On the heels of the 287k print in June, the FOMC acknowledged this by saying “job gains were strong in June following weak growth in May.” They added this new line on the labor market that wasn’t there previously: “On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months.” They repeated that household spending was growing “strongly” but “business fixed investment has been soft.” They took out the line that “the housing sector has continued to improve” but I can’t figure out why. The benign inflation commentary was similar to the June meeting notwithstanding an 8 yr high in June core CPI at 2.3%.

Esther George, who did not dissent at the June meeting as she wanted to wait until after the UK vote, went back to voting for a rate hike of 25 bps.

Bottom line, we can call this a boring, non event meeting but there was a clear change to the hawkish side on the labor market commentary after the bounce back seen in June. This only brought the 3 month average to about 150k but the Fed seems intent on telling the markets that a September hike is a possibility. They do this not because they are intent to raise but to just give them flexibility with the markets as not to put them offsides if the data meets their rate hike threshold in coming months. Thus, this ongoing game of whether and when to hike a measly 25 bps continues. The 2 yr note yield at .74-.75% is down slightly from yesterday.

I just sat down with Guy Adami and Dan Nathan for the first of many podcasts for The Boock Report. It’s about 45 minutes long and we cover the FOMC statement tomorrow, what other Central Banks like the ECB and BoJ are doing. And ultimately what it all means for the dollar, yields, commodities, equities and the economy as a whole. I specifically discuss what was in the last FOMC statement and what to look for tomorrow. I believe the Fed may start becoming more hawkish in there choice of language and that may have an effect on risk assets even though the market is pricing in such a small chance of rate hikes before the election in November. You can listen in on the entire discussion here:

Flash version:

MP3 version:

The following is the odds the market is placing on the path for the Fed for the balance of 2016. As you can see tomorrow’s meeting is basically in “no chance” territory. But things get more interesting into the end of the year:

 

How about the data today ahead of tomorrow’s Fed Statement?

After a bad 2 yr note auction yesterday, the 5 yr today was equally poor. The yield of 1.18% was well above the when issued of 1.16-.165%. The bid to cover of 2.27 was below the previous 12 month average of 2.44 and the weakest in 7 years. Also, dealers got stuck with almost 42% of the auction vs the one year average of 33%. That is the most since August 2015.

Bottom line, the demand for short term US paper really dried up over the past 2 days. What is this saying about tomorrow’s Fed statement? What happened to the demand for yield? What happened to all that foreign buying? In response, the 2 yr note yield is touching .78%, exactly where it was the day of the UK referendum on June 23^rd. The 5 yr yield of 1.15% compares with 1.26% on June 23^rd and 1.07% on June 24^th.

The yen is rallying to a 2 week high and is also at its pre Brexit level as stimulus junkies are realizing that the size of the fix may not be what they hoped for. To say expectations are high for another big round of stimulus is an understatement. The Japanese Finance Minister Aso said they are still unsure on the total size of the fiscal package and he also said monetary policy should be best left with the BoJ implying no coordination. For the all the focus on the 1st two arrows of Abenomics, the most important 3rd arrow has gotten completely lost unfortunately. Tax and labor market reform are the keys to faster economic growth, not more of the same on the fiscal and monetary front that has been essentially ongoing for decades. The Nikkei fell 1.4% overnight to a 2 week low.

The US 2 yr note yield is up another 1 bp to .75% after yesterday’s awful auction, the highest since the day of the June 23rd UK vote. The odds of a rate hike by yr end are also at the most since June 23rd at 46%. The 2s/10s spread is down another 4 bps and lower by 8 over the past 3 days to just 80 bps. It was at 96 bps on June 23rd. Today we see the July Markit PMI services index, July consumer confidence, July Richmond manufacturing survey and June new home sales.

In Europe, bank stocks continue to trade terribly with the Euro STOXX bank index back to a 2 week low led by a 5% decline in Commerzbank after an earnings update. Italian banks are weak as well. With the ongoing damage being done to the profitability of many global banks with interest rates where they are, how will it be possible not to see further economic weakness. We eagerly await the results of the ECB bank stress tests this week.

The pound is down slightly after BoE member Martin Weale said he is now leaning towards more monetary action (it stopped being an actual economic stimulant a while ago) after seeing the very weak PMI numbers last week. Just two weeks ago he said he was in no rush to act. Patience and humility with what they can do after everything that has already been done is still nowhere apparent. RBS is out today in a letter to its business clients that if the BoE goes down the NIRP road, it “could result in us charging interest on credit balances.”

