Yield Curve Flattens & GDP Estimate Falls To 1.9%

Stocks Rally On Monday

Investors were dismayed on Friday because 3 of the top banks beat earnings estimates, but stocks still fell. Then the Syrian air strikes were announced which made some, such as myself, think stocks would fall again on Monday. However, stocks were able to rebound as the S&P 500 was up 0.81%. This led the S&P 500 to cross into positive territory for the year. The market continues to stay at the low end of its recent range. The biggest technical worry is a downtrend with lower highs forming. The all-time high was 2,873. The high in March was 2,787. To break that trend, S&P 500 would need to rally 109 points. Every sector was green on Monday as there was broad-based buying. Telecom did the best as it increased 1.48%. Financials underperformed as the sector was up 0.47% even though the big four banks all beat estimates.

Yield Curve Flattens

The 10-year bond had a reversal on Monday as it increased to 2.86% in the morning, but then closed flat at 2.83%. The 2-year yield didn’t reverse as sharply, so it was up 2 basis points to 2.38%. That means the curve flattened. The latest difference between the ten years and the two years is only 45 basis points. The long bond yield not increasing implies the bond market isn’t sold on great economic growth in 2018. The short end of the curve is seeing yields increase because the Fed is expected to raise rates 1-3 more times this year. The charts below compare the yield curve in various maturity dates with the Fed funds rate. The Fed funds rate crossing above the difference doesn’t signal anything. The curve flattening increases the odds for a 2019 recession, which are currently still pretty low.

NY Fed President Bill Dudley stated on Monday that the market understands more than 4 rate hikes in 2018 are unlikely. That’s true according to the CME website which shows the futures are pricing in a 5.3% chance of more than 4 hikes. In the past few days, the chance of at least 4 hikes increased as it’s now at 39%. The higher that percentage increases, the more the yield curve will flatten. If the Fed hikes 3 times, it could steepen.

President Trump Picks Clarida & Bowman For Fed Positions

The other notable announcement in the monetary policy realm on Monday was that President Trump nominated Richard Clarida to be the Fed vice chair. He also nominated Michelle Bowman to fill an open governor’s slot. His nomination of Marvin Goodfriend has been stuck in the Senate for months. Clarida is a global strategic adviser at Pimco who thinks financial regulations have gone too far just like Trump’s other picks. John Williams will be the NY Fed president starting on June 18th. Once all these changes are finalized, the Fed will be transformed. The first task these newcomers will need to face is continuing the policy normalization process.

OK Retail Sales Report

The headline retail sales growth was solid, but weak core readings, pushed down GDP expectations. Sales returned to month over month growth after two months of shrinkage. Month over month retail sales were up 0.6% which beat the consensus estimate for 0.4%. The month over month sales excluding autos were up 0.2% which met estimates. That was the same growth as last month. Excluding autos and gas, retail sales were up 0.3% which missed estimates for 0.5% and was the same as the prior report.

As you can see in the chart below, real retail sales were up 2.1% year over year; they were up 2.3% if you exclude food. The green arrows point to the times were year over year sales went negative which signaled an incoming recession. Positive growth means there won’t be a recession in the intermediate term. The big story from this report is the rebound in auto sales as March growth was 2%. There had been weakness in the past few months because the replacement buying in September after the hurricanes pulled demand from late 2017 and early 2018. Department store sales were down 0.3% and clothing store sales were down 0.8%. Building materials stores saw a 0.6% decline and sporting goods stores saw a 1.8% decline month over month.

The positives in this report were that restaurants saw a 0.4% increase and furniture stores saw a 0.7% increase. Unsurprisingly, online sales were up 0.8% after a 0.9% gain in February. While the headline growth in this report was strong, the year over year growth excluding autos and gas fell 2 tenths to 3.9%. The chart below examines this core weakness. As you can see, the three month average of year over year retail sales fell to 4.1%. It’s still above the all-important 2.5% mark, but it’s down from the 5.4% average in December.

This weakness led the GDP Nowcast from the Atlanta Fed to fall. The estimate for real personal consumption expenditures growth fell from 1.1% to 0.9%. As you can see from the chart below, this caused the GDP estimate to fall from 2% to 1.9%. Back on February 1stwhen, the GDP Nowcast expected much higher economic growth, the estimate for consumer spending was 4%. The hope for economic bulls is that service spending and inventory spending help GDP because the consumer looks weak. The CBO showed how out of touch it is with the recent data when it predicted 3.3% GDP growth for 2018.

Conclusion

The positives on Monday were the rally in stocks and the 2% growth in auto sales. The negatives were the weak core consumer spending and the flattening yield curve. One positive factor to keep in mind is that the other Fed Nowcasts are more positive than the Atlanta Fed. The NY Fed expects 2.79% growth Q1 which was up 2 hundredths of a point. It expects Q2 growth to be 2.87% which was down 4 hundredths of a point. The St. Louis Fed remains far outside mainstream forecasts as it forecasts 3.36% growth for Q1. I would be shocked if growth exceeds 3%.

 

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Don Kaufman: Trade small and Live to trade another day at Theotrade.