THE CLOUDS TO THE FED’S SILVER LINING

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16 March 2017 By David Ader, Chief Macro Strategist for Informa Financial Intelligence

Ader’s Musings…A funny thing happened on the way to Fed hikes.

Let me skip over the most obvious event of the week just passed which is the ‘dovish’ Fed rate hike. I say dovish not because it’s news but because the analytical emphasis is on the subdued nature of the statement and various forms of projections (which were little changed). The latter includes the annoying dot plot, which has proven to be pretty useless as a forecasting tool beyond simply listening to Fedspeak which anyway should have the more immediate influence. I simply don’t know why people focus on the dots when they go out to 2019 and the longer-run and forecasting so far in the future is largely guesswork.

The most recent hawkish rhetoric did a very good job of preparing the market for a hike and teased it into pricing in a modicum of hawkish anticipation. In other words, the hike was fully priced in and then some so the resulting rally on ‘dovish’ aspects reflects largely a relief trade that dovetails with technical formations I’ll get to in just a moment. I am not the only person who notes the last hike came with a 1% handle on GDP in Q4 and this one with the Atlanta Fed GDPNow forecast at 0.9% for Q1. (That’s at the low end of the forecast range, but most retain a 1-handle.) After some recent hard data, others have downgraded forecasts, too, but the consensus is somewhat higher. Still, Fed hikes with subpar GDP gains like that is notable. My takeaway is we won’t need another three this year to keep animal spirits under control. Within the statement a few things stand out. One is that it referenced investment as having picked up ‘somewhat.’ It has, but from really lousy levels and it’s curious where it came from. Gross Private Domestic Investment was up 1.45% in Q4, but of that inventories contributed the bulk at 0.94%. Time was when higher inventory builds extracted from growth in the subsequent quarter if demand wasn’t gaining commensurately. Non-residential fixed investment was up a paltry 0.17%. The FOMC’s ‘firmed somewhat’ was rightly subdued. This remains a very important aspect to the recovery of the last few years; corporate America simply is not investing for future productivity gains.

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THE CLOUDS TO THE FED’S SILVER LINING The statement also brought up core inflation running below target for the first time, which is interesting, and in January was at

1.7% based on the core PCE price measure. The statement said inflation was running closer to the 2% target and fair enough, but there is some wiggle room. It was interesting to see the language change that they expected inflation to ‘stabilize’ around 2%, which seems to hint it can get over that level without provoking alarm. They did shift from seeing ‘only gradual increases’ in Fed funds to ‘gradual.’ Unlike me, the Fed chooses its words carefully and so that simple change implies they feel freer to proceed with hikes.. though in reality it’s so subtle and nuanced as to give little reason than to add, say, 5bp to latter 2017 Fed Fund futures.

The Wall Street Journal carried an interesting piece on Thursday, especially as it dovetails with something I’ve been commenting on. The headline was “Economic Growth Lags Behind Rising Confidence Data.” This came out before the Philadelphia Fed report which, though weaker at the headline level, nonetheless showed strength in all its sub categories from prices paid and received to new orders and employment. The upshot of the WSJ piece is that while confidence and stocks are robust, the underlying data has yet to conform. To quote, “Yet the US economy shows few signs of breaking out of its long stretch of subpar growth.” They cite the recent Retail Sales report, Trade data, and drop in Home Sales, and pay heed to the unseasonably warm weather up until now. For example, the February NFP report showed a whopping gain of 235k with at least decent components. However, the curious category of ‘those out of work due to bad weather’ came to 157k against a 10-yr average of 364.3k. Those seasonal adjustment factors anticipated vastly more people not showing up and so the strength in NFP is a bit misleading if you consider the weather component.

I won’t go into dreadful details comparing some data with the various measures of confidence or the stock market other than to say that to the extent those are up on the hopes and promises of the Trump Administration’s policies, well, like expectations for the FOMC we’ve discounted a lot and have yet to see what it all looks like. I’ve read a lot about GOP infighting on the changes to the Affordable Care Act, for example, and protracted budget battles to ensue.

