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Markets End Quarter on a Choppy Note  

June 30, 2017 

**An unexpected decline in U.S. orders for business equipment in May indicates cooling capital-goods investment may weigh on second-quarter economic growth, Commerce Department data showed Monday. Orders for non-military capital goods excluding aircraft fell 0.2% (the estimate was for a 0.4% gain) after a 0.2% increase in the prior month. Shipments of those goods, which are used to calculate gross domestic product, fell 0.2% after 0.1% gain the prior month. Bookings for all durable goods fell 1.1% (the estimate was for a 0.6% drop) following 0.9% decline in the previous month.   Excluding transportation equipment demand, which is volatile, orders rose 0.1% (the estimate was for a 0.4% gain). The broad slowdown in equipment orders and shipments raises the risk that business investment will provide less of a boost than anticipated to the economic rebound this quarter, leaving the heavy lifting to household spending. The outlook for capital-goods production is clouded by cooling automobile sales, while overseas markets -- though improving -- are yet to show the kind of demand acceleration that would spur exports of U.S. made goods. In addition, some companies may be waiting for clarity on more favorable tax policies from Congress before stepping up investment. 

We had a couple of Fed governors giving speeches this week with comments that were worthy of note. New York Fed President William Dudley indicated that easier financial conditions support the Fed tightening policy. A muted market response to plans to shrink Federal Reserve’s balance sheet “suggests that these communications have generally been effective in fostering an orderly adjustment in expectations about how we are likely to normalize our balance sheet,” he went on to say. “Monetary policymakers need to take the evolution of financial conditions into consideration,” Dudley said in remarks delivered Sunday at the Bank for International Settlements’ Annual General Meeting, in Basel, Switzerland and posted online Monday. “For example, when financial conditions tighten sharply, this may mean that monetary policy may need to be tightened by less or even loosened. On the other hand, when financial conditions ease, as has been the case recently, this can provide additional impetus for the decision to continue to remove monetary policy accommodation.” Additionally, Federal Reserve policy maker John Williams also spoke this week indicating he sees interest rates rising as inflation moves up. He made the case Monday for further gradual increases in interest rates, saying he expects inflation to rise to the central bank’s 2 percent target next year as unemployment edges lower. “Gradually raising interest rates to bring monetary policy back to normal helps us keep the economy growing at a rate that can be sustained for a longer time,” Williams said in remarks prepared for delivery at the University of Technology Sydney. The comments by the president of the Federal Reserve Bank of San Francisco suggest that he’s lining up with Fed Chair Janet Yellen, his predecessor at the bank, in an emerging debate on how to respond to an easing in inflation during the last few months. While some Fed officials have argued for a pause in the rate-hiking campaign to wait for clearer signs that inflation is indeed headed higher, Yellen has played down the significance of recent weak price data and suggested that the Fed remains on course for higher rates. Williams seemed to agree. “Some special transitory factors have been pulling inflation down,” he said. “But with some of these factors now waning, and with the economy doing well, I expect we’ll reach our 2 percent goal sometime next year.” 

Those special factors include a steep drop in the cost of mobile-phone services. That helped pull down the Fed’s favorite inflation gauge to 1.7 percent in April from 1.9 percent in March and 2.1 percent in February. Williams also saw a danger in the Fed allowing the unemployment rate to fall too far. “The very strong labor market actually carries with it the risk of the economy exceeding its safe speed limit and overheating, which could eventually undermine the sustainability of the expansion,” he said. At 4.3 percent in May, the U.S. jobless rate was already below what Williams thinks is its long-run sustainable rate of 4.75 percent. And he sees it dropping some more. “Given the strong job growth we’ve been seeing in the United States, I expect the unemployment rate to edge down a bit further and remain a little above 4 percent through next year,” Williams said. The Fed earlier this month raised interest rates for the second time this year. Policy makers have penciled in one more rate increase for 2017 and three more for 2018, according to projections released after their June 13-14 meeting. Williams is not a voting member of the Federal Open Market Committee this year but will vote in 2018. Williams affirmed the Fed’s intention to begin trimming its $4.5 trillion balance sheet this year, saying the central bank would start off “nice and easy.” The aim will be to gradually reduce bond holdings in a widely telegraphed and predictable fashion, he said. “I hope I’ll not be perpetuating an unfair stereotype about economists if I say that ‘boring’ is a virtue,” Williams said. “Indeed, my new mantra is, ‘Boring is the new exciting.’”  It’s nice to see a Fed governor with a sense of humor! 

