In April, new home sales totaled 662k, 18k less than expected. Also, March was revised down by 22k to 672k. As this data measures contract signings, it is a more up to date measure of the industry relative to existing homes (out tomorrow) which measures closings. The rise in mortgage rates, up now by 65 bps year to date to a 7 year high, are impacting behavior as to be expected. On one side it is encouraging some to buy now and lock in that long term mortgage while it is likely impacting decision making for others that are focused on what their monthly payment will be.

Months’ supply rose a tick to 5.4 from 5.3. All of the sales decline m/o/m was out West. The median home price was $312,400, down m/o/m BUT the average home price rose to $407,300 and that is a record high. So we have rising rates and expensive prices. The end result should not be a surprise, more trepidation on the part of the buyer. On the flip side, a strong labor market, rising wages and that wall of potential millennial demand waits in the wings.

APRIL NEW HOME SALES

Thanks to the service sector, the US Markit service and manufacturing composite index rose to 55.7 in May from 54.9. The service component was up 1.1 pts m/o/m to 55.7 while manufacturing was little changed at 56.6 vs 56.5 in April.

On services Markit said “May data signaled a slight slowdown in new business growth from the 3 yr peak recorded in April. Backlogs rose to the best since March 2015. Of note and to my consistent theme, “Service providers signaled a robust and accelerated increase in their average cost burdens in May. The rate of input price inflation was the steepest for 3 months, which firms linked to higher oil related costs and rising commodity prices.”

With manufacturing, new orders, production and backlogs all rose as did payrolls. Importantly, “business optimism regarding the year ahead outlook was the highest since February 2015.” As part of this, inventory restocking rose to the highest since January. On inflation, “latest data signaled intense pressure on supply chains, with average lead times lengthening to the greatest extent since the survey began in May 2007. Manufacturers widely commented on stretched supplier capacity and logistics delays. Robust demand for raw materials and rising commodity prices resulted in another steep increase in input costs across the manufacturing sector. The overall rate of input price inflation eased slightly since April, but was still among the fastest seen over the past 7 years. Moreover, prices charged by manufacturing companies continued to rise at the strongest rate since June 2011.”

Bottom line, this level in the Markit composite index is consistent with GDP growth of 2.5-3% according to them. Higher cost pressures remain a challenge but companies will do their best to deal with it. The $64k question for the Fed is to what extent rising costs get passed on to the consumer and shows up in PCE and CPI. As for the market response, there never is one as they focus on ISM data instead.

While the Turkish lira continues its free fall and is garnering major attention, I continue to focus on the market reaction to the new Italian government. Bond yields continue to blow out. After a 7 bps respite lower yesterday, the 2 yr yield is up 11 bps today at +.31%. It was -.31% 2 1/2 weeks ago. The 10 yr yield is spiking by .13% to 2.45%. It was 1.79% 2 1/2 weeks ago. This is a country with a debt to GDP ratio of 132% and gross government debt of 2.3 Trillion euros. The Italian stock market is down by 1.5% and its 10% year to date return just a few weeks ago is down to a gain of 4.6%.

Thanks to the selloff in Italian bonds, the Portuguese 2 yr yield is back above zero also, up by 8.5 bps to +.03%, the highest since September. Their 10 yr yield is back at 2%, up by 5 bps. UK gilts, French oats, German bunds and US Treasuries are the safe havens this morning, along with the dollar and gold.

Gold is performing pretty well in the face of the dollar strength. The dollar index is at the highest level since mid December and gold is 2.5% higher since then. The same can be said for the CRB index which closed yesterday at the highest level since July 2015. Also, gold is above where it was in mid December when the 5 yr real rate was about .35% vs .70% today. I remain bullish.

CRB INDEX

With respect to Turkey, President Erdogan has been creating a dictatorship there for himself for years that is now coming home to roost. He’s been dangerous for their economy, political institutions and the independence of its central bank for years.

Japan’s manufacturing PMI for May softened to 52.5 from 53.8 and that is a 9 month low. Price pressures in the US and in Europe due to capacity issues is also apparent in Japan. Markit said “there was further evidence that supply side constraints may be impacting output potential, as material shortages contributed to the greatest lengthening of delivery times in 7 years. Consequently, input prices soared at the fastest pace in 52 months.” Employment, backlogs and new orders all fell. The lone bright spot was higher export sales likely due to the recent weakening of the yen.

