ISM, Payrolls, FOMC, BoJ

The ISM non manufacturing index for August was weak, falling to 51.4 from 55.5 in July and that was well below expectations of 54.9. This is the worst print since February 2010 when it was at 50.8. New orders sunk by 9 pts to just above 50 at 51.4. Backlogs fell back below 50 at 49.5 vs 51 in July. Employment was barely above 50 at 50.7, down .7 pts. Export orders (only some service co’s report exports) plunged by 9 pts to 46.5. Prices paid were little changed at 51.8. Of the 18 industries surveyed, just 11 saw growth vs 15 in July. For new orders, only 8 companies saw growth vs 13 in July. For employment, half of the companies asked said they are adding staff vs 12 in July.

For the bottom line, I’ll leave it to ISM who said “the majority of the respondents’ comments indicate that there has been a slowing in the level of business for their respective companies.” I’ll add this, the amount of economic data points that are not just missing expectations (US Citi surprise is down 40 pts over the past 6 weeks) but are outright soft are growing. Throw out the September rate hike and I have no idea why solely on the data some think December is on the table as the trajectory is for weaker growth. The only thing keeping a rate hike alive is the rhetoric we’ve heard from some voting members (of course including the troika) over the past three weeks which I highlighted this morning. The Treasury market response is as expected, higher prices and lower yields. The 2 yr yield is at .76% vs .79% on Friday. The stock market continues to celebrate mediocrity and declining earnings.

Friday’s payroll report continues the multi year economic recovery best defined as mediocre. Putting the details aside for a moment and particularly the specifics of the jobs data, let’s look ONLY at Fed commentary from VOTING members recently in order to gauge the likelihood or not of a rate hike in coming weeks irrespective of Friday’s print. Based SOLELY on this (and NOT on the data), I think the market is underestimating the possibility of a hike in September notwithstanding the jobs figure which will be revised two more times in coming months and again next year. Bottom line, it comes down to whether the Fed will focus on one piece of economic news (and thus continue to day trade the data) or are they backing away from their obsession with each individual figure in and of itself. As a reminder, on June 6th, 2016 in a speech Janet Yellen said this after seeing the May jobs report: “Although this recent labor market report was, on balance, concerning, let me emphasize that one should never attach too much significance to any single monthly report.” The underline is of course mine.

All of the following comments we know came before the BLS report:

1. Last Thursday, voting member Loretta Mester said “It seems like a gradual increase from a very low interest rate that are at now is pretty compelling to me…The economy is basically at full employment.” She believes that 75-150k of monthly job gains is what is needed to keep the unemployment rate steady.
2. On Wednesday, voting member Eric Rosengren said “the Fed’s mandated goals are likely to be achieved relatively soon, and keeping interest rates low for a long time is not without risks.” Ya think? He then went on to cite the “rapid price appreciation in the commercial real estate sector.”
3. Of course Yellen mentioned the case has “strengthened in recent months” for a rate hike.
4. Fischer said in his CNBC interview the day of Yellen’s Jackson Hole speech, “We’re reasonably close to what is sort of this full employment and the inflation rate this year is higher than last year’s.” In what Mester took notice of, Fischer on August 21st said in his speech: “Estimates of monthly job gains needed to keep the unemployment rate steady range widely, from around 75,000 per month to 150,000 per month, depending on what happens to labor force participation among other things.”
5. To repeat what Dudley said in mid August, “We’re edging closer towards the point in time where it’ll be appropriate to raise interest rates further” and that it’s possible in September.

I will also look at this debate from another angle and it is a play on the stock vs flow thesis that the Fed came up with years ago in analyzing their influence on interest rates from their weekly purchases vs the growing size of their balance sheet. Looking at the flow of the data over the past few months, it is easy to argue that a rate hike now doesn’t make much sense: job growth slowing, ISM manufacturing back below 50, GDP growth averaging just around 1.5% over the past four quarters, a peak in auto sales (highly sensitive to the cost and terms of credit), etc… Looking at the stock however, why are short term interest rates now about where they were during the Great Depression in the early 1930’s as we approach year 8 of this economic expansion? See the chart below on short term rates I found online from my friend Jim Bianco that stops in 2011 but you get the point as it says a million words about how off the rails monetary policy has gone and this says nothing about all the QE:

 

After we hear from non voting member Williams today, the hawks Lacker and voting member George tomorrow and voting member Rosengren and non voting member Kaplan on Friday.

Lastly, KEEP YOUR EYE ON JGB’s! As the BoJ is the most aggressive bank out there, longer end yields continue to rise. The 10 yr yield was up another 1.5 bps overnight and is almost back to zero at -.018%. It was at -.29% just six weeks ago. The current level is the least negative since mid March. The BoJ is beginning to realize the damage the yield curve is doing to their banking system and there is chatter that in their month end review, there may be an attempt to let the curve steepen again. They have already been cutting back on buying paper with maturities of 10+ yrs. Considering the extent of the bond bubble, this will be quite a needle to thread.