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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!

Fed Governors Send Strong Signal March Rate Hike Likely

Federal Reserve Governor Jerome Powell said the case for a rate increase at the U.S. central bank’s March meeting has “come together,” joining the chorus of Fed officials signaling a hike is coming soon.  “We’re as close to our mandates as we’ve been in a very long time,” Powell said, speaking in an interview on CNBC on Thursday.  “The case for a rate increase in March has come together, and I do think it’s on the table for discussion.”  Powell said that he still sees three rate increases as appropriate for this year, though that outlook could change along with conditions in the economy.  Powell’s comments on Thursday were in line with or slightly stronger than his previous statements, including his Feb. 22 remarks that it would be appropriate to raise interest rates “fairly soon.”  The policy-setting Federal Open Market Committee meets on March 14-15 in Washington, and investors are looking for an increase at that gathering after New York Fed President William Dudley and Fed Governor Lael Brainard this week both expressed a newfound willingness to raise rates soon.  Brainard in particular is worthy of note as she has a great deal of influence and she has been dovish to this point.  Accelerating inflation, a stronger labor market, nascent wage gains and a relatively benign international outlook are giving Fed officials the confidence to advocate a faster path for rates this year.  The central bank expects to make three increases in 2017, based on its December economic projections.  If that happens, it would mark a pickup from the Fed’s one-a- year pace in 2015 and 2016.  The FOMC will give its new quarterly forecast in March.

We had a great deal of important economic news out this week on the U.S. economy so here is a summary of those updates.  The fewest Americans in almost 44 years filed applications to collect unemployment benefits last week, indicating the job market continues to power forward.  Jobless claims fell by 19,000 to 223,000 in the week ended Feb. 25, the fewest since March 1973 and below the lowest projection in a Bloomberg survey of economists, a report from the Labor Department showed Thursday.  The median forecast called for 245,000 applications.  The weekly decline, which was the largest this year, shows employers are keeping dismissals at a minimum as demand remains steady and the labor market stays tight.  Federal Reserve policy makers will take persistent job growth and falling separations into consideration at their monetary policy meeting later this month.

Pending home sales, which reflect contract signings, declined in January as affordability became an issue for potential buyers.  A pickup in mortgage rates since the November election, higher home prices and fewer properties to choose from are limiting progress in residential real estate.  At the same time, steadily increasing wages and a growing economy remain sources of support.  Contracts to buy previously owned U.S. homes, released by the National Association of Realtors in Washington, dropped 2.8 percent (the forecast was for a 0.6 percent advance), which was the most since May.  Contract signings rose 0.8 percent in December, revised down from a previously reported 1.6 percent gain.  The index increased 2.7 percent from January 2016 on an unadjusted basis.

Orders for U.S. durable goods rebounded in January, a sign companies remained upbeat at the start of the year.  Bookings for goods meant to last at least three years rose 1.8 percent after a 0.8 percent decrease in December, Commerce Department data showed Monday.  Bookings for non-military capital goods excluding aircraft -- a proxy for future business investment -- unexpectedly fell 0.4 percent after a 1.1 percent jump in the prior month that was larger than previously estimated.  Before January, demand for business equipment had shown marked improvement as companies grew more upbeat about the economy’s prospects and global markets began recovering.  Faster growth, along with corporate tax reform and reduced regulations may spur investment, which has been a laggard during the current economic expansion.  Even with the latest decline, bookings for capital equipment increased at an 8.9 percent annualized pace over the three months ended in January, the fastest since 2014.  Such investment includes machinery, computers and communications gear.

The U.S. economy grew in the fourth quarter at a 1.9 percent pace, unchanged from an initial estimate, as slower investment by businesses and state and local agencies offset stronger household purchases.  The gain in gross domestic product, the value of all goods and services produced, was smaller than the median forecast in a Bloomberg survey for a 2.1 percent annualized rate.  Consumer spending, the biggest part of the economy, rose 3 percent, more than projected, Commerce Department data showed Tuesday in Washington.  The results reinforce the leading role that consumers continue to play in the current expansion, helped by a tight job market, low borrowing costs and rising confidence.  Optimism that President Donald Trump will lower taxes, reduce regulation and rebuild infrastructure may also encourage businesses to step up investment this year, contributing to growth.  Economists’ growth estimates ranged from 1.7 percent to 2.6 percent.  The GDP release is the second of three for the quarter, with the third scheduled for late March, when more information is available.  The economy expanded at a 3.5 percent pace in the third quarter.

