The Market Today

Fed Sees End to Balance Sheet Normalization, Uncertainty on Rates; Trade Developments in Focus

by Craig Dismuke, Dudley Carter

December’s Capital Goods Orders Confirm Concerns Created by Increased Uncertainty: Total durable goods orders were softer than expected in December although November’s activity saw slight positive revisions. Total orders were up 1.2%, less than the 1.7% economists had expected, thanks to a solid month for transportation. Excluding the transportation categories, core orders were up just 0.1%, less than the 0.3% estimate, while November’s orders were revised from -0.4% to a better -0.2%. Total orders received no help from the important capital goods categories, which indicated business orders of equipment dropped 0.7% to close out 2018 and November’s disappointing 0.6% decline was an even-worse 1.0%. On a positive note, shipments of business equipment were expected to be flat in December but instead rose 0.5%. The data confirms that uncertainty late in the year weighed on U.S. business activity and that concerns on multiple front, including global trade, will be a key to helping support a recovery in business investment.


Jobless Claims Drop More Than Expected after Weeks Elevation: Initial jobless claims were lower than expected last week, helping somewhat allay fears caused by unexpectedly weak readings from the week before. Initial claims rose 216k in the week ended February 16, down from 239k the week before and better than the 228k economists had expected. The reading was the lowest level in four weeks. Despite the positive drop, the four-week average ticked up as the best week (200k) in almost 50 years rolled out of the calculation. The level of continuing claims from two weeks ago also fell more than expected.


Philadelphia Fed Outlook Flops: The Philadelphia Fed Business Outlook index fared much worse than expected in February, falling more than 21 points to a 33-month low (since May 2016) of -4.1. New orders and shipments both collapsed and accounted for most of the decline. The employment index actual rose while priced paid, an indication of inflation pressures, retreated. Helping to offset some of the disappointing, an index tracking expectations for six months from now actually ticked higher, although it remained at one of its weaker levels in recent years.


Early-Morning Fedspeak: Already Tuesday, we’ve heard from two Fed officials who support the Fed’s plan to leave interest rates unchanged until the data warrants otherwise. In an early-morning interview with CNBC, St. Louis Fed President Bullard summed up his take on yesterday’s Minutes, saying “I think the message from my point of view is the normalization process in the United States is coming to an end.” Bullard continues to be the most vocal opponent of any additional rate hikes. He said he argued against the December hike and believes the current range of 2.25%-2.50% is “a little bit too high.” Bullard believes the end date for the balance sheet normalization will be announced “in the next couple of months.” Atlanta Fed President Bostic said he thinks rates are “close to neutral now” and “we need to be more and more careful we don’t overshoot” by moving into restrictive territory.


Economists Expecting Little Recovery for Existing Home Sales to Start 2019: At 9:00 a.m. CT, the National Association of Realtors is expected to report a modest 0.2% increase for existing home sale in January. Existing home sales sank 6.4% in December to 4.99MM units, the weakest pace in more than three years.



Yesterday – Stocks and Yields Ended Modestly Higher after the Fed Minutes: Stocks and Treasury yields finished modestly higher Wednesday after the January Minutes explained in more detail the Fed’s newfound patience and confirmed speculation that the Fed could wrap up its portfolio roll-off later this year (more below). After an uneventful morning session, stocks had crept modestly higher ahead of the Minutes’ release. A knee-jerk drop was quickly erased and the major indices ended near their pre-meeting levels. The Dow and S&P 500 closed up 0.2%. The marginal improvement pushed the S&P 500 to 2,785, 18.4% above its December low and less than 6 points (0.2%) from its December 3 level, the day before its historic year-end collapse began. Treasury yields rose in early morning trading but had edged back closer to unchanged before the Minutes. Yields showed little response to Fed document and by the end of the day the 2-year yield was just 1.0 bp higher at 2.50% while the 10-year yield had risen 1.1 bps to 2.65%. Despite the Fed keeping a rate hike later this year on the table, Fed Funds futures continued to price in a greater likelihood that the next rate adjustment will be downward.


Overnight – Fed Gets Update on Two of Its Downside Risks: Global stocks are mixed Thursday and core sovereign yields have generally drifted higher after the Fed’s Minutes (more below) detailed a long list of uncertainties that warranted patience. There were developments overnight on two items the Fed included as downside risks: the U.S.-China trade conflict and a slowdown in European economic growth. A report out Wednesday evening indicated that the U.S. and China were working to draft documents that could serve as a framework for a trade deal. Treasury yields jumped on the headline. According to CNBC, “Negotiators are drawing up six memorandums of understanding on structural issues: forced technology transfer and cyber theft, intellectual property rights, services, currency, agriculture and non-tariff barriers to trade.” A subsequent story from Bloomberg said the agreement on agriculture could include China buying an additional $30B of U.S. product each year. China imported just over $20B of U.S. agricultural products in total in 2017. As for Europe’s economy, preliminary composite PMIs for February topped estimates despite continued weakness in manufacturing. Activity in France perked up and strength in Germany’s services sector (five-month high) helped offset the manufacturing PMI sliding to 47.6, the lowest level since December 2012. Weakness in Germany caused the Eurozone-wide manufacturing PMI to contract for the first time since June 2013. However, services sector activity was the best in three months and optimism hit its highest level in four months. Around 7:30 a.m. CT, U.S. stock futures were just below breakeven and Treasury yields were at their highs of the day (2-year +2.1 bps at 2.52%, 10-year +3.4 bps at 2.68%).



Patient Fed is Uncertain About Rates Amid Elevated Risks, But Agrees on Ending Balance Sheet Normalization in 2019: The January Minutes shed more light on the Fed’s about-face on policy, highlighting an increased level of uncertainty amid tame inflation. The Minutes detailed a longer list of downside risks than upside risks, with the only upside risk being that that downside risks might clear up more quickly than expected. In addition, many saw less upward pressure on inflation meaning the Fed could wait for the outlook to clear up. Following a detailed dashboard of uncertainties they are monitoring, they explained why being patient doesn’t pose a risk to the economy (i.e. policy near neutral, inflation muted, asset prices less stretched). However, a hold is not a halt and many officials believed that if the uncertainty subsided, the need for patience would need to be revisited. Several officials still believed a rate hike could occur later this year, with even more onboard if inflation moves higher. Of equal interest was the Fed’s plan for its balance sheet and the Minutes were more specific than previous communications. Almost everyone agreed that ending the portfolio run-off later this year would be appropriate and that an announcement to that effect should be made soon.


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