The Market Today

Dow Busts 22,000 as Fed Officials Wrestle with Inflation, Labor, Forward Path

by Craig Dismuke, Dudley Carter

Today’s Calendar – Labor Data Solid before Tomorrow’s BLS Report; ISM Manufacturing on Calendar: Initial jobless claims for the week ending July 29 fell from 245k to 240k bringing the 4-week moving average down to 242k.  With the exception of late-May, the 4-week moving average has held between 240-245k since February.  Elsewhere, “U.S.-based employers announced plans to cut payrolls by 28,307 jobs in July, the lowest monthly total since November 2016.  Meanwhile, over 88,000 hiring announcements were recorded last month, the third-highest hiring month of the year and highest July total on record,” according to a report released this morning by Challenger, Gray & Christmas. Through the first 7 months of 2017, job cut announcements were down 29% from this period in 2016.


The July ISM Non-Manufacturing index will be released at 9:00 a.m. CT and is expected to show a slight pullback from June’s report, while remaining at a reasonably strong level.  We will finalize our July labor market projections after this release.  June’s Factory Orders report and the Durable Goods Orders final revision will also be released at 9:00 a.m.  The markets are likely to be focused on tomorrow’s BLS labor reports although there are few expectations of a disastrously weak report.  Out of 80 economists contributing to Bloomberg’s survey, only 3 project nonfarm payrolls grew less than 160k.


Overnight Activity – Bank of England Holds Rates and Inflation Forecast Steady, Cuts Outlook for Growth and Wages: A bit of a role reversal overnight with weakness in Asian equities being countered by a slightly firmer tone in Europe. The mixed trading followed another major milestone for the U.S. Dow on Wednesday (more below). European yields had edged higher from Wednesday’s levels but have since weakened with those in the U.K. Yields in the U.K. moved sharply lower with the British Pound after the Bank of England announced its latest policy decision. The bank voted 6-2 to leave its policy rate unchanged. In its updated outlook, the bank shaved 0.2% off its 2017 GDP forecast, now 1.7%, and 0.1% off of 2018, now at 1.6%. The inflation forecast was mostly intact at 2.8%, 2.5%, and 2.2% from 2017 to 2019, but expectations for 2018 wage growth were dropped from 3.5% in May to 3.0%. Sanguinely, those not-so-rosy forecasts are premised on a smooth Brexit. The forecasts also assumed two rates hikes over three years with the first coming in 3Q18. Nonetheless, the Statement noted that rates may need to rise at a faster pace than markets are pricing in if forecasts are achieved. The decision also weighed on Treasury yields which fell immediately alongside yields in the U.K. The 2-year yield is down 0.8 bps and the 10-year yield has fallen 3.0 bps to 2.24%.


Yesterday’s Trading Activity – Apple Pushes Dow over 22,000: The Dow managed to close above 22,000 Wednesday and record its sixth consecutive record close. However, the milestone was met on weak breadth with more than half of the stocks within the index closing down on the day. The blue-chip index’s 52-point gain (0.2%) outpaced a more modest 1 point (0.05%) gain for the S&P and a less-than-one-point drop (0.00%) for the Nasdaq. As expected after strong earnings, iPhone sales, and growth outlook, Apple contributed 48 of the Dow’s 52 points. Treasury yields inside of 30 years rose. The response by yields to ADP’s jobs report was nearly imperceptible but there was a bit of volatility around Treasury’s announcement of its Q3 refunding schedule. In a press conference that followed, a Treasury official said they are still studying ultra-long bonds as an alternative, said primary dealers expect the Fed will begin unwinding the balance sheet in October, and acknowledged the potential need for greater borrowings based on wider projected deficits. The 2-year and 10-year yields both rose 1.8 bps to 1.36% and 2.27%, respectively. The Dollar slipped again and returned to its 15-month low set on Monday.


Mester Expects Markets to Absorb Balance Sheet Unwind, Watching Inflation: In comments at a community banking conference, Cleveland Fed President Mester said she believes markets can absorb the “really gradual” unwinding of the Fed’s portfolio when it begins. Outside of Treasurys, she believes that its unlikely that the process will have a notable impact to mortgage-backed securities or the mortgage market itself. As to the weakness in inflation measures, Mester indicated she’s “scrutinizing” the data but her “suspicion” is that the weakness is transitory and that it will “dissipate over time”. She did concede, however, that “there could be something more going on, and I want to look at the data” before deciding on her policy.


Williams Sees Fall Beginning for Balance Sheet Unwind, Maybe One More 2017 Hike: San Francisco President John Williams expressed frustration with inflation, saying that the central bank still has a ways to go on that portion of its mandate. However, he still believes inflation will reach the 2% target in a year or two. While he says he’s still data dependent, he indicated maybe one more hike this year and three more in 2018 will be appropriate. He believes the longer run fed funds rate is around 2.5% and that longer rates will rise in coming years. On when balance sheet normalization will began, Williams said September seems an appropriate time for the announcement.


Rosengren Says Tight Labor Market Supports Additional Tightening: In an interview with the WSJ, Boston Fed President Rosengren said the economy is near a point that may create wage pressure with the economy “probably a little past full employment.” As a result, the Fed should continue to gradually tighten policy, according to Rosengren, who said he expects one more hike this year. On the upcoming balance sheet unwind, and markets expectation for a September announcement, Rosengren said, “I do think the market has appropriately started to say, ‘Gee, this seems to be about the right time’”.


ICYMI – July Monthly Review: Yields were caught between the push and pull of potential convergence between the Fed and ECB and continued political uncertainty after the Senate failed pass a healthcare reform bill and several shake-ups at the top of the White House staff. Click here for the full monthly review to see how global markets responded to the month’s activities.

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