In European Central Bank news, Mario Draghi called for continued euro-area stimulus this week even as the economy enters a new phase in its upturn, saying support is still needed to entrench the trend. “All the signs now point to a strengthening and broadening recovery in the euro area -- deflationary forces have been replaced by reflationary ones,” the European Central Bank president said on Tuesday in Sintra, Portugal. “However, a considerable degree of monetary accommodation is still needed for inflation dynamics to become durable and self-sustaining. So for us to be assured about the return of inflation to our objective, we need persistence in our monetary policy.” The comments at the annual ECB Forum reflect the intensifying public debate over whether the central bank should continue pumping liquidity into the financial system after more than four years of economic growth and improving resilience.  Policy makers didn’t use their latest policy meeting to discuss whether to wind down their 2.3 trillion-euro ($2.6 trillion) bond-buying program, which is scheduled to run until the end of this year, meaning investors may get relatively short notice of any change. The euro jumped as Draghi said that most factors damping inflation are temporary. The Governing Council used its June 8 meeting to say that risks to growth are now broadly balanced instead of tilted to the downside, and dropped its expectation that interest rates might be cut again. Draghi acknowledged that further changes in the policy stance are coming, but said they should be slow. “In the past, especially in times of global uncertainty, volatility in financial market prices has at times caused an unwarranted tightening of financial conditions,” he said. “So in the current context where global uncertainties remain elevated, there are strong grounds for prudence in the adjustment of monetary-policy parameters, even when accompanying the recovery. Any adjustments to our stance have to be made gradually, and only when the improving dynamics that justify them appear sufficiently secure.” The ECB president did leave room for policy steps that would signal a reduction in the pace of stimulus, without necessarily tightening financial conditions. That could encourage more hawkish members of the Governing Council to push for action. “As the economy continues to recover, a constant policy stance will become more accommodative,” Draghi said. “The central bank can accompany the recovery by adjusting the parameters of its policy instruments -- not in order to tighten the policy stance, but to keep it broadly unchanged.” We respect Mario Draghi and his position – traders seem to also have a great deal of confidence in his ability to lead the central bank. 

In other European news, euro-area economic confidence jumped to the highest level in a decade as the European Central Bank edged toward unwinding unprecedented stimulus. An index of executive and consumer sentiment rose to 111.1 in June from 109.2 in May, the European Commission in Brussels said Thursday.  The reading is the strongest since August 2007 and compares with a median estimate of 109.5 in a Bloomberg survey of economists. The report comes two days after ECB President Mario Draghi confounded investors by arguing that there’s room to adjust stimulus measures as the economy improves, even though he called for prudence and patience.  A gauge for private-sector activity signaled the euro-area economy recorded its fastest expansion in six years in the second quarter as business confidence in Germany hit a record and consumer sentiment in France surged. 

The job market continues to boost U.S. consumer confidence as expectations rise. An unexpected rebound in U.S. consumer confidence reflects a buoyant labor market and improved business conditions, though Americans are slightly less optimistic about where things will be in six months, data from the New York-based Conference Board showed Tuesday. The Confidence index rose to 118.9 (the estimate was for 116) from 117.6 in May. The present conditions measure increased to 146.3, highest since July 2001, from 140.6 the prior month. The gauge of consumer expectations for the next six months fell to 100.6, the lowest level since January, from 102.3 the previous month. Americans are drawing encouragement from an economy that continues to provide jobs, rising stock and home prices and steady pay gains, as the share of respondents expecting higher incomes was the second-highest since 2002. At the same time, the easing of the overall expectations index adds to other sentiment figures that suggest mounting skepticism about the ability of Washington lawmakers to enact economic policies that will drive growth. “Expectations for the short-term have eased somewhat, but are still upbeat,” Lynn Franco, director of economic indicators at the Conference Board, said in a statement. “Overall, consumers anticipate the economy will continue expanding in the months ahead, but they do not foresee the pace of growth accelerating.” 

Sustained increases for home prices in 20 U.S. cities in April indicate the housing industry is juggling stable demand with a shortage of inventory, figures from S&P CoreLogic Case-Shiller showed Tuesday. The 20-city property values index rose 5.7% year-over-year (the estimate was for a 5.9% gain). The national price gauge increased 5.5% year-over-year. The seasonally adjusted 20-city index climbed 0.3% month-over-month (the estimate was for a 0.5% increase). Stubbornly low inventory in housing, particularly for more affordable properties, has helped drive steady home-price gains. While rising property values are helping cushion homeowners’ balance sheets, they also are inhibiting lower-end buyers, especially first-timers, from getting a piece of the action, as wage gains haven’t kept pace. At the same time, industry demand remains healthy, with solid job gains and low mortgage rates supporting purchases. “Since demand is exceeding supply and financing is available, there is nothing right now to keep prices from going up,” David Blitzer, chairman of the S&P index committee, said in a statement. “The supply of homes for sale has barely kept pace with demand and the inventory of new or existing homes for sale shrunk down to only a four-month supply. All 20 cities in the index showed year-over-year gains, led by a 12.9 percent advance in Seattle and a 9.3 percent rise in Portland, Oregon.  

