Ambassador Financial Group, Inc.

Transcription

1 Economic Commentary for the Week Ending February 5, 2016 Key Observations and Conclusions The American Bankers Association predicts fed funds will end the year between 1% and 1.25%. The futures market is signaling a 10% probability for a rate hike in March. Spending is not keeping pace with income growth, and the latest core PCEPI is deflationary. Although the ISM Manufacturing s PMI is below 50 for the fourth month in a row, new orders are back in expansion mode. The nonfarm payroll increase (159,000) missed the estimate, but wage growth (+0.5%) exceeded its estimate (but the number was fueled by state-level minimum wage hikes). The key indexes in ISM Non-Manufacturing remain above 50 but are eroding quickly. Commentary and Further Analysis Now that Yellen has taken the first step in rate normalization, the question that will be debated in economic corners is, how fast will the Fed lift rates going forward? It was reported last week that the Economic Advisory Committee of the American Bankers Association (a committee of bank economists) foresees three rate increases by the Federal Open Market Committee in 2016, with the federal funds target rate at between 1% and 1.25% by year-end. The ABA s committee debated two scenarios. One scenarios is that the financial turmoil to start the year is the start of a larger problem, and basically it s one and done for the Fed and that December s target rate increase was a mistake. The other scenario that they outlined is one where the economy will show resilience in the next few months and the year-opening sell-off is a thing of the past and then you re in a world where you re expecting the Fed to hike two, three or four times. Interestingly, the ABA s view is that the latter scenario is more likely to play out, although they conceded that the market is placing a high weight on the more pessimistic outcome. Readers of our commentary know that the consensus at Ambassador is that the economy remains fragile, so we also lean more toward the one and done scenario. The fed-funds futures market, as of Friday, is placing just a 10% probability on a rate hike in March, when the Fed meets next. The reason for the bifurcation in sentiments within the market revolves around what s happening in China and with oil. Some argue that the market is too heavily discounting the problems tied to China and low oil prices. Not all industries are hurt by low oil prices; likewise, the consumer is better off with low prices at the pump. To date, it seems the market is still stunned by what s happened with oil and the implications for inflation or possible deflation. For the week, the Dow closed at 16, down points or 1.6%.

2 The 10-year yield ended last week at 1.86% down 8 basis points for the week. By week s end, the spread between the 2-year and 10-year Treasurys was 112 basis points down 6 basis points for the week. Based on more extreme maturities on the yield curve, the spread between the 6-month and 30-year Treasurys ended the week at 223 basis points down 9 basis points. In case you missed it, in Wednesday s Morning Commentary from the Ambassador trading desk, it was observed that [at] just 112 bps, this is officially the flattest yield curve since January 2008, when the Great Recession was beginning. There are four key economic indicators and reports issued last week that correlate closely with the bond market: Personal Income and Outlays, ISM Manufacturing, Jobless Claims, and Employment Situation. Personal Income and Outlays The latest report is not terrible, but there are items that were enough to nearly shift me from bullish to neutral on Personal Income and Outlays. First, spending is not keeping pace with income growth, and the latest core PCE number is deflationary. Neither the gap between income and spending nor the deflationary data is good for market psychology. The good news is that we continue to see solid income growth. However, consumers are not stepping up their spending as a result. The savings rate is now at +5.5%. We have to go back to the end of 2012 to find savings at this level. Personal income is up 0.3% on a M/M basis for December. This matches the consensus estimate and is within the consensus range of 0.0% to 0.5%. Showing a lack of balance that I don t like to see, the M/M change in spending is 0.0%. This number is 0.1% under the consensus estimate and is at the bottom end of the consensus range of 0.0% to 0.5%. Favorably, the prior month s income growth was left unrevised at a healthy 0.3%, while the spending number was revised up 0.2% to a terrific +0.5%. While I m disappointed to see spending flat in December, the 0.2% upward revision for November is the factor that held me back from shifting down to neutral on this report. The M/M change to the headline PCE price index for December is 0.1%, which is 0.1% under the consensus estimate and is 0.2% lower than the prior month s revised number. This again is evidence that inflation is stuck. Similarly, the M/M change to the core PCE price index for December is 0.0%, also 0.1% below the consensus estimate and 0.2% below the prior month s number. Thus, the inflation numbers remain low and steady, but might be inching downward. I ll be very interested to see if a clear trajectory emerges. As for the Y/Y PCE price index, the headline index came in at 0.6% for December, up 0.2% from the prior month s number, but the core index is unchanged from last month, registering +1.4%. The PCEPI data generally suggest that inflation is still stuck, although monthly wages and salaries increases have been 0.5%, 0.6%, and now 0.2% for December, thus averaging over 0.4% a pretty good number over the last quarter.

