The Market Today
U.S. Retailers Have Big Month in May, ECB Sets End Date For QE
by Craig Dismuke, Dudley Carter
Blowout Retail Sales for May: This morning’s most important U.S. report was May’s retail sales release. And it didn’t disappoint. Retail activity in May was much stronger than expected, topping expectations at both the headline and control group level. Headline sales rose 0.8% last month, double the 0.4% gain expected, while sales excluding autos increased 0.9% compared to forecasts for a 0.5% gain. When sales of gasoline (+2.0%) are also removed, activity improved 0.8%. But more important for GDP purposes is how much was spent in the control group categories. Control group sales, which removes building materials (+2.4%) and food service (+1.3%) in addition to autos and energy, rose 0.5%. That was 0.1% better than expected supported by above-average gains in clothing and accessories, miscellaneous store retail, health and personal stores, and general merchandise retailers. Core activity looks even stronger when combined with a positive revision for April (+0.6% versus 0.4% previous estimate). Bottom Line: The May retail sales reports adds credence to the growing expectations consumers are loosening their grips on their wallets and spending their way out of a slow three months from December through February. This aligns with lower tax bills, the improving labor market data, and the elevated levels of consumer confidence. It should also lead to positive revisions to 2Q growth estimates which are already projecting a solid quarter.
In the other morning reports, higher oil prices pushed overall import prices up 0.6% in May while the cost of imports, excluding petroleum, rose a more modest 0.1%. The jobless claims data were stronger than expected, with initial claims falling from 222k to 218k, one of the stronger levels since the early 1970s, while continuing claims fell a surprising 49k to 1.697MM, the lowest since 1973.
Despite the positive implications of this morning’s U.S. data, it has had little perceptible impact on U.S. assets. Investors seem more focused on the ECB’s latest decision (more below).
Yesterday – Stocks Fell, Yields Rose as Fed Decision Proved More Hawkish: Trading was relatively uneventful before the Fed announced a quicker expected path of rate hikes, sending equities lower, the Treasury curve higher and flatter, and creating volatility for the U.S. Dollar. After hovering around unchanged for the first half of trading, the major indexes dropped immediately following the Fed’s announcement and finished near their lows of the day. The S&P 500 tried to recover with financial stocks but as they reversed, so too did the broader index. Ten of the index’s 11 sectors closed lower for the day. The rise and fall of the financials sector mirrored the post-meeting volatility in Treasury yields. The initial knee-jerk sell-off in Treasurys, that had sent the 2-year yield up almost 7 bps and the 10-year yield up nearly 6 bps, was pared notably by the close. The 2-year yield rose 2.9 bps to 2.57% while the 10-year yield added just 0.6 bps. The rate path implied by Fed funds futures ended slightly steeper, with the biggest changes occurring in 2019. The Dollar reversed its Fed-driven gains to finish near the lows.
Overnight – ECB Gets More Specific as It Looks to End QE at the End of 2018: Global equities had weakened overnight following yesterday’s post-Fed losses and in front of this morning’s ECB decision. Movements in sovereign yields were mixed. Similar to trends in Asia, U.S. Treasury yields had pulled back with longer yields back below levels immediately before yesterday’s Fed announcement. However, investors in Europe appeared to be setting up for a hawkish ECB decision. Italian yields rose the most (+10.7 bps 10-year) while German Bunds saw smaller shifts (+2.0 bps 10-year). The Euro, which strengthened against the Dollar yesterday after the Fed decision, was at its strongest level in more than a month. In its Statement, the ECB altered the wording to explain that it will cut its 30 billion Euros of net purchases by half for October through December, at which time they will end them altogether. They will continue reinvesting cash flows from maturities for an unspecified period of time. They were more specific in the rate guidance as well. Instead of pledging to keep rates where they are “for an extended period of time”, they now expect them “at their present levels at least through the summer of 2019” or until they’re comfortable with inflation trends. The Euro slipped with European yields as investors awaited more color from Draghi’s press conference. Before this morning’s U.S. retail sales data the 2-year yield was down 1.0 bps with the 10-year yield 2.4 bps lower, pushing the related spread to 37 bps for the first time since 2007. U.S. equity futures were stronger and the Dollar had recovered on a softer Euro.
Fed Accompanies a Rate Increase with a Stronger Outlook and a Call for a Fourth 2018 Hike: As expected, the Fed unanimously voted to raise its target range for the seventh time this economic cycle to 1.75% to 2.00%. But with that already priced in, it was the Statement and updated projections investors were anxious to see. The biggest debate ahead of the meeting was around what to expect in the 2018 dots. In the SEP, a single official moved from expecting three hikes this year to four which was enough to move the median. And this drove the market’s initial reaction of a flattening sell-off in Treasuries. In addition to a fourth hike this year (to 2.375%), the median estimate still expects three hikes in 2019 (to 3.125% now instead of 2.875%) while the 2020 longer run dots were unchanged. The quicker tightening pace was presumably the result of the slightly stronger 2018 growth outlook (2.8% instead of 2.7%) and, maybe more so, the forecast that the labor market will move even further past full employment. The estimate of longer run unemployment was left at 4.5% while the 2018 estimate fell from 3.8% to 3.6%; 2019 and 2020 estimates were lowered from 3.6% to 3.5%. The Statement also reflected the pick-up in economic activity to a “solid” rate and acknowledged the move lower in unemployment. The current hike and quicker projected path led to the removal of a sentence saying the Fed Funds rate would remain below neutral “for some time”. The most interesting development from Powell’s press conference may have been the announcement that, beginning in 2019, each meeting will be accompanied by a press conference to “improve communications”. He also said the “economy is in great shape” and noted that it’s too early to “declare victory” but “the recent inflation data have been encouraging”. Bottom Line: The cumulative results reflect a bit of a paradigm shift from the FOMC. They have been in a tightening mode 1) to get away from an “emergency policy” position 2) in anticipation that the economy was strengthening. They now appear to be tightening because they believe 1) the economy is at full capacity with the expectation that 2) they are keeping it from running too hot.