- Weekly market focus
- Transitory Q1 GDP report has little impact on Fed expectations
- U.S. ISM manufacturing index expected to show a back-to-back decline but remain relatively strong
- U.S. PCE deflator expected to cool
- U.S. markets await FOMC, payrolls, and French election
Weekly market focus — The markets this week will focus on (1) the Tue/Wed FOMC meeting where the odds are minimal at 13% for a rate hike, (2) Friday’s April payroll report (expected +190,000 after March’s weak +98,000), (3) this coming Sunday’s French presidential election where centrist Emmanuel Macron is heavily favored over far-right Marine Le Pen, (4) another heavy earnings week with reports from 128 of the S&P 500 companies, (5) whether Tuesday’s U.S. April vehicle sales report shows a rebound after March’s plunge and relieves some of the market concern about weak U.S. consumer spending, (6) the possibility of a U.S. government shut-down this Friday night if Congress does not approve new spending authority, and (7) comments by Yellen, Fischer, Evans and Williams this Friday that may provide some color on whether the Fed is writing off weak Q1 GDP as transitory and how quickly the Fed’s discussions are moving for balance sheet reduction. The European and Chinese markets are closed on Monday for the May Day holiday.
Transitory Q1 GDP report has little impact on Fed expectations — The federal funds futures curve last Friday was unchanged for the 2017 contracts and tightened slightly by 1-2 bp for the 2018-19 contracts after the Q1 GDP and ECI reports. Friday’s Q1 GDP report of +0.7% was mildly weaker than the market consensus of +1.0%. The weakness in Q1 GDP stemmed mainly from weak consumer spending, which eked out only a +0.3% increase versus the strong +3.5% pace in Q4.
Offsetting the already-expected consumer weakness, however, there was an upside surprise in business investment, which rose sharply by +10.4% and contributed a hefty +1.62 points to Q1 GDP. The report illustrated that businesses are finally spending again after the year-long earnings recession that ended in mid-2016. In addition, the Q1 GDP report would have been stronger at +1.6% had it not been for the -0.93 point GDP subtraction caused by inventories.
The markets are awaiting the Fed’s view of the Q1 GDP report, but it appears that the Fed plans to write off the Q1 report as the result of transitory factors. In fact, the Fed may now have even more to worry about due to the strength in business investment combined with Friday’s news that the Q1 employment cost index (ECI) surged to a 10-year high of +3.2% (q/q annualized). The rise in wages should help revive consumer spending and keep the Fed on its toes about inflation. If anything, last Friday’s news likely convinced the Fed that it needs to stick with its plan for two more rate hikes this year, assuming that consumer spending revives in Q2.
The market is discounting only a 13% chance of a rate hike at this week’s Tue/Wed FOMC meeting, but the odds rise to 70% for the following meeting on June 14. Fed Chair Yellen will not hold a post-meeting press conference this week and the FOMC will not release new macroeconomic forecasts or new Fed dots until its next meeting in June. The market is fully discounting the Fed’s next +25 bp rate hike by September and is discounting about a 50% chance for a second rate hike by December.
U.S. ISM manufacturing index expected to show a back-to-back decline but remain relatively strong — The market is expecting today’s Apr ISM manufacturing index to fall by -0.7 to 56.5, adding to March’s -0.5 point decline. Confidence is cooling a bit in the U.S. manufacturing sector due to the slow-moving Republican agenda and trouble in auto sales. Still, today’s expected ISM report of 56.5 would be a relatively strong level that indicates that manufacturing optimism still prevails.
The markets will also be carefully watching today’s April ISM new orders sub-index, which fell by -0.6 to 64.5 in March from Feb’s 10-1/2 year high of 65.1 but remained in strong shape. Today’s final-April Markit manufacturing PMI is expected to be left unrevised from the preliminary-April report of -0.5 points to 52.8, a report that supported expectations for a decline in today’s April ISM index.
U.S. PCE deflator expected to cool — Today’ s Mar PCE deflator is expected to ease a bit, which would give the Fed some breathing room to decide on the timing of its next rate hike. The consensus is for today’s March PCE deflator to ease to +1.9% y/y from Feb’s 5-year high of +2.1% y/y. Meanwhile, the March core PCE deflator is expected to ease to +1.6% y/y from Feb’s 4-3/4 year high of +1.8% y/y.
The PCE deflator, which is the Fed’s preferred inflation measure, is actually running hotter than it looks since the PCE deflator rose by +3.0% and the core deflator rose by +2.5% in the past three months (annualized). However, the markets are not particularly worried about inflation as seen by the fact that the 10-year breakeven inflation expectations rate is currently at 1.92%, down from the levels of higher than 2.00% seen earlier this year in the wake of the November election.
U.S. markets await FOMC, payrolls, and French election — Despite this week’s big news schedule, volatility remains low with the VIX at 10.82 and the TYVIX at 4.65. Stocks and T-note yields move higher early last week mainly because of centrist Emmanuel Macron’s favorable showing in the first round of the French presidential election on April 23. Stocks last week also received a boost from the strong Q1 earnings season. The T-note market will be cautious this week as it waits to see if the Fed releases any information on its balance sheet reduction discussions. The U.S. markets this week may be hesitant to do much ahead of this Sunday’s French presidential election as they wait for 100% assurance that Marine Le Pen will not be the next French president.
