Productivity and Wages: A Whiff of Inflation Wafting Through the Macroeconomic Air?

June 7th, 2016 9:50 am

Excellent piece on wages via Stephen Stanley at Amherst Pierpont Securities:

The productivity decline in Q1 was shaved, roughly as expected and in line with the modest upward adjustment to GDP for the period.  The 0.6% annualized fall in Q1 productivity took the four-quarter gain to 0.7%, still quite close to the 0.5% annual pace seen since the beginning of 2011.

However, the bigger story, as I had flagged, was the inclusion of new benchmark wage and salary income data for Q4 and Q1 that was incorporated into these figures for the first time.  Hourly compensation was boosted from a 0.9% annualized gain in Q4 to a 3.6% rise and the Q1 increase was bumped up from 3.0% to 3.9%.  These revisions take the four-quarter average to 3.7%.  This, in turn, fed through to increases in unit labor costs.  The unit labor costs advances in Q4 and Q1 are now 5.4% and 4.5% respectively, and the year-over-year increase accelerated to 3.0%.  This is significant, as any time unit labor costs are rising faster than price inflation, it means that labor markets are exerting upward pressure on inflation.  We have seen a noticeable uptick in core services inflation within the core CPI, which makes sense as services industries tend to be the most labor-intensive.

There are two broader points that I want to make about the wage picture.  First, though there seems to still be a consensus among Street economists and market participants that wage growth remains sluggish, in reality, wages have finally begun to move higher in earnest.  The anecdotal and survey evidence has been pointing to rising wages for a while, but the data were slow to fall into line.  Now they have.  The hourly compensation figures within this report have moved the most (which is typical, as these data tend to be the most volatile).  Hourly compensation gains have exceeded a 3% pace in 5 of the past 7 quarters, and, at 3.7% year/year, are running at roughly double the pace of a few years ago.  Meanwhile, average hourly earnings have picked up from a 2% trend to around 2½%.  Finally, the wages and salaries component of the ECI has been running at around 2% year/year in recent quarters, up from about 1½% a few years ago, and is set to pick up toward 2½% in Q2, when an outlier +0.2% reading drops out of the 4-quarter window.  Chair Yellen yesterday took note of the pickup in wages, citing the acceleration in average hourly earnings as “a welcome indication that wage growth may finally be picking up.”

Second, economists are missing a vitally important point about wages.  Though it took several years, Street economists finally realized that a slowdown in trend productivity growth meant that estimates of potential GDP growth needed to be moved lower in tandem.  However, they still apparently haven’t figured out that the same downshift in productivity growth means that wage gains will also ratchet down commensurately.  Firms are not going to give workers raises for productivity growth that is not occurring (at least not if they want to stay in business).  So, the consensus view on wages continues to be that anything less than 3% growth is sub-par/sluggish/inadequate because that was the prevailing pace prior to the last recession.  In reality, if trend productivity growth has slowed by 100 BPs, then so must the estimate of sustainable wage gains.  Although very few economists are recognizing it, we are already well on the way to an inflationary labor market situation.  While I agree that Chair Yellen signaled that there will be no rate hike in June and I understand why her speech was interpreted as suggesting that the Fed is on hold for a while (after all, that has been almost always been the smart bet for this Fed), I thought the most significant shift in Yellen’s rhetoric pertained to this question.  She argued that labor market slack is essentially gone, she acknowledged that wage growth is picking up, and she even alluded to my point about the relationship between productivity and wages (“recent weak productivity growth likely helps account for the disappointing pace of wage gains during this economic expansion”).  While she and her colleagues continue to have difficulty gathering the gumption to pull the trigger on a move until conditions are picture perfect, Yellen seems to be finally recognizing that the current economic landscape may not be consistent with the very easy stance of monetary policy.

 

Market Update

June 7th, 2016 9:08 am

Via an anonymous market participant:

5 yr German bonds broke below the -0.40 deposit rate which
makes them ineligble for purchase by the ECB.  It is forcing the
ECB further out the yield curve and is taking 10 yr bunds to
record low yields.  US Treasurys are getting dragged along.

