Headline PCE inflation grew by 2.1% y/o/y and 1.8% at the core level with .1% and .2% gains m/o/m respectively in February. The headline rate is above 2% for the first time since 2012 and the core gain matches the quickest since October 2012. I’ll continue to harp on the sticky influence of services inflation as it was up by 2.5% y/o/y and remains in a tight 2.4-2.5% range since last summer. The goods side saw durable goods pricing lower by 2.1% but that is also a pretty consistent trend while nondurable (thanks to energy) prices rose 3.1%. So, services inflation, goods deflation remains the theme at least at the core level. As the Fed loves the PCE instead of the CPI, the nearing of their 2% core inflation rate coincides with their determination of hiking at least 3 times this year. As there are 8 meetings, it’s still pretty damn gradual.
As nominal spending was up by just .1% m/o/m, real spending was basically zero in February. As for income growth, private sector wages/salaries were higher by .5% m/o/m and 6% y/o/y. That y/o/y number is very encouraging for wage earners finally but not so much for corporate profit margins whose biggest beta is labor costs. That 6% figure matches a multi year high. The savings rate rose two tenths as a result to 5.6%, the most since September.
Bottom line, REAL spending is negative now for the first two months of the year after an average of 3 tenth gains in Q4. A decline in spending on services and durable goods were the main reason. This of course is in direct contrast to the ebullient headline consumer confidence figures but not too dissimilar to the mediocre spending plans that we’ve seen in those same consumer confidence figures. How one feels doesn’t always equate to how they behave and anyway, don’t look at consumer confidence numbers as a leading indicator. Just look at the historical peaks and troughs as to how dead wrong consumers were on what was to come.
As for inflation, the Fed has basically met their obsession with 2% inflation at the same time real rates remain firmly negative. Looking at the real 5 yr yield, it’s at -.11% vs +.43% on the day the Fed starting hiking rates in December 2015. Therefore, we can argue that conditions are actually easier today notwithstanding 3 hikes. It’s thus no wonder that the dollar index is not much higher than the level in December 2015 before the Fed embarked on these 3 hikes and as we expect 2 more this year. I’ll say again, it’s about REAL rates in where the dollar goes. To the gold bears who don’t like the yellow metal because the Fed is raising nominal rates, it’s up 16% since that first rate hike because of the behavior of real rates. I’m still bullish on that ‘pet rock.’
After the flood of Fed speak this week with almost all (Kashkari won’t at 10am today) reiterating their desire for two more hikes this year, with a few saying maybe three, the end result in terms of market expectations has the odds at 64% of two more vs 54% one week ago. The 2s/10s spread is narrower by 2 bps on the week to 113 but was 110 on Wednesday. That spread was 100 bps on election day and 116.5 the day after. The Fed is realizing how far behind they need to be even though they won’t admit it. They keep telling us that they basically have satisfied both mandates, give or take, which means that today they should have rates at a normalized level defined as 100-300 bps above the rate of inflation which would mean at least a 3% fed funds. Their dots say they’ll get to 3% in 2019 vs .825% today.
A day after Trump was met by his economic advisors on their tax reform ideas and Wilbur Ross said no decisions have been made, the founder of Uniqlo had some fighting words for the border adjustment tax proposal. In an interview with Japanese media, Tadashi Yanai, the chairman of Fast Retailing said if the tax is implemented, “I would withdraw from the United States…We would not be able to make really good products in the US at costs that are beneficial to customers. It would become meaningless to do business in the US market.” Not only is Uniqlo a major retailer and employer in the US, it is also a major tenant of landlords in a landscape of retail distress. The Senate pushback against the BAT is enough that we will not likely see it but without it the cut in corporate tax rates will then be much more modest. I’m not a fan of the BAT.
We saw a bunch of important economic news out of Asia overnight. China’s state sector weighted manufacturing PMI rose a touch to 51.8 from 51.6 which was a tenth above the estimate and the best since April 2012. New orders, export orders, output and employment all were higher while price pressures moderated. The services index, which does include construction, was up by .9 pt to 55.1 and that was the highest since May 2014. The components here were much more mixed with new orders and backlogs up but employment and export orders down. Both input and selling prices fell m/o/m.