The U.S. economy’s first-quarter growth was less tepid than previously reported, as consumer spending and trade added more to expansion, Commerce Department data showed Thursday. Gross domestic product rose at a 1.4% annualized rate (the forecast and previous estimate were for 1.2%). Consumer spending, the biggest part of the economy, rose 1.1% (the forecast and previous estimate were for 0.6%). Exports grew at a 7% rate, which was revised up from the prior estimate of 5.8% growth. While the revision was more positive than most analysts anticipated, the report still underlines a relatively weak start to the year, with consumer spending growing at the slowest pace since 2013.  Weather and other temporary factors in the period, along with rising wages and salaries, support the idea of a consumer-led rebound in the second quarter.  Federal Reserve policy makers raised interest rates earlier this month, seeing the first-quarter slowdown as transitory as the labor market improves further. The Commerce Department attributed the latest upward revision to spending data for financial services, insurance and health care.  Exports of industrial supplies and materials were higher than previously reported, boosting trade’s contribution to expansion in the period. Analysts estimate the U.S. economy will grow at a 3 percent rate in the April-to-June period, though the slowdown in equipment orders and shipments reported earlier this week raises the risk that business investment will provide less of a boost than anticipated.  Cooling automobile sales and a housing sector limited by a scarcity of affordable homes also remain headwinds for the economy this year. 

As always, stay tuned!

Markets Steady As Government Shutdown Looms

Temporary government funding runs out at midnight Friday and the House and Senate are seeking an agreement on a temporary extension.  Democrats are demanding that spending legislation include a provision permanently shielding about 690,000 undocumented immigrants brought to the U.S. as children from deportation, while Republican want to keep that issue separate from funding and budget negotiations.  Senate Democrats were poised on Friday to block a bill to stave off a government shutdown at midnight, as the stalemated debate over the budget and immigration defied quick resolution.  The House voted 230-197 Thursday night to pass a short-term funding measure that would keep federal operations running through Feb. 16 while Democrats, Republicans and the White House negotiate on a budget for defense and domestic programs and legislation to protect some undocumented immigrants from deportation.  The Senate took an initial vote to advance the bill late Thursday, but was headed toward an additional procedural step on Friday requiring 60 votes that Democrats say they will be able to thwart.  At least two Republicans have said they would join in opposition to the House-passed bill.  Senate Republican leaders vowed to keep repeatedly seeking votes to reconsider the legislation.  “Then we will see how many times Democrats will vote to shut down the government,” Texas Senator John Cornyn, the second-ranking Republican in the chamber, said.  Senate Democratic leader Charles Schumer joined some other senators, including Republican Jerry Moran of Kansas, in advocating passage of a very short-term spending measure that would provide funding for only a few days or a week while differences are negotiated.  House members dismissed that idea earlier in the day Thursday, and they are scheduled to be in recess next week.  Republicans and Democrats cast blame on each other for the predicament, and there’s no clear way out because members of the House and Senate are making a variety of demands in exchange for their votes.  Welcome to business as usual in Washington DC! 

We had limited economic data released in this Holiday shortened trading week as company earnings season kicks in. 

The preliminary University of Michigan consumer sentiment survey for January fell to 94.4 versus the estimate for 97 and 95.9 in the prior month.  The current economic conditions index fell to 109.2 vs. 113.8 last month while the expectations index rose to 84.8 vs. 84.3 last month.  The tax overhaul was “spontaneously” mentioned by 34% of respondents, 70% of whom said the impact would be positive and 18% of whom thought it would be negative.  60% of respondents said that the pace of economic growth had recently improved in early January.  While the majority expected good economic times during the year, ahead, half of all consumers anticipated a growth slowdown during the next five years.  Also, 72% of consumers anticipated higher interest rates during the year ahead, up from 69% in the prior three months but below the 2017 peak of 77% recorded in April. 

U.S. filings for unemployment benefits plummeted to the lowest level in almost 45 years in a sign the job market will tighten further in 2018, Labor Department figures showed Thursday.  Jobless claims decreased by 41k to 220,000 compared to the estimate for 249,000.  That was indeed the lowest level since Feb. 1973 and the biggest weekly drop since April 2009.  The four-week average of initial claims, a less-volatile measure than the weekly figure, fell to 244,500 from the prior week’s 250,750.  The drop in claims shows that companies are increasingly holding on to their employees amid a shortage of skilled labor.  Businesses are struggling to find workers to fill positions, particularly in manufacturing and construction, as cited in some anecdotes for the Federal Reserve’s Beige Book released Wednesday.  The figures suggest the unemployment rate of 4.1 percent, already the lowest since 2000, could be poised to decline further.  The latest week for claims includes the 12th of the month, which is the reference period for the Labor Department’s monthly employment surveys.  Caveats for the latest numbers include the fact that the week was sandwiched between two periods containing holidays, when data tend to be more volatile.  In addition, more states than usual had estimated figures. 