JPMorgan Duration Survey

June 7th, 2016 7:34 am

Via Bloomberg:

Treasury Client Survey Shows All-Clients Modestly Net Long: JPM
2016-06-07 11:22:24.222 GMT

By Stephen Spratt
(Bloomberg) — In week ended June 6, all clients survey
shows longs rise, shorts fall, leaving a modest net long, though
stands close to 4-week average.

* Active clients moves to net long; sits 12 percentage points
longer than its 4-week average
* All clients (June 6 vs May 31)
* Long: 20 vs 16
* Neutral: 64 vs 66
* Short: 16 vs 18
* Active clients
* Long: 40 vs 20
* Neutral: 50 vs 60
* Short: 10 vs 20

* NOTE: JPM Treasury Client Survey Shows Most Neutrals Since
Feb. 16

Credit Pipeline

June 7th, 2016 6:52 am

Via Bloomberg:

IG CREDIT PIPELINE: ANZ to Price; More Names Added to List
2016-06-07 09:37:40.698 GMT

By Robert Elson
(Bloomberg) — Set to price today

* Australia & New Zealand Banking Group (ANZ) Baa1/BBB-, to
sell $bench 144a/Reg-S perp subordinated contingent
convertible securities, via managers ANZ/Citi/DB/GS/MS; IPT
7.25% area

LATEST UPDATES

* Emera (EMACN) Baa3/BBB, to held investor calls June 2-3 in
connection with sr debt and hybrid securities offerings;
company may issue up to $800m notes, filing shows
* Abu Dhabi National Energy (TAQAUH) A3/A, mandates
BNP/C/FGB/HSBC/NBAD/SG for investor meetings June 8-10;
144a/Reg-S USD bond may follow
* Air Liquide (AIFP) A3/A-, held calls regarding Airgas
refinancing; planned to refinance the $12b loan backing the
deal via a combination of USD, EUR long-term bonds
* Raymond James Baa2/BBB, has engaged BAML/JPM/RayJ to arrange
investor meetings June 13-15; last priced a new deal in 2012
* ITC Holdings (ITC) Baa2/BBB+, filed an automatic debt
securities shelf; last issued May 2014
* USAID Ukraine (AID) heard to be in the works with possible
full faith & credit deal
* Bayer (BAYNGR) A3/A-, said to secure $63b financing, via
BAML/CS/GS/HSBC/JPM, for Monsanto (MON) A3/BBB+ bid; co.
likely will issue $20-$30b bonds to refinance part of the
bridge loan
* Omega Healthcare Investors (OHI) Baa3/BBB-, to hold investor
meeting, via BAML/JPM, June 14
* Poinsettia Finance Baa2/BBB+, mandates MS to arrange
investor meetings June 6-9; USD 144a/Reg-S deal may follow
* Fibra Uno (FUNOMM) Baa2/na, mandates BBVA/DB/GS/SANTAN for
investor meetings June 6-7; USD 144a/Reg-S deal may follow
* The Sultanate of Oman Baa1/BBB-, mandates
C/JPM/MUFG/NBAD/NATIXIS to arrange investor meetings June
2-7; USD 144a/Reg-S deal may follow
* Kingdom of Saudi Arabia (SAUDI), weighing sale of $10b-$15b
after end of Ramadan in July
* May replicate Qatar’s $9b sale by issuing 5y, 10y, 30y
bonds, sources say
* Great Plains Energy (GXP) Baa2/BBB+ to issue long-term
financing including equity, equity-linked securities and
debt prior to closing of Westar Energy (WR) A2/A deal; says
financing mix will allow it to maintain investment-grade
ratings
* Apple (AAPL) Aa1/AA+, may return to market
* It priced $12b in 9 parts Feb. 16
* Re-opened 3 of the above issues for $3.5b March 17
* Merck & Co (MRK) A1/AA; has not priced a new issue since
Feb. 2015, $1.5b matured May 18
* General Electric Company (GE) A3/AA-, has yet to issue YTD;
parent GE Co has $11.1b maturing this year, $2.3b matured in
May
* GE may be among high grade industrials to add leverage
in 2016, BI says in note (see point 3)

