Economic Notes – June 2, 2014


Written by: Jon McGraw

  • Economic data looked a bit better, as winter weather problems continue to dissipate towards more normal ordering and manufacturing conditions. However, some data remains lackluster (GDP for the first quarter was revised down into negative territory). The ECB stands poised to ease to stem deflation fears and spur economic growth.
  • Markets reached new all-time highs again, as large-caps outperformed small-caps. Bonds also gained as interest rates fell to their lowest levels in months.

(+) The durable goods report for April came in a little better than expected, gaining +0.8% versus an expected decline of -0.7%. Removing transports from the equation lowered the gain to +0.1%, compared to a forecast of no change, and ‘core’ orders (which removes transportation goods) declined -1.4%, which lagged the -0.3% median consensus forecast. Core shipments fell almost a half-percent in April, but were revised up six-tenths of a percent for March, which was a positive surprise. A large increase in defense orders of over +30% was a primary reason for the differential.

(+) The Chicago PMI accelerated higher in May, up to 65.5 from 63.0 last month (consensus called for a slight decrease to 62.1), representing the highest reading since last October. New orders rose a bit, while order backlogs rose to a 3-year high.

(0) Personal income for April rose +0.3%, which was on par with forecast. The wages/salaries rose by a few tenths, while dividends received gained at a slightly faster pace and the pace of transfer income fell somewhat (related to Medicaid and other ACA-related payments). Consumer spending fell by -0.1% for the month, slower than the expected gain of two-tenths, and appeared to be mostly caused by a sizable decline in electric/gas utility spending as the weather warmed up nationwide. These adjustments brought the savings rate up four-tenths to an even 4.0%. Both headline and core PCE prices rose +0.2%, as expected, bringing the 12-month rolling change to +1.4%. This inflation metric is consistent with other formal government measures and below the Fed’s 2% target.

(+) The S&P/Case-Shiller home price index rose +1.2% in March, while was roughly double the expected increase. Almost the entire 20-city group experienced an increase in prices, but leading results were in the upper Midwest, with over-2% gains in Detroit, Minneapolis and Chicago (speculation, but you have to assume some better weather played a role in this). This took the rolling 1-year gain to +12.4%, which remains strong but has decelerated a bit from last year’s pace.

(+) The FHFA house price index for March rose +0.7%, outpacing estimates by a few ticks. The New England and West North Central (Dakotas through Missouri) areas led with the strongest gains. Year-over-year, the index is up +6.5%, so a more tempered pace and lower absolute gains than the Case-Shiller version. The FHFA has broader geographic focus than the 20-large city Case-Shiller report, but a narrower financing restriction (Fannie Mae/Freddie Mac mortgages only). Urban areas have grown/recovered at a much better clip than rural, especially in the sun belt of California, Las Vegas and Miami.

(-) Pending home sales rose +0.4% in April, but underwhelmed the expected increase of +1.0% (and -10% below the level last year at this time). The Midwest saw a 5% increase, followed by a nominal gain in the Northeast, while the West and South declined. From that them, it’s fairly intuitive that weather rebound had quite a bit to do with this, in keeping with other housing numbers recently.

A branch of the Fed conducted a study on the source(s) of housing weakness over the last several quarters, and the combination seemed to be higher mortgage interest rates, tightened lending standards and bad weather. These played an impact in roughly equal amounts, so you might call it a perfect storm, so to speak. No doubt there are other factors involved as well, such reluctance of homebuilders to build despite apparent need—in fear of 2008 repeat.

(+) The Conference Board consumer confidence survey for May rose 1.3 points to 83.0, which happened to fall right in line with forecast. Consumer assessments of the current situation as well as future expectations both improved a bit, as did the labor differential. Overall, the survey level is almost as high as it’s been since the financial crisis. Specifically, the ‘jobs are hard to get’ component fell to it’s lowest level since 2008.

(+) The final draft of the Univ. of Michigan consumer sentiment survey rose a tick from the initial estimate to 81.9. This was about six tenths lower than expected, as consumer assessments of current conditions fell a bit, while future expectations improved. Inflation expectations moved up a bit further, to 3.3%, while 5-10 year expectations remained just under 3% as they typically have in recent years.

(+) Initial jobless claims for the May 24 ending week fell to 300k, from 327k the prior week, and lower than the 318k consensus estimate. There was no special news affecting the release. Continuing claims for the May 17 week came in 17k lower to 2,631k, below the 2,650k expected and a new post-recession low.

(-) Lastly, the 2nd estimate of 1st quarter GDP was revised downward from an initial small positive +0.1% to a sharply negative -1.0% (analysts had expected a deterioration to -0.5%). The bulk of the drag in economic results were due to a larger drag in inventory investment, which has been the most volatile and most-revised culprit in several GDP reports as of late. A few other items offset each other by changes of less than a tenth of a percent, so not really worth mentioning. Real gross domestic income for the quarter (not reported in the prior release) fell -2.3%, which is one of the weakest results since the last recession.