The benchmark Treasury yield rose to the highest level in more than three years, extending a selloff in the world’s largest-debt market that began last September.  The 10-year yield climbed to as high as 2.6407 percent Friday, a level unseen since September 2014, from 2.6256 percent.  Flows were skewed toward selling, with dip-buying demand muted given recent price action and decent volumes in cash and futures.  Yields on U.S. debt have been rising on the prospects of more Federal Reserve rate hikes and increased government debt issuance to finance America’s widening budget deficit.  President Donald Trump’s plan to release his infrastructure proposal as early as January and a rally in oil prices to a three-year high have also boosted growth and inflation expectations.  The U.S. two-year yield has been climbing since September and on Jan. 12 topped 2 percent for the first time since 2008, reflecting expectations for Fed policy tightening.  Longer-term yields are on a gentler slope, a function of inflation struggling to meet the Fed’s 2 percent target.  The long end has also been weighed down by low rates elsewhere, which have enhanced the appeal of U.S. debt.  The result has been a marked flattening of the yield curve - seen by some as a potential harbinger of economic weakness. 

The Federal Reserve is working to relax a key part of post-crisis demands for drastically increased capital levels at the biggest banks, according to people familiar with the work, a move that could free up billions of dollars for some Wall Street’s giants.  Central bank staffers are rewriting the leverage-ratio rule - a requirement that U.S. banks maintain a minimum level of capital against all their assets - to better align with a recent agreement among global regulators, said two people who requested anonymity because the process isn’t public.  The people said the Fed effort is drawing opposition from the Federal Deposit Insurance Corp., an agency with authority over banking rules that’s still led by a Barack Obama appointee.  Spokesmen for the Fed and the FDIC declined to comment, as did a spokesman for the Office of the Comptroller of the Currency, another banking regulator involved in the discussions.  In December, U.S. regulators agreed with their overseas counterparts to set a new leverage-ratio standard representing a minimum level for member countries of the Basel Committee on Banking Supervision.  The change could increase capital demands for some European institutions but is less stringent than what the U.S. adopted after the crisis.  U.S. regulators are now aiming to scale back part of their existing ratio and add a new surcharge that would still leave overall capital requirements lower than they are now, the people said.   

U.S. banking watchdogs have largely been taken over by appointees of President Donald Trump, who argues that deregulation will free banks to provide credit needed to boost economic growth.  Key Trump appointees include Randal Quarles, the Fed’s vice chairman for supervision, and Joseph Otting, head of the OCC.  Fed Governor Jerome Powell - Trump’s nominee to replace Chair Janet Yellen - spoke in support of recalibrating the leverage ratio months before the Basel committee took action, a move he said “could help to reduce the cost that the largest banks face.”  Even slight changes could have a big impact on firms including Morgan Stanley, and custody banks such as State Street and Bank of New York Mellon.  Work on a proposal is proceeding quickly at the Fed, one of the people said, and it could represent an easier path for banks to win relief than relying on a politically divided Congress to pass legislation revising the leverage ratio.  The Treasury Department has also tried to get into the act, suggesting in a June report that Wall Street should get a break on some parts of the requirement - such as letting banks exempt certain assets from their leverage ratio calculations, including cash on deposit with the Fed.  Complex capital rules generally need approval from the Fed, the FDIC and the OCC.  While the OCC is said to be cooperating with the Fed’s work, the FDIC is still led by Martin Gruenberg, an Obama administration holdover who has said changes to the capital rules will weaken the industry. 

U.S. factory production rose for a fourth straight month in December, capping the strongest quarter since 2010 and underscoring a resurgence in manufacturing that’s primed for further advances, Federal Reserve data showed Wednesday.  Factory output rose 0.1% versus the estimate for a 0.3% gain after rising an upwardly revised 0.3% last month.  Total industrial production, which also includes mines and utilities, increased 0.9% versus the estimate for a 0.5% rise after a revised 0.1% decrease the prior month.  Capacity utilization, measuring the amount of a plant that is in use, rose to 77.9% compared to the estimate for 77.4% from 77.2% the previous month.  The smaller-than-expected December gain in manufacturing output reflected a 0.1 percent drop in production of nondurable goods, including petroleum and chemicals.  Output of durable goods rose a solid 0.3 percent.  Factory output increased at a 7 percent annualized rate in the fourth quarter, the strongest since the second quarter of 2010.  Combined with national and regional surveys of purchasing managers, the figures indicate manufacturing was robust at the end of the year.  Stronger consumer spending, increased business investment and more shipments of merchandise to overseas customers are providing plenty of fuel for the nation’s producers.  What’s more, the lowest business inventory-to-sales ratio in three years could translate into increased production in coming months. 

As always, stay tuned!

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  • Tax Changes Approved
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