MANDATES/MEETINGS

M&A-RELATED

* Abbott (ABT) A2/A+; ~$5.7b St. Jude buy, ~$3.1b Alere buy
* $17.2b bridge loan commitment (April 28)
* Sherwin-Williams (SHW) A2/A; ~$9.3b Valspar buy
* $8.3b debt financing expected (March 20)
* Shire (SHPLN) Baa3/BBB-; ~$32b Baxalta buy
* $18b loan to be refinanced via debt issuance (Jan 18)
* Molson Coors (TAP) Baa2/BBB-; ~$12b MillerCoors buy
* $9.3b bridge (Dec 17)
* Teva (TEVA) Baa1/BBB+; ~$40.5b Allergan generics buy
* $22b bridge; $5b TL commitment (Nov 18)
* Duke Energy (DUK) A3/A-; $4.9b Piedmont Natural buy
* $4.9b bridge (Nov 4)
* Anthem (ANTM) Baa2/A-; ~$50.4b Cigna buy
* $26.5b bridge (July 27)

SHELF FILINGS

* Tesla Motors (TSLA); automatic debt, common stk shelf (May
18)
* Debt may convert to common stk
* Reynolds American (RAI) Baa3/BBB filed automatic debt shelf;
sold $9b last June (May 13)
* Statoil (STLNO) Aa3/A+, files debt shelf; last issued USD
Nov. 2014 (May 9)
* Corporate Office (OFC) Baa3/BBB-; debt shelf (April 12)
* Rogers (RCICN) Baa1/BBB+; $4b debt shelf (March 4)

OTHER

* Discovery Communications (DISCA) Baa3/BBB-; may revisit bond
market this yr, BI says (May 18)
* Ford Motor Credit (F) Baa2/BBB; may have ~$7b issuance this
yr (May 10)
* Wal-Mart (WMT) Aa2/AA; 2 maturities in April (April 1)
* GE (GE) A1/AA+; $25b debt possible for M&A, buybacks (Jan
29)

Some Corporate Bond Stuff

June 7th, 2016 6:51 am

Via Bloomberg:

IG CREDIT: Volume, Spreads Improve; Issuance Remains the Focus
2016-06-07 10:03:53.18 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $13.2b vs $12.1b Friday. 10-DMA $14.9b; 10-Monday
moving avg $13.4b.

* 144a trading added $2.4b of IG volume vs $2.3b on Friday

* The most active issues:
* ABIBB 3.65% 2026 was 1st with client and affiliate
trades accounting for 73% of volume; client buying 2.4x
selling
* GS 3.85% 2024 was next with client flows taking 100% of
volume
* AET 4.375% 2046 was 3rd with client and affiliate trades
taking 88% of volume
* DELL 6.02% 2026 was most active 144a issue; client and
affiliate flows took 91% of volume

* Bloomberg US IG Corporate Bond Index OAS at 156.0 vs 156.5
* 2016 high/low: 220.8, a new wide since Jan. 2012/150.8
* 2015 high/low: 182.1/129.6
* 2014 high/low: 144.7/102.3

* BofAML IG Master Index at +155 vs +156
* 2016 high/low: +221, the widest level since June
2012/+152
* 2015 high/low: +180/+129
* 2014 high/low: +151/+106, tightest spread since July
2007

* Standard & Poor’s Global Fixed Income Research IG Index at
+202 vs +203
* +262, the new wide going back to 2013, was seen
2/11/2016
* The widest spread recorded was +578 in Dec. 2008

* S&P HY spread at +645 vs +651; +947 seen Feb. 11 was the
widest spread since Oct. 2011
* All time wide was +1,754 in Dec. 2008

* Markit CDX.IG.26 5Y Index at 74.3 vs 77.3
* 73.0, its lowest level since August, was seen April 20
* 124.7, a new wide since June 2012 was seen Feb. 11
* 2014 high/low was 76.1/55.0, the low for 2014 and the
lowest level since Oct 2007

* Current market levels
* 2Y 0.799%
* 10Y 1.735%
* Dow futures +59
* Oil $49.92
* ¥en 107.79

* IG issuance totaled $4.55b Monday; June now stands at $24.8b
* May ended at a record $209.51b; stats and recap
* YTD IG issuance now $828b; YTD less SSAs $686b

More FX

June 7th, 2016 6:50 am

Via Marc Chandler at Brown Brothers Harriman:

Yen Bucks Heavier Dollar Tone

  • Yellen dropped the guidance used at the end of May, when she said in the “coming months”
  • The RBA statement was considerably less dovish than the market is expected
  • Sterling inexplicably shot up almost two cents in a matter of minutes in Asia; it quickly came off amid talk of a trading error
  • Germany reported stronger than expected IP
  • The US economic data today is not the kind that moves the markets
  • Reserve Bank of India kept rates steady at 6.5%, as expected
  • Taiwan reported May trade earlier today; Chile reports May trade later

The dollar is mostly softer against the majors.  The Aussie and sterling are outperforming while the yen and the euro are underperforming.  EM currencies are mostly firmer.  KRW, MYR, and IDR are outperforming while CNY and the CEE currencies are underperforming.  MSCI Asia Pacific was up 1%, with the Nikkei rising 0.6%.  MSCI EM is up 1.6%, with Chinese markets up modestly.  Euro Stoxx 600 is up 1.3% near midday, while S&P futures are pointing to a higher open.  The 10-year UST yield is flat at 1.73%.  Commodity prices are mixed, with oil up 0.5% and copper down nearly 2%.  

The Japanese yen is the only major currency not to be gaining against the US dollar today.  Emerging market currencies, save the Chinese yuan, are also advancing against the greenback today.  

The yen rose 3.5% against the dollar last week, and rising equities and commodities are weighing on the yen now.  The dollar rose to almost JPY108 in Asian trading and is consolidating in the European morning.  The JPY108.30 area is the first retracement objective, which is a little above the five-day moving average (~JPY108.05).  

Asian equities gained today, with the Thai market only exception.  The MSCI Asia Pacific Index gained 1% and extended its advancing streak to a third session.  It has risen in eight of the last 10 sessions.  European shares are also advancing, with the Dow Jones Stoxx up 1.25% after gapping higher at the open.  Energy and materials are leading the advance, as commodities have rallied (with Brent nearing $51), though financials are right up there as well.  

There are five main developments.  The first was Yellen’s speech yesterday.  While the Fed Chair expressed concern about the disappointing employment data, she continued to suggest a rate hike would be appropriate if the economic data continued to strengthen.  However, she dropped the guidance used at the end of May, when she said in the “coming months.”  Her speech yesterday did not offer a time frame.  

The August Fed funds futures contract, the cleanest read for expectations of the late-July FOMC meeting firmed further as the market reduced the odds of a July move.  At 43 bp, the August contract is pricing in a 24% chance of a hike.  On May 27, the August contract implied 56 bp or a 76% chance of a hike.  This has helped keep the dollar on the defensive.  

The second development is the Reserve Bank of Australia meeting.  There was no change in rates, as widely anticipated, but the statement was considerably less dovish than the market is expected.  This sent the Australian dollar up a little more than 1% to lead the majors.  The Aussie was bid through $0.7400 to $0.7450.  The next retracement is found near $0.7500.  The RBA’s assessment that the current cash rate may be sufficient for CPI to return to target effective dashes ideas for a follow-up rate cut after the April move.  

The third development today is sterling’s strength.  Sterling inexplicably shot up almost two cents in a matter of minutes in Asia (~$1.4475 to $1.4660).  It quickly came off amid talk of a trading error.  However, on the push back, it found support near $1.4500 and managed to trade back above $1.4600 in the European morning.  One-month implied volatility is making new highs today above 22% (it was near 16.6% on May 27) and the put-call skew is at a new record extreme (~6.9%).  UK stocks are underperforming, but the FTSE is the best performingG7 equity market over the past week.  UK gilts are also underperforming, with 10-year yields three bp higher near 1.30%, while most eurozone benchmark yields are lower.  

Fourth, yesterday’s unexpectedly poor German factory orders (-2.0% vs. expectations for a 0.5% fall) left investors ill-prepared for the stronger than expected industrial production report today.  The 0.8% gain follows a revised 1.1% decline in March (initially -1.3%) and February (-0.7%).   Going back to through the second quarter last year, German industrial output has risen only one month every quarter.  The weak orders data warn that although output began Q2 on a firm note, there may not be much follow-through.  

If, as we have argued, the euro is correcting the slide from May 3 (~$1.1615) to May 30 (~$1.11), then at its current level (~$1.1370), it has retraced 50% of the move.  The next retracement is found near $1.1420.

