Janet Yellen in her testimony today said:
With regard to the outlook, I expect economic growth to continue at a moderate pace sufficient to generate some further strengthening in labor market conditions and a return of inflation to the Committee’s 2 percent objective over the next couple of years.
With respect to what this means for interest rates she is prepping the market for a hike next month by saying:
Were the FOMC to delay increases in the federal funds rate for too long, it could end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of the Committee’s longer-run policy goals. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and ultimately undermine financial stability.
She then went on to say AGAIN that the pace of increases will be gradual.
This last point is most important because the adjustment in the US Treasury market has been anything but gradual over the past few weeks and what is happening before our eyes is a central bank that will not be driven into policy changes by its own volition. It will instead be dragged by the market instead. Yellen and Company don’t realize that yet because they continue to believe in an econometrically driven ‘neutral rate’ of theirs that has rates lower than they otherwise would be historically speaking. There wasn’t much of a market response because Yellen didn’t really say anything new.
Dating back to when record keeping began in 1977, September saw the largest month of net foreign selling on record of US notes and bonds, totaling $76.6B. This brings the total amount of selling over the 12 month time period to $310B. It was back in 2011 and 2012 when foreigners were net buyers annually of about $400b. Of the $76.6B, $45B came from Asia where China sold another $15B worth (now $83B of selling over the past four months) and Japan liquidated a net $18B. There was also large selling out of the UK which could be anyone using the UK as a conduit. Russia happened to sell $10B worth. Where most of the selling over the past year has been from central banks, September saw net selling from private holders too. They sold $30B of the $76B.
Bottom line, the bear case on US treasuries didn’t start last Tuesday night. Seeds have been sown for many months now and TIC data like this just adds to the pressure. While likely to consolidate the recent spike in yields short term, I remain of the belief that rates will continue higher in 2017 where a 3 handle will be likely in the US 10 yr. If correct, it then begs the question of what it means to the valuations of all other assets that have been priced off this risk free rate.
Headline CPI in October jumped by .4% m/o/m but as expected and this brings the y/o/y gain to 1.6%, the highest since October 2014. Energy price gains on a y/o/y basis is the main reason as they have accelerated due to easy comparisons. Food prices were flat m/o/m but down .4% y/o/y confirming the food deflation we’ve heard from supermarket companies. The core rate was up just .1% m/o/m, one tenth less than expected. The y/o/y gain was 2.1% vs 2.2% in the month prior. A factor in the m/o/m slowdown was that there was no change in medical care costs but that comes after large gains in previous months and the y/o/y rise is still 4.3%. Rent gains are still robust as they rose .4% m/o/m and 3.8% y/o/y. Owners equivalent rent, the faux look at rent, was up by .3% and 3.4% m/o/m and y/o/y respectively. Rent gains are moderating in NY and San Francisco but still remain strong in other areas. Also, if the rise in interest rates continues, expect more households to choose to rent. As for overall services ex energy, prices rose another .2% m/o/m and 3% y/o/y continuing the trend of sticky services inflation.
Bottom line, I continue to expect headline inflation to move higher in coming months due to the base effect of energy prices and combine this with stubborn services inflation and the now growing possibility of higher wages and a fiscal jolt to the US economy and interest rates are likely to continue shifting higher.
Jobless claims totaled 235k, the lowest level since 1973 and was well below the estimate of 257k and down from 254k last week. Smoothing this number out since it’s such an unusual outlier relative to expectations brings the 4 week average down to 254k from 260k last week. Continuing claims, delayed by a week, fell by 66k to the lowest since 2000. My bottom line remains the same as they’ve been for a while now with the modest pace of firing’s. The labor market is tight in the context of still many workers not in the labor force but that don’t seem so inclined in coming back unless they are paid more.
Housing starts in October totaled 1.32mm, well more than the estimate of 1.156mm and that’s the best level since August ’07. There was a jump in both single family and multi family starts. For single family the increase was 84k m/o/m to 869k (most of the gains occurred in the South and West) while multi family normalized at 454k after the plunge to 269k from 440k in the month prior. The permit change wasn’t as drastic as the starts rise as single family permits rose by 20k while multi family permits were down by 16k.
Bottom line, the increase in homebuilding in a market that is inventoried constrained is good to see. Most importantly though we need homes built priced below $250k in order to bring in more first time households. The caveat though with today’s October data is that it comes before the sharp spike in interest rates.
The Philly November manufacturing survey fell a touch to 7.6 from 9.7 last month. That was about in line with the estimate. There was a sharp 25 pt gain in inventories. New orders and backlogs also rose. Employment remained negative but a bit less so while the average workweek was higher. We also saw a sharp rise in the inflation components as prices paid was up by almost 20 pts and prices received spiked by almost 20 pts to the highest since May 2014. The overall 6 month outlook was a bit muted as this component fell by 3.3 pts to the lowest since March.
Bottom line, a now stronger dollar and soft overseas trade will limit gains in US manufacturing but hopefully domestic growth can offset those headwinds, especially with new fiscal policies to be enacted with the new administration. Also of note, inflation pressures are beginning to show up as stated above and also within a special question where businesses were asked the annual percent change that US consumers will pay for goods and services in Q4, that rose to 2.3% from 2% in Q3.