The Market Today
Powell Open to Changing ‘Gradual’
by Craig Dismuke, Dudley Carter
Unusually Weak Report on Housing Construction: Housing starts fell 12.3% in June, a very disappointing report. Starts were expected to fall 2.2% after a 4.8% increase in May. The decline was driven by a 19.8% drop in the volatile multi-family category. However, single family starts also fell an unusually large 9.1%. The declines brought the YoY rate down to -14.5% for multi-family activity and +0.0% for single family starts. The weakness was fairly broad-spread with starts in the Midwest falling 35.8%, falling 9.1% in the South, down 6.8% in the Northeast, and off 3.0% in the West. Building permits, the state prior to actual starts, were also weaker-than-expected. Permits fell 2.2% MoM (exp. +2.2%) which was driven by a 12.5% decline in multi-family permits and a 0.6% drop in single-family. Overall, this is certainly a disappointing report for one of the strong areas of housing. However, the data is volatile with large revisions. As such, we will wait for more reports confirming weakness before raising any red flags.
Powell Returns to the Hill: Fed Chair Powell speaks before the House Financial Services Committee today beginning at 9:00 a.m. CT. The Federal Reserve releases its Beige Book report in anticipation of their the August FOMC meeting at 1:00 p.m.
Yesterday – Tuesday’s Turnaround Took Nasdaq to New All-Time High: Tech shares led losses on Monday and was out in front of the subsequent rebound on Tuesday. The Nasdaq led gains among the major indexes with a 0.6% daily improvement. Shares of Amazon rose for a ninth consecutive session to a record per-share price of $1,844 after quickly erasing an opening drop. Technical glitches, which initially tarnished the highly publicized Prime Day event, were quickly forgotten by investors after certain estimates showed sales in the event’s first 12 hours were up nearly 90% from last year’s event. Also lifting equity sentiment was the snapback and smaller drag by shares of Netflix. The video streaming company fell 14% at the opening bell after disappointing subscriber growth but bounced back to close down just over 5%. The S&P 500 added 0.4% to its highest finish since February 1. In addition to stronger stocks, Treasury yields rose after Fed Chair Powell said the Fed expected to continue with gradual rate increases, for now (more below), amid a strong U.S. outlook. The 2-year Treasury yield rose 1.9 bps to 2.62%, representing its highest close since July 30, 2008. The 10-year yield was about flat at 2.86% which meant the spread between the two to a new cycle low of 24 bps (read Powell’s take on the yield curve below).
Overnight – Earnings Boost European Equities, Weak Inflation Hits British Pound, Dollar Strengthens to One-Year High: Sovereign yields were reflecting a modest risk-off bid despite solid equity gains across Europe. Notwithstanding a mixed session in Asia, the Stoxx Europe 600 had traded 0.5% higher and shares of technology companies were the clear outperformers. The index’s three biggest individual gainers were up more than 10% after reporting better-than-estimated quarterly earnings results. Sentiment diverged somewhat in the U.S. where the tech-heavy Nasdaq was actually lagging a mixed morning for U.S. futures. Shares of Alphabet Inc. (i.e. Google) were lower in pre-market trading after the EU announced it was fining the company a record $5 billion as the result of an anti-trust suit tied to the delivery of its Android operating software. A slight risk-off tone in sovereign yields pushed the German 10-year yield 1 bp lower to 0.33% and lifted the Italian 10-year by 1.5 bps to 2.48%. A bigger move, however, was made by U.K. Gilts after a June inflation miss. The 10-year yield fell 4.8 bps after headline CPI inflation held at 2.3% YoY instead of rising to 2.5% and core dipped from 2.1% to 1.9%, its lowest level since March 2017. The British pound also took a hit, sliding to a more than 10-month low against the Dollar. Against a broader basket of goods, the greenback firmed for a second day to a new one-year high. Treasury yields were modestly lower.
Gradual Rate Hikes Remain the Best Way Forward… “For Now”: Fed Chair Powell echoed the tone from the Fed’s June meeting in his first of two weekly appearances before U.S. lawmakers. His upbeat assessment of the economy could be summed up by a single sentence from the five pages of prepared remarks. Powell noted “With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that—for now—the best way forward is to keep gradually raising the federal funds rate.” The “for now” was quickly latched onto by pundits positing it as Powell potentially acknowledging a willingness to pause rate hikes if warranted. One possible factor warranting a pause could be the slope of the yield curve. In Q&A, Powell noted “The shape of the yield curve is something we talk about a lot,” adding “what really matters is what the neutral rate of interest is. People think that longer-run rates tell us something about the longer-run neutral rate, that’s why I think the slope of the yield curve matters.” Implicitly, he portrayed the belief that a curve inversion, caused by the short end rising, would signal restrictive policy. Hiking into inversion, according to that line of thinking, would be out of an assumed necessity to choke off undue inflation pressures. On inflation, Powell said core inflation finally reaching the 2% target was “a very positive thing” but said he “wouldn’t declare victory” based on just one report. Another factor that might warrant a pause would be an economic disruption. When pressed on U.S.-involved trade spats, Powell said the Fed is “committed to staying in our lane” but acknowledged they’ve “heard a rising chorus of concern which now begins to speak of actual capex plans being put on ice for the time being.”
Home Builder Confidence Holds in July: The NAHB’s Housing Market Index showed home builder confidence was unchanged in July. At 68, the headline index matched its lowest level of 2018 but equaled the average reading since the beginning of 2017. The index tracking current sales was flat with June and matched its lowest level since September. There were offsetting moves in the other two major indexes. The future sales index slipped to match its weakest reading since November 2016 while foot traffic from prospective buyer perked up to its best level since February. The NAHB’s chief economists said “Builders are encouraged by growing housing demand, but they continue to be burdened by rising construction material costs.”
Industrial Production Rose More than Expected But Trend Marginally Softer After Revisions: Industrial production rose 0.6% MoM in June, supported by a better-than-expected 0.8% MoM increase in manufacturing and a 1.2% improvement in mining that offset weaker utilities output. Utilities output was down 1.5% in June on less electricity usage, a trend consistent with softer energy services prices in last week’s CPI report. The stronger month for manufacturing was primarily driven by a bounce back in durable goods production. After falling 1.6% in May, the worst month since the recession, durables activity bounced back 1.6%. And while most categories were stronger, auto production stood out from the crowd. Motor vehicle production popped 13.9%, the second strongest month of the cycle, after sinking 13.3% in May, the worst month in the cycle. A fire at an auto parts supplier was blamed for the May disruption for autos and, as expected, proved to be a temporary headwind.