Fifth, given the primary results in Puerto Rico and the Virgin Islands over the weekend, and super-delegate (party officials rather than chosen in a primary) pledges, it appears that Clinton has sufficient delegates coming into today’s primaries (five states including California) to secure the Democratic nomination.  Today’s primaries are still important, as Clinton would like to secure as many delegates as possible and to be able to claim victory without the super-delegates.  Sanders performance may determine his negotiating strength in setting the platform or other key decisions going forward.  

Typically, when a candidate secures their party’s nomination, they see a bump in the polls.  Trump has had a particularly rough time over the last two weeks.  Even some of his supporters have cringed at some of the remarks.  To win, of course, Trump has to do better than Romney, the 2012 Republican candidate.  Most surveys show that Trump is a few points ahead of Romney with the non-college educated white vote, but is lagging Romney by low double digits among the college educated whites.  Meanwhile, Clinton appears to be a couple of percentage points ahead of Obama with the African-American and Latino vote.

The US economic data today is not the kind that moves the markets.  Non-farm productivity is likely to be revised up following the upward revision to Q1 growth.  However, it will likely remain negative, and the weak productivity growth remains an important economic puzzle.  Unit labor costs may edge lower from the 4.1% initial estimate.  Consumer credit is due out late in the session.  After a record level (~$29.7 bln) in March, a return to trend (six-month average is ~$18.4 bln) is expected.  Canada reports the IVEY PMI.  A softer number from April’s 53.1 reading is anticipated.  The US dollar is approaching the CAD1.2740 area, which is the 62% retracement of May’s run-up.  

Reserve Bank of India kept rates steady at 6.5%, as expected.  The RBI said that its inflation forecasts are retained, but with an “upside bias.”  Both CPI and WPI inflation have been ticking higher, which clearly warrants caution ahead of the monsoon season.  Until the inflation outlook is clearer, the RBI is likely to remain on hold.  Governor Rajan would not comment on reports that he does not intend to return for a new term is concerning, as he is well-respected by the markets.  We expected Prime Minister Modi will do his best to keep him on, but some of his allies want a more dovish choice.  

Taiwan reported May trade earlier today.  Exports came in at -9.6% y/y vs. -9.9% expected, while imports came in at -3.4% y/y vs. -10.8% expected.  This comes after weaker than expected Korean exports last week, with exports -6% y/y and imports -9% y/y.  Chile reports May trade later today, with exports seen at -6% y/y and imports at -5% y/y.  Overall, forward looking indicators such as export orders and PMIs suggest little relief ahead in terms of global trade.

Early FX

June 7th, 2016 6:48 am

Via Kit Juckes at SocGen:

<http://www.sgmarkets.com/r/?id=h10ab4727,173bafbb,173bafbc&p1=136122&p2=3adbd798aad72d81a8d4efa6c94648c5>

The S&P index continues to edge ever closer to last year’s all-time high, unperturbed by signs of softness in the economy or indeed, by the downturn in corporate earnings. The Fed’s on hold for now and probably until after the Presidential Election and that’s all that matters. Fed Chair Yellen’s speech in Philadelphia yesterday reaffirmed a desire for gradual interest rate increases and could have been read as a sign that the FOMC isn’t going to be deterred by one month’s weak employment data, but the market focused instead on the Fed’s data-sensitivity. They seem to be keener on markets pricing in the possibility of a rate move, than actually delivering one. And while markets view the world in that way, then riskier assets will continue to find some support. EMFX bears will have to be patient, and indeed, we’re getting no joy today out of shorts in AUD, NZD or GBP either, but I still don’t understand why the yen isn’t weaker. CAD/JPY, for example, has scope to re-couple with risk sentiment now that oil prices are steadier and the lurch up in Japanese real yields is behind us. UISD/JPY looks out of line with the most recent real yield moves, let alone with the S&P.

CAD/JPY looks too low relative to equity markets

[http://email.sgresearch.com/Content/PublicationPicture/227015/1]

USD/JPY fell too far

[http://email.sgresearch.com/Content/PublicationPicture/227015/2]

The big overnight movers are the pound (regaining some of yesterday’s politically-inspired fall) and the Australian dollar, which has reacted positively to the RBA leaving rates on hold. The RBA cut rates in April and after stronger then expected growth data, isn’t in a big hurry to act again. The Statement was balanced however and the lack of inflation and the global and trade environment could see a further cut in due course. We’re not bailing out of our AUD shorts, though at these levels, AUD/NZD is a good buy.

