The Market Today

Fed to Release Beige Book after Brainard Points to June Hike but Questions Tightening Further Out

by Craig Dismuke, Dudley Carter

Today’s Calendar – Mortgage Applications Moderate, Pending Home Sales Expected to Improve, Fed To Release Beige Book: Mortgage applications fell 3.4% as purchase applications weakened for a third consecutive week. Refinance applications dropped 5.6% after last week’s 10.5% improvement and accounted for 43.2% of the total weekly volume. Looking through the weekly noise using a four-week rolling average, the gap remains wide between refinance and purchase activity since the election. However, refinancing has stabilized and slowly recovered since reaching a trough in late December.


In the day’s only scheduled Fedspeak, Dallas Fed President Kaplan offered no changes to his recent comments on monetary policy. By the end of 2017, he expects two more hikes and the gradual and predictable process of unwinding the balance sheet to begin.


Later this morning, MNI will release its May Chicago PMI which is expected to show a slight pullback from April. Following that report, the NAR will release the pending home sales results for the month of April. The number of contracts signed in April is expected to be show only modest improvement following a weaker March result. However, any size gain would be a favorable outcome considering the widespread weakness in the other housing data for the month of April. A week ago, the NAR reported existing sales fell 2.3% in April and Census Bureau data showed a significant 11.4% drop in sales of new homes.


At 1 p.m. CT, the Fed will release its May Beige Book in anticipation of its June 14 meeting two weeks from today. The last Beige Book release in mid-April showed modest to moderate growth in economic activity and a broadening of modest wage gains as a result of continued firming of the labor market. Markets currently expect the Fed to raise its target rate range to 1.00% to 1.25% when the Committee convenes in June.


Overnight Activity – European Stocks Lead as British Pound Falls and Oil Drops: European stocks are leading the way Wednesday following a mixed session in Asia. European sovereign yields are mixed but little changed relative to Tuesday’s levels. The British pound is underperforming other major global currencies as mixed polling results have raised the level of uncertainty ahead of next week’s parliamentary elections. Oil prices are lower by more than 2% as the battle between OPEC and U.S. shale producers continues to create uncertainty about supply balance on the global stage. On the economic front, China’s official May manufacturing PMI was better than expected (unchanged) at 51.2. The non-manufacturing PMI improved to 54.5. Japan’s April industrial production data showed improvement but missed estimates. In Europe, Germany’s retail sales were weaker than expected. Inflation in the Eurozone slowed more than expected in May after reaching a four-year high in April. Headline inflation dropped from 1.9% to 1.4% while core inflation fell 0.3% to 0.9%. Treasury yields are up less than 1 bp outside of two years as equity futures point to modest gains at the open and the Dollar inched lower.


Yesterday’s Trading – Stocks Pull Back From Records, Treasury Yields Fall as Brainard Questions Forward Path: Stocks fell back from record highs set last Friday as the energy and financial sectors led the S&P to a daily loss of 0.1%. Energy companies fell the most as energy commodities tumbled. Natural gas prices experienced the most severe drop, but crude prices and gasoline also declined. The losses in commodities materialized even as the Dollar remained near its six-month low. The Dollar weakened as Treasury yields pulled back on comments from Fed Governor Brainard about her expectations for monetary policy. Seen as maybe the most dovish Fed member and a proxy for Fed Chair Yellen as it relates to policy paradigm, Brainard believes a rate hike could be appropriate soon but was less certain about projections further out (more below). The Treasury curve flattened for a fourth day with a 1.0 bp drop on the 2-year yield (1.284%) and a 3.7 bp drop on the 10-year yield (2.210%) leaving the additional premium for holding the latter at 0.92%. The 10-year yield was the second lowest since the week of the election.


Consumer Confidence Down More than Expected: The Conference Board’s May consumer confidence index declined more than expected and April’s index was revised lower. After rising in four of the first five months following the election (March peak), confidence has softened in two straight months. Despite a rosier present assessment, consumers reported less confidence in the future. The expectations index dropped to its second lowest level of the year on a migration to the middle on expectations for business conditions and the number of jobs. More people expect no change in these metrics while fewer expect them to worsen or improve. The difference between those expecting their incomes to increase versus decrease tightened and fewer consumers expect to purchase an auto or home within the next six months. As to markets, one-year inflation expectations were unchanged, fewer consumers expect interest rates to rise, and a larger number predict the stock bull will continue to run.


Home Prices Continue to Press Higher: The March S&P Corelogic Case-Shiller Home Price Index showed home prices continued to press higher as demand remains solid and inventories remain tight. The index tracking home prices in 20 of the largest U.S. metro areas showed prices rose 5.89% in March. A separate index tracking prices more broadly showed prices rose at a slightly slower pace of 5.75% across the country. The YoY increase in March was the fastest for both indices since the summer of 2014. Persistent firming in the U.S. labor market has continued to kindle steady demand while supply remains at historically low levels. Supply of existing homes was just 3.8 months in March, well below the 6 months considered a good balance between supply in demand. The net effect of steady demand and tight supply is that prices continue to show upward momentum.


Brainard Expects Another Rate Hike Soon, But May Balk at Much More With Inflation Soft: Comments from Fed Governor Brainard made headlines Tuesday given her ascribed role as a proxy for Chair Yellen’s current thought process. Consistent with messaging in the May Minutes last week, Brainard seems committed to another rate hike fairly soon (we read as June). She pointed to key positives in the form of a brighter global outlook and the expectation for a second quarter bounce back in U.S. economic activity. However, she cautioned that “lack of progress” in core inflation is a “source of concern”. She also noted that recent weakness in inflation readings and the stubbornness of price pressures to respond to a tightening labor market could cause her to reassess her forward path if such weakness persisted. This segued into comments on the neutral rate in which she speculated the rate was “very low” and that “we are not far at all from neutral.” On the balance sheet, she expects another couple of rate hikes could satisfy the “well under way” threshold for normalization needed to begin a gradual phasing out of cash flow reinvestments.

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