The Market Today
FOMC Minutes Point to June Hike, Give Details of Possible 2017 Balance Sheet Adjustments
by Craig Dismuke, Dudley Carter
Today’s Calendar – Trade and Inventories Disappoint, Jobless Claims Remain Steamy; Brainard and Bullard to Speak: In the April Advance Goods Trade Balance report, the trade deficit increased more than expected, rising from $65.1b to $67.6b. The $2.5 billion increase in the trade deficit will likely lead to a larger-than-expected trade deficit in April which will pull back fractionally on 2Q GDP expectations. Weaker exports of autos and consumer goods along with increase imports of capital and consumer goods weighed on the balance. Also weighing on 2Q GDP projections will be the disappointing reports on inventories at both the retail and wholesale levels, both of which declined 0.3% MoM in April. Despite the weaker data on trade and inventories, initial jobless claims continued their run of hot reports with claims increasing from 233k to 234k, 4k below expectations. The labor data, with the exception of the overall participation rate, continues to point to a tight labor market. FOMC Governor Lael Brainard will be speaking in a panel discussion on the global economy this morning while St. Louis Bank President Bullard will speak in Tokyo tonight. Brainard has been seen as a key indicator on what Chair Yellen may be thinking on monetary policy.
Overnight Activity – OPEC Extends Production Cuts through March, Oil Falls: As expected, OPEC elected to extend current production quotas for another nine months in an effort to trim global supply back to balanced. Despite Saudi Arabia’s Oil Minister surmising the deal is an “almost certain option to do the trick”, oil prices faded on the news. After rising 4.1% this month on speculation of the extension, oil prices are down more than 1% since the overnight announcement. The energy sector dragged European equities into negative territory but most exchanges have recovered to nearly unchanged. Ahead of this morning’s U.S. economic data, U.S. equity futures have ignored the weakness in Europe and declining crude prices and were pointing to solid gains at the open. Also in front of this morning’s data, Treasury yields were essentially flat despite Europe sovereign curves flattening on lower yields. The Dollar index dropped to a 96 handle during Asian trading but has since slowly climbed back to almost even.
Yesterday’s Trading – Fed Minutes Push S&P to New Record Close as Treasury Yields and the Dollar Fall: U.S. stocks gained on Wednesday after the release of the Fed Minutes pushed the major indices higher to break the sideways trading that defined the morning session. The Fed Minutes gave a strong hint for another rate increase in June and offered insight into how the Fed may implement a roll-off cap to phase out cash-flow reinvestments of its balance sheet holdings (more below). Materials led the S&P to a new record high close of 2,404 gains but sectors that typically benefit from lower rates (e.g. utilities and real estate) closed in the second and third slots. This was consistent with lower Treasury yields outside of two years. The 2-year yield fell 2.1 bps to 1.28% with the 10-year yield 3.0 bps lower at 2.25%. As yields fell, so did the dollar. The market response indicated the tone of the Minutes was not as hawkish as some had projected it might be. Crude prices fell for the first session in six days before the Thursday OPEC decision.
FOMC Minutes Pave Way for June Hike: The Minutes from the FOMC’s May 2-3 meeting, as expected, appear to set the stage for a June hike. The Minutes note that “Most participants judged that … it would soon be appropriate for the Committee to take another step in removing some policy accommodation.” This phrasing is consistent with previous communications leading up to a rate hike. As for the weaker-than-expected inflation report from March, the Minutes show that most participants expect this to be transitory. There remains a high likelihood of a June 14 rate hike absent market-jarring news out of Washington, and/or shockingly weak ISM and labor reports for the month of May.
FOMC Minutes Portend 2H17 Balance Sheet Adjustments: Perhaps the most insightful news in the Minutes was related to the SOMA portfolio. According to the Minutes, “Nearly all policymakers indicated that … it likely would be appropriate to begin reducing the Federal Reserve’s securities holdings this year.” Additionally, “nearly all policymakers expressed a favorable view” of a plan calling for: 1) monthly caps on the amount of the portfolio allowed to run off, 2) any cashflow in excess of the monthly caps would be reinvested, 3) quarterly adjustments to the caps, 4) low caps initially, and 5) a final cap that would be maintained until the balance sheet is normalized. Not included in the balance sheet normalization plan are any references to the outright sale of securities.
Existing Home Sales Fall While Prices Rise: Existing home sales for the month of April fell more than expected, down 2.3% for the month. Single family sales dropped 2.4% while multifamily dropped 1.6%. The biggest drop came from the South where sales fell 120k or 5.0% MoM. Sales in the South were particularly strong in the first three months of the year as a warmer winter likely inflated early year activity. The median price of homes sold rose 3.5% during the month. Multifamily prices have accelerated notably over the last two months which may be playing into affordability. The inventory of existing homes for sale did rise but remain very tight at just 4.2 months of supply. Combined with the disappointing New Home Sales report from Tuesday, the April housing data once again shows just how bumpy the housing data has become.
Home Prices Continue 5 to 6% YoY Growth Rate: The March FHFA home price index showed home prices up 0.6% MoM and 6.2% YoY. Prices in the Pacific and Mountain States continued to grow at the strongest year-over-year pace while prices in the New York/New Jersey/Pennsylvania region have seen the weakest growth. The overall pace of home price gains continues to trend between 5 and 6% according to the primary price reports. Low inventory, decent demand, higher construction costs, and low mortgage rates continue to drive home price gains.