The Market Today

Stronger Incomes and Slower Spending Lifts the Savings Rate, Core PCE Inflation Firms Again

by Craig Dismuke, Dudley Carter

Today’s Calendar – Stronger Incomes and Slower Spending Lifts the Savings Rate, Core PCE Inflation Firms Again: In the less important data this morning, the jobless claims data was mixed with initial claims ticking down 2k to 238k while continuing claims rose unexpectedly to 1.957MM. Despite the better read on initial claims, the 4-week average inched higher but remains at a level indicative of a healthy and tightening labor market. The surprise jump in continuing claims boosted the total unemployment insurance rolls off levels not seen since 1973. At 1.957MM, continuing claims touched their highest level since early September. In a broader context, however, the level of the persistently unemployed remains near its cyclical lows post-Great Recession.


In the more meaningful reports, personal income figures were better than expected in October with nominal incomes holding at 0.4% (down slightly to 0.394% when carried out a few decimal points) and real (or inflation adjusted) disposable incomes up 0.31%. The gain in real disposable income was the strongest since May and ended a two-month streak of slightly negative growth for the metric. The gains were driven partially by the nominal income improvements and partially by moderation of the energy-driven jump in inflation from the last couple of months. On a slightly more disappointing note, real spending fell slightly short of estimates and September’s result was revised down from 0.6% to 0.5%. And while the spending trajectory is a bit softer than expected, it led to an increase in the savings rate for the first time since May. Given the gains in income, the higher savings rate, the early indications of the success of Black Friday Sales, and this week’s 17-year high for consumer confidence, the overall outlook for the consumer remains positive.


In the inflation data, the MoM results for headline (+0.1%) and core (+0.2%) price changes matched estimates. The headline YoY rate of 1.6% came in just above expectations of 1.5% and the core YoY rate met estimates at 1.4%. The report also included a revision to September’s figures that show a slightly stronger-than-expected pace of price gains at the core level. The initial MoM result of 0.1% was revised up to 0.2% which pushed the YoY rate up from an initially estimated 1.3% to 1.4%. After this morning’s report, core inflation has strengthened in each month since July and the YoY rate has risen for two consecutive months. This will be the last inflation report the Fed sees before the CPI print for November that is scheduled to be released the same day the Fed makes its next policy decision on December 13. When paired with yesterday’s anecdotal evidence in the Fed’s Beige Book (more below), this should give those Fed members who want to hike in December some level of comfort that inflation is at least stabilizing.


Overnight Activity – Tech Weighs on Global Equities, European Yields Slip After Weak Inflation Print: After U.S. tech stocks tumbled in yesterday’s session (more below), the sector has been the biggest drag on equities around the globe. Despite the pressure form tech companies, Japan’s Nikkei improved 0.33% but was the only Asian-Pacific nation to notch a gain. Economic data showed softer-than-expected industrial production figures for Japan in October but slightly better-than-expected November PMIs for China. The Stoxx Europe 600 is up 0.14% midway through Thursday’s session and was experiencing a similar rotation to yesterday’s U.S. shifts – out of tech and into telecom and financial names. U.K.’s FTSE 100 continued to struggle as the British Pound made another leg higher overnight on a report that it may agree to keeping an open border with Northern Ireland. In addition to the “divorce bill” discussed yesterday, the Irish border was one of the more notable hurdles to a final agreement. The Pound touched a more-than-two-month high against the Dollar and was the strongest in four weeks against the Euro. The news also helped lift U.K. yields again while yields elsewhere across Europe edged lower. Germany’s 10-year yield dropped 0.8 bps after rising more than 2bps earlier in the day. The turnabout followed a weaker than expected CPI print that missed at both the headline and core levels. Core YoY inflation held at 0.9%. The inflation miss was reported just after data showed the Eurozone’s unemployment rate unexpectedly fell to 8.8%, its lowest level since January 2009. Oil prices are up and will remain in focus today after it was announced that OPEC representatives have agreed to extend production cuts through the end of 2018. It is reported that Russia has yet to sign on the any such agreement. Ahead of this morning’s U.S. income and spending and PCE inflation data, U.S. equity futures were up roughly 0.3% and Treasury yields were essentially unchanged from Wednesday.


Yesterday’s Trading Activity – Tech Weighs on Stocks, Treasury Curve Steepens the Most Since July as Longer Yields Jump: There was a substantial divergence in the paths of the three major U.S. equity indices on Wednesday as the Nasdaq tumbled 1.27% while the Dow bounced by 0.44%. The S&P split those performances by holding almost unchanged, slipping just 0.04% on the day. The uneven activity was consistent with traders who pointed to a rotation out of technology stocks – explains the weakness of the Nasdaq – and into financials and telecommunications companies. Progress on tax reform and industry-favorable remarks yesterday from Fed Chair Nominee Powell on financial regulations were credited as primary catalysts for the rotation. Technology has outpaced the other two sectors so far in 2017. Despite the mixed performance for equities, Treasury yields rose, led by a sharp increase in longer yields. Yields were already under pressure ahead of U.S. trading as a jump in U.K. yields had pushed sovereign yields up more broadly. A positive tone in Fed Chair Yellen’s opening statement (released ahead of time) for her testimony before a Congressional Economic Committee and a stronger-than-expected GDP revision added to the upward pressure for longer yields. Early-afternoon speculation that Senate Republicans had the votes needed to move forward and put their tax bill to a full vote (approve the “motion to proceed”) gave yields a late boost and solidified the shift higher. On the day, the 2-year yield rose 1.6 bps, the 5-year yield added 4.6 bps, and the 10-year yield closed 6.1 bps higher; those represented the biggest single-day increases for the 5-year and 10-year yields in more than a month. As a result, the curve steepened more than 4 bps between 2s and 10s, the most in a single day since July.


