The Market Today
U.S. Stocks and Treasury Yields Break Their Recent Downtrend Overnight
by Craig Dismuke, Dudley Carter
Key Fed Comments and an Update on Business Spending: Most of today’s economic events will occur after markets open Tuesday, with Fed Chair Powell’s comments at 8:55 a.m. CT expected to draw a crowd of traders watching for any headlines from his remarks. Already this morning, we’ve heard from Chicago Fed President Evans, a current year voter, that he’s “pretty comfortable” with the current policy setting but he’s a little “nervous” about inflation continuing to run below 2%. He said the real economy still appears to be solid despite a higher level of uncertainty. He said the markets are seeing something he doesn’t see in the data, but were activity indicators to weaken, the Fed has capacity to respond with easier policy.
Powell will discuss policy strategy at a conference hosted by the Chicago Fed as part of the Fed’s current framework review. His thoughts on alternative policy frameworks could affect expectations for interest rates over the medium- and longer-term, while any comments on the recent market volatility and its effect on the outlook may indicate whether the Fed Chief is sympathetic to market expectations for easier Fed policy in the second half of the year. Yesterday, Bullard from St. Louis become the first official to say a rate cut may be needed to support the economy and inflation amid greater uncertainty (more below). Fed Governor Brainard is scheduled to moderate an afternoon panel at the same event at the Chicago Fed.
At 9 a.m. CT, April’s Factory Orders report will include revisions to business investment expectations, but good news is likely to be dismissed due to the negative sea change in sentiment in recent weeks.
Yesterday – Markets Increase Bets Fed Will Cut Rates After Bullard Admitted Easier Policy May Be Around the Corner: U.S. stocks moved in and out of negative territory during morning trading and ended the day mixed despite a large drag from the tech sector. The Dow inched up by a hardly-noticeable 0.02% while the S&P 500 closed 0.3% lower. The Nasdaq posted the largest decline of the three major indices, dropping 1.6% following and into correction. The communications services sector was the biggest drag on the S&P 500, sliding 2.8% as shares of Google’s parent Alphabet Inc. fell 6.1% and Facebook’s stock dropped a more-severe 7.5%. Both companies were the subject of headlines describing likely antitrust scrutiny of the companies by the DOJ and FTC. The tech sector and consumer discretionary sectors also fell more than 1%. The muted trade on most stock exchanges stood in stark contrast to another volatile snap lower in Treasury yields. Yields had declined overnight on follow-through of trade worries from last week, but snapped lower after Fed President Bullard became the first official to admit a rate cut may be around the corner. Fed funds futures rallied higher in price (lower in yield) to imply 65 bps of easing before 2020. The 2-year yield dropped 8.6 bps to 1.84% and has dropped 33 bps over a tumultuous five-day stretch. The 10-year yield slipped 4.8 bps to 2.07%, 25 bps below the 3-month T-bill rate.
Overnight – U.S. Stocks, Yields Break Slide: U.S. assets broke their recent downtrend overnight, with equity futures strengthening following the Nasdaq’s slide into a correction and Treasury yields pushing up from Monday’s close at technically treacherous levels across the curve. Chinese stocks led declines in a softer start across Asia but European equities climbed alongside U.S. futures. As had been expected, the Reserve Bank of Australia cut its overnight rate by 25 bps to 1.25% amid an uncertain global backdrop, a move that “will help make further inroads into the spare capacity in the economy.” Despite a recovery in equities, yields across mainland Europe were lower after economic data perpetuated the confounding dynamic of tightening resources and tepid price pressures. The Eurozone’s unemployment rate nudged 0.1% lower as expected in April to a new cycle-low of 7.6%, but core inflation slipped more than expected in May to 0.8% YoY. Some, however, suspect the timing of Easter may have skewed the figure downward. Treasury yields reversed higher from the outset of the overnight session after a five-day slide had pushed yields to extremely low levels. The 2-year yield rose 6.8 bps around 7:15 a.m. CT to 1.90% while the 10-year yield had added 4.8 bps to 2.12%. There were reports out overnight that Senate Republicans were considering stepping in with legislation to stop President Trump’s plans for tariffs on Mexico, and Mexico’s foreign minister said he sees odds of a positive resolution to the current disagreement at about 80%.
