More tariff talk (this time with Mexico if they don’t curb migration flows), and China compiling an “Unreliable Entities” list (foreign companies that have recently stopped supplying Chinese firms) has markets in a risk-off mood yet again with yields reaching fresh YTD lows. Taking a slight break from the geo-political, this morning we also received personal income and spending numbers for April. Incomes rose 0.5% versus 0.3% expected while personal spending rose 0.3% versus 0.2% expected. Adjusted for inflation, real personal spending was flat for the month (as expected) versus an impressive 0.9% gain in March. Perhaps most importantly, the Fed’s preferred inflation measure, core PCE, was up 0.2% for the month but remained at 1.6% year-over-year. Core PCE was 2.0% at the beginning of the year so the “transitory” move lower in inflation looks to be a bit more “sticky” than perhaps some at the Fed reckoned. That “stickiness” in inflation, not to mention the quickly unwinding global situation, are a couple reasons the Fed may start messaging that a pre-emptive rate cut could be coming in the second half of the year. We explore those reasons in more detail below.
As Treasury yields have plummeted to new year-to-date lows on a seemingly daily basis, some have looked at the domestic economic scene and expressed amazement, or at least befuddlement, at the angst shown by fixed income investors. So, is this making mountains out of mole hills with the market poised to rebound, or are there legitimate concerns underlying the move lower in yields such that this rally may have more staying power?
Those expecting a back-up in yields after the rending-of-garments in stocks is completed point to a few things, most notably labor market strength and the still strong consumer confidence readings. Labor market strength, however, is a lagging indicator and consumer confidence readings can be a trailing indicator as well. If the labor market slows, you can bet consumer confidence will turn south as well. Also, confidence readings tend to be a case of watch-what-they-do-not what-they-say. Take them with a grain of salt, as they say. And what the consumer has been doing lately has been to retrench a bit this year except for a burst of buying in March.
In addition to the mediocre real personal spending for April, other recent reports are pointing to a continued hesitancy on the part of the consumer. Pending home sales for April fell 1.5% versus March and missed the modest 0.5% expected gain. Pending home sales are based on contract signings, and, thus, are one of the more contemporaneous indicators we have for the housing market. Three out of four areas of the country posted declines in sales (the Midwest being the only area with a gain), and that comes after mortgage rates fell rather precipitously in March. One would have reasonably expected a better performance here given lower mortgage rates and moderating home prices.
Also, the advance goods trade balance report for April posted a near as-expected deficit of -$72.1 billion but within the details of the report both imports and exports fell. Also, wholesale inventories rose a whopping 0.7% in April versus 0.1% expected and that points to perhaps a third straight quarter of inventory build that will have to be reversed soon, especially if weaker sales overseas persist.
While domestic economic indicators have slipped a little of late, they aren’t likely setting off alarm bells in the Marriner-Eccles Building yet. One of the key metrics, however, the Fed is focused on to guide near-term rate policy is inflation and both indicators released this week point to continued softness in price levels and that might be getting some Fed officials to sit a bit more upright. The “transitory” label given to the recent downtrend in inflation may need to be revisited. The second revision to first quarter GDP found core PCE (the Fed’s preferred inflation gauge) dropped from 1.3% in the first estimate to 1.0%. Today’s April core PCE number was 1.6%YoY, as expected and just above March’s downwardly revised 1.5%, but still a long way from the 2% target.
With the 2yr Treasury at1.99% and the 5yr note at 1.97%, the market is essentially pricing in two 25bps rate cuts. If these Treasury yield levels hold, the Fed will feel the need to start messaging that a preemptive rate cut could be coming in the second half of the year. The June Dot Plots will certainly be in for changes. Expect the 2020 hike to be repealed and the long-run rate of 2.75% to be revised lower. With more contemporaneous domestic economic indicators wobbling just a bit, inflation refusing to lift, the trade war quickly becoming an entrenched affair, and the just-completed E.U. vote pointing to some splintering in the traditional power centers of the Eurozone, investors do have plenty of reasons for handwringing. Thus, the downshift in global economic prospects has legitimate underpinnings and expecting the U.S. to continue to withstand it is wishful thinking.
The Fed would be wise to get ahead, or alongside, this shift in sentiment and mood and begin to lay the groundwork for a preemptive cut, if not in June, at some point in the second half of 2019. And making that cut a 50bps move with the prospect of more to come in 2020 may put some steepness back in the curve and stabilize stocks.
Inflation Readings Still Trending Lower
If there is a single metric that one can point to that will influence the Fed’s it is inflation. The full employment mandate, by almost every measure, has been met, but the price stability mandate, and the 2% target, has been trickier. The graph shows a few core price measures with core PCE (green line), generally recognized as the Fed’s preferred measure, trending below the 2% target. The latest Fed minutes mentioned the Dallas Fed Trimmed Mean estimate (shown here in blue) as members try to convince themselves they are near the 2% target. Watch these core inflation measures, and if they continue heading south, combined with trade angst, the Fed will be compelled to move to rate cuts sooner than later.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||2.34%||-0.01%||1 Mo LIBOR||2.44%||UNCH||FF Target Rate||2.25%-2.50%||3 Year||1.959%|
|6 Month||2.36%||-0.02%||3 Mo LIBOR||2.52%||UNCH||Prime Rate||5.50%||5 Year||1.962%|
|2 Year||1.99%||-0.16%||6 Mo LIBOR||2.52%||-0.05%||IOER||2.35%||10 Year||2.126%|
|10 Year||2.18%||-0.15%||12 MO LIBOR||2.57%||-0.10%||SOFR||2.40%|