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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!

Economic Data Begins to Feel the Impact from Hurricane Harvey and Irma

Our thoughts and prayers are with those and for those in Florida and the other states impacted by Hurricane Irma.  

Consumers in Texas and Florida are expected to boost U.S. car and truck purchases late this year and into 2018 after an initial sales drag from hurricanes Harvey and Irma.  Without the bump from buyers needing to replace damaged vehicles, the U.S. auto market was at risk of dipping below 17 million units this year, according to LMC Automotive.  The researcher now expects deliveries to exceed that threshold and has raised its 2018 outlook for new light-vehicle sales in the U.S. by about 100,000 to 17.1 million.  The U.S. market may see an increase of about 160,000 units related to Harvey, along with gain of about 40,000 tied to Irma, analysts with Evercore ISI estimated in a note to clients Monday.  Automakers have begun appealing to replacement buyers, with Ford Motor Co. and Fiat Chrysler Automobiles NV offering an employee discount to owners of vehicles lost or wrecked in Texas.  “We’re going to see some creative marketing around this - not in a non-compassionate way,” said Jeff Schuster, LMC’s senior vice president of forecasting.  “People that really are left without a vehicle and without a whole lot of options - it’s going to give them some choices that get them into a vehicle relatively inexpensively.”  U.S. auto sales were depressed by Hurricane Harvey in August and will likely be pressured again in September by Irma.  Cox Automotive estimates that 200,000 to 400,000 vehicles will end up being harmed in Florida, bringing the total damaged by the two storms to almost 1 million units.  That level of damage would create replacement demand for as many as 600,000 vehicles over the next two to three months alone.  The initial drag and subsequent bounce from Irma should be less than Harvey because the industry “dodged a bullet” in Florida, Jonathan Smoke, Cox Automotive’s chief economist, said in an email.  The storm grew less severe as it made landfall in Florida and led to less flooding than feared. 

In U.S. economic news, rising U.S. wholesale prices in August reflected the biggest jump in energy costs since January, while underlying inflation remained contained, a Labor Department report showed Wednesday in Washington.  The producer-price index (PPI) rose 0.2% month-over-month (the estimate was for a 0.3% rise) after a 0.1% drop the previous month.  The PPI rose 2.4% year-over-year after a 1.9% gain in prior 12-month period.  Excluding food and energy, the core gauge rose 0.1% month-over-month and 2% year-over-year.  About three-fourths of the monthly gain in the headline gauge came from goods, most of which was due to a 9.5 percent jump in gasoline, along with the biggest rise in jet-fuel costs since 2009.  Since the PPI pricing date was Aug. 15, the data shouldn’t have captured the effects of Hurricane Harvey, said Scott Sager, a Bureau of Labor Statistics economist.  The PPI excluding food, energy, and trade services, a measure some economists prefer because it strips out the most volatile components, rose 1.9 percent from August 2016, the same as the prior month.  That indicates broader inflation is taking time to pick up.  Price pressures in the production pipeline are still relatively contained, helping keep the Federal Reserve’s preferred consumer-price measure below its goal and one reason why policy makers plan to raise borrowing costs only gradually.  Central bankers will update their interest-rate forecasts next week, indicating whether the chances of a December hike have ebbed.  The history of hurricanes such as Katrina indicates inflation measures could remain elevated for a few months, economists said. 

U.S. job openings unexpectedly rose to a record in July, indicating resilient demand for workers, Labor Department figures showed on Tuesday.  The number of positions rose by 54,000 to 6.17 million (the estimate was for 6 million) from 6.12 in June.  Hiring increased to 5.5 million from 5.43 million while the hiring rate also rose by 3.16 million.  Americans quitting their jobs rose 2.1% from the prior month while layoffs declined.  A rising trend in available positions highlights robust labor conditions as steady sales and economic growth keep companies on the hunt.  A tighter job market has also placed a premium on skilled and experienced employees, helping explain why economists anticipate smaller monthly payrolls growth as those workers are on staff.  In August, the economy added fewer jobs than forecast while the unemployment rate crept up from a 16-year low.  The JOLTS report also showed more people quitting their jobs, considered a gauge of workers’ willingness to leave their place of employment because they’re confident of finding a better position.  That indicates larger wage gains may soon start to materialize.  The quits rate, which matched its post-recession high, is among indicators of labor-market slack that Federal Reserve Chair Janet Yellen monitors. 

