Economic Notes: September 15, 2014


Written by: Jon McGraw

  • In a slower week for economic data, results came in tempered to positive (retail sales being a more important release), but included no major surprises. Geopolitically, the highlight originated from a developed market this time, as polls showed a stronger possibility of Scotland’s secession from the United Kingdom before this coming week’s vote.
  • Equity and fixed income markets were both lower, with little extreme news to move the needle in either direction, but an upcoming Fed meeting and concerns over when rates may be increased have taken the forefront again.

(0) Retail sales numbers for August came largely as expected, rising +0.6% on a headline level, meeting consensus. Auto sales rising +1.5% played a significant role, while gas station sales fell nearly a percent on lower gasoline prices and building materials gained over a percent.   Taking out the usual volatile components, the core/control retail sales figure rose +0.4%, just a tick below expected, but some prior revisions upward by several tenths for the past few months helped. The year-over-year change in the headline figure from 2013 is +5%, with autos running at a +9% rate.

Speaking of which, auto sales have been quite good as of late, expanding again to over 17 mil. units, due to a variety of incentives and finally responding after a lackluster sales situation in recent years (proving that although the average life of a vehicle on the road has lengthened steadily, cars are still wearing out at some point). As a related aside, gasoline prices have remained relatively cheap this year, comparted to last year and their 10-year averages. Ironically, as these have depressed headline retail sales (gasoline is 10% of the index), this represents a significant expenditure to the majority of households in that pricing is inelastic—the magnitude of consumption isn’t affected as much by what the per-gallon price is—unlike consumer discretionary/leisure items in the index where tough times can postpone a purchase.   On the positive side, cheaper gasoline (and energy in general) removes an implied ‘tax’ on consumers, so should theoretically allow for increased spending in other areas. It affects businesses the same way at the next level.

(0) Import prices fell -0.9% for August, compared to expectations of a -1.0% drop, so no real surprises. The monthly figure was led by a -4.4% decline in petroleum, a large component of this series, while the ex-fuel segment rose a nominal +0.1%. Year-over-year import prices show a decline of -0.4%, which has translated into a negative contributing inflation force.

(-) Wholesale inventories for July rose less than expected (+0.1% vs. consensus +0.5%), which was the slowest rate of the last 12 months; in addition, they were revised down for June by a tenth of a percent (a third of the growth). A bulk of the weak inventory builds were due to declines in farm products and computers, which were down -8% and -4%, respectively. Total business inventories rose +0.4%, in keeping with forecast, led by an increase in retail inventories.

(+) The NFIB small business optimism survey rose almost a half-point for August, to 96.1, surpassing expectations by a tenth of a point. Business plans for capital spending saw the largest improvement, reaching a new recovery high, in fact. Other components didn’t change dramatically: improvements included general forward-looking expectations and job openings, while expectations for sales and future hiring fell a bit.   However, a quarter of respondents noted again that job openings are difficult to fill, and a fifth noted an increase in wage costs—the second highest proportion encountered in this cycle thus far. Inflation pressures didn’t look to be a problem, although employer expectations for wage pressures were noted. Improvements in this survey have accelerated to stronger levels, but absolute readings remain low (perhaps due to an extremely low starting point this cycle).

(+) The preliminary September University of Michigan consumer sentiment survey came in a bit better than expected by 0.6 of a point, and rising about a point from last month, to 84.6. Underneath, future expectations for the future improved by several points, but consumer assessments of the current situation worsened a bit. Inflation expectations for the 1- and 5-year upcoming periods actually ticked down a bit to 3.0% and 2.8%, which is right around the average of recent years as well as historical results over the long term.

(-) The JOLTs job openings report for July didn’t change much from the prior month, down -2k coming in at 4,673k (but below an expected 4,700k). Compared to the unemployment rate, job openings continue to look somewhat elevated. The hiring rate (3.5%) and quit rate (1.8%) were unchanged, and still underperforming where they should be at this point in the cycle—based on the observations with a variety of economists and FOMC members, who use these as part of their deeper assessment of conditions beyond the headline unemployment rate.

(-) Initial jobless claims for the Sep. 6 ending week rose to 315k, which came in above the 300k expected. Continuing claims for the Aug. 30 also rose, to 2,487k (although 3k below expectations). This is a seasonal transition period, with Labor Day and the return to school for many temporary workers; additionally, it appears mass layoffs in two large Atlantic City, NJ casinos could have played a role.