3 ISM Manufacturing Index Ambassador Financial Group, Inc. My expectations for the ISM Manufacturing Index report were low and the latest report is a disappointment, with one important exception. New orders are back in expansion mode, and that is the most important number in my book. Nevertheless, we now have the PMI below 50 for four months in a row. The last time we had such a bad run of readings was when the PMI was below 50 for 12 consecutive months. The latest value for the PMI is This is 0.1 point below the consensus estimate and within the consensus range of 47.0 to Moreover, the current index value is 0.2 points more than the value registered last month. The gain in January is minor, and the poor performance this month is no surprise. Generally, the regional reports continue to reflect weakness, consistent with this report, but there was a glimmer of hope from the Chicago region in its latest report, as its business barometer index jumped from 42.9 to The silver lining to this latest report is that two out of three of the subindexes that I follow most closely are up, with both flipping from contraction to expansion mode. The most revealing index in terms of an indicator for future activity is the new orders index. This month that index is up 2.7 points to After experiencing two back-to-back months of contracting new orders, this is a positive sign. But it s only one month, and backlog orders continue to contract. Moving much less significantly but also favorably, the production index inched up 0.3 points and now stands at 50.2 for January. As with new orders, this index had been in contraction mode for two back-to-back months so it s great to see it back above 50. Most important for the labor situation, the employment index lost 2.1 points and is now in contraction mode for two back-to-back months. The current index reading is With hiring so far beneath 50 and new orders just squeaking above 50, I expect to see hiring remain in contraction mode for awhile longer. Jobless Claims Consistent with the concern I voice below about the service sector of the economy and the less rapid hiring, the latest jobless claims number shows less strength than we are accustomed to seeing. I m okay with the level; it s the trajectory that has me concerned. The new claims number is 285,000. This current number is 5,000 above the consensus estimate but is within the consensus range of 274,000 to 290,000. Moreover, the latest new claims number is 8,000 above the prior week s number, which was revised downward to 277,000. Because there was a revision to the prior week s claims, the prior week s four-week moving average was revised to 282,750. As for the current average, it moved up 2,000 to 284,750. Generally, I m satisfied with any number below 300,000, but I keep a close eye on the trend, and we re 5,000 higher than one month ago. I m looking for signs that 2016 will be a better year than 2015; I m having a tough time finding that evidence.

4 Employment Situation Ambassador Financial Group, Inc. We got an indication last Wednesday when the ADP number was released that Friday s Employment Situation report would be a great number. The ADP estimated that private payrolls expanded by 205,000 in January. The consensus estimate was 190,000, so the number came in 15,000 higher than expected. Yet, two days later, the government s estimate of the number of jobs created fell short of expectations. However, despite the lower-than-expected number, there is enough good news in the report for me to remain bullish. Below are the specifics from Friday s Employment Situation report: The nonfarm payrolls number for January is up 151,000 falling short of the consensus estimate of 188,000 by a sizable 37,000 and is well beneath the consensus range of 170,000 to 215,000. The net revision for the prior two months (2,000) is insignificant, with 28,000 to the November number and 30,000 to the December number. The unemployment rate eased down 0.1% to 4.9%. This is 0.1% lower than the consensus estimate but falls within the consensus range of 4.9% to 5.0%. So no surprise here. Favorably, the current rate of job growth remains above the estimate of 90,000 to 125,000 jobs needed in order to keep pace with the number of new entrants into the job market but falls toward the bottom of the estimate of 150,000 to 200,000 jobs needed in order to improve the unemployment rate (when the labor-force participation rate holds steady). Thus it s interesting to see that the unemployment rate went down. (See the next bullet.) Also good news, the LFPR is up 0.1% to 62.7%. The rising LFPR should have served to hold the unemployment rate at 5.0%, so the 4.9% is somewhat a surprise. Considerably lower than the ADP s estimate of 205,000 in new jobs, the government estimates that private payrolls are up 158,000 22,000 below the consensus estimate and also just beneath the consensus range of 160,000 to 206,000. The public sector lost 7,000 jobs last month, thus contributing nothing to the labor market gains. This means that 100% of the jobs were created by the private sector. I like to see less than 10% coming from the public sector, so the 100%/0% split is quite favorable. For those who feel the public sector i.e., the government is bloated, this is welcome news. The revision (24,000) to the December private payroll number from 275,000 to 251,000 is not a surprise given the overall revision to nonfarm payrolls. Initially we thought the public sector (government) added 17,000 jobs in December; now we know they added only 11,000. The disappointing M/M change of 0.0% to average hourly earnings reported last month was left unrevised, but for January we got a 0.5% increase. At this stage of the recovery, we like to see workers making more income to spend, so I am pleased to see this sizable wage growth this month. However, the number was fueled by state-level minimum wage hikes. Over the last year, wages are up 2.5%. This is just a little ahead of inflation. The average workweek inched up to 34.6 hours. This exceeds the consensus estimate by 0.1 hours. The U6 unemployed and underemployed rate in January held steady at 9.9%. (The U6 unemployment rate counts not only people without work seeking full-time employment, but