Bottom line, you can call it stabilization as so many do or call it a turn for the better in their economy but I don’t know what to call it because I don’t know what is driving it. Is it continued state sponsored and shadow driven fiscal stimulus based growth or something organic? I can’t differentiate. The Shanghai comp was up by .4% but the H share index in Hong Kong was down by .8%. With it being the last day of the quarter, China’s money market rates spiked with the 7 day repo rate up 139 bps to 4.5%. Industrial metal prices are down slightly. The Journal of Commerce index of industrial materials though is still just 4 pts from the highest level in 27 months. As I’ve said for more than a year now, the rise in industrial metals prices off the early 2016 lows has been mostly supply driven as a 5 yr bear market instituted discipline.
The Japanese unemployment rate fell to the microscopic level of 2.8% in February from 3% in January and was two tenths less than expected. One has to go back to 1994 to last see that rate. The job to applicant rate held at 1.43, the highest since 1991. I’d think that wages would be skyrocketing with these kind of numbers but it unfortunately is much more nuanced. Full time workers are still seeing anemic increases while part time workers who are filling these jobs at this stage of the cycle are seeing better gains.
We also saw inflation data out of Japan which I believe is the true bastion of price stability to the dismay of the BoJ, in contrast to the nonsense obsession of a 2% annual price rise. February core/core prices rose .1% y/o/y as expected and down from .2% in January. There obviously remains quite a distance between this and the 2% rate. Imagine for a moment the amount of trees that needed to be cut down to print all that yen in order to get a .1% rise in core/core inflation. I’m not an environmentalist by the way. Headline inflation rose .3% y/o/y and prices ex food were up by .2% (considered core). The forward looking March CPI in Tokyo saw price declines across all 3 components. To my point about true price stability, core/core prices are up on average .4% per year since 1990. US inflation in contrast is up on average by 2.5% y/o/y. Is it a surprise then that the yen is up 40% vs the US dollar since 1990?
A decline in Japanese banks for the 11th day in the past 14 sent the Nikkei lower by .8% which brings the Nikkei as the only major global stock market that is now down on the year, by 1%. Yield curve control with no yield curve is literally destroying the profitability of the Japanese banking system. The Indian Sensex is the best performing Asian stock market year to date with an 11% gain. It’s been one of my favorite EM markets every since Modi was a candidate for Prime Minister and it still is.
Lastly out of Asia, industrial production in South Korea in February fell 3.4% m/o/m, much worse than the estimate of down .3%. IP was still up 6.6% y/o/y and I continue to believe we’ve seen the bottom for now in global trade after a challenging few years.
Repeating what I said yesterday after Germany’s CPI number, to the delight of the European wage earner but to the dismay of the ECB, headline CPI for the eurozone in March was up 1.5% instead of the 1.8% that was expected and down from 2% in February. Core inflation was higher by .7% y/o/y vs .9% last month and one tenth less than expected. Energy prices were still up 7.3% y/o/y and food was higher by 1.8% but that is a slowing pace from February. At the core level, it still is services that is driving higher prices as they rose by 1% y/o/y but that is down from 1.3% last month. Goods price gains remain modest as they rose just .2% for a 2nd month.
Bottom line, some are blaming the timing of the Easter holiday as last year it was in March and this year it is not. I don’t know how to quantify that though. What is clear to me is that higher inflation doesn’t drive faster economic growth and the benign level of inflation has been a saving grace for European consumers and the European economy is seeing pretty decent growth right now. On the CPI miss, the 5 yr 5 yr euro inflation swap is lower by 2.5 bps to 1.58%, the lowest since November as we get closer to recycling out the rise in energy prices. So while Mario Draghi and Co. are cutting monthly QE by 25% on Monday, they still believe that more asset purchases and negative rates will all of a sudden change the inflation picture along with Haruhiko Kuroda in Japan.
The German economy continues to rock and roll as the number of unemployed in November fell by 30k (the most since 2011), well more than the estimate of -10k and the unemployment rate fell to a new post reunification low of 5.8%. A spokesman for the labor agency said “The job market continues to develop favorably. With the onset of spring activity, the number of unemployed people has declined, employment growth is continuing unabatedly, and demand for new employees continues to be high.” Imagine where German interest rates would be if monetary policy was run by the Bundesbank and they still had the Deutsche Mark.