Two Preconditions of Fed Tightening Evident in Last Week’s Data

The Yellen Fed is wary of tightening too soon. It wants to see significant improvement in labor markets. (We’re seeing it.) It also wants to see evidence that U.S. inflation has formed a bottom. This precondition for a tighter Fed policy is also being fulfilled – CPI inflation has been steady and slow…but not slowing.

U.S. Economic Activity Looks Good

  • Initial unemployment claims dropped to 284k, the first reading this cycle below 300k and the lowest since early 2006. These are boom-time readings, not recovering economy readings.
  • CPI came in at 2.1% y/y; Core was 1.9%.
  • About 200 S&P 500 companies have reported so far; more than 70% (slightly better than average) have beaten consensus.
  • The Chicago Fed National Activity Index, a gauge of economic activity, was slightly above-trend.
  • The Markit U.S. manufacturing PMI softened a bit, to 56.3…still strong (50 is break-even).
  • The Richmond Fed’s manufacturing index (zero is break-even) rose from 4 to 7–solid; hiring was notably strong.
  • The Kansas City Fed manufacturing index rose from 6 to 9, lifted by durable goods producers and employment. Rising quit rates particularly among machinists and welders were cited.

Home Sales are OK. Price Appreciation Continues to Decelerate

  • Existing home sales rose to a 5.04 mm Seasonally Adjusted Annual Rate (SAAR) in June, above expectations, but still down 2.3% year over year (y/y). That said, the share of sales which are foreclosures and short sales is down from 15% one year ago to 11%.
  • New home sales fell to a very disappointing 406k SAAR (-11.5% y/y) and May was revised lower. The value of new homes built/sold is part of GDP; when existing homes sell, it’s only the commissions, fees, etc. that are counted.
  • The median existing home price was $223,000, up 4.3% y/y
  • The median new home price was $273,500, up 5.3% y/y.
  • Federal Housing Finance Agency (FHFA) home price index appreciation slowed to 5/5% y/y.

SEC Tightened Rules on Money Market Funds
The SEC dropped the hammer on institutional money market funds last week, when it voted 3-2 to force the funds (aggregate assets of $2.4 trillion) to move to floating net asset values.

European Economics
The UK continues to lead the mainland. UK GDP (3.1% y/y preliminary) has investors watching the Bank of England (BoE). The BoE left rates unchanged, but is widely expected to start raising rates before the Fed.

  • Spanish unemployment rate fell to 24.5%, the lowest level in two years.
  • Eurozone flash manufacturing (51.9) and services (54.4) PMIs were solid. France (49.4) continues to struggle.
  • On the downside: the monthly German Ifo business climate index slid further, its third consecutive decline.

Despite its Known Flaws, the Euro Retains Some Appeal
On January 1, 2015, Lithuania will join the Eurozone, dropping its currency and adopting the euro. Lithuania will represent about 1% of Eurozone GDP. Apparently, Lithuania fears the Russians more than the euro.

Japan: Moving from Deflation to Stagflation?

  • Flash July manufacturing PMI slid from 51.5 to 50.8.
  • The Japanese government downgraded its growth outlook for the fiscal year ending March 31, 2015 from 1.4% to 1.2%, citing weak exports and the tax increase.
  • The trade deficit hit a record high in the first half of 2014, hurt by higher energy imports, a weaker yen, and disappointing exports (-2% y/y).
  • Headline CPI was up 3.3% y/y. The sales tax is temporarily boosting Japanese CPI and energy is up around 10% y/y.; underlying core inflation excluding the impact of the sales tax hike is just over 1%.

Last Week in The Capital Markets

  • Currencies: The dollar was up about ½% against the yen and euro. Key Emerging Market currencies (including the Yuan) generally rise modestly against the dollar.
  • Bonds: The 10-year Treasury yield ended down 2 basis points (bps) to 2.48; the 10-year TIP yield fell 6 bps to 0.20%. The BoA Merrill Lynch High Yield Index fell 3bps to 3.75%. German 10-year Bund yields were unchanged at 1.15%; Japanese 10-years hit new cycle lows, ending down 2bps to 0.52%.
  • U.S. Equities: The S&P 500 Index hit new highs Wednesday and Thursday before selling off Friday, ending the week flat. Over the week, Energy, Information Technology, and Health Care (each up 0.7-0.8%) led; the Consumer Discretionary sector (-1%) lagged. Amazon was down 10%; Facebook was up 10% and Apple was up 3%.
  • International Equities: MSCI AC World Index was up 0.4%. MSCI Emerging Markets Index (+1.5%) led, followed by MSCI Japan (+0.9%) and MSCI Europe (0.6%); the U.S. lagged.
  • Commodities: WTI oil fell 1% to $102. An aside for contrarians: inventories at Cushing, OK are at a six-year low. Gold fell 1% to $1,295.

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

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About Sam Wardwell

Sam Wardwell, CFA, is Senior Vice President and Investment Strategist at Pioneer Investments. He joined Pioneer in 2003.
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