The Eurozone manufacturing and services PMI for May fell 1 pt m/o/m to 54.1 and no change was expected. This is now at the lowest level since November 2016 and is only a few months removed from the highest in years. The data still contains some caveats according to Markit, “While prior months have seen various factors such as extreme weather, strikes, illness, and the timing of Easter dampen growth, May saw reports of business being adversely affected by an unusually high number of public holidays.” Let’s of course hope they are right but they also said “it’s also becoming increasingly evident that underlying growth momentum has slowed compared to late last year, especially in relation to exports. Hiring has consequently shown signs of being reined in. More expensive oil and rising wages are meanwhile continuing to push companies costs higher, but weak final demand means firms are struggling to pass these higher costs onto customers.” The euro is falling to the lowest level since November.

Thankfully for the British household April CPI slowed to a 2.4% y/o/y increase from 2.5% in March. That was one tenth less than expected. The core rate moderated to 2.1% from 2.3%. Producer price pressures remain though as PPI was up 5.3% y/o/y, up from March but was below the estimate. Output charges grew by 2.7% which was above. The pound is lower on the CPI miss because who knows what the BoE will do now. The 2 yr gilt yield is lower by 3 bps. I’ll say again, the BoJ, ECB and BoE could enter the next economic downturn (whenever it might come) all with rates at basically at zero. The ECB and BoE are turning Japanese.

A slower pace in the rise in inflation along with quicker wage increases in the UK did help retail sales in May according to CBI. Sales rebounded after a few weather distorted months but CBI said “there’s no let up in inflation for shoppers as prices are still rising strongly.”

Thanks to an almost 10 bps w/o/w jump in the average 30 yr mortgage rate to 4.86% in the US, the highest level in 7 years, mortgage applications fell again. Purchase applications to buy a home fell for a 4th straight week by 2% and its y/o/y gain is down to 2.7%. The index sits at the lowest level in 6 weeks. Refi’s, highly sensitive to rate changes, fell by 3.7% w/o/w and are down by 27.4%. The audience of potential household’s that would refi continues to shrink with higher rates. It was in December 2000 the last time the rate of refi’s was this low. As you can’t get much more interest rate sensitive than in housing as people focus on their monthly nut, the only question was to what extent did behavior change in response to the rise in rates rather than if they would.

AVERAGE 30 YR MORTGAGE RATE

I talked about peak profit margins that might be upon us in response to the growing cost pressures via higher commodity prices, trucking costs and labor. If you didn’t see yesterday, AZO raised its SG&A forecast to 6.5-7.5% from about 5% mostly due to higher wages. Great for the consumer but not so much for earnings. We’ll soon see what they are able to pass on to the consumer.

The 2 yr note auction was mixed again. The yield of 2.59% was a hair better than the when issued of 2.595%. The bid to cover of 2.88 was a touch above the one year average of 2.85. On the other hand, dealers got stuck with 45.4% of the auction, the most in any 2 yr auction since December 2017 and is the 2^nd most since December 2016.

Bottom line, here is another Treasury auction with yields at about a decade high and still bringing only mediocre demand. The possible reasons we all know: 1)higher inflation expectations. Today, the implied rate in the 2 year breakeven is at 2.0% vs 1.5% one year ago and vs 1.17% last July, 2)rising commodity prices, CRB index today at highest level since July 2015, 2)ton of supply, 3)lackluster demand from overseas, 4)realization that the Fed wants to keep on keeping on with hiking short term rates.

In response, the now off the run 2 yr yield is little changed at 2.57%. Tomorrow, you’ll see 2.595% if no change from here.

2 yr YIELD

CRB INDEX

After giving back 3 years of monetary suppression in 6 trading days, Italian yields are lower today. The 2 yr yield is down by 7 bps as is the 10 yr yield. Italy certainly has its own political dynamic and a debt to GDP ratio of 130% at the same time the new regime wants to bust out the deficit. But, the dramatic reaction in its bonds, the 3rd largest bond market in the world, in just a week of trading in the face of everything the ECB has done should be a wake up call of maybe what is to come as we get closer to the end of ECB QE this year and NIRP next year.

