The Market Today
Italy Remains in Focus but Fears Ease; WH Goes Ahead with China Tariffs; ADP +178k
by Craig Dismuke, Dudley Carter
Busy Day Including ADP Report Pointing to Expected Slowdown in Job Growth: This morning’s economic calendar is packed with data. The May ADP Employment report projected that 178k private payrolls were added in the month, slightly weaker than economists’ projections of 190k. In addition, ADP’s April projection was notched down from +204k to +163k (the BLS already reported April private payroll growth of +168k). The May ADP data points to job gains settling closer in-line with the range economists expected coming into the year – and should not be interpreted as a weak labor market.
1Q GDP Revision from +2.3% to +2.2% Sets up 2Q for Better Growth: The first quarter’s GDP report was revised down from +2.3% to +2.2% in the first revision. Personal consumption was revised down from +1.1% to +1.0%. Business investment was revised meaningfully higher, up 9.2% versus the initial estimate of +6.1%. Inventory growth was marked much lower, from +$33.1 billion to +$20.2 billion, setting the stage for a better inventory bump in 2Q. This marks the first release of corporate profits for the quarter which actually fell 0.6% QoQ pre-tax. Corporations saved $117.4 billion on tax payments, thanks in part to the tax law and in part to a weaker quarter for profits. Wages and salaries rose $119.5 billion in another sign of firming wages. All told, the 1Q GDP revision points to a better acceleration in 2Q and is likely to keep the Fed rate path on track.
Mortgage Applications Pull Back: Also released this morning, mortgage applications for the week ending May 25 fell 2.9% on another 4.7% decline in refi apps and a 1.9% drop in purchase apps. Mortgage rates did pull back during the reference week with the 30-year mortgage rate dropping from 4.53% to 4.42%. The 4-week moving average for refi apps has now dropped to its lowest level in over 10 years. Purchase apps continue to trend higher, broadly, but potential homebuyers reference weak inventory and rising prices as a growing challenge – more so than higher mortgage rates at this point.
White House Proceeds with China Tariffs in Response to “Discriminatory” Trade Practices: The White House announced overnight that they were pushing forward with implementation of tariffs on $50 billion of Chinese imports despite saying a week ago that the trade was on hold. Recall that these tariffs were the outworking of an investigation by the USTR into the “acts, policies, and practices of the Government of China related to technology transfer, intellectual property, and innovation.” The investigation determined that the Chinese government had acted in a fashion which was “unreasonable or discriminatory and burden[ed] or restrict[ed] U.S. commerce.” The USTR’s findings will undoubtedly make their way to the WTO over the coming months which will arbitrate on their validity. Nonetheless, the Chinese are expected to retaliate. According to a report from the NYT, an unnamed spokesperson for the Chinese Ministry of Commerce said, “We feel surprised by the tactical statement issued by the White House, and yet it was also unsurprising … This is clearly contrary to the consensus that China and the U.S. reached not long ago in Washington. No matter what measures the U.S. side unveils, China has the confidence, the capacity and the experience to defend the interests of the Chinese people and core national interests.” We read the last sentence of the unofficial response as confirmation that retaliation will follow.
It is evident that President Trump values the perception of unpredictability in negotiations. However, starting a trade war because of a negotiating preference would damage the Administration’s credibility as a pro-business Administration, and have significant economic consequences. Already, U.S. businesses are raising concerns over the uncertainty regarding trade with China. It is important that a solid strategy is behind the President’s tactical unpredictability. It is unknown at this point what the broader strategy may be, but the markets are giving this some leeway.
Yesterday – Day of Excitement as Italian Political Drama Rattles Global Investors: U.S. investors attempted to right the global ship on Tuesday but the tempest emanating from Italy proved too strong a force. European markets moved notably on Monday while the U.S. was closed and saw even wilder swings on Tuesday in response to the developments in Italian politics. The break-up of a populist coalition in protest of the President pulling his support for its forming a government raised the probability of new elections and cemented a longer period of near-term uncertainty in the region. U.S. stocks opened moderately weaker and Treasury yields had risen from lows reached during early European trading. However, the attempt at stability proved futile as the S&P 500 tumbled 1.2% on the day, only slightly better than 1.4% drop for European stocks, but better than its -1.6% intraday low. The cumulative effect of the flight to quality drove the biggest intraday yield swing for the Treasury curve since Brexit. The 2-year yield ended down 15.7 bps, the 5-year yield sank 18.1 bps, and the 10-year yield fell 15.0 bps. The markets also priced in an impact to Fed policy expectations, as the risk-off tone shaved nearly one full hike off of the path through the end of 2019. The Dollar benefited from the beat-up Euro and reached its strongest level since November.
Overnight Trading – Markets Brush Off China Tariffs (for now) and Calm in Wake of Italian Uncertainty: Markets calmed down overnight after a knee-jerk day of volatility over the Italian political drama. While nothing has changed politically, it does appear that investors learned a lesson from the Greek tragedy that they hope applies to the Italian situation – that the outlook may be bleak but leaving the Eurozone is a much taller mountain than the rhetoric sometimes indicates. At the end of the day, Italy leaving or forming a parallel currency are the real risks but both face L’Alpe-D’Huez-type mountains. As such, after falling 14% over three weeks, Italy’s FTSE MIB stock index has rebounded 3% today from yesterday’s low. Italy’s 10-year debt yield has dropped from 3.42% to 2.94% while the 2-year has dropped from 2.76% to 1.69%. The move has lifted Eurozone stocks across the board with the Euro Stoxx 50 up 0.6%. After falling 392 points yesterday, the DJIA is up 166 points in overnight trading. As the risk has been put on the back-burner, Treasury yields have risen overnight with the 2-year yield back up to 2.40% and the 10-year back up to 2.87%. Perhaps most intriguing has been the movement of Fed Funds futures contracts. The implicit likelihood of a third rate hike in 2018 move from 100% to just 54% yesterday but are now back up to 84%. Meanwhile, the news that the White House is proceeding with tariffs has made little noticeable impact to the markets this morning. The apparent focus remains on Italy and the Euro.
Confidence Improved in May on Mixed Details: The Conference Board showed consumer confidence matched estimates in May and rose from a revised lower April result. The headline index of 128 was the third strongest since 2000 and driven higher by gains in both the present situation and expectations indexes. Positively impacting the present assessment was a migration of respondents into the group who see business conditions as good and employment opportunities as plentiful. The number of additional people who saw jobs as plentiful as opposed to hard to get jumped to a new high since March 2001. Going forward, the optimism was more muted. Consumers still expected strong hiring to continue but there was moderation in income expectations and the share expecting further improvement of the business landscape. On spending expectations, the number planning to buy a home tumbled to match its lowest level since the middle of 2016. Those expecting to buy a car slipped to its second lowest level since mid-2016. Those expectations have been affected by inflation expectations, which climbed to match the highest level since 2015.