The Market Today

FOMC Hikes, Confounded by Inflation; Retail Sales Show Big Start to Holiday Shopping

by Craig Dismuke, Dudley Carter

Today’s Calendar – Holiday Shoppers Get Early Start in November Retail Sales Report:  The November Retail Sales report confirmed the optimism around holiday shopping, rising 0.8% MoM at the headline level (exp. +0.3%).  Auto sales fell 0.2% MoM as the hurricane effect continues to wind down.  Gasoline sales rose 2.8% which would one would expect to be a drag on non-gas items.  And building material sales rose a solid 1.2%.  Core sales, excluding the three aforementioned categories, rose a strong 0.8%, the seventh best month of the past five years.  Online sales rose 2.5%, electronics/appliance sales rose 2.1%, furniture sales rose 1.2%, and sporting goods sales rose 0.9%.  All of these results were remarkably strong.  Looking at the quarterly tracking data, retail sales now point to consumption growth of 3.5% in 4Q.  However, there are two factors which have likely skewed the results.  There were six full shopping days in November after an early Thanksgiving, giving consumers more time to make holiday purchases during the month.  Second, retailers began discounting items even earlier this year, with many running Black Friday sales specials in the week before Thanksgiving.  As such, some of December’s activity was likely pulled into November this year.


Initial jobless claims for the week ending December 9 fell from 236k to 225k, another very low reading.  November’s import price index showed prices up 0.7% MoM but up just 0.1% when excluding petrol products.  The Bloomberg Survey of Economists is scheduled to be released this morning at 7:45 a.m. CT which is likely ot show some changes to 2018 GDP growth rates given the progress on tax reform.  And Markit will release their manufacturing and service sector PMI reports at 8:45 a.m.  October’s Business Inventories report is expected to show a slight pullback in inventories.


Overnight Activity – ECB Makes Significant Upgrade to Growth Outlook, Remains Focused on Subdued Inflation: Yesterday’s late-day loss of momentum that limited gains for U.S. equities seemed to weigh on global markets overnight. Equity markets are mostly weaker across Asia and Europe with the Stoxx Europe 600 down 0.4% and near its lows of the day. After the Fed hiked as expected yesterday, markets turned their focus to the latest policy decisions from two other key central banks. As expected, neither the Bank of England nor the European Central Bank made changes to their monetary policy stance. After hiking last month for the first time in 10 years, the Bank of England left its bank rate unchanged at 0.50%. The details of the decision acknowledged CPI inflation’s tick higher to 3.1%, noted a slightly slower pace for growth in Q4, but continued to project “further modest rate increases…over the next few years” as economic slack continues to tighten. Also as expected, the ECB left its policy stance unchanged after trimming the level of its 2018 net asset purchases in half to 30B Euros. The statement continued to display the ECB’s willingness to increase those purchases if the outlook “becomes less favourable”. In his early remarks, ECB President says that economic momentum is solid and broad-based and provided solid positive revisions to the growth forecast for the next several years . However, he also noted that an ample degree of stimulus is still needed for inflation and expects inflation will average 1.7% in 2020. Looking at U.S. markets, Treasury yields were higher overnight and inched up even more after this morning strong U.S. retail sales report. The 2-year yield is up 4.1 bps to 1.82% while the 10-year yield has added 2.9 bps to 2.37%. U.S. equity futures are slightly stronger ahead of trading.


Yesterday’s Trading Activity –Yields Fall after Weak CPI Report, Fifth Rate Hike of the Cycle: Investors had a lot on their minds Wednesday as they attempted to digest another weak inflation report released just hours before another rate increase by the Federal Reserve. Treasury yields had drifted higher in the overnight session as they tracked moves by their European counterparts. However, that trend reversed sharply when the BLS released its November inflation report that showed, despite an energy-driven increase in headline prices, core inflation fell short of estimates for a seventh time in the last nine months. In just a matter of minutes, the 10-year yield fell from up 2 bps on the day to down 3bps. Yields had partially recovered ahead of the Fed announcing an increase in the fed funds range to 1.25% to 1.50%, but again drifted lower on the decision. Notwithstanding a bit of wordsmithing in the Statement, the messaging of the overall decision remained largely the same: the U.S. economy is performing well, the labor market is strong, but inflation continues to fall short (more below). Yields continued to drift lower during Chair Yellen’s uneventful press conference in which there were more questions on Bitcoin than the shape of the curve. By the close, most of the curve was lower by more than 5 bps. The 2-year yield fell 5.3 bps to 1.77% in the largest single-day decline since May 17, the day the New York Times reported that President Trump had asked former FBI Director Comey to call off an investigation into for National Security Adviser Flynn. The 5-year dropped 6.7 bps to 2.11% and the 10-year yield fell 5.9 bps to 2.34%, the biggest moves since early September. The Dollar also weakened in response to the daily data but stocks were mixed at the close. The S&P had an eventful day, actually dropping on reports of a deal on the tax plan, rising following the Fed’s rate hike, but fading to close down 0.05% and at its daily low point. The Dow and Nasdaq fared better, rising 0.33% and 0.20%, respectively.


Fed Hikes on Increased Expectations for Growth, A Lower Projection for Unemployment, But No Change in the Inflation Outlook: As expected, the FOMC voted in favor of a raising rates for a third time in 2017 to a target rate range of 1.25-1.50%. In the Statement, the most notable change was the number of dissenters; Chicago’s Evans joined Kashkari in voting against the hike. The Fed continued to see the economy as solid, the labor market as strong, but inflation below target. However, the Committee still expects that inflation will stabilize around the 2%-target – a belief that was reinforced by the unchanged projection in the SEP for core PCE inflation to drift back to 2.0% by 2019. Also in the SEP, the median funds rate projections for 2018 (2.125%) and 2019 (2.688%) were unchanged. The 2020 projection did increase by roughly one hike to 3.06%. On the economy, the Fed projected slightly stronger growth over the next three years but still expects trend growth of just 1.8%. The unemployment rate is now expected to fall further below the longer-run 4.6% expectation, dropping to 3.9% in 2018 and 2019 (0.2% less than expected in September). Overall, the cumulative result is as-expected. The Fed moved forward with their third hike of the year. However, inflation remains confoundingly weak keeping them from ratcheting up their forward rate projections. The biggest surprise is arguably the faster GDP growth projection for 2018. Ironically, even with GDP projected to expand 0.7% faster than sustainable and the unemployment rate to be 0.7% below sustainable next year, the Fed still projects inflation to be below their 2 percent target.  While they are confident in the stability of the economy, they remain perplexed by the unresponsiveness of inflation.

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