The UK CBI industrial orders index for May fell to -3 from +4. The estimate was +2. That matches the weakest figure since October 2016, just a few months after the Brexit vote. The CBI said “UK manufacturing has lost some steam since the start of the year, on the back of a softening in both domestic and global growth” but export order books do remain “well above historical average.” The selling price trend was little changed at 19 vs 18 in the two prior months. Notwithstanding the data miss, the pound is higher as are most currencies vs the dollar today on a bounce after the recent weakness. Gilt yields are higher too along with German bunds, French oats and US Treasuries. These moves in the UK are being helped by BoE member Vlieghe who said he sees 1-2 rate hikes a year for the next 3 years. Rate hike odds for the 1st one this year are at about 50% by August.

After the news yesterday that China was likely going to completely scrap all limits on the number of kids people can have, Shanghai Aiyingshi jumped by 10%. They retail maternal and children products such as diapers and baby clothing. Beingmate Baby and Child was up 1.4%. They make baby food. Also of note, companies that do business with ZTE saw nice rallies as trade tensions ease.

On the trade front, China said they will cut its auto import tariff to 15% from 25%. A victory of course for car makers but most of the beneficiaries will be European and Japanese car makers as the US doesn’t export as much there as GM and Ford have their own plants and partners already in China. China imported 10% of its imported cars from the US but some of that was European cars produced in the US.

BoJ Governor Kuroda speaking to Parliament reiterated that “it is appropriate for the Bank to pursue the current powerful monetary easing with persistence in order to achieve a price stability target at the earliest possible time” because “there is still a long way to go to achieve the price stability target of 2%.” In other words, more of the same in terms of policy on the hopes of a different result. The yen is little changed as were JGB yields as there was no surprise with the comments.

The response in China and elsewhere in Asia to the Mnuchin time out in the ‘trade war’ was actually pretty mixed. The H share index closed unchanged while the A share index in Shanghai was higher by .6% as was the Hang Seng. Australia, the China proxy, was flat on the day and the Nikkei saw no change too. I remain hopeful that a deal satisfactory to both sides will come of this. I also repeat that interest rates are the most important thing for stocks now and that should be #1 on the priority list in terms of focus.

The other important news today is that China is discussing the end of all restrictions on having kids “according to people familiar with the matter” according to BN. They reported that “The State Council, China’s cabinet, has commissioned research on the repercussions of ending the country’s roughly four decade old policy and intends to enact the change nationwide, said the people, who asked not named while discussion government deliberations. The leadership wants to reduce the pace of aging in China’s population and remove a source of international criticism, one of the people said.” Buy baby food and diaper makers, short condoms.

Giuseppe Conte is the new PM of Italy of the 65th Italian government since WWII. I never heard of him. He’s a law professor and not a politician. He’ll be more of a figure head dealing with a populist agenda. That populist focus is what has markets up in arms. The French Finance Minister said yesterday, “If the new government takes the risk of not respecting its commitments on debt, the deficit and the cleanup of banks, the financial stability of the entire euro zone will be threatened.” What he didn’t mention is that this possibility would coincide with the end of ECB QE and NIRP next year.

The sharp selloff in Italian debt continues today. The 2 yr yield is up another 7.5 bps to +.17%, the highest since August 2015 and has basically given back nearly 3 years of declines in a week. A week ago Friday it was at -.28%. Did someone once say ‘risk happens fast’? The 10 yr yield is up by 5 bps to 2.28%, up 40 bps in 6 trading days and just 10 bps from the most since October 2014.

2 yr ITALIAN YIELD

For the 2nd month in a row the Japanese trade data missed expectations but did improve in April from the pace of March. Exports were up by 7.8% y/o/y vs the estimate of up 8.7%. The gains were led by semi’s and autos. Imports grew by 5.9% vs the forecast of up 9.8%. I wish we can separate out any change of behavior with the trade tariff proposals which the Japanese have not be exempt of. They are now threatening their own retaliation. This data follows the contraction in the Japanese economy in Q1.

The US dollar strength continues but so does the rise in commodity prices, thus for now breaking that close inverse relationship and I believe highlighting the underlying bid to commodities generally. We keep focusing on oil specifically but food prices all of a sudden are at 9 month highs. Corn today is near a 2 yr high. Copper is up 1.3% on the China/US Mnuchin comment as are soybeans too. Aluminum is around unchanged.