It hasn’t been decided yet, but the ECB is expected by many economists to be the first central bank to lower interest rates into negative levels. This goes beyond the conventional ‘zero-bound’ that usually governs the natural interest rate relationship between borrowers and lenders. Traditionally, you’ve always been paid something to deposit funds or take on a loan (savings account, bond, etc.); the question has always been how much you’re getting in return. How does this work?

Normally, just like with the Fed, member banks are paid a low rate of interest in return for placing overnight reserves at the ECB (much like we would for doing so at our local bank); instead, the member banks would earn no interest and actually pay an additional fee/tax (the negative interest) to store money there. It’s all meant to incent banks to do something else with their money than stash it with the central bank—such as making loans to businesses and consumers to spur economic growth. That’s the hope, anyway. Another issue is ensuring banks are operationally ready to handle a ‘negative’ rate regime, which goes against almost all classic banking principles. Officials claim to have a handle on it, as this move has been threatened for a while.

Market Notes

U.S. stocks experienced a generally flat-to-slightly positive week, as the S&P set a new all-time high again. From a sector standpoint, defensive utilities and consumer staples outperformed, while consumer discretionary and industrials lagged by gaining just under a percent. While all market caps were sharply higher, large-caps outperformed small-caps again and the Russell remains in negative territory on the year.

In foreign markets, Europe and Japan gained a percent and a half while the U.K. was flat. In Japan, business confidence and employment have improved, demonstrating that the recent sales tax increase may not have been as damaging as first feared. European peripherals such as Italy and Spain performed well, in light of an upcoming ECB meeting where expectations are for an easing of monetary conditions. German unemployment rose by 25k, which was higher than expected, but didn’t excessively weigh due to the upcoming policy meetings.

Emerging markets generally lost ground on the week in several regions. Indian stocks fell back several percent in a reversal of the sharp election rally in recent weeks. Russia moved higher early with discussion of a trading bloc with several former Soviet republics following the large deal with China for natural gas exports the previous week but came back to earth. The Ukrainian election of a moderate private sector-oriented candidate (billionaire chocolate magnate) who seemed somewhat ambivalent to leaning towards the West or East appeared to placate the situation in that part of the world for the time being. Thailand experienced a coup again (the week before last, actually), but this happened so many times—as in a dozen times since 1930—that markets weren’t exactly fazed.

The ten largest banks in China reported a large increase in overdue loans (588 billion yuan ~ $94 billion worth) last year, which was a 21% increase over the prior year and highest level since 2009. It seems government efforts to thwart ‘shadow banking’ activities have created a more difficult environment for the paying back of more traditional bank loans. The overheated property market seems especially vulnerable, as the president of the country’s biggest developer noted the ‘golden era has passed,’ and is focusing more on owner-occupiers rather than investors.

Will this be a Bear Stearns-like tipping point? Many economists don’t think so. But the Chinese have been aware of this growing problem for some time, haven’t really addressed it until recently, but may need to use a portion of their vast foreign exchange reserves to shore up the system. The good thing is that there is an ample amount of reserves to do so, for now. As China’s economy slows to a more moderate pace, their status as the world’s growth engine may erode.

Bonds were unchanged on the front part of the yield curve, but gained a bit on the long end by a few basis points, despite almost $100 billion in new supply last week. Consequentially, long treasuries ended up with the best returns, gaining a percent, followed by strong results from international developed and emerging market debt—which generally gained over a percent. Several European areas gained on hopes for ECB easing measures this week (i.e., negative interest rates discussed earlier) to boost economic growth and calm deflation fears. Other sectors gained a few basis points, with the exception of floating rate and Japanese debt, which lost by a few ticks. The yield on the 10-year treasury ended the week/month at 2.48%, which is quite low, and even lower from a ‘real’ after-inflation perspective. This drop has certainly bucked the growing ‘smart money’ view that rates are too low, with Consensus Economics estimates for rates 12-months out to be in the 3.4-3.8% range.

Real estate returns were led by Europe and U.S. mortgages, the latter due to strength in bonds, while Asia and U.S. retail and residential lagged—albeit still with positive returns.

Commodity indexes were down a few percent on the week, with negative returns from energy, precious metals and agricultural commodities. Natural gas contracts were sharply higher, bucking the trend, related to the Russian-Chinese deal to set a floor on prices. Aluminum and cocoa were also higher on the week, likely as a contrarian response to low pricing and crop shortages. Gold and silver were the worst performing assets on the week, for gold the largest weekly drop in eight months and silver in 11 months, as investors moved cash to equities and Ukrainian geopolitical tensions eased.

Have a great week!