The Fed is Playing Hamlet to the Markets

To taper or not to taper—that is the question the Fed is asking itself. What’s moving the market is (it appears) the odds of Fed action. For the first half of last week, “good news was bad news” as stock and bond markets apparently interpreted better economic data as suggesting an earlier QE (Quantitative Easing) Taper. On Friday, the market apparently decided the jobs report was good enough to further reduce downside risks to the economy but not strong enough to spur the Fed to action.

Last week’s labor market reports were solid but not so good that a December taper must be priced in

  • Wednesday’s employment report published by ADP hinted at a strong government report Friday . . . it didn’t disappoint.
  • Payroll employment rose 203k and net revisions to prior months added another 8k.
  • Over the last year, full-time employment is up 1.3 million. Part-time employment is flat.
  • The unemployment rate dropped to from 7.3% to 7.0%, but the drop was exaggerated by federal employees returning from the government shutdown; pre-shutdown the rate had been 7.2%.
  • Initial unemployment claims fell to 298k in the Thanksgiving week good, but subject to holiday distortions.

Q3 real GDP growth was revised up from 2.8% to 3.6% . . . not as good as it looks, but certainly not bad

  • Much of the upward revision was due to higher inventories, which doesn’t directly signal future strength. Excluding inventory growth, GDP growth would have been only 1.9%, but the inventory-to-sales ratios remain low. The reason: service sector growth is slow. But sale of goods are rising as fast as inventories, so this inventory growth doesn’t signal a need for future production cutbacks.
  • U.S. after-tax corporate profits were up 2.8% in Q3 and 5.8% year over year (y/y).

The Fed Beige Book showed the economy continuing to expand at a modest-to-moderate pace

  • Seven Fed districts see growth as “moderate” while five characterize growth as “modest.”
  • Seven districts described unchanged labor market conditions; five districts saw improvement.
  • Concern about future cost increases attributable to the Affordable Care Act and other federal regulations were cited, but price inflation was generally seen as well-contained.

November manufacturing reports point to continuing economic strength

  • The ISM Purchasing Managers Index (PMI) posted its fifth consecutive monthly gain, hitting 57.3 (highest since April 2011) on strong new orders and backlogs; the employment component rose to 56.5.
  • The ISM non-manufacturing PMI faded from 55.4 to 53.9, weaker than expected, but the underlying details were generally robust.
  • Global PMIs are generally strong (broad global expansion) but lower than U.S. levels (we’re leading).

Inflation remains MIA (Missing in Action). Housing data so-so

  • The GDP price deflator rose at a 2.0% annual rate in Q3 but was up only 1.3% y/y.
  • Core PCE inflation was 1.1% y/y.
  • October new home sales rebounded from September weakness; they’re up 22% y/y.
  • Purchase mortgage applications fell 4%.

Some encouraging sign for consumers spending

  • The BEA reported that lower proprietors’ farm income pulled personal income down 0.1% in October after solid gains in the two prior months; personal consumption expenditures ticked up.
  • The University of Michigan consumer sentiment index jumped from 75.1 to 82.5. Both the current conditions and expectations components were strong.
  • Consumer credit card debt rose for the first gain since May.
  • Vehicle sales jumped 7.7% m/m to a 16.3 million SAAR (seasonally adjusted annual rate).

Washington watch: waiting

  • Congress watch: December 13 non-binding target date for budget agreement; January 15: shutdown if no deal; February 7: debt ceiling deadline.
  • The House will recess for the year on December 13. Rumors are circulating that there might be a budget deal by then.
  • The Fed, the CFTC and the FDIC will vote on the Volcker rule next week. The SEC will probably also act.
  • Next Fed meetings are December 17-18, January 28-29 (Bernanke’s term ends on January 31)
  • Extended unemployment benefits are due to expire on December 31. 1.3 million people would see the benefits end immediately; another 0.9mm would see their benefits end during Q1.

Detroit can cut pension benefits, bankruptcy judge rules

  • A U.S. bankruptcy judge ruled (a) that Detroit is eligible for bankruptcy protection and (b) that U.S. bankruptcy law trumps the Michigan state constitution… pension benefits can be reduced in a bankruptcy proceeding.
  • Comment: this is a major positive for municipal bond markets: would be much worse if all the shortfalls hit bondholders

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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