In any event the bond market did post improvement last week, sharply so relative to the recent range but not exactly strategic in its magnitude. There is a technical case to be made for that price action beyond the sense of FOMC relief or, hmmm, a bit of buying vs. some stumbling out of Washington. For a while I’ve pointed out that sentiment in bonds is sharply oversold as well manifested by the Daily Sentiment Indexes which appear starting to reverse from extremes.

You can see this, too, on the technical charts. 10s pulled back from an approach to a bit of support near a channel projection with stochastics oversold. I slated the 21- and 40-day MAs at about 2.47+% as a first target and given the price action push the potential to 2.40% near term and an outside show to the low 2.30s (trendline). I’m not really bullish. Rather I’m playing ranges. I also like 5s/30s edging to the 200-day MA at 117 and am pretty indifferent to 2s/10s and 2s/5s doing much. I was surprised that my charts favor a bit of flattening though admittedly they are not too compelling.

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THE CLOUDS TO THE FED’S SILVER LINING

Speaking of inflation (was I?) we did get CPI on Wednesday which came in pretty much as expected. I bring it up because the 2.7% YoY gain is well above the Fed’s target but did little to the market, presumably because it was on consensus and we were waiting for the FOMC. The angle I’ll offer up is that such a gain puts REAL YoY Hourly Earnings down to 0% and REAL Average Weekly Earnings to -0.3%. In short, higher inflation isn’t translating to real wage gains. Until it does, I think REAL people will not accelerate their spending habits tremendously. It’s interesting to see the behavior in TIPS against some soft reads on the inflation front. NFIB lists inflation as THE single Least Important Problem amongst their members. Interest Rates and Financial are the next Least Important Problem and just over that is Cost of Labor. No signs of inflation here. FYI their biggest problems are 1) Taxes, 2) Quality of Labor and then 3) Government Regs. If we go back a bit to the U Michigan Survey, we’ll find 5-yr inflation expectations at 2.5% vs. a cycle low of 2.3%. 1-yr expectations are slightly higher but correlate extremely well with simple gas prices. Perhaps the FOMC was smart to change the language to read that it expected inflation to ‘stabilize’ around 2%. P.S. did you see auto buying intentions in the recent Consumer Confidence Poll? Plunged. I’ve been reading that there are a lot of cars in inventory, too. Ward’s report the Days ‘Supply of light vehicles is up, too. Keep an eye on this.

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THE CLOUDS TO THE FED’S SILVER LINING

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THE CLOUDS TO THE FED’S SILVER LINING

David Ader is Chief Macro Strategist for Informa Financial Intelligence. For further information on our products and services, please see: https://financialintelligence.informa.com/ Bringing 30 years of investment strategy experience to his role at Informa Financial Intelligence, David Ader has held senior positions at major investment banks and financial information firms as well as serving on investment policy committees and management teams. Most recently Partner, Head of Government Bond Strategy for CRT Capital, he headed the team voted #1 in U.S. Rates Strategy for the last 11 years and #1 in Technical Analysis for the last five years in Institutional Investor’s annual survey. Informa Financial Intelligence obtains information for its analysis from sources it considers reliable, but does not guarantee the accuracy or completeness of its analysis or any information contained therein. Informa Financial Intelligence and its affiliates make no representation or warranty, either express or implied, with respect to the information or analysis supplied herein, including without limitation the implied warranties of fitness for a particular purpose and merchantability, and each specifically disclaims any such warranty. In no event shall Informa Financial Intelligence or its affiliates be liable to clients for any decision made or action taken by the client in reliance upon the information or analyses contained herein, for delays or interruptions in delivery for any reason, or loss of business revenues, lost profits or any indirect, consequential, special or incidental damages, whether in contract, tort or otherwise, even if advised of the possibility of such damages. This material is intended solely for the private use of Informa Financial Intelligence clients, and any unauthorized use, duplication or disclosure is prohibited. This material is not a comprehensive evaluation of the industry, the companies or the securities mentioned, and does not constitute an offer or a solicitation of an offer or a recommendation to buy or sell securities. All expressions of opinion are subject to change without notice.