"The issue is, you're not going to have a lot of inflation showing up when you have no velocity." -- Rick Santelli
What Now, Doctor?
The domestic macro has been rather soft of late. I don't think anyone doubts where the Fed wants to take policy. I don't think anyone doubts where the Fed will indeed take policy, on June 14. The many talking heads of the FOMC have been out and about. They have made clear their intent. Yet, as I type out this note this morning, strength works its way back into benchmark U.S. 10-year paper. The spread between the two year and the 10-year is now down to 0.937%. Though increasing the fed funds rate by a quarter of a point in two weeks seems almost baked into the cake, the belief that the Fed will be able to stay on mission beyond that just is not there. Softer macro may or may not be enough for the FOMC to slow down the pace of rate hikes. Is it also enough to pause intended management of that balance sheet that has become so front and center?
You'll certainly find more out today. Nothing in our macro world really matters to our policy makers more than consumer level inflation. Core CPI, released for April on May 13, has slowed on a year-over-year basis now for three consecutive months. It is running at 1.9%, below the Fed's originally stated target for the first time since October of 2015. The Fed watches the PCE Price Index more closely than it does CPI. Fine, we expect the Core print for April to stroll in at 1.5% today. The inflation that the Fed had counted on just may not be there. Transitory? Maybe. What, just what is a data-dependent central bank to do?
Phillips Curve Follies
It has become painfully obvious that the Phillips Curve does not necessarily work the way it is written in the textbooks. Low unemployment does not necessarily correlate to increased consumer level inflation. Why? For one, a part-time economy is not the same as an economy that works full-time. Sarge, this condition is starting to improve. True, but even at that, these people likely feel that they have ground to make up before they will ever again feel comfortable. Need evidence? Credit scores are higher, while consumer credit struggles to grow. That's kind of telling. Not comfortable. No, not at all. More people working part-time for longer than what might be considered "natural" have put downward pressure on both the natural rate of unemployment and on discretionary spending.
The already mentioned improvement has been painful for many. Rising costs for health care are another obstacle. Even rising incomes -- which we have seen to a mild degree -- are not enough to overcome the rapid rise in what people must spend on necessities. Lastly, the scars. The scars of the "great recession" are real. Many people that you might speak to in the aisles of discount retailers will tell you their tales of woe, if you let them open up. There really are not so many "I'm OK now" stories out there. These people tell you of what they used to do for a living in the "old days".
So, it appears that deflationary pressures still exist. They are both behavioral and structural. Today's data will tell us more. An upside surprise would allow the Fed to remain on track. A disappointing print will force the Fed to address the situation in the June statement. A developing trend of disappointment in the space would force comment, and put the FOMC in the awkward position of planning contingencies around what it was that they had intend. Time will tell, but not too much time.
Where We Stand
Terrorism in the U.K. North Korean saber rattling. Chinese credit rating downgrades. Domestic political risk, and plenty of it. Calloused over? We will face April data on income, spending, and inflation today, and May numbers on employment later in the week. Mr. Market seems unfazed. The S&P 500 tacked on 1.4% last week, and has now gained 7.9% for the year. The Nasdaq Composite is a runaway train. Both stand at record levels. Even the small-caps and the transports, both trailing broader markets badly year to date, have at least moved to the plus side of zero for 2017. That simply was not the case as recently as two weeks ago.
Do we care? Oh, at some point we will. Perhaps the improvement posted by the Bureau of Economic Analysis to the revision of first-quarter GDP, largely based on consumer behavior, was enough. Enough for what, exactly? Well, while the headline number for growth moved from paltry up to merely lousy (0.7% to 1.2%), the Atlanta Fed is still projecting (a fairly robust) 3.7% growth for the second quarter. Even after Friday's horrendous prints for April durable goods both ex-transportation and ex-defense. A full month of rather soft macro has left those forecasts at still-elevated levels. Growth returns to trend? That would certainly be helpful for at least the transports, not to mention suddenly lower fuel costs going forward.
Oh, I think we do care. We just care less about items that do not easily translate into dollars and cents than we do about items that in both the immediate front and the forward look impact corporate performance in a quantifiable way. You can read that as improved earnings coupled with an improving Europe. At this point, progress on policy would merely be a positive not yet priced in.
08:30 - Personal Income (April): Expecting 0.4%. March 0.2% m/m.
08:30 - Consumer Spending (April): Expecting 0.4%, March 0.0% m/m. Income has been stronger than spending thus far in 2017. While expectations of 0.4% monthly growth in both spaces would be a best for the year, it would be the third time reached for income, while it would be far better than anything seen as far as spending goes since December. To see consumer activity start to catch up would make a lot of economists feel a lot better, especially after a month of very shaky macro.
08:30 - PCE Price Index (April): Expecting 1.7% y/y, March 1.8% y/y.
08:30 - Core PCE (April): Expecting 1.5%, March 1.6% y/y. Here it is, the item that the markets wait on with bated breath. Perhaps only Jobs Day and quarterly GDP data (of late) matter as much as consumer level inflation as far as the trajectory of monetary policy is concerned. That leaves just this and the CPI. The Fed chooses to focus here. The markets choose to focus on the Core year-over-year print as their barometer for the Fed's success in creating inflation.
09:00 - Case-Shiller HPI (March): Expecting 5.7%, February 5.9% y/y. As measured on a year-over-year basis, home prices have been on fire, as were most of our other measures of housing market health. Some common monthly sales tallies have shown weakness in April. That is at least partially due to a lack of supply. That should not be a factor. However, if this item finally cools a bit, even if we see a 5.7% tag for growth in the unadjusted, 20- city print, that could hardly be called soft.
10:00 - Consumer Confidence (May): Expecting 119.6, April 120.3. Confidence eroded somewhat in April, off incredibly high levels in March. (March brought us the most optimistic headline reading for this series in seventeen years.) While holding close to these lofty levels, some give was seen in expectations for job conditions, business conditions, and income on a six-month look.
10:30 - Dallas Fed Manufacturing Index (May): Expecting 15.4, April 16.8. The streak of unanimous monthly headline expansion across the major regional Fed district manufacturing surveys came to an end this month in New York. On top of that, Richmond had a close call as well. Dallas is different. Throughout the long "depression" suffered by the manufacturing sector across our nation, Dallas easily suffered the most as oil prices collapsed. Now that production has ramped up throughout the southwest, Dallas should have no problem clearing the zero mark that separates expansion, and contraction.
17:00 - Fed Speaker: Federal Reserve Gov. Lael Brainard is set to speak on both the economy, and monetary policy from New York City. Last Thursday, Brainard indicated that she is feeling a bit better about "weak global economies", and that they pose less of a threat to our own economy than they have over the past few years. Guess that thought is fairly unanimous at this point.
Sarge's Trading Levels
These are my levels to watch today for where I think that the S&P 500, and the Russell 2000 might either pause or turn.
SPX: 2439, 2426, 2418, 2411, 2405, 2397
RUT: 1399, 1392, 1386, 1376, 1367, 1357
Today's Earnings Highlight (Consensus EPS Expectations)
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