Today’s data calendar is distinctly empty. UK House prices, Norwegian industrial production, final Euro zone GDP data, the US consumer credit and the Canadian Ivey PMI – none of it likely to move markets. We’ll get Chinese FX reserves data overnight and the RBNZ tomorrow evening. This morning also saw Swiss FX reserves, up to a new high at CHF 602.1bn, indicative of how hard they have to work to compensate for a lack of capital outflows.

None of this is a recipe for buying vol, though maybe, given the way markets are now priced, using buying EUR/USD puts as protection ahead of the UK EU referendum now makes sense.

Auction Previews

June 6th, 2016 9:59 pm

Via TDSecurities:


Treasury will auction a total of $56bn this week, selling $24bn in 3s on Tuesday, $20bn in reopened 10s on Wednesday, and $12bn in reopened 30s on Thursday. With $32bn of holdings maturing at mid-month settlement, net cash raised at the sale will total $24bn. With no SOMA holdings maturing, there will be no Fed add-ons this week (for more on add-ons see here). Given the ongoing grind lower in global interest rates and the sharp decline in the pricing for June and July rate hikes, we expect this week’s auctions to see strong demand. The 2yr, 5yr, and 7yr auctions two weeks ago saw extremely strong end-user demand, with all three auctions stopping through the screens for the first time since November 2015 and dealers seeing record low takedowns.

·         3s: The May auction saw strong results, stopping 1.5bp through the screens as investment funds took a record-high 47% of the auction. Averages suggest a stop 0.1bp through the screens and a 65% buy side award (63% to indirects and 12% to directs). The repo specialness of the current 3yr issue and decline in market rate hike expectations bode positively for the sale.

·         10s: An insatiable global demand for yield should help drive buying at the 10yr auction. The May 10yr auction saw the lowest primary dealer takedown on record as both investment funds and foreign investors stepped up their buying. Averages hint at a stop 0.7bp through the screens and a 77% buy side award (64% to indirects and 13% to directs).

·         30s: Long bond auctions have seen mixed results in recent months, tailing 1.1bp in May. Averages hint at another 0.5bp tail this month, with 71% awarded to the buy side (61% to indirects and 10% to directs). Steepening in the curve following the weak May payroll report may nevertheless provide some concessions, ensuring decent auction demand, particularly as 30yr reopenings tend to fare better than new issues.

Gennadiy Goldberg

Dissecting Yellen

June 6th, 2016 2:23 pm

Via Stephen Stanley at Amherst Pierpont Securities:

Chair Yellen took a relatively upbeat tone in her speech today.  In fact, to reprise an analogy that I used to analyze her last speech in late March, she characterized the growth, employment, and inflation “glasses” as mostly full, albeit with an appropriately sober approach reflecting her dovish and nervous bent.  My interpretation is that she still believes the economy is on track to dictate a couple of rate hikes this year (though, of course, she was not that specific), as long as the data come in as she expects.  Of course, as we saw last Friday, there are frequently surprises in the data, so she failed to provide any specifics regarding her opinion about when the Fed will next hike rates.  In my view, the FOMC wants to move as soon as the data justify it.  My reaction to this speech is that it supports my view that the FOMC will move in July (assuming that the data cooperate of course), and I would interpret today’s speech as the first step in a process of laying the groundwork for such a move.  To make a July rate hike happen, I think the two biggest things we will need to see are: 1) a bounceback in June payrolls (released July 8), as a reassurance that labor markets remain healthy and 2) Q2 GDP tracking estimates remaining above trend (anything with a 2-handle will do) after Q1’s disappointing growth.  Any additional firming on the wage and/or price fronts would further bolster the case for a rate hike sooner rather than later.

As I noted above, I thought that she took a pretty optimistic tone on a number of key economic questions.

