler as the DAX has decline 0.4% on more disappointing economic data. Factory orders fell unexpectedly in December and the country’s construction PMI hit a three-month low. The lack of economic events also left room for headlines about last night’s State of the Union Address. Markets showed little response to the speech that discussed the major topics of interest for investors (e.g. government funding bill/border wall, China trade negotiations, infrastructure bill) but included few surprises on the matters. U.S. equity futures were mixed but less than 0.1% changed while Treasury yields had ticked lower by around 1 bp.
ISM Services Activity Slowed More Than Expected to Start 2019: Activity in the U.S. services sector slowed more than expected to start 2019 according to the ISM’s January Non-manufacturing PMI. The headline PMI fell from 58 to 56.7 compared to economists’ expectations for a modestly firmer 57.1. January’s reading matched its lowest level since 2017. The biggest driver of the decline was a pullback in the new orders index, which dropped 5 points to 57.7, one of the weaker reading in recent years. Overall business activity also slowed from its brisk pace late in 2018 while employment actually improved. While weaker than levels later in 2018, employment remained at a relatively solid level for the cycle. The comment sections captured the two major topics weighing on the minds of respondents. Of the nine comments selected for publication, seven included a reference to tariffs or, more frequently, the government shutdown. Reinforcing concerns about trade, the new export orders index experienced its third-largest decline of the cycle to its lowest level since January 2017. The weaker-than-expected PMI reinforces concerns the U.S. economy started 2019 at a sluggish pace, but also included signs of potential relief should the U.S. and China reach a deal on trade and Democrats and Republics find common ground on funding.
Dallas Fed President Kaplan Sees Monetary Policy at “Critical Juncture”: In an essay published Tuesday, Dallas Fed President Kaplan said the economy likely grew 3% during 2018, a strong year to be sure, but that the emergence of “economic and financial uncertainties…merit close monitoring” and puts Fed policy at a “critical juncture.” While he believes the “labor market is extremely tight” and the Fed is “meeting its inflation mandate,” several “structural forces” are helping to somewhat offset “cyclical inflation pressures” in the labor market and should keep inflation pressures “somewhat muted; I don’t expect inflation to run away from us.” In addition to a long list of near-term headwinds to the outlook, Kaplan believes concerns about longer-term headwinds (i.e. aging population, weak productivity, elevated debt levels) are weighing on longer yields. In conclusion, Kaplan said “I believe it would be prudent for the Fed to exercise patience and refrain from taking further action…until the economic outlook becomes somewhat clearer. …I believe the Fed has the luxury of being patient over the next several months. Exercising patience will be critical if we are to achieve our dual-mandate objectives of maximum sustainable employment and price stability.”