The economic surprises keep piling up on the negative side of the ledger as the Federal Reserve persists in tightening policy or at least pretending that it is. If a rate changes in the wilderness can the market hear it? Outside of the stock market’s rise to record highs, it’s difficult to find evidence that the Fed’s extraordinary policies of the past decade have been very effective.
And I’m not sure quantitative easing can be blamed for pushing asset valuations to incredible heights, once again. I’m also not sure exactly what the Fed is trying to accomplish and I don’t think it really does either. All evidence points to the nonsensical idea that interest rates need to be raised so the Fed will have room to cut them later. Unfortunately, that is as logical as monetary policy gets these days.
I may not know what’s going on and Fed Chair Janet Yellen surely doesn’t, but the bond market usually does. Unlike Yellen we here at Alhambra do pay attention to what the bond market is telling us. It isn’t a tale of full employment and imminent wage and cost-push inflation. It also isn’t a tale of robust growth that needs reining in lest it get out of control and put too many people back to work. So, we are left scratching our collective heads trying to figure out what exactly is motivating Yellen & Co. to try and slow down an economy moving at the speed of a sloth.
The economic data released since our last update wasn’t kind to the Fed’s narrative or reputation. Things that seemed to confirm the Fed’s desire to raise rates were the Labor Market Conditions Index, the JOLTS report, the weekly jobless claims data and some of the central bank’s regional manufacturing surveys.
The reports that didn’t support a rate hike were factory orders, productivity, the ISM manufacturing report, wholesale and business inventories and sales, PPI, CPI, retail sales, industrial production, housing starts and consumer confidence.
The Fed fears that, with the unemployment rate down to 4.3 percent, people will soon have the confidence and courage, heaven forfend, to ask for a raise. If that were allowed to happen, then those people might then go out and spend it on something, which might lead to sellers raising prices if Amazon didn’t exist. Based on the most recent retail sales report – and the fact that Amazon’s stock just hit an all-time high – that fear would seem to be vastly overblown.
Sales were down 0.3 percent when they were expected to rise by all of 0.1 percent. The current year-over-year rate of slightly less than 4 percent is about as good as it’s gotten in the past four years or so but that is paltry compared to past expansions. The weakness was widespread with department store sales leading the way, down 1 percent.
Slowing Car Production
Industrial production and factory orders offered no respite. IP was flat with auto production down 2 percent and business equipment down 0.7 percent. Factory orders were down 0.2 percent with durable goods down 0.8 percent. That makes sense in light of the inventory reports which showed contraction at the wholesale level as well as overall. That might be a potential bright spot for the future but alas the inventory draw was matched by a drop in sales.
Rounding out the weak reports was the report on housing starts last Friday. Housing has been one of the few bright spots in this economy but it has been dimming recently. Starts and permits were both down sharply. Single-family starts were down 3.9 percent and permits off 1.9 percent, while multi-family took a bigger hit, down 9.7 percent and 10.4 percent respectively. The apartment building boom that has driven residential investment for the past few years would appear to be over, at least for now. Absorption rates are falling, vacancies are rising and rents have all but stopped rising. Friday’s report knocked down estimates of second-quarter GDP growth to less than 2 percent. The big rebound in second quarter growth that everyone was expecting isn’t amounting to much.
We can see the weakness in our market-based indicators. The yield curve flattened by another 6 basis points and has now given up all the steepening that started last August and accelerated after the election. Stocks may still hope for tax reform but the bond market has given up and faced the reality that any change in economic policy is probably not going to happen during the recesses of the oxymoronically named Senate Intelligence Committee.
Inflation expectations, taking their cue from the PPI and CPI reports, also fell, down 8 basis points since the last update:
The nominal 10 year note yield actually didn’t change since the past update. Rates moved up slightly but then fell right back:
Further confusing the picture, TIPS yields rose. Inflation expectations fall and real growth expectations rise ever so slightly. There might be a lesson for the Fed in there somewhere.
The move in the yield curve would seem to be all about inflation expectations and again I am left wondering what exactly the Fed thinks it is fighting.
Meanwhile, credit spreads actually widened since the last update. Well, if you want to call 3 basis points widening. Risk appetite has not waned even in the face of weak economic data.
The dollar didn’t change much since the last update but the trend since the beginning of the year is pretty obvious and none of the recent action changes that.
Gold was down slightly since the last update but as with the dollar index the trend since the beginning of the year is obvious and not supportive of the growth story.
The Bloomberg Commodity index fell through support. Not exactly looking for a boom:
As I’ve been writing for years now, our economic situation hasn’t changed much. Growth is still capped around 2 percent with risks apparently to the downside especially with the Fed intent on heading off non-existent – so far – inflation.
Our market indicators do not point to any imminent problems but they do continue to point to weaker growth than widely expected by economists and stock speculators. I suppose the Amazon/Whole Foods deal last week does show a certain amount of animal spirits still extant in the corporate suite. It also shows that anyone hanging their policy hat on rising inflation is likely to be disappointed. Amazon’s business model is essentially based on predatory pricing. When will anti-trust finally become a problem for Jeff Bezos? Anyone want to bet on why he bought the Washington Post? There’s a reason every company with any exposure to groceries saw its stock tank last Friday around 8 a.m.
The Fed is expected to raise rates at least once more this year and start to unwind its bloated balance sheet. I’ll be shocked if they accomplish the first but happy if they at least start on the latter. And I’ll be even happier if they concentrate on selling the longer term bonds they own. A bullish steepening of the yield curve – long rates rising faster than short rates – might not be sufficient by itself to revive growth but it certainly wouldn’t hurt. Steeper yield curves are associated with higher growth while flat or inverted ones are associated with lower growth. Correlation and causation are hard to disentangle – is it higher growth that steepens the curve? Or a steeper curve that leads to higher growth? I don’t know for sure but I’d venture a guess that it is a little of both. Time to find out if you ask me. Nothing else has worked.
Joe Calhoun is chief executive officer of Alhambra Investment Partners, a registered investment advisory based in Palmetto Bay, Florida. CLICK HERE to read more of his work.
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