Market Notes

U.S. stocks suffered a down albeit quiet week, with a variety of mixed messages and lack of any strong positive catalysts to take indexes higher.   Smaller-caps suffered on par with large-caps, but foreign equities overall lagged domestic names. From an industry standpoint in the U.S.,   technology was the only positive-performing group on the week (seemingly helped by Apple’s iPhone 6 release and introduction of their wristwatch), while energy and utilities suffered the worst—not surprising due to weaker crude prices and fears of higher interest rates.

A 1% gain in the U.S. dollar served as a headwind for the bulk of foreign markets. In developed nations, Japanese equities were only down a half-percent, while Europe and the U.K suffered declines of 1-2%. Emerging markets experienced the worst week, led by weakness in Brazil (-10%) as Moody’s downgraded their outlook from stable to negative due to ‘sustained low growth and worsening debt metrics.’ Support for the current president appeared to solidify—lowering chances for change during upcoming elections in a few weeks there. Hopes for change through leadership reshuffling often add an element of bullish optimism to EM equities, especially in the wake of a new reformer (as we’ve witnessed in India this year), although the change has to occur within a certain time limit. If chances for reform (i.e. getting conditions/policies more inline with what developed markets deep appropriate) dissipate, often, so do the returns. Russia and China were also down last week, but by only half as much as Brazil.

Speaking of the U.S. dollar, over last 2 months, the USD Index (dollar versus basket of major world currencies) is up +6%. The threat of accommodation and monetary stimulus tends to depress currency values, which explains the weakness in the Yen and Euro as of late (notably the latter, after potential QE commentary). There are a few reasons for this, one of which is the more immediate ‘carry’ effect, in that the correspondingly lower interest rates are less attractive to long-only fixed income investors, so they gravitate their money flows somewhere else (this is a key component in how currency ‘values’ are monitored). Another is the economic reason, incorporating the fact that monetary stimulus is potentially inflationary, and that erodes the value of a currency over time. So, currency reactions are often a combination of both.

Bond markets experienced a negative week as well, with long bond yields moving higher on the order of 10-15 bps (quite a bit for a single week these days—for context’s sake, this corresponds to at least a -1% move on a bond with a duration of 10 years; obviously worse the longer you go out the curve). Accordingly, long bonds were the worst performing domestic area, with short debt and floating rate faring a bit better. Foreign bonds were the worst performing, declining about a percent beyond the rest of the group, explainable by the dollar’s strength.

With a week free of geopolitical/military drama for the most part, it appeared central bank policies and the risk of higher interest rates at some point in the coming year took center stage. The current obsession is about when the FOMC will eventually raise the Fed Funds rate, and a white paper put out by the San Francisco Fed seemed to fan the flames a bit, implying investors may be underestimating potential increases in rates from currently low levels of rate volatility. More to come mid-week in a special note after the Fed meeting, but the guesses for this occurring remain centered around mid-2015 (more or less). It’s almost irrelevant, as markets are sure to move well before then, rendering the actual hike itself a formality. The Fed rate increase is more symbolic of a regime shift than it is meaningful from a mathematical perspective, as the difference between 0.00-0.25% and 0.25% is quite small from the standpoint of most bond buyers and model inputs that are driven from such risk-free rates. Bigger shifts of 0.25% or 0.50%, though, will start to matter, but that will also be dependent on the reasons behind them (stronger growth or inflation fears).

Real estate was negative across the group, with weakness in risk assets and interest rate timing fears. Europe was down the least, while U.S. retail and residential suffered the most.

Commodities prices generally came in a few percent weaker, influenced as of late by strength in the U.S. dollar, which has the inverse effect on commodity prices overall (which are priced in dollars). On the week, cotton gained several percent, but came back to earth after Chinese buyers balked at the high prices by cancelling orders.   The weakest areas were nickel/industrial metals as well as coffee and sugar in the softs group. Year-to-date, agricultural commodities are down 10-15%, on record harvest results, while industrial metals remain in the lead (nickel several times higher than others). Gold has earned just a few percent this year, as real yields in bonds have tightened once again. Crude oil is now just under where it began the year, in the low $90’s, after getting as high as $107 mid-summer.