Home prices in 20 U.S. cities rose in the 12 months through December at the fastest pace in almost a year, while nationwide the gain in values was the biggest since 2014, according to S&P CoreLogic Case-Shiller data reported Tuesday.  The 20-city property values index advanced 5.6 percent from December 2015 (the forecast was 5.4 percent) after climbing 5.2 percent in the year through November.  The national home-price gauge climbed 5.8 percent in the 12 months through December, the most since June 2014 while the seasonally adjusted 20-city measure rose 0.9 percent from a month earlier (the forecast was 0.7 percent).  A limited number of listings is keeping home values elevated as buyers compete for properties. 

The consumer comfort rose to an almost 10-year high in the final week of February on increased optimism about the U.S. economy and more favorable views about personal finances and the buying climate, the weekly Bloomberg Consumer Comfort Index showed Thursday.  The consumer comfort index climbed to 49.8, the highest since March 2007, from 48 the prior week.  This gauge has increased in four of the past five weeks while the personal finances measure rose to 59, the highest level since July, from 56.4 the prior week.  The gauge of economic views increased to 46.8, strongest since March 2007, from 45.2 while the buying-climate index improved to 43.7, the highest since April 2015, from 42.5 the prior week.  Confidence extended its significant climb that began after the inauguration of President Donald Trump.  While some respondents are embracing his plans to reduce taxes and boost the economy, the highest sentiment reading for full-time workers in 16 years shows Americans are also taking comfort in brighter employment prospects.  Still, a report Wednesday that showed higher inflation is chipping away at personal incomes and indicates that faster wage growth is needed to drive bigger gains in consumer spending.

In European news, euro-area output rose to the highest level in almost six years in February as growth in the region’s top four economies accelerated.  A composite Purchasing Managers’ Index climbed to 56.0 from 54.4 in January, putting the currency bloc on track for quarterly growth of 0.6 percent, IHS Markit said on Friday.  The reading is in line with economist forecasts and a previous flash estimate.  Output was led by manufacturing, according to the London-based company.  A gauge for services activity also strengthened.  “The final PMI numbers paint a bright picture of a euro- zone economy starting to fire on all cylinders,” said Chris Williamson, chief business economist at IHS Markit.  Strengthening growth in Germany, France, Italy and Spain “suggest an increasingly sustainable and robust-looking upturn.”  The European Central Bank has decided to continue buying assets until at least the end of 2017, supporting the region’s firming recovery amid political risks.  While inflation -- currently at 2 percent -- and a slew of economic indicators have signaled the economy might be more robust than projected, ECB President Mario Draghi has pointed to underlying weakness as evidence that stimulus is still necessary.  The Governing Council will convene in Frankfurt on March 8-9.

Euro-area inflation accelerated to the fastest pace since January 2013, providing fresh arguments to those calling for an exit from the European Central Bank’s monetary stimulus program.  Consumer prices rose 2 percent in February from a year earlier, the European Union’s statistics in Luxembourg said Thursday.  That matched the median estimate of 47 analysts surveyed by Bloomberg.  The rate was 1.8 percent in January.  Rising oil prices have been pushing up inflation across the euro area, including in Germany, its largest economy, Spain and Italy.  Meanwhile, the euro area’s core inflation, which strips out volatile elements such as energy was unchanged for the third consecutive month in February at 0.9 percent.  The divergence between the two inflation indicators highlights the challenges facing the ECB in choosing the right amount of monetary stimulus.  While headline inflation is moving upward in line with the central bank’s goal of a rate below but close to 2 percent, the persistent weakness of core inflation is a source of concern for officials including ECB President Mario Draghi.  The euro-area unemployment was unchanged at 9.6 percent in January, the lowest since May 2009, statistics agency Eurostat said in a separate release Thursday.  In the same month, producer prices in the 19-member bloc rose 0.7 percent from December when they had increased 0.8 percent.

As always, stay tuned!

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