Overall Pending Home Sales in October Boosted by Rebound in the South: Pending home sales rose a stronger-than-expected 3.5% in October and, despite some geographical diversity in the gains, a rebound in activity in the South was a major reason for the positive result. Weakness in the data was widespread in August and activity in the South remained sluggish in September because of the hurricanes, even as other regions experienced a recovery. A return to normalcy in October boosted contract signings in the South by 7.4%. Elsewhere, pending sales in the Midwest rose 2.8% and activity in the Northeast edged up 0.5% while contract signings in the West dipped 0.7%. The Chief Economist for the National Association of Realtors, the group responsible for compiling the pending sales data, said about the report that “Home shoppers had better luck finding a home to buy in October, but slim pickings and consistently fast price gains continue to frustrate and prevent too many would-be buyers from reaching the market.” In the October existing sales report released a week ago, inventories fell on a YoY basis for a 29th consecutive month and the months of supply dropped to its lowest level for an October on records reaching back to 1999.


Yellen Tells Congress She Expects Gradual Tightening to Continue Despite Uncertainty Surrounding Inflation: Outgoing Fed Chair Yellen had a mostly upbeat message on the economy in the opening statement to what is likely her final testimony before the Joint Economic Committee of Congress. She said that “economic growth appears to have stepped up from its subdued pace early in the year” and added that “the economic expansion is increasingly broad based across sectors as well as across much of the global economy.”  In the conversational Q&A portion of her appearance, she noted that there are encouraging signs in the labor market but the continued decline in the unemployment rate has resulted in only modest wage gains so far during this expansion. She expanded on this perplexing labor dynamic by admitting that the relationship between unemployment and inflation has diminished. Even with unemployment so low and economic activity picking up at home and abroad, weakness in inflation metrics signals that neither the job market or the economy are currently running too hot. Nonetheless, the tightening labor market and better growth – paired with her (uncertain) expectation that inflation will move to 2% over the next couple of years – lead her to believe that the way forward is paved with additional gradual rate hikes to take the overnight rate back towards a neutral setting. On other matters, she was mostly mum on tax reform, talked about demographic disparities in the level of economic recovery, highlighted a concern around the sustainability of the national debt, and continued to show support for trimming regulations on smaller financial institutions but not a full repeal of Dodd-Frank.


Fed’s Beige Book Showed Steady Economic Activity, Strengthening Price Pressures: The latest Beige Book, released ahead of the Fed’s meeting in two weeks’ time, noted that anecdotal evidence across the 12 Fed Districts showed activity continued to increase at a “modest to moderate pace” and highlighted a “slight improvement in the outlook.” Fed contacts also said they were “generally optimistic” about holiday sales, and rightfully so based on early analyses of Black Friday spending. Housing “remained constrained” and “manufacturing activity expanded” moderately. The assessment of the labor market was essentially unchanged with widespread tightness in the labor market resulting in “modest to moderate” wage growth, even as finding qualified workers remained a concern across multiple Districts. A potential partial explanation for the pace of wage gains was the fact that many employers reported leveraging “signing bonuses and other nonwage benefits to retain or attract employees.” As to broader inflation, pricing pressures had picked up with “modest to moderate growth in selling prices and moderate increases in non-labor input costs”. One notable change in November was that “in many cases” increases in manufacturing input costs were pushed down to the consumer whereas they were absorbed by producers in October. Nothing in the anecdotal evidence should dissuade the Fed from hiking in December which seems to be the majority’s desire.


San Francisco’s Williams Expects the Fed to Keep Hiking: John Williams from the San Francisco Fed has become one of the most hawkish Fed voices as of late. Williams said his base case is for four hikes before the end of next year as a strengthening economy should lead to a pick-up in wages and inflation. He said he expects the unemployment rate will fall to as a low as 3.75% next year which should push wage growth above 3% and help drive an acceleration in broader inflation next year.


Kashkari Hosts Twitter Q&A: As he’s done many times before, Minneapolis Fed President Neel Kashkari hosted an impromptu Q&A Wednesday on Twitter to discuss monetary policy and other matters with his more than 20k followers (click here to view Kashkari’s Twitter feed). As to him potentially jumping on board with a December hike, Kashkari started by saying that while the Fed’s mandate is related to total inflation, core inflation is a better indicator of the more sustainable underlying trend. And if core inflation keeps falling, he sees no reason to “tap the breaks” by raising rates. In a barrage of other tweets, Kashkari touched on a range of topics. He said the Phillips Curve makes sense conceptually but noted low inflation expectations could be affecting the relationship. He said the Fed should first show it can achieve its inflation mandate before even thinking about changing to a different policy framework, for credibility’s sake. He doesn’t expect negative rates in the U.S., but wouldn’t say “never”. He mostly dismissed the fact that technology is weighing on inflation, primarily because productivity was also low. He said it wasn’t the Fed’s job to protect investors when asked about how severe of a drop in the stock market the Fed could stomach without stepping in. He quipped that the dot plot should be called forward “mis”guidance because of the inherent uncertainty in monetary policy and economic projections. And he addressed the flattening of the Treasury curve as a current concern of his.

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