After yesterday’s soft 5 yr note auction, the 7 yr note auction was a mixed bag but 2 of the 3 components that markets focus on were slightly better. The yield of 2.335% was a touch below the when issued of 2.337-.38% but the bid to cover of 2.45 was below the one year average of 2.52 and the lowest in 5 months. The level of direct and indirect bidders totaled 79%, a bit above the 12 month average of 76%.
Bottom line, in light of the Treasury weakness this week leading up to the auction and the sharp selloff we saw in European sovereign bonds today, the market was set up for a disappointing auction. Not getting it has resulted in a bounce in prices and a drop in yields to little changed on the day. The 10 yr yield did touch 2.55% a few hrs ago at the time the Italian 10 yr yield hit the high of its day up 17 bps. That Italian yield closed up 12 bps and the 10 yr yield is unchanged on the day at 2.51%.
Initial jobless claims totaled 259k, 12k more than expected and is up from 237k last week. The holidays have messed around with the seasonal adjustments so let’s smooth it out. The 4 week average is 246k, the lowest since 1973 vs 248k last week. Continuing claims, delayed by a week, rose by 41k and seems to have bottomed out back in November.
Bottom line, there was noise around the new year holiday and MLK but I’m sure the optimism around Trump’s new policy is certainly having a positive impact in that employer’s are now even more inclined to hold onto their employees in light of the tight availability of people willing to work and hopes for faster economic growth.
The advance look at the trade of US goods (not services) in December saw a deficit of $65b that was in line with expectations. Exports jumped by 3% m/o/m driven by capital goods while imports were up by 1.8%. Cutting the corporate tax rate is the key aspect of Trump’s tax reform as we know but the border adjustment tax proposal is expected to fund half of it. The goal of this tax is not just to raise money but to encourage the manufacture of goods in the US which in turn would close this large deficit in the trade of goods.
Markit said its US services PMI index for January improved to 55.1 from 53.9 in December. That puts it at the best level since November 2015. Markit said “The latest survey revealed a robust expansion of business activity and another strong increase in incoming new work. Meanwhile, service providers were more upbeat about the business outlook than at any time since May 2015.” Employment fell slightly from the 15 month high seen in December. With respect to the inflation side, “Inflationary pressures eased since December, but were still among the highest seen over the past year and a half.” Markit said the pace of confidence for both manufacturing and services points to 2.5% annualized growth in January. They have a 2.3% estimate for full year vs 1.6% in 2016.
Bottom line, we can add this figure to many others that are ebullient for the new economic regime we have in Washington, especially after the previous 8 years. We now need to see to what extent this translates into actual business activity because all these confidence indices are reflecting is the direction of change, not the degree. Importantly tomorrow we’ll see actual durable goods orders for December where capital investment has been a key missing piece of the recovery.
New home sales in December totaled 536k annualized, well below the estimate of 588k and down from 598k in November. It’s also the slowest pace of contract signings since February. For the full year new home sales averaged 561k vs 502k in 2015 and just 440k in 2014. The 25 year average however for perspective is 708k not adjusted for population change. We thus still have a ways to go. Months’ supply rebounded to 5.8 from 5.0 as the number of homes for sale rose by 10k while sales fell. The median price rose by 7.9% y/o/y and combined with the rise in mortgage rates was not a help. The rise in price was in part due to mix as sales of homes priced above $500k rose while those priced below $300k was down. The average 30 yr rate in December was 4.36% vs 4.03% in November and 3.72% in October.
Bottom line, new home sales are still relatively depressed and now the rise in rates is beginning to have an impact on top of high prices. We need more homes for sale priced below $300k and unfortunately the total amount of homes sold priced between $200k and $300k fell to the lowest since September 2015. Of course rates are still historical low and maybe the reaction was more sticker shock to the near 20% rise in interest rates which will then settle down. We’ll see but this reaction does point to the very high sensitivity parts of our economy have to changes in rates after getting very accustomed to extraordinarily low levels for a very long time. Trumponomics will have to deal with the reality of a potentially changing interest rate regime.
Thankfully the 20,000 DJIA hats were finally worn so we can move on. Also keep your eye on the DAX as its getting within 4% of its April 2015 peak. The broader euro STOXX 600 though still remains about 12% below its 2015 top. Coincident with the global rally in equities and hopes for faster business activity, bond yields continue higher. In Japan, the JGB 10 yr yield rose 2 bps to 9 bps. It’s of course barely above the zero the BoJ wants it at (yield curve control!) but that matches the highest yield in a year. The 40 yr yield closed at .99%. It was 7 bps back in July. The French 10 yr yield is above 1% for the first time since December 2015, up 4 bps on the day. The German 10 yr is just shy of .50%. The worst performer is Italy as their 10 yr yield is jumping by 8 bps to 2.20%, the most since July 2015.
I completely missed the story yesterday morning that the BoE will likely end its corporate bond QE buying sooner than expected. In a speech by the BoE executive director for markets the night of Jan 24th said “It seems probable that the bank will be able to complete the purchase program faster than we thought possible” because they’ve been able to buy more than they expected because of the flood of supply. The Barclays SPDR sterling corporate bond ETF is down to a one month low today. Pressure will be intense on the BoE to end QE this year as inflation pressures intensify. The corporate bond buying program could end by the Spring.
The UK economy grew by .6% q/o/q and 2.2% y/o/y in Q4, exactly as seen in Q3 but one tenth more than expected. While the growth is still somewhat modest, it certainly is much better than feared after the UK vote. The real test from here though is how consumers handle higher inflation and to what extent corporates can deal with the margin squeeze of the spike in input prices. The services side, boosted by consumer spending, led the growth in Q4. Helped by the weak pound, manufacturing grew by .7% q/o/q but that’s up just 1% y/o/y. The 10 yr Gilt yield is at 1.51%, up more than 4 bps to the highest since May, more dragged up by the global rise in yields. The pound is down a touch along with other currencies vs the dollar as the dollar index hovers around 100. I like the pound along with the euro because of the growing pressure on the BoE and ECB to further taper or end QE this year. The pound also now has help from a more clear path from Theresa May.
I keep mentioning the signs of global trade bottoming out (for now as much depends on China from here) with recent export data seen out of South Korea, Singapore, Japan and Taiwan. Today Hong Kong said exports grew by 10.1% y/o/y, almost twice the estimate of up 5.1%. All of the gain was to Asia as exports to the US, Germany and the UK fell. Imports were up by 8.7% vs the forecast of up 5.9%. For the full year though, Hong Kong exports were down by .5% vs 2015 reflecting the slow global trade story we heard all year. Hong Kong faces a tough situation in coming years as they are import US Federal Reserve policy via the peg where we will be the only major central bank to be raising rates this year. Layering on higher rates onto an epic property bubble is never a good combination. The Hang Seng did close up by 1.4% joining the global equity rally.
On the highly debated US border adjustment tax possibility that is a key component of the Paul Ryan ‘Better Way’ plan, I saw the first estimate of what it could mean for economies outside the US. Credit Suisse estimates that GDP growth in Asia could be cut by .5% driven by a 4% drop in exports. I did not see data for the possible impact on Europe. I saw this on DJ so did not see the guts of the piece and to what extent they see the FX markets adjusting.