The focus over the last week was a step-up in Trump’s trade wars – adding Mexico again on top of the ongoing confrontation with China -- and the promise by the Fed that if the trade issue starts to dampen growth, they will “act as appropriate” to rescue the US economy stock market. 

As the market was worried about the impact of tariffs on imports from Mexico (mostly cars assembled there by US auto makers), Fed Chair Powell surprised the markets (and me, I must admit) by implying that the Fed could cut rates if the trade disputes started to impact the economy. Before his opening remarks at a Fed conference, he made what was clearly a well-thought-out statement addressing market concerns. He mentioned the risk that the trade disputes pose to the US and global economy and said the Fed is “closely monitoring the implications of these developments for the US economic outlook” and that it would “act as appropriate to sustain the expansion.” “Closely monitoring” is Fed code for “we’re worried about this.” “Act as appropriate” means “cut rates.”

Powell’s comments followed Monday’s comments by St. Louis Fed President Bullard, one of the most dovish members of the FOMC, who said the Fed might have to cut rates soon to sustain the economy. Bullard’s comments ignited a huge move in the Fed funds futures to discount lower rates in the future. If Powell had wanted to challenge the market’s view, he would’ve done so. He purposely didn’t. On the contrary, he used that opportunity to more or less confirm what Bullard had said. Powell’s comments were backed up by similar comments from Vice Chair Clarida and Governor Brainard.

The market took these comments to heart and sent Fed fund rate expectations down sharply. Maybe Powell will rescue Trump after all, despite the latter’s criticism of the Fed chair.

The idea that the Fed might need to cut rates got a further boost when the ADP employment report showed an astonishingly low increase in jobs of only 27k, vs expectations of 185k. Given the Fed’s dual mandate and its requirement to promote “maximum employment” as well as “stable prices.”, that raised hopes of a cut in rates even more – a “bad news as good news” reaction.

The stock market has risen sharply in hopes? Expectation? of a “Powell Put,” that is, if the situation deteriorates further, the Fed will as usual bail everyone out. But really, how bad is the situation? Not that bad, I would argue.

First off, any slowdown in activity seems to be confined to manufacturing. The service sector, which accounts for a greater part of the US economy, is still doing quite well. That’s clear from looking at the divergence between the Institute of Supply Management (ISM) purchasing managers’ indices (PMI) for the manufacturing and the service sectors. The manufacturing PMI has been slipping recently; the reading for May fell to 52.1 from 52.8, down sharply from 56.6 at the beginning of the year. But note that it’s still above 50, meaning that manufacturing is still expanding, albeit at a slower pace. Meanwhile, the service-sector PMI rose to 56.9 from 55.9 – it’s even higher than the January level of 56.7.

The divergence between the two indices isn’t as bad as it was in 2015/16, when there was a big scare about growth. Furthermore, the manufacturing PMI is still above 50, whereas in 2015/16 it was below the “boom or bust” line. And remember:  the US didn’t go into recession then!

The trade war is likely to affect manufacturing, but will it affect services? Can it send the entire economy into recession? I would argue that as long as employment is rising, fears of a recession are overblown.

That brings us back to the ADP report and the new questions about employment. The ADP report is inconsistent with everything else we know about the labor market and may well turn out to be a fluke or a temporary blip, just as February’s bizarrely low nonfarm payroll (+20k) was followed by a healthy +196k the next month and a robust +263k the month after that.

The jobless claims figures don’t show any change in the employment picture. They remain at a historical low, which is even more amazing considering that they are not adjusted for the rise in population over the years.

Looking at the Conference Board consumer sentiment survey, the “jobs plentiful” index exceeds the “jobs hard-to-get” index by as much as it did back in the heady days of the late 1990s boom time.

The job index of the National Federation of Independent Businesses (NFIB), the small business association, is near a record high. The “jobs openings hard to fill” index is at a record high.

The NFIB data provides quantitative corroboration for the view from Wednesday’s Beige Book, which was positive on employment, too. It suggested that the main constraint to higher employment growth is a lack of workers, not a lack of jobs:

Employment continued to increase nationwide, with most Districts reporting modest or moderate job growth and others reporting slight growth, an assessment similar to the previous reporting period. Solid hiring demand was noted for retail, business services, technical, manufacturing, and construction jobs and by staffing agencies in general. However, stronger employment growth continued to be constrained by tight labor markets, with Districts citing shortages of both high- and low-skill workers…(emphasis added)

Even in the beleaguered manufacturing sector, the ISM manufacturing employment PMI is still above 50, suggesting that manufacturers are still hiring. 

