The Market Today
Tariffs on Mexico Added to List of Downside Risks, Core Inflation Firms Up
by Craig Dismuke, Dudley Carter
Personal Spending and Income Exceed Expectations on Investment Income and Gasoline Outlays: Personal income and spending were stronger than expected in April, real spending was unchanged as expected, and spending figures for March, on both a nominal and real basis, were revised up 0.2% to 1.1% and 0.9%, respectively. April’s better-than-expected 0.5% growth in income occurred despite a weaker result for the compensation component. Wages and salaries were up 0.3%, down from a 0.4% gain in March. Slower growth in workers’ paychecks were offset by a 2.3% recovery in interest income, the largest monthly gain since 2015, and a 0.7% increase in dividends. In the spending data, goods purchases were up 0.2% as higher energy outlays offset a broad, auto-led retreat across the durables categories. Services spending rose 0.3% in April. The unchanged result for real personal is consistent with the earlier weakness we saw in April’s retail sales data, signaling a slow start to the quarter for the consumer.
Firmest Month for Core Inflation Since 2017: In this morning’s inflation data, the Fed’s preferred inflation measure rose 0.31% in April which lifted the YoY rate from 1.44% to 1.51%. Stripping out weaker food prices and increased energy costs, core prices were up 0.25% last month, the firmest month for core price gains since October 2017. Compared with the April 2018, core prices were 1.57% higher, up from a 1.49% annual rate in March. Firmness in the core categories will give the Fed some comfort in their expectation that some of the recent weakness will prove to be transitory.
Later Today: Two Fed Officials will speak later today, Atlanta’s Bostic at 8:15 a.m. CT and New York’s Williams at 11 a.m. CT. The MNI Chicago PMI for May will be posted at 8:45 a.m. CT and is expected to show a rebound from April’s more-than-two-year low. Already this week, a couple of regional Fed surveys have come up short of expectations. Finally, at 9 a.m. CT, the University of Michigan’s May consumer sentiment index will be revised. If economists are correct, confidence will be revised down 0.9 points from the initial estimate but will still represent the best level for the index since 2004.
Yesterday – Precipitous Drop in Treasury Yields Persisted, Despite Equities Stabilizing: U.S. stocks recovered from a brief bout of afternoon weakness to end the day higher while Treasury yields tumbled to new lows that deepened an inversion of the 3-month T-bill and 10-year Treasury note. The S&P 500 rose for the first time this week, adding 0.2% from Wednesday’s close which marked its lowest level since early March. Seven of the index’s 11 sectors strengthened yesterday, led by an 0.7% gain for real estate stocks and an 0.6% improvement for the tech sector. Energy companies weighed the most on the major indices as crude prices collapsed following the release of the EIA’s weekly petroleum report. The report, which showed production at a record, an unexpected build in gasoline stocks, and a smaller-than-expected decline in crude inventories, sent WTI down 4% for the day. Treasury yields, which had had steadied against a more stable global backdrop, tumbled as crude prices sank. The 2-year yield dropped 4.8 bps to 2.06% as Fed Funds futures continued to price in an increasing chance of multiple Fed cuts through 2020. The 10-year yield dropped 4.7 bps to 2.21%, deepening the inversion to the 3-month bill rate to 15 bps, the most since 2007. Thursday’s rally left the entire span between the 2- and 10-year Treasury notes below the bottom of the Fed Funds range.
Overnight – Weak Chinese Data Upstaged by Trump’s Announcement of Tariffs on Mexico: Thursday’s reprieve for equities was short-lived thanks to a larger-than-expected contraction of China’s manufacturing sector and a surprise announcement from the White House that tariffs will be placed on Mexico until they help solve the illegal immigration issue at the southern border. China’s manufacturing PMI slid to 49.4 in May, worse than the 49.9 expected and the second weakest since 2016. The data shows trade tensions continue to take a toll on the world’s second largest economy. China’s CSI 300 dipped 0.3% on Friday, a relatively solid performance by global comparison. Japan’s Nikkei dropped 1.6% as the yen rallied amid the renewed risk-off tone and the Stoxx Europe 600 was earlier trading down 1.3% and at its weakest level since February. Auto stocks were the biggest drag in Europe and the sector hit hardest by President Trump’s announcement Thursday night that the U.S. would use tariffs on Mexican imports as leverage in the border crisis battle. Starting June 10, the White House plans to impose a 5% tariff on all Mexican imports, a rate that will increase each month until it reaches 25% in October, unless Mexico aides in ending the flow of illegal immigrants across the southern border. The U.S. imported just under $350B in goods from Mexico, second only to China in size, with autos and machinery representing the top categories. Mexico is also the largest foreign provider of agricultural products. President Trump said, “If the illegal migration crisis is alleviated through effective actions taken by Mexico, to be determined in our sole discretion and judgment, the tariffs will be removed.” The Mexican peso tumbled over 3% overnight to a new low for the year. U.S. equity futures were down more than 1% just before 7 a.m. CT and the rally in Treasurys picked up its pace. After Germany’s 10-year yield fell to a new all-time low of -0.21%, the 10-year Treasury yield dropped 5.4 bps to 2.16%, another new low since September 2017. The 2-year yield fell an even-more-aggressive 7.0 bps to below 2.00% for the first time since January 2018. Fed Funds futures repriced higher (rates lower), implying a market expectation for nearly 50 bps of easing from the Fed by the end of the year.
Pending Home Sales Pulled Back Unexpectedly in April: Pending home sales declined unexpectedly in April, dropping 1.5% compared with the small 0.5% gain economists were expecting. Risks to expectations appeared to be tilted the downside considering a notable decline in purchase applications in the second half of the month. Activity pulled back in three of the four geographic regions, led by a 2.5% drop in new contracts in the South, which accounts for the largest share of existing home sales. April’s decline cuts into positive trend for pending sales to start 2019 and points to the potential for continued moderation of existing sales in the months ahead.
Clarida Said “Very Good” Economy Not Yet Ready for a Rate Cut: Fed Vice Chair Clarida indicated that he is keeping an eye on the downside risks hanging over the economic outlook, but he isn’t yet ready to rewrite his path for the policy rate. In a relatively sanguine speech, Clarida noted that “the current stance of policy remains appropriate” with the U.S. economy “in a very good place” and considering the Fed’s expectation “that some of the softness in recent inflation data will prove to be transitory.” However, he said that “if the incoming data were to show a persistent shortfall in inflation, …or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook” then “the Committee would take into account in assessing the appropriate stance for monetary policy.” After saying he was aware of the “brief” inversions of the yield curve recently, he reiterated, “Let me be very clear, that we’re attuned to potential risks to the outlook, If we saw a downside risk to the outlook, then that would be a factor that could call for a more accommodative policy.”