The Market Today
Retail Sales Boom in 4Q While Core Inflation Continues Stabilizing
by Craig Dismuke, Dudley Carter
Today’s Calendar – Retail Sales Boom in 4Q While Core Inflation Continues Stabilizing: Retail sales for the final month of the year rose 0.4% at the headline level and 0.3% MoM when excluding autos and gas. Both missed economists’ expectations by 0.1% but there were also significant revisions higher to the November figures. As we expected, November proved to be the standout month for retail sales given the early Black Friday sales and the longer post-Thanksgiving shopping period than normal. Core sales were revised up in November from +0.8% to +1.4%, making it the best monthly gain for retail sales since April 2005. Unlike this year when sales also accelerated in December (albeit at a slower pace, sales in May 2005 fell 0.6%. As for December’s data, gasoline sales were flat MoM, building material sales posted a strong 1.2% gain, and auto sales rose 0.3%. The core data now points to personal consumption growing over 3% in 4Q which should result in GDP growth over 2.5%, possibly as high as 3.0%.
December’s CPI report showed a firmer reading on inflation than expected. Headline CPI rose 0.15% MoM bringing the YoY rate down from 2.2% to 2.1%, as expected. However, at the core level, prices rose 0.28% MoM and brought the YoY rate up from 1.7% to 1.8%. Energy prices were dragged down by a 2.7% drop in motor fuel but food prices grew for the first time in five months, up 0.15%. As for core items, housing inflation less energy rose 0.32% on a 0.34% increase in owners’ equivalent rents and a 0.79% increase in lodging prices. Gains in new (0.64%) and used (1.36%) car prices reversed a weakening trend seen this past year. Medical care prices were notably stronger than they have been recently reports, driven by an increase in medical care goods. Looking at our broad-based indication of inflation pressure which considers core items ex. shelter and medical care, the YoY rate of gain has improved in six of the last seven.
Bottom Line – This morning’s data shows a superb quarter for the consumer, one that is unlikely to be replicated in 1Q18 despite tax cuts and wage hikes, and a continued firming of the core inflation data. This data should give the Fed cover to continue hiking.
Yesterday’s Trading Activity – The Weekly Ups and Downs Continue for U.S. Interest Rates: Ahead of Thursday’s U.S. session, longer yields had fallen after a Chinese Agency discredited as “fake news” speculation they’d quit investing in U.S. Treasurys but popped higher following hawkish Minutes from the ECB. The first half of the day was quiet but yields dipped around lunch as another Treasury auction elicited strong interest from the outside. Wednesday’s auction of 10-year notes was followed up on Thursday by a similarly strong auction of 30-year bonds. Bid-to-cover for the reopening of the Long Bond was the best since December 2014 and the awarded yield stopped through by more than 2 bps. Indirect bidders recorded a record takedown of 71.5% leaving primaries with a record-low 21.2% award share. It seems the recent cheapening of longer securities whet the appetite of some yield-hungry buyers. Mid-afternoon, yields edged higher again after New York Fed President Dudley discussed concerns that the economy could overheat in the coming years and cause the Fed to hike faster. On the day, the 2-year yield rose 1.2 bps while the 10-year yield settled down 1.3 bps. Demand for stocks was unaffected by the stronger Treasury buying and all three indices closed at new record highs. The energy sector led broad gains the S&P as crude prices moved to more than three-year highs. The Dollar fell victim to a stronger Euro on the back of those ECB Minutes but the greenback’s weakness was even more broad. Thursday’s losses took the American currency back near its weakest level since 2014.
Overnight Activity – Equities Improve as Earnings Season Begins, Euro Remains Strong, Rates Rise on CPI and Retail Sales Beat: Ahead of a busy morning in the U.S., equity futures had strengthened against a firmer global backdrop, the Dollar had moved within a couple of ticks of its weakest level since 2014, and Treasury yields had inched higher across the curve but by less than 1 bp. On the equities front, the major U.S. banks began reporting earnings. JPMorgan kicked things off by reporting an adjusted earnings figure that topped estimates. One of those major adjustments to GAAP earnings data was the stripping out of a $2.4B hit from the passage of tax reform. JPMorgan said it expects the tax plan to benefit the economy and its business going forward and sees its effective rate dropping from roughly 32% to 19% in 2018. In foreign exchange markets, European currencies were outperforming. The Euro received another lift from reports positive progress was made between Chancellor Merkel’s CDU and the SPD in attempting to form a coalition government. Rates were quieter, but this morning’s firmer-than-expected CPI and retail sales reports broke that silence. Immediately following the reports, Treasurys made a more-than-3 bp shift higher across the curve. The 2-year yield jumped to 2.01%, a new high for the cycle. The 5-year moved up to 2.38%, a new high since 2011. The 10-year yield rose to 2.59%, its highest level since March.
Dudley Sees Risk of Economy Overheating and Forcing the Fed to Do More: New York Fed President Dudley’s Thursday comments took a hawkish tone towards future monetary policy adjustments. Dudley said he’s worried about the economy overheating over the next few years, in part because of the recent passage of Republicans’ tax cuts, and believes the case for more gradual rate increases remains strong. Dudley cautioned, “While the fact that inflation is below the FOMC’s 2 percent objective argues for patience, I think that is more than offset by an outlook of above-trend growth, driven by accommodative monetary policy and financial conditions as well as an increasingly expansionary fiscal policy. …Moreover, if the labor market were to tighten much further, there would be a greater risk that inflation could rise substantially above our objective.” This led Dudley to summarize that, “the Federal Reserve may have to press harder on the brakes at some point over the next few years.”
Walmart Wage Hike Absolutely Positive for Growth in the Short-Term: After Walmart announced an increase in its minimum wage to $11 per hour yesterday, along with a one-time bonus of up to $1,000 depending on employee tenure, there have been questions galore about the larger meaning of Walmart’s decision. Politico, for example, took issue with the news in an article saying, “Republicans are basking in a wave of good publicity for their giant tax cut. … The result is a giddy sense of hope for … Trump and congressional Republicans who pushed through their unpopular tax-cut plan over total opposition from every Democrat in Congress. … But economists have a warning: Enjoy it while it lasts … While the wage hikes and bonuses are undoubtedly positive, they may produce only a temporary economic boost that fades in later months. Gains could be undercut by rising deficits caused by slashing federal revenue by at least $1.5 trillion over ten years” Walmart is the world’s largest employer, employing over 2.3 million people including 1.5 million workers in the U.S. Walmart, along with the hundreds of other companies who have announced pay raises (including many large and community banks), reflect two things. First, it is an outright positive that the tax savings are not all going directly back into stock buybacks or dividends. Both are good for the economy but not as necessary at this point in the cycle as a little firmer wage growth. Second, the broad nature of the announcements, now including the largest private employer, reflects a tightness in the labor market that is likely to lead to further wage gains. Not all wage hikes are created equally. Those that are forced on companies by government decree come at the expense of profitability which naturally leads to a reduction in employment. Those that come from competitive pressure at a time when companies are receiving a reduction in expenses (tax expense) are positive and should not lead to a reduction in employment. The bigger risk commentators should be focused on is the risk that the economy overheats in 2018 and 2019 as wage gains create more inflation than desired by the Fed, leading to a faster pace of rate hikes, and a meltdown of the sugar-high in financial market valuations.