The Market Today

Fed Pauses Rate Hikes, Willing to Adjust Balance Sheet Run-Off if Needed

by Craig Dismuke, Dudley Carter


Employment Cost Index Continues Modest Growth Trend: The 4Q Employment Cost Index rose a solid but slightly less-than-expected 0.7% QoQ.  This brought the YoY rate up to 2.9%, its highest growth rate of this economic cycle.  Beneath the headline, wages were up 2.9% YoY while benefits rose 2.7% YoY.  As one of the broadest measures of labor costs, the ECI index is closely watched as an indicator of potential inflation pressure.  Even with the solid quarterly result, the index is consistent with only minimally more core inflation pressure.


Hurricane Shutdown Hits Claims:  Initial jobless claims for the week ending January 26 rose 53k to 253k, the largest single-week jump since 2002 other than the reports impacted by Hurricanes Harvey, Sandy, and Katrina.  The government shutdown and holiday-volatility likely contributed to the increase despite the fact that the headline claims number excludes federal employees.  As such, the claims data show that the fallout from the shutdown was likely to have had a meaningful impact on private-sector workers as well.  Presuming another shutdown does not occur, the impact is expected to be temporary.


New Home Sales:  At 9:00 a.m. CT, the delayed November new home sales data will be released.  It is expected to show a 4.8% MoM gain in sales.  If so, sales will still be down 19.9% YoY.  More important may be the size of any early-2019 rebound given the recent drop in mortgage rates.



Yesterday – Fed’s Official Shift to Patience Sends Stocks Surging, Yields Sliding: U.S. stocks rallied sharply Wednesday as the yield curve bull steepened and the Dollar weakened after the Fed made its shift towards patience official. Positive earnings surprises from Apple (Tuesday after markets closed) and Boeing had pushed stocks and yields both higher heading into the Fed’s announcement. However, the two quickly diverged after the Fed’s Statement language tilted more dovishly than expected (more below). Stocks rocketed higher and yields lower after the Fed’s new favorite words, “patient” and “muted inflation”, officially made their way into the Statement while a judgement for “some further gradual rate increases” was removed. Additionally, they released a statement that they stood “prepared to adjust any of the details” of balance sheet normalization if they felt it was having unintended effects on the economy and financial markets. The S&P 500 rose 1.6%, trailing a 1.8% gain for the Dow and an impressive 2.2% rally for the tech-heavy Nasdaq. With the Fed’s rate hikes seen as officially on hold and the outlook for the balance sheet slightly less worrisome, the 2-year Treasury yield fell 6.5 bps to 2.51% as Fed Funds futures priced in a more indefinite Fed pause. The 10-year yield dropped 3.2 bps to 2.68%, the lowest since January 4. The Dollar sank 0.4% to its second lowest level since October.


Overnight – Fed’s Decision Yields to Global Growth Data, U.S.-China Trade Meeting: Despite Wednesday’s sharp rally in U.S. equities, foreign stock indices reflect a more muted response to the Fed’s officially electing patience in lieu of previous expectations for further gradual rate increases (more below). Stocks in Asia were mostly higher while European equities have held around unchanged. China’s CSI 300 rose just over 1% despite the latest manufacturing PMI showing activity contracted again in January. The official PMI rose 0.1 point to 49.5, posting its first consecutive contractions (< 50) since early 2016. Thursday’s anxiety-increasing report only emphasizes investors’ need to hear Chinese and U.S. officials announce positive progress at the end of today’s key meeting on trade in Washington. President Trump tweeted this morning that the meetings are “going well,” but also that 10% tariffs will increase to 25% on March 1 if a “complete deal, leaving NOTHING unresolved” is not reached. In Europe, Italian stocks were keeping risk sentiment in check after data showed the country’s economy contracted 0.2% and fell into a recession in 4Q (-0.1% 3Q). The broader Eurozone matched 3Q’s 0.2%-growth rate in 4Q and the YoY rate slowed from 1.6% to 1.2%, the weakest pace since 2013. Global growth developments were a key factor cited by the Fed for its electing a “wait-and-see” approach. Treasury yields extended their post-Fed pullback with the entire curve down just under 1 bp earlier. The 2-, 3-, and 5-year yields were all back inside of the Fed’s target range of 2.25%-2.50%. Tech was leading a mixed session for equity futures as shares of Facebook surged 11% in pre-market trading after topping expectations for revenue, earnings, and daily active users on Wednesday.



Fed Nixes Future Hike Language, Open to Changing Balance Sheet Run-off: The FOMC tilted notably dovish in January’ policy decision, changing their forward rate guidance and putting the balance sheet normalization process on the table. The Official Statement omitted “some further gradual increases” from the wording altogether, instead saying that “in light of global economic and financial developments” and “muted inflation pressures,” the Committee would “be patient as it determines what future adjustments … may be appropriate.” Additionally, the assessment that “risks to the economic outlook [were] roughly balanced” was stricken. As it relates to the balance sheet, the Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization said they are “prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments.” In his press conference, Chairman Powell said the “current policy stance is appropriate at this time” and noted “the case for raising rates has weakened somewhat” because “inflation readings have been muted” and “the risk of financial imbalances appears to have receded.” He added that “common-sense risk management suggests patiently awaiting greater clarity” on recent “cross currents and conflicting signals about the outlook.” Bottom Line: The markets were anticipating a dovish decision given recent market developments and the shift in tone from Fed officials.  By modifying the forward rate guidance and putting changes to the balance sheet normalization process on the table, investors are likely to interpret this policy decision as sufficiently supportive. Fed’s Chair Powell’s emphasis of patience in his press conference will only add to that interpretation.


Pending Home Sales Fell Unexpectedly Despite Mortgage Rates Pulling Back: Pending home sales fell unexpectedly in December, marking a third month of slowing contracts on existing home sales. Total sales fell 2.2% in December, compared with estimates for a modest 0.5% increase. Fewer contracts were signed in three of the four regions with the biggest disappointment marked by a 5.0% plunge in the South, the largest decline for the region since April 2011. There was a 1.7% uptick in contracts on homes in the West. The recent Home Builder surveys from the NAHB showed prospective buyer traffic slowed notably late in 2018 as mortgage rates climbed to a November peak. While that report is more directly tied to sales of new homes, the trend could logically be applied to the existing home sector as well. While rates fell throughout December and reached nine-month lows in recent weeks (Freddie Mac Survey rate was down from 4.94% in November to 4.45% last week), any positive effect may yet be a month or more away as potential buyers re-start their searches. For now, however, pending home sales at a near-five-year low (April 2014) point to continued weakness in existing home sales to start 2019.


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