Treasuries opened weak yesterday on some modestly positive news out of Europe and China, and the early weakness worsened after a stronger-than-expected February ISM Non-manufacturing report revealed a services sector apparently unfazed by the global slowdown story. That early weakness, however, reversed as the day wore on, and with no new news on a China trade deal Treasuries finished mostly unchanged. This morning, Treasuries are holding modest gains as the ADP Employment Change Report posted a decent result with 183,000 new jobs but that missed the 190,000 expectation, while the January number was revised up from 213,000 to 300,000; the highest ADP print in this cycle. The Friday jobs report should be a mean-reversion story with 180,000 new jobs expected compared to the outsized back-to-back months of 300,000+new jobs. Based on a five-year average, today’s ADP number implies a 208,000 jobs print for Friday, but recent ADP results have a sketchy correlation so take that estimate for what it’s worth. Other aspects of Friday’s jobs report are likely to show a labor market that continues to hum despite year-end market volatility, the government shutdown, and the oft-mentioned global slowdown. All that being said, while the labor market expands, and wage gains remain over 3%YoY, demand-driven inflation remains muted and as long as that is the case Treasuries are likely to remain range-bound.
|Economic News||That Troublesome First Quarter GDP||Agency Indications|
As more and more of the delayed December economic reports are released it’s becoming obvious that the month was a real stinker as far as economic performance goes. The bloodbath in the stock market, the government shutdown, and slowing in global growth prospects gave consumers and businesses reason to pause and pause they did. Everyone paused, that is, except the Fed. The Fed’s pause came a month later, perhaps a little late but pause they eventually did.
As the calendar turned to 2019, and stocks rebounded in January and February in near historical measure, consumer and business confidence rebounded and it looks like economic reports are starting to reflect that as well. Short of the February jobs report on Friday the week’s second-most anticipated release is the ISM Non-Manufacturing Index for February. Recall the ISM Manufacturing report last week was the weakest print in two years, albeit still in expansionary territory. The soft manufacturing read was perhaps the beginnings of payback for the inventory overbuild that occurred in the second half of 2018 and was noted in the fourth quarter GDP release. In any event, whatever the cause of the manufacturing slowdown it didn’t seem to bleed into the services sector.
The ISM’s non-manufacturing, or services, index rose 3 points to 59.7, the biggest gain in a year, with the increase driven by 13-year highs in gauges of new orders and business activity. The result easily topped the Bloomberg consensus expectation of 57.4. Advances in three of the four index components indicate businesses remain optimistic about consumer demand for services and that the effects of the government shutdown are fading. The report also indicates that continuing trade tensions and a dimming global-growth outlook aren’t weighing as much on service providers as it is for manufacturers. For example, export orders rebounded from a two-year low. On the downside imports fell to the lowest since 2017 while the employment gauge fell to an eight-month low, although it remained at a historically elevated level. In summary, a positive read on the 90% of the economy that is services-based with little sign of lingering hesitation after the soft patch at year-end.
The ISM report was followed by another look at the housing market with new home sales unexpectedly rising in December after a downwardly revised November release. The pace of single-family new home sales increased to 621,000 annualized and while that beat expectations the November number was revised down by 58,000. The report was delayed more than a month as a result of the government shutdown and as such it’s a little stale. The fact sales rose, however, is a good sign as affordability has only improved in 2019 with mortgage rates dropping nearly 50bps since the November highs. Another sign affordability is improving is the median new home price dropped 7.2% from a year earlier. This is most likely a function of lower-priced homes constituting a bigger portion of the sales, but it was probably aided too by a slowing in home price appreciation from the early 2018 pace. In fact, year-over-year median new home prices have dropped in three of the last four months which is another reason we expect housing activity to improve as we move into spring and the combination of lower mortgage rates, moderating home prices and strengthening wage gains bolster the housing affordability equation.
Thus, we see the soft economic patch that characterized year-end to be just that a soft patch with a rebound in consumer spending coupled with increased business confidence following. While first quarter GDP is expected to be below recent trends (Bloomberg consensus 2.0%), the statistical quirk of the first three months to print low with a rebound in the second quarter is now a well-known feature. Thus, the market, and most likely the Fed, will look past first quarter weakness and wait on the expected second quarter rebound before making any changes to their patient posture. That means any shifts in Fed policy will likely be a second-half to late-year development.
That Troublesome First Quarter GDP
For a decade now , residual seasonality has accounted for significant disparities between estimates for first quarter GDP and the actual data. In the graph notice earlier this decade expectations for first quarter trended well above initial estimates. Economists have become more aware of the issue in recent years, resulting in less-aggressive forecasts for the initial print. Given that in each of the past three years, the lackluster first quarter pace was followed by a strong second quarter rebound, the Fed will most likely wait to see GDP for the first half of the year, rather than relying solely on the troublesome first quarter read before effecting any change in Fed policy.
Agency Indications — FNMA / FHLMC Callable Rates