Hong Kong exports fell for the 15th month in the past 16 y/o/y. They fell 1% in June from last year and that was a bit better than the estimate of down 1.6%. While China said imports from Hong Kong in June rose 71% y/o/y, Hong Kong said exports to China were up just 1.8% y/o/y. Hong Kong exports fell 7.3% to the US, by 10.3% to the UK and by 8.2% to Japan. Exports to Germany were up 1% y/o/y. Imports fell by .9% but that was much better than the forecast of a 5% drop. Looking ahead, the government said “the external trading environment remains challenging given the uncertainties associated with the outcome of the UK referendum in favor of leaving the European Union, slow recovery in the advanced markets, monetary policy divergence among major central banks and heightened geopolitical tensions in various regions.” The Hang Seng index was up by .6% and mainland indices rallied as well.

The Markit PMI services index for July slowed to 50.9, a 5 month low and down from 51.4 in June. It’s also the 2^nd lowest print in years. New orders fell but employment was up slightly. Also, “business sentiment improved markedly from June’s record low.” Markit summed up the report by saying “The US service sector remained stuck in a low gear at the start of the third quarter of 2016, with growth of activity remaining subdued amid a slower rise in new business. This is particularly disappointing given the decent numbers posted by the manufacturing sector last week. A bit more encouraging was the rebound in business confidence following June’s survey low, suggesting that a return to stronger growth will be possible once the current soft patch comes to an end. Whether this will be before the presidential election or not remains to be seen, however.” As the market cares much more about the ISM figure, this figure is not a focus today but points to the still mediocre US economic growth rate.

The Conference Board’s consumer confidence index fell a hair to 97.3 in July from a revised 97.4 in June (revised from 98) but that was slightly better than the estimate of 96. The Present Situation component rose to the best level since September but Expectations moderated a touch. As for the answers to the labor market questions, those that said Jobs Were Plentiful fell .2 pts to a 5 month low but those that said jobs were Hard To Get were down by 1.4 pts. Overall employment expectations were about flat. After jumping by 1.7 pts in June, Income expectations fell by 1.6 pts. Consumer spending plans were subdued. Those that plan to buy a car fell almost 2 pts to the lowest level since October while those that plan to buy a home rose just .1 pt off the lowest level in a year. Also, buying plans of major household items rose only marginally from a 5 month low. One year inflation expectations fell one tenth to 4.7%. Business conditions were mixed to slightly better. Bottom line, the data is “suggesting the economy will continue to expand at a moderate pace” while “consumers remain cautiously optimistic about growth in the near term” according to the Conference Board.

New home sales in June totaled 592k annualized, 32k more than expected and up from 572k in May which was revised up by 21k. Sales now are at the most since February ’08 and continue to creep closer to the 25 yr average of 715k. Sales in the South and Northeast were flat m/o/m but lifted in the Midwest and West. As sales exceeded the increase in the number of homes for sale, months’ supply fell to 4.9 from 5.1. The median price was up by 6.1% y/o/y to back above $300k. Bottom line, with the dearth of inventory in some markets it is nice to see a lift in the sale of new homes but there still is a modest pace of sales for lower price homes where first time households need to see. A reason for that is the growing cost of lots, labor and fees that crimp the margins of selling a home for less than $250k. It was homes priced between $400-500k that saw the biggest lift as sales priced below that price fell m/o/m. I’ll say again, the housing market continues its recovery but still in an escalator type fashion rather than something more linear. In terms of historical rates, there still is a lot of catch up to be had.

The July Richmond manufacturing survey improved by 20 pts to +10, well better than the estimate of -5. Smoothing out the volatile nature of this number puts the year to date average to 4 vs 2 last year. New orders and shipments were up while backlogs were flat. Employment was up a touch and interestingly, “firms continue to report wage increases.” As for the future, “firms expected moderate growth in shipments and in the volume of new orders.” This included “mild growth in the number of employees.” Bottom line, Richmond has been the best manufacturing region so far in July as NY flat lined, Philly was down and Dallas was much less bad. Next week’s ISM is expected to print 53 vs 53.2 in June.

