The Market Today
Fed Looks through Recent Weakness, Points to June; House Passes Spending Bill
by Craig Dismuke, Dudley Carter
Today’s Calendar – Trade Deficit Improves, Productivity Falls, Jobless Claims Plunge: In this morning’s economic data, the March trade deficit was expected to increase $900 million but actually shrunk $100 million. The net effect of the deficit not increasing will be a positive 0.1% increase in the 1Q GDP revision. Also released, the preliminary read on 1Q productivity showed a larger-than-expected decline of -0.6%. The 4Q moving average for productivity is now at 1.1% while the 5-year average is a worrisome 0.5%. Weak productivity continues to be a major challenge for growth and one that does not appear to be reversing. In fact, when controlling for actual number of hours worked in today’s always-connected environment, productivity is likely to be even worse than the headline data reports. As productivity declined in 1Q, unit labor costs pushed 3.0% higher, another result consistent with the tail-end of a business cycle. The 4Q average for unit labor costs is now at 2.8% and is one of the few indicators pointing to inflation. Initial jobless claims for the week ending April 29 fell from 257k to 238k, the fifth lowest reading since 1973. At 9:00 a.m. CT, the final March Durable Goods Orders report is scheduled for release. Already, we have seen indications of slowing business investment heading into 2Q after a stellar 1Q.
Overnight Session – European Equity Rally Adds to Upward Pressure on Sovereign Yields: Many markets remain shut in Asia while European shares are notably stronger after a mixed closed yesterday for U.S. exchanges. Energy shares are leading the 0.6% for the Stoxx Europe 600 despite crude prices falling to within cents of their lowest level since November. France’s CAC rallied to its most valuable level since 2008 as Germany’s DAX set a new all-time record high. Positive earnings results from several key European companies were credited for the positive tone underlying risk assets. U.S. equity futures are higher by a healthy 0.3%. The Euro is outperforming other major currencies after polls showed Macron was successful in defending his lead in last night’s French presidential debate. The strength in the Euro has undone yesterday’s Dollar gains and left the greenback hovering around its weakest level since the week of the U.S. presidential election. Equity gains have added to the upward pressure on sovereign yields that began yesterday after the Fed chose to look past recent weakness in the economic data and maintain their call for gradual adjustments to monetary policy (more below). Ahead of this morning’s U.S. data, the 2-year Treasury yield is up 1.2 bps to 1.31% with the 5- and 10-year notes up 1.8 bps to 1.87% and 2.34%, respectively.
Yesterday’s Trading – Fed Explains Away Economic Weakness, Lifts Yields and the Dollar: U.S. stocks traded lower at Wednesday’s open as Apple and other tech companies slipped to crown the Nasdaq as the day’s worst performing major index. The early morning malaise was made worse after government inventory data showed a smaller-than-expected reduction in U.S. crude supplies and a surprise build for gasoline. Treasury yields were higher in the morning session but only modestly so. But the main focus Wednesday was on what the afternoon Fed Statement would say about the recent soft streak for the data and if they would signal a potential June hike; markets had largely dismissed a hike at yesterday’s meeting. After the Fed Statement kept June teed up by rationalizing away the recent weakness in economic activity (more below), stocks bounced to pare their daily loss, Treasury yields moved to their daily highs, and the Dollar reached its highest level since the French election. The 2-year yield rose 3.6 bps to 1.29%, the 5-year yield settled 4.9 bps higher at 1.85%, and the 10-year yield gained 3.8 bps to 2.32%. The chances of a June rate increase settled at 90% Wednesday according to fed funds futures.
Fed Holds, Targets June, Markets Follow: As expected, the FOMC held its target range steady between 0.75%-1.00% yesterday, acknowledged the recently weak data, but managed to keep a June hike on the table. The Official Statement noted that growth had slowed leading up to the meeting but that “the slowing in growth during the first quarter [was] likely to be transitory”. Looking through the weakness, the Statement highlighted continued strengthening in the labor market, positive fundamentals underpinning household spending despite the weak rate of 1Q consumption, firmer business fixed investment, and inflation “running close to the Committee’s 2 percent longer-run objective.” As a result, the Committee continues to expect “gradual adjustments in the stance of monetary policy.” Coming into this morning, Fed Funds Futures now project a 97.5% chance of a 25 bps hike at the June meeting.
House Passes Spending Bill to Avoid Saturday Government Shutdown: The House passed a spending bill on Wednesday afternoon, a first step in avoiding a government shutdown on Saturday. The Senate must also pass the bill and the President must sign it; both are expected to happen. Both Republicans and Democrats are claiming victory in the bipartisan bill, logically implying that it calls for more spending than cuts. Included are a $19.9 billion increase in defense spending, continued funding for Planned Parenthood, continued appropriations for health insurers, $1.5 billion for border security (enough to repair fencing but not enough to build a wall), and a $2 billion increase in the National Institutes of Health budget. The bill keeps the government funded through September, at which time President Trump has indicated he will fight harder for his priorities.
ISM Non-Manufacturing Index Lifts Spirits after Run of Weak Data: The ISM Non-Manufacturing index provided a little relief from a recent run of weak economic reports, rising more-than-expected from 55.2 to 57.5. Looking at the sub-components of the report, there was widespread strength. The new orders index, a key indicator of future activity, increased 4.3 points to its highest level since 2005. The new export order index also rose another 3.0 points to its second-highest level in the data’s 20-year history, illustrating the impact of better global growth and the recent Dollar weakness. Inventories appear to be rising, a positive sign for 2Q GDP. The only negative indicator was a 0.2 point drop in the employment index, remaining consistent with slower job growth in April. However, the ISM employment report has lost some of its correlation with private payroll growth post-recession and now appears to be more reactionary than predictive. The composite ISM index (combining both the non-manufacturing and manufacturing reports) is now consistent with YoY GDP of 3.4%, up from 2.5% after the March data. Overall, the report is a welcomed, positive surprise after a string of weak reports on GDP, the manufacturing sector, job growth, and auto sales.