5 it also counts discouraged workers who have stopped looking and part-time workers who desire full-time work.) I enjoyed Steve Liesman s comment on Squawk Box after the labor report was released on Friday. His estimate of 159,000 jobs was the closest of six analysts on the panel. He observed that while compound interest is the most powerful force, reversion to the mean is the second most powerful force. (I m paraphrasing.) We have been running around 200,000 jobs per month, which is good. So given that we saw 262,000 jobs created in December (higher than usual), it should not be a surprise to anyone that we dropped down to this lower number of 151,000. Other Economic Indicators and Reports of Note As we review last week, there are four other important economic indicators and reports of note: Construction Spending, Motor Vehicle Sales, ISM Non-Manufacturing Survey, and Productivity and Costs. Construction Spending Last month I shifted from bullish down to neutral. One reason was the 0.4% contraction in M/M construction spending. But now we learned that the downturn was even steeper at 0.6%. Expectations for December were for a nice rebound, but that did not materialize. For the latest month (December), the growth is a pautry +0.1%. This latest number is 0.5% behind the consensus estimate and falls below the consensus range of 0.3% to 1.3%, making this the negative shocker of the week and reaffirming my neutral rating. Based on the number from two months ago (0.6%) and the most current number (+0.1%), the trajectory of construction does not look particularly healthy as we enter Weather for November and December was quite mild and should not have been an adverse factor in fact the opposite. But, as I concluded last month, the Y/Y number remains healthy enough to stay at least neutral on construction spending for now. The figure to the left (source: Federal Reserve Bank of St. Louis) reminds us that the Y/Y numbers were losing momentum during 2014, but then the trend showed a strong rebound during However, during the second half of 2015 the pattern seemed to repeat itself as numbers were losing momentum again. The latest Y/Y number is 8.2%, 2.3% lower than last month s number. One year ago, the Y/Y number was 7.2%, so at least we re somewhat better now, despite the recent downturn in the time series. The hope is that we again see a rebound during 2016, and that this time it is sustainable.

6 Motor Vehicle Sales Ambassador Financial Group, Inc. As a banner year came to a close last month, we ended the year a bit on a sour note, as the numbers for December were down. So I was looking forward to seeing how we d start the new year, and I m pleased to see that despite fewer selling days this January compared to last January, the month was great. Total vehicle sales for Janaury are 17.6 million units. This exceeds the consensus estimate of 17.5 million and is at the top end of the consensus range of 16.5 million to 17.8 million units. January s total sales are 0.3 million or 1.7% higher than last month s sales. Domestic vehicle sales for Janaury are 14.2 million units. This easily beats the consensus estimate of 13.6 million and is above the top end of the consensus range of 13.3 million to 14.0 million vehicles. January s domestic sales are 0.3 million or 2.2% higher than last month s sales. I want to remind our readers that vehicle sales make up about 20% of total retail sales, so solid numbers for motor vehicles sales will help boost retail sales numbers. It s always interesting to see which brands are growing the fastest. If we compare January 2016 to January 2015, we find that Fiat Chrysler Automobiles (up 6.9%) takes first place. The other large producers are in the following order for the Y/Y comparison: Nissan (up 1.6%), GM (up 0.5%), Honda (down 1.7%), Ford (down 2.8%), Toyota (down 4.7%), and Volkswagen (down 14.6%). Given that all the other manufacturers had sales in excess of 100,000 units, Volkswagen s future with barely 20,000 units sold in January looks bleak. ISM Non-Manufacturing Index I ve been back and forth on this report. Last month I shifted up from neutral to bullish because the service sector remains very strong during this period of deterioration in the manufacturing sector. However, this month I m back down to neutral. We really count on a strong service sector, so I m not pleased to see the deterioration in the latest ISM Non-Manufacturing Index data. I have noted that the non-manufacturing industries account for about 90% of private-sector employment which helps explain why the Employment Situation report numbers have looked so strong despite the weakness in manufacturing. But now that non-manufacturing is growing less quickly, I expect employment numbers to reflect this going forward. For January, the composite index dropped 2.3 points, moving from 55.8 to This falls 2 points below the consensus estimate of 55.5 and is at the bottom end of the consensus range of 53.0 to 56.5, meaning that the number is somewhat a negative surprise. All three of the subindexes that I follow most closely got hit significantly last month. Production plummeted 5.6 points, moving from 59.5 to Falling to a lesser degree, new orders lost 2.4 points, moving from 58.9 to While I m disappointed to see both indexes down, I view the new orders index to be the more important of the two. On a positive note, both production and new orders have now been in growth mode for 78 consecutive months and remain above 50.