According to the Case Shiller home price index, prices fell for a 2^nd straight month but only by the slightest amount. On a y/o/y basis, prices were higher by 5.2% but that was the slowest pace of gain since September. Robust price gains were seen in Portland, Seattle, Denver and Dallas. NY and DC were the main laggards. Bottom line, the seasonally adjusted 20 city index is just below the highest level since October ’07 and is just 9% from the 2006 peak. As I’ve stated in the past, I’m actually rooting for a slower pace of home price gains because too many households have been priced out. With persistent rent gains now reaching a point where monthly payments aren’t much different than mortgage payments, a slower pace of home price gains could help catalyze new purchases.

 

A few months ago I referred to monetary policy as entering a Jungleland where central bankers are essentially lost in the woods. After seeing Guns N Roses Saturday night, I’ll refer to this week as Welcome to the Jungle.

The week is all about the Fed and the BoJ. The key questions to be answered are will the former raise the possibility of a rate hike this year and will the latter amp up more of the same with the possible discussion of a perpetual bond. As for the Fed, let’s look at the June statement and how things have changed since:

What was said in June is bolded:

the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up.

Since then, the BLS printed a job gain for June of 287k on one hand but only an average of 150k over the past 3 months on the other. Technically speaking, the pace of job growth does continue to slow. As for the economy, on June 15th when the last statement was released, the Atlanta Fed GDPNow forecast was 2.7% for Q2. Today it sits at 2.4%. And that’s with a 60 point increase in the US Citi Surprise index.

Although the unemployment rate has declined, job gains have diminished.

The June unemployment rose and see above for the pace of job gains.

Growth in household spending has strengthened.

Since then retail sales data from the government was good but auto sales printed the 2nd lowest level of sales since early 2015 and here are some anecdotal retail comments from last week: Howard Shultz at SBUX on weaker comps than expected, “No one should misinterpret or in any way look at the challenges that we and many, many other companies are facing as something that has been done before. This is quite unusual. It’s unsettling.” Dunkin Donuts CEO said “consumers had gone into a bit of a funk during the quarter.” The YUM CEO said the US was in a “malaise” and quarterly sales were soft. He cited a June survey by GenForward of 18-30 yr olds that said ¾ of them “said they believed the US was in decline… not particularly good news from what people are thinking.”

Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft.

Housing continues with its improvement, albeit bumpy still. Net exports are still a drag and business investment sucks to be perfectly blunt.

Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports.

Headline inflation remains well below for sure but June core CPI printed 2.3% for freaking sake, an 8 year high. How about an acknowledgement on the part of the Fed. Yes, I acknowledge the pressure on goods prices but services inflation is widespread. The Atlanta Fed wage tracker printed up 3.6% on June 14th (this data point was most likely not in the Fed staff report for the statement on June 15th), the highest since December 2008.

Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

The 10 yr inflation breakeven at 1.51% is little changed with the June 15th closing print of 1.50%. This stat mostly follows commodity prices anyway.

Finally…

In determining the timing and size of future adjustments to the target range for the federal funds rate” they will assess “labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

1. Labor market conditions: Will they solely look at the June print or average the past 3 months together?
2. Inflation: Does core CPI matter to them at all? Does Dennis Lockhart tell them about his bank’s wage data?
3. Financial and international developments: The S&P 500 is at an all time high with valuation comparisons to 1929 and 2000. As for high yield bonds, Martin Fridson, the well known high yield analyst (I’m quoting WSJ here) said this week “Factoring in interest rates, economic conditions and the availability of credit, Mr. Fridson calculates that in only 9 months over the past 2 decades have yield bonds been more overpriced than today.” International developments cut both ways, China is perceived to be stabilized for the sole reason of massive credit growth and fiscal stimulus while Europe post referendum is one big question mark.

Bottom line: The Fed has every reason to wake the markets up to a possibility of a rate hike soon but then again, it depends on how they look at the data and/or the 3rd mandate, the markets.

As for the BoJ and the possibility of more QE, whatever form it might take and whatever Abe has up his sleeve, I only can leave you with this picture:

For those historians, the BoJ first tried QE in 2001.

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I’ll be hosting a webinar tomorrow, previewing the FOMC decision and discussing The Boock Report product which you can participate in as a free preview. Registration for the webinar and The Boock Report is free, with no obligation and no credit card required.

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