May’s ISM Manufacturing PMI Hit 31-Month Low: The ISM’s May manufacturing PMI confirmed the drop-off in activity from April’s pace that was reflected in Markit’s flash survey released a couple of weeks ago. The headline ISM manufacturing PMI dropped 0.7 points to 51.2 last month, a new low for the survey under the Trump administration, on weaker production, less pressure in the supply chain, and slower inventory growth. It wasn’t all bad news in the details, however, with key readings on new orders and employment both firming in May. While those cushioned the disappointment somewhat, they are likely to be dismissed as not fully capturing re-escalation of U.S. trade tensions with China, and couldn’t capture the concern about tariffs on Mexico that were announced on the final day of May. A comment from a chemical products manufacturer captured the concerns and complexities that tariffs on Mexico add to trade decisions for U.S. corporate executives. The respondent said, “The threat of additional tariffs has forced a change in our supply chain strategy; we are shifting business from China to Mexico.”
Construction Spending Comes up Short in April but Revisions Result in Better Overall Trend: Total construction spending was unchanged in April, falling short of the 0.4% gain economists had expected. However, both of the prior months were revised stronger, leaving total spending over the last three months at a better cumulative level than previously estimated and posing upside risks to 1Q GDP in the final revision. In the details of the April report, private spending contracted 1.7%, led by a 2.9% decline in non-residential activity, the largest since January 2013. Residential spending declined a smaller 0.6%, marking the eighth decline in spending on housing projects in the last nine months and extending a disappointing trend for the series. Another drop in home improvement spending offset increased multi-family activity, while single family home construction saw now change. The public sector was solely responsible for total construction not contracting in April, with total federal spending 7.4% higher than in March while activity at the state and local level rose 4.6%. Public spending is off to a hot start in 2019.
Bullard Believes a Rate Cut Could Occur Soon: St. Louis Fed President Bullard became the first official to signal the markets may be right in forecasting a lower Fed Funds rate in the months ahead. Bullard conclude an ominous update on his outlook for the economy by noting that, “A downward policy rate adjustment may be warranted soon to help re-center inflation and inflation expectations at target and also to provide some insurance in case of a sharper-than-expected slowdown.” The two additional bullet points on his conclusion summarized well the in-depth support throughout the broader presentation for why he sees little reason for policy to remain at its current setting. The Fed “faces an economy that is expected to grow more slowly going forward, with some risk that the slowdown could be sharper than expected due to ongoing global trade regime uncertainty. In addition, both inflation and inflation expectations remain below target, and signals from the Treasury yield curve seem to suggest that the current policy rate setting is inappropriately high.”
ICYMI – May 2019 Monthly Review: Trade tensions returned unexpectedly in May, sending the S&P 500 down 6.6% and knocking 38 bps off the 10-year Treasury yield. President Trump caught markets off guard early by announcing the U.S. would raise the 10% tariff rate on $200B of goods imported from China to 25%, and was considering taxing the remaining balance. China retaliated with higher tariffs on roughly $60B of U.S. goods. But the bigger surprise came late on a surprise announcement from President Trump that the U.S. would impose a gradually-increasing 5% tariff on all Mexican imports unless the country helps cut-off illegal immigration across the border. That final blow to sentiment cemented a steep monthly decline in interest rates, leaving the 2-year yield at 1.92%, its lowest level since January 2018, and the 10-year yield at 2.12%, the lowest since September 2017. With markets worried about the economic impact of escalating uncertainty, Fed Funds futures repriced to reflect an expectation for 50 bps of easing by the end of 2019. Click here to see the full Monthly Review.