In short, I believe the market’s assumption that the Fed is going to cut interest rates soon is premature. Clearly they might if the economy turns down, or even if it looks like the economy is likely to turn down, but as it stands now, it seems to me that they can afford to remain “patient.” That being said, I would expect the dollar to recover over the medium term, although it may take some time before people realize that a rate cut is not imminent. The key date is June 19th, when the Federal Open Market Committee (FOMC) decides on interest rates. The statement, the press conference following the meeting, and the famous “dot plot” of FOMC members’ interest rate projections will tell us what we need to know on this matter.


The coming week:  US CPI, retail sales, lots of China & UK data, SNB meeting

The main focus next week will be Wednesday’s US consumer price index (CPI). The CPI isn’t the inflation gauge that the Fed actually targets –that’s the personal consumption expenditure (PCE) deflator, or more accurately, the core PCE deflator – but the market pays attention to it almost as if it were.

In any event, the CPI data are not likely to give much ammunition to the rate-cut supporters. The headline figure is expected to show a small slowdown in inflation, but the core measure is expected to remain at the previous month’s level. In any case, both are right around the Fed’s target and would only reinforce the idea that they can remain “patient” with regards to rates.

Furthermore, when the Fed looks at trends in inflation, they often look at the short-term movement. And when we look at the three-month change in inflation annualized, we see that actually, headline inflation is going through the roof. It’s likely to come down as oil prices fall, but in any event, these data should give the Fed no reason to think a rate cut is necessary any time soon. USD positive.

Other important US data out during the week include the Job Offers and Labor Turnover Survey (JOLTS) on Monday; the NFIB small business survey and producer prices on Tuesday; and retail sales, industrial production and the U of M consumer sentiment survey on Friday. The JOLTS survey, which tells us how many unfilled jobs there are, may attract more attention than usual as the market ponders whether the US labor market is indeed cooling.

China announces a number of important indicators during the week. Monday is the trade balance; Wednesday is CPI and PPI; and Friday, the usual trio of retail sales, industrial production and fixed asset investment.

The China trade data is likely to show that the trade war with the US is having an effect. Exports and imports are both forecast to be down on a yoy basis. The trade surplus is forecast to rise a bit though, even as exports fall (slightly) faster than imports. Note that the series may not be consistent, because not all forecasters will forecast all variables.

The other data though are expected to show that the Chinese economy continues on its merry way without much disruption. Retail sales are expected to be up, while industrial production and fixed asset investment are expected to continue at about the same pace. Is that a testimony to the resilience of the Chinese economy or the creativity of Chinese statisticians? We’ll never know.

Britain has a number of important indicators out during the week as well. On Monday it’s short-term indicator day, with the monthly GDP data, industrial production and the trade figures. And then Tuesday we get the UK employment data.

The GDP data is expected to show yet another month of contraction, while the 3m/3m change is also expected to slow. 

The outlook for UK growth is bleak. The 3m/3m change in GDP tends to track the UK composite PMI, but the two have diverged recently. In my view, the odds are that the GDP figures will start to follow the PMI, not that the PMI will start to follow the GDP.

Elsewhere, Japan releases its current account balance on Monday and producer prices and core machinery orders on Wednesday.

There’s only one major central bank meeting during the week: the Swiss National Bank (SNB) on Thursday. The SNB is structurally boring nowadays, because on the one hand they can’t start to raise rates until the European Central Bank does for fear of causing the already overvalued CHF to strengthen further. On the other hand, their interest rates are already the lowest in recorded human history, so although they say there’s more that they can do, their options are limited indeed. They could start intervening in the FX market again, as they threatened, but so far no evidence of that happening.

The graph suggests that there has been some change in rate expectations in Switzerland, namely that the market expects further loosening in a year or two. But be sure to note the scale:  the difference between the 2-year yield now and three months ago is just 12 bps, or half a rate cut. This may be in line with ECB President Draghi’s comment that the next move in ECB rates is more likely to be down than up.

In any event, I don’t expect any major change in policy or stance at this meeting and so it should be neutral for CHF.


Market data for 7 June

Data as of 05:30 GMT


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Marshall Gittler

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