7 The weakest index among the three that I track most closely has been the employment index. For the month, the employment index fell 4.2 points, moving from 56.3 to As with the other two indexes, the employment index remains above 50 and, thus, hiring has now been expanding in the non-manufacturing sector for 23 months in a row. I expect the growth will continue this month given that the index remains above 50 and new orders are expanding, but the trajectory on the indexes are concerning. While this latest report was enough of a disappointment to move me down to neutral, the feedback from the field remains generally positive. An educational services firm stated, Research funding [is] expected to increase during 2016 and will result in higher employment when compared to calendar year Another firm, this time in the retail trade sector, said, Sales have improved, [and] we are feeling more optimism, but remain concerned about the impact of global unrest. Productivity and Costs As a reminder, last week s Productivity and Costs report was a new report for the fourth quarter (A revised report will follow next month.) The prior quarter s Q/Q gain in productivity was 2.1%, while the Q/Q change in unit labor costs was +1.9%. The estimates for fourth quarter show a surprising 3.0% decrease in productivity and a 4.5% rise in unit labor costs. When productivity falls, more workers are needed to produce the same output, so that can fuel hiring. On the other hand, if productivity of our workers slips, that makes them less competitive with foreign labor. (Bernie Sanders likes to remind everyone about jobs going overseas.) I have shifted down to bearish on the latest report. As for the rise in unit labor costs, that can occur if wages are rising and/or productivity is falling. For the latest quarter, output rose by just 0.1% (bad news) while compensation improved by 1.3%. Of course, improvements in compensation are good for workers but erode their competitive position versus overseas (assuming overseas workers comp rises less quickly). The productivity loss was a surprise, while the increase to unit labor costs was not. The consensus estimate for productivity is 1.8% and the consensus range is 2.6% to 0.5%. Thus, the reported number of 3.0% misses the consensus estimate and falls beneath the consensus range. The consensus estimate for unit labor cost is +4.4% and the consensus range is +1.9% to +5.4%. Thus, the reported number of +4.5% is consistent with expectations, although how we got there is perhaps a surprise. The expectation was for a better productivity number along with more significant wage growth. As a reminder, both productivity gains/losses and unit labor costs serve as indicators of future inflation. If productivity goes down and/or unit labor costs go up, this puts pressure on inflation and vice versa. The current combination of falling productivity and rising unit labor costs, with unit labor costs possibly accelerating, should be viewed as potentially inflationary. However, there will likely be a lag in the inflation impact because of the modest 1.3% increase in compensation.

8 The Week Ahead Ambassador Financial Group, Inc. In the Weekly Economic Calendar below for this week, I highlighted the two economic indicators and reports that correlate most closely with the bond market: Jobless Claims at 8:30 a.m. on Thursday; and Retail Sales at 8:30 a.m. on Friday. In addition, there are six other reports I want to look at: JOLTS at 10:00 a.m. on Tuesday; Import and Export Prices at 8:30 a.m., and Business Inventories and Consumer Sentiment at 10:00 a.m. on Friday; and then Factory Orders and International Trade from the prior week. John S. Walker, Ph.D., CFA Director of Research & Chief Economist Monday, February 8, JWalker@ambfg.com Weekly Economic Calendar Date Time Economic Data Point Survey Prior 02/08/ :00 Labor Market Conditions Index Change /09/ :00 NFIB Small Business Optimism /09/ :00 JOLTS Job Openings /09/ :00 Wholesale Inventories MoM -0.10% -0.30% 02/09/ :00 Wholesale Trade Sales MoM % 02/10/ :00 MBA Mortgage Applications % 02/10/ :00 Monthly Budget Statement $10.1b -- 02/11/ :30 Initial Jobless Claims k 02/11/ :30 Continuing Claims k 02/11/ :45 Bloomberg Feb. United States Economic Survey 02/11/ :45 Bloomberg Consumer Comfort /12/ :30 Import Price Index MoM -1.50% -1.20% 02/12/ :30 Import Price Index YoY -6.80% -8.20% 02/12/ :30 Retail Sales Advance MoM 0.10% -0.10% 02/12/ :30 Retail Sales Ex Auto MoM 0.00% -0.10% 02/12/ :30 Retail Sales Ex Auto and Gas 0.30% 0.00%

9 02/12/ :30 Retail Sales Control Group 0.40% -0.30% 02/12/ :00 Business Inventories 0.10% -0.20% 02/12/ :00 U. of Mich. Sentiment /12/ :00 U. of Mich. Current Conditions /12/ :00 U. of Mich. Expectations /12/ :00 U. of Mich. 1 Yr Inflation % 02/12/ :00 U. of Mich Yr Inflation % 02/12/2016 N/A Revisions: Producer Price Index