The U.S. median household income rose to a record last year and the poverty rate fell, as steady economic growth helped improve the lot of more Americans, according to annual data from the U.S. Census Bureau released Tuesday.  Median, inflation-adjusted household income increased 3.2% to $59,039 last year, from $57,230 in 2015.  Median incomes for black and Hispanic households rose at more than double the rate of white households; female householders outpaced males.  The poverty rate declined to 12.7% from 13.5%; representing 40.6 million Americans.  The results show improving incomes helped to make a further dent in poverty in 2016, which was President Barack Obama’s final year in office.  Strength in the labor market likely played a role.  The economy added 2.2 million jobs last year and the unemployment rate had declined to 4.7 percent by year end.  It’s fallen further in recent months to a 16-year low.  While poverty is declining gradually, a sustained acceleration in wages remains elusive in this expansion.  Last year’s poverty rate wasn’t “statistically different” from the 12.5 percent pre-recession level in 2007, according to the Census Bureau on Tuesday.  The annual report gives a more comprehensive, though less timely, snapshot than the Labor Department’s monthly employment report, which shows average hourly earnings of workers on private nonfarm payrolls, or the Commerce Department’s monthly personal income report. 

Filings for jobless benefits in the U.S. unexpectedly settled back last week, underscoring a resilient labor market even as the Atlantic hurricane season introduces added volatility to the figures, Labor Department data showed Thursday.  Jobless claims decreased by 14,000 to 284,000 (the estimate was for 300,000).  Continuing claims dropped by 7,000 to 1.94 million in the week ended Sept. 2.  The four-week average of initial claims rose to 263,250 – the highest level since August 2016 - from 250,250.  Applications for unemployment insurance last week were estimated for Florida, Georgia and South Carolina - states that were impacted by Hurricane Irma.  Meanwhile, Texas reported an unadjusted 11,800 decrease in filings, following a Hurricane Harvey-related 51,683 surge in the week ended Sept. 2.  The spike was responsible for breaking total initial claims out of a subdued pattern.  Harvey, which made landfall on Aug. 25, and Irma will probably continue to add to the swings in the jobless claims data.  Before the storm-related volatility, the overall labor market had been making progress.  Employers remain averse to firing people as there’s a shortage of qualified workers.  That has kept the underlying trend in jobless claims near the lowest level in more than four decades. 

Oil traded near a five-week high after the International Energy Agency and OPEC boosted their forecasts for crude demand this week.  Futures were steady in New York Friday after rising 3.8 percent in the previous three sessions.  Global demand will climb this year by the most since 2015, the IEA said Wednesday.  OPEC on Tuesday raised estimates for the amount of crude it will need to supply in 2018 on stronger consumption from Europe and China.  U.S. oil output gained last week as operations returned after Hurricane Harvey.  Oil in New York has fallen about 8 percent this year as the effort to drain a global glut by the Organization of Petroleum Exporting Countries and partners including Russia is stifled by increasing output from the U.S. to Libya.  OPEC and its allies are discussing extending supply cuts past the end of March by more than three months, according to people familiar with the matter.  The IEA report “was taken as confirmation of the prevalent supply-tightening narrative, that that oil surplus is slowly disappearing,” said Norbert Ruecker, head of commodity research at Julius Baer Group Ltd.  Still, crude is “trading at the upper end of a fundamentally justified price range” and the “upcoming seasonal demand soft patch is set to create near-term headwinds.”  We shall see! 

Inflation may finally be getting back on track to reach the Federal Reserve’s goal, as the U.S. cost of living accelerated following a weak stretch of readings, Labor Department data showed Thursday.  The consumer-price index increased 0.4% month-over-month (the estimate was for a 0.3% gain) after 0.1% rise the prior month.  The figure rose 1.9% year-over-year compared to the estimates of 1.8%.  Excluding food and energy, the so-called core CPI rose 0.2% month-over-month, which matched estimates, and rose 1.7% year-over-year compared to the estimates for a 1.6% increase.  The increase in the core index was driven by biggest gain in shelter costs since 2005.  The lodging category rose by a record, rebounding from a drop that dragged down inflation in the previous month.  The 0.2 percent rise in the core gauge ends a five-month streak of weaker-than-expected readings, and may soothe some concerns that inflation is slowing more broadly, though it will take more readings to determine whether the pickup can be sustained.  The increase in the lodging category indicates the earlier decline in the sector was transitory.  Energy prices rose by the most since January and may reflect some impact from Hurricane Harvey.  CPI data is collected throughout the month, and since the storm occurred in late August, the Bureau of Labor Statistics expects most of the data to come from before the storm, BLS economist Steve Reed said Wednesday.  Data collection was disrupted in two of the 87 U.S. urban areas where prices are gathered.  Economists have said headline inflation measures could remain elevated for several months as the data more fully incorporate the fallout from Harvey and Irma.  The improvement, were it to persist, would make it more likely that the Fed will raise interest rates in December.  Policy makers meeting next week are expected to keep rates on hold while announcing the start of a gradual process to shrink their $4.5 trillion balance sheet.  Over time, businesses may get more pricing power as household spending climbs, while the steady labor market, the weakening dollar and improving global demand would also help to boost inflation.  The Fed’s preferred gauge of inflation, a separate Commerce Department figure based on consumer purchases, has matched or exceeded the central bank’s 2 percent goal in only two months of the past five years.  Some Fed officials focus on the measure excluding food and energy, which is also below their target. 

As always, stay tuned!

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