ADP employment expected to show another strong report
Unemployment claims remain elevated over holidays
Rise in inflation expectations to 2% will keep Fed in a hawkish mood in 2018
Weekly EIA report
ADP employment expected to show another strong report — The market consensus is for today’s Dec ADP employment report to show a solid increase of +190,000, matching Nov’s report of +190,000. The expected report of +190,000 would be a little weaker than the 12-month trend increase of +201,000. Payrolls are evening out after the hurricane disruptions that produced a weak +96,000 report in September and a partial offset with a strong +235,000 report in October.
On the labor front, the market is mainly looking ahead to Friday’s Dec unemployment report. The consensus is for Dec payrolls to show an increase of +190,000, down from Nov’s +228,000 but stronger than the 12-month trend increase of +173,000. Payrolls showed a very weak report of +38,000 in September due to hurricane disruptions, but then rebounded with strong reports in Oct (+244,000) and Nov (+228,000).
The consensus is for Friday’s Dec unemployment rate to be unchanged from November’s 17-year low of 4.1%. The unemployment rate is already at the 4.1% level that the FOMC is forecasting for 2018-19 and is below the FOMC’s estimate of a long-run unemployment rate of 4.6%. Despite the tight unemployment rate, wages have yet to show any substantial gains. The consensus is for Friday’s Dec average hourly earnings report to be unchanged from Nov’s +2.5% y/y, which is below the 8-1/2 year high of +2.9% posted in Dec 2016. However, wages are likely to move higher in coming months since the labor market remains tight and since minimum-wage hikes took effect on Jan 1 in 18 states.
Unemployment claims remain elevated over holidays — The unemployment claims data is in generally good shape but is somewhat elevated due to holiday distortions. The initial claims series is +22,000 above October’s 44-year low of 223,000 and the continuing claims data is +75,000 above November’s 4-year low of 1.868 million. The consensus is for today’s initial claims report to show a -3,000 decline to 242,000 and for the continuing claims report to show a -18,000 decline to 1.925 million. The claims data in general continues to show a tight labor market in which businesses are holding on tightly to their employees.
Rise in inflation expectations to 2% will keep Fed in a hawkish mood in 2018 — The Fed’s preferred inflation measure, the PCE deflator, is still in a subdued state with the Nov PCE deflator at +1.8% y/y and the core PCE deflator at +1.5% y/y. However, the conditions appear to be ripe for upward pressure on inflation in 2018 and that is likely to force the Fed to make good on its current intention for three rate hikes in 2018.
There are several indications that higher year-on-year PCE deflator figures are coming. First, the deflator has shown strength in the past three months. On a 3-month annualized basis, the PCE deflator has risen by +3.1% and the core PCE deflator has risen by +1.8%, stronger than the year-on-year figures.
Second, there is upward pressure on prices at the producer level. The Nov final-demand PPI rose to a 6-year high of +3.1% y/y and the Nov core PPI rose to a 5-1/2 year high of +2.4% y/y. In addition, Wednesday’s ISM manufacturing prices-paid sub-index rose by +3.5 points to the high level of 69.0.
Third, inflation expectations have risen fairly sharply in the past several weeks with the 10-year breakeven rate on Wednesday reaching a new 9-1/2 month high of 2.01% and closing the day at 2.00%. The market is expecting inflation to average 2.0% over the next ten years, right on the Fed’s inflation target, even if the Fed is still looking backwards at the PCE deflator.
Inflation expectations have been pushed higher in part by the sharp +46% rally in oil prices seen since mid-2017. Feb WTI crude oil prices on Wednesday in fact rallied sharply to a new 2-3/4 year nearest-futures high of $61.97 and closed the day up +2.09%. Crude oil is moving higher on tighter global and U.S. crude oil inventories combined with geopolitical worries about the protests in Iran and about Saudi Arabia’s more belligerent policies.
Inflation worries and strong economic data have caused the markets to substantially boost market expectations for Fed tightening in 2018. The market has driven the Dec 2018 federal funds futures contract (in yield terms) sharply higher by more than +50 bp since mid-2017 to a contract high of 1.91% on Wednesday. The market is now expecting +53 bp worth of Fed rate hikes in 2018, which is +10 bp more than expectations seen just a month ago.
Rising expectations for inflation and Fed tightening in 2018 have been instrumental in pushing T-note yields higher. The 10-year T-note yield two weeks ago reached a 9-3/4 month high of 2.50% and is currently just below that high at 2.45%. We look for continuing upward pressure on T-note yields in coming weeks from inflation worries, strong economic data, and increased expectations for Fed tightening. We believe the market is underestimating the Fed’s rate-hike intentions for 2018 and that T-note yields will move higher as it becomes clearer that the Fed will make good on its forecast for three rate hikes to push the funds rate target up to +2.00%-2.25%.
Weekly EIA report — The market consensus for today’s weekly EIA report is for a -5.0 mln bbl decline in U.S. crude oil inventories, a +2.0 mln bbl rise in gasoline inventories, a +500,000 bbl rise in distillate inventories, and a -0.3 point decline in the refinery utilization rate to 95.5%. Crude oil inventories are now only +9.4% above the 5-year average, the tightest level in 3 years.