Labor markets: First, she downplayed the May employment report, arguing that “one should never attach too much significance to any single monthly report.”  She pointed out that a number of other indicators “remain positive.”  She noted that wages are “finally…picking up.”  Most strikingly, she argued that “I believe we are now close to eliminating the slack that has weighed on the labor market since the recession,” which is by far the most upbeat assessment she has given on labor market slack in this expansion.

Economic growth: The context for growth is that Q1 was quite soft, and policymakers want to see a Q2 bounceback, the same situation that the Fed found itself in last year.  A year ago, the FOMC decided to wait until it saw the actual Q2 numbers (which came out at the end of July) even though they were very confident that Q1 was an anomaly.  That pause ended up lasting all the way until December after markets melted down in the summer.  This year, officials seem more willing to step out on faith and move ahead of the actual Q2 data, as long as the monthly inputs to GDP look good (the July FOMC meeting occurs 2 days before the preliminary estimate of Q2 GDP is released).  Yellen noted that “while spending data for the second quarter are limited at present, recent data on retail sales and motor vehicle sales point to a significant step-up in consumer spending and GDP growth this quarter.”  This sounds a bit less wait and see than what we were hearing at this point a year ago.

Inflation: As with the labor market, Yellen struck me as mostly positive in discussing inflation.  She repeated that the twin headwinds of falling oil prices and a stronger dollar had been holding down inflation and are now fading.  Thus, she expects “inflation will move up to 2 percent over the next one to two years.”

On the global front, she is “cautiously optimistic that these headwinds” (from economic developments abroad) are now fading.”  She dedicated all of 2 sentences to the looming Brexit vote and did not seem all that worried about it (using the word “could” to describe the risks, i.e. not ascribing a high probability to adverse consequences).  With regard to financial conditions, she pointed out that “over the past few months, financial conditions have recovered significantly and many of the risks from abroad have diminished, although some risks remain.”  I agree with that assessment, but I would not have been surprised to hear Yellen take a more worried stance.

On business investment, clearly the worst performing sector of the economy, she argued that “the largest declines in drilling activity are likely now behind us.”  She also went on to predict “I expect investment to rebound,” though she added caveats that there are risks to consider.

Risks/Uncertainties: Chair Yellen is a worrier.  And she is uncommonly good at it.  So, while her point estimates struck me as cautiously optimistic, she did not disappoint in terms of laying out the various risks that could derail her view.  She noted 4 uncertainties.  First, will domestic demand remain strong in the face of a lackluster global landscape.  She thinks so, but weakness in investment and last Friday’s jobs number are enough to give her reason to indulge her worries.  Second, “global risks require continued attention.”  She seems pretty relaxed about China and Brexit but reminds that “investor perceptions of and appetite for risk can change abruptly.”  Third, what is the story with weak productivity growth?  She is “cautiously optimistic” that productivity will pick up in the coming years.  The piece left unsaid here is that it is not clear in which direction monetary policy should respond if productivity turns out worse than the Fed expects.  Finally, she notes uncertainty about how quickly inflation will move back to 2%.  The risks here are two-fold.  Oil prices and/or the dollar could move sharply, bringing back the headwinds that she noted are fading.  And some measures of inflation expectations have moved lower.  She is not sure that true underlying inflation expectations have moved, but “the indicators have moved enough to get my close attention.”

Even with all of these risks, the tone of the speech is that these are the things that could go wrong, but that there are good reasons to believe that they will not.  In contrast, in Yellen’s March speech, she seemed genuinely worried that the risks she discussed were as likely than not to come to fruition.

Monetary Policy: She describes current policy as appropriately stimulative.  She notes that with inflation below 2%, there is reason to allow a “mild undershooting of the unemployment rate considered to be normal in the longer run” to get back to 2% more quickly.  She also reprised the asymmetric risks argument that as long as the Fed is close to zero rates, it has to be extra careful to avoid a relapse in the economy.  She concludes that “I continue to believe that it will be appropriate to gradually reduce the degree of monetary policy accommodation, provided that labor market conditions strengthen further and inflation continues to make progress toward our 2 percent objective.”  One concession that she made, perhaps in response to the May employment report, was to remove any timeframe.  So, unlike in late May, when she used the phrase “in the coming months,” she leaves it strictly up to the data to determine the timing of future moves.  But she suggested that her June SEP projections will be at least as good as her March numbers, so it is not a stretch to infer that she is still on board with two rates hikes in 2016 if her forecasts are realized.

