Fed Chair Jerome Powell addressed the Council on Foreign Relations yesterday in New York and offered economic and policy comments that were mostly in keeping with the dovish outlook from last week’s FOMC meeting. Both in prepared remarks and Q&A Powell didn’t try to restrain the market’s view on future rate moves, but there was some pushback on the possibility of a 50bps cut in July. Odds are 100% that a rate cut will be forthcoming at the July 31 meeting and fed funds futures see the funds rate at 1.625% by year-end. By year-end 2020 fed funds futures are calling for a 1.32% rate and a nearly identical 1.28% at year-end 2021. So, if an easing cycle commences next month, futures are expecting it to continue and stretch through 2020.
Recall the Fed mentioned increasing “uncertainties” about the economic outlook and that they would “act as appropriate to sustain the expansion” in last week’s FOMC statement. Given the tepid economic reports yesterday (more on that below), along with denunciations flying back and forth between D.C. and Tehran the “uncertainties” seem only to be increasing, and that is likely to maintain a safe haven bid in Treasuries. Two examples illustrate the strength in Treasuries. First, the 10-year note yield closed below 2% yesterday (although it’s giving some back this morning on optimism for the Trump/Xi meeting this weekend. Color us skeptical). Second, despite the yield on the 2-year note being 63bps below the effective fed funds rate, the Treasury was able to easily sell $40 billion in new supply despite the lowest yield in nearly two years and 40bps below where it auctioned 2-year notes in May. The market conviction that the Fed is poised to ease, and ease repeatedly, is only getting stronger.
One of the economic releases we referenced above was the preliminary read on durable goods orders for May. Overall orders were down –1.3% versus -2.8% in April which implies further declines but at least the rate of decline is improved. Orders less the volatile transportation sector were up 0.3% versus down –0.1% the prior month. Shipments of non-defense ex-air items (a proxy for business investment) were up 0.7% versus 0.4% in April. So the increase in shipments and orders ex-air is a bright spot in an otherwise uninspired report. One of the issues bedeviling the sector is the inventory buildup evidenced in the last two GDP releases and as that overhang is worked off it is a headwind in the face of softening global demand and increased uncertainty.
Another of the releases we alluded to above that reflected increasing economic “uncertainty” was the Conference Board’s Consumer Confidence Report for June. The headline consumer confidence reading for June fell from 134.1 to 121.5 versus an expected 131.0—the biggest miss since February 2009. In addition, the -12.6 decline was the largest one month drop since August 2011. The headline index is the lowest since September 2017. In the details, the present situation index declined from 170.7 to 162.6 and the expectations index fell from 105.0 to 94.1. While the Fed will always stress one data point does not a trend make, with two-thirds of the economy tied to consumer spending any wavering of confidence should raise some eyebrows. While consumers have somewhat blissfully navigated the travails of the trade war to this point, this release, if it’s repeated next month, could suggest the consequences of the trade war are beginning to drain some of the household sector confidence and that will crimp future spending.
The soft economic news didn't end with the consumer confidence reading as a pair of housing releases point to potential trouble spots in that sector despite lower interest rates. First, sales of new homes fell to a five-month low in May. Sales dropped 7.8% to a 626,000 annualized pace versus an upwardly revised 679,000 rate in April. Expectations were for sales to top 684,000 annualized. Purchases fell in the Northeast and the West, where they dropped the most since 2010. Sales rose in the South and Midwest. The median sales price decreased 2.7% from a year earlier to $308,000. The weaker report suggests headwinds remain in the housing sector despite lower mortgage rates and moderating price appreciation.
Finally, the last bit of data out yesterday, the S&P CoreLogic Case-Shiller 20-City Home Price Index, decelerated in April for a 13th straight month to the weakest pace since 2012. The index posted a gain of 2.5% from a year earlier matching most estimates while prices were unchanged month-over-month. With home price gains moderating to rates under annual wage gains, along with lower mortgage rates, one would expect housing activity to improve but that is not the case as evidenced by the new home sales numbers. Add this to the list of “uncertainties” the Fed will ponder during the next month.
If the Fed was hoping for some help in the data to prevent the first rate cut in more than 10 years they didn’t get it with this latest round of information. While the July 5th jobs report is no doubt a key release for the Fed, the job market is somewhat a lagging indicator. Another point to mention, with the softening trend in home price appreciation the owners equivalent rent component in CPI is likely to weaken as well and that’s been one the key components driving what inflation we have experienced.
Consumer Confidence & Expectations Edge Lower
With two-thirds of the U.S. economy based on consumer spending, gauging the confidence of the consumer is a key tell on future activity. The falloff in the latest confidence reading does present some troubling signs if it continues. First, the drop in the headline index from 134.1 to 121.5 was the biggest monthly drop since August 2011. In addition, the expectations index declined sharply to 94.1 from 105.0. As the graph shows, the year-end stock selloff damaged both confidence and expectation readings but they subsequently rebounded, albeit at lower levels. With China trade war angst and Iran saber-rattling growing can we expect another bounce this time around?
Agency Indications — FNMA / FHLMC Callable Rates
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