I think one could make a good case for the next rate hike occurring in either July or September.  I tend to be more upbeat than most on the economy and, in particular, I think that, as Yellen acknowledged for the first time today, labor market slack is virtually gone, and wages and prices are on an upward path.  So, I think the Fed is falling behind the curve by dilly-dallying and, more importantly, I think that a significant portion of the FOMC believes that as well, and the resistance from most of the doves is softening.  As I laid out at the top, several things need to happen over the next 7½ weeks for the Committee to feel comfortable raising rates in July.  I would also note that, regardless of what they say publicly, if it can, I think the FOMC would like to avoid raising rates in September (and the early November meeting is off the table) due to the proximity to the presidential election, which adds to the appeal of a July move (and would have made June look better if not for the May employment report debacle).  Yellen’s speech does not really definitively tip the scales with regard to July vs. September, but I think it does confirm that unless we get more ugly data surprises, the next move is coming sooner rather than later.

Commodity Rebound

June 6th, 2016 7:17 am

Via Bloomberg:
June 6, 2016 — 6:29 AM EDT

The four-year bear market that pushed commodities to the lowest level in a quarter century is coming to end as supply constraints drive a recovery in everything from soybeans to zinc.

The Bloomberg Commodity Index, which tracks returns from 22 raw materials, is on track to close more than 20 percent above its low on Jan. 20, meeting the common definition of a bull market. While the index has come close to breaking out of the bear market that began at the end of 2011, it has never sustained a rally long enough, until now. It’s still down about 50 percent from the high reached in that year.

Raw materials have outperformed bonds, currencies and equities this year on speculation that supply disruptions and production cuts are whittling away the surpluses that caused the biggest price collapse in a generation while demand improves. Citigroup Inc. said last month that commodities had turned a corner, increasing its forecasts for metals to grains amid an oil-led recovery.

“The broad-based recovery in commodity markets this year has tipped several
markets into bull market territory,” Mark Keenan, head of commodities research for Asia at Societe Generale SA in Singapore, said by e-mail. “Overall, sentiment is good but remains cautious, the market is evolving significantly, specifically across the oil markets.”

Brent crude has surged above $50 a barrel from a 12-year low in January amid disruptions from Nigeria to Venezuela, and as U.S. output declined, pressured by OPEC’s policy of sustaining production. The global oil market has flipped to a deficit sooner than expected, Goldman Sachs Group Inc. said in May.
Structural Deficit

Prices of zinc, used to rustproof steel, climbed above $2,000 a metric ton for the first time since July last week after mine production cuts by Glencore Plc and others. Goldman Sachs has dubbed zinc the “bullish exception” among metals.

“Zinc has been the best performing industrial metal this year, supported by
fundamentals,” Keenan said. “It should continue to improve over the medium term as the concentrate market moves into structural deficit and the recent cutbacks take hold.”

Soybean meal and soybeans have the strongest returns of any commodity on the Bloomberg index this year. Futures for the agricultural products used in livestock feed and cooking oil are up 58 percent and 33 percent, respectively, as floods reduce crops in South America and concern mounts that dry weather will cut U.S. output.

Gold and silver are also among the strongest performers this year after concern over the health of the global economy and a retreat in the U.S. dollar bolstered demand for precious metals as stores of value.
Producer Shares

The recovery has boosted the shares of the miners, drillers and farmers supplying the world with raw materials. The Bloomberg World Mining Index is up 23 percent after a three-year collapse, with BHP Billiton Ltd., the world’s biggest mining company, up 7.6 percent. Exxon Mobil Corp. has advanced about 13 percent while Archer-Daniels-Midland Co., one of the largest U.S. grains traders, has risen 19 percent.

China’s economy will have to stabilize and U.S. industrial production recover for there to be a sustained recovery in commodities prices, Dominic Schnider, head of commodities and Asia-Pacific foreign exchange of the wealth-management unit at UBS Group AG, said by phone. Until that happens, they may retreat again, he said.

“Commodities have outperformed, that’s the reality,” Schnider said. “I still think prices can fall in the short run, they should find a bottom during summer. I think prices of commodities in general, not so much base metals but predominantly energy, will come off again.”