As the market awaits Fed Chair Powell’s noon comments on the economy the second read on third quarter GDP was unchanged at 3.5% but there was some shuffling in the details. Consumer consumption dipped from 4.0% to 3.6% with the drop most noticeable in durable goods (cars and appliances). The dip in consumer spending was offset, however, by an upward revision in non-residential investment, but the 2.5% revised gain (up from 0.8) pales in comparison to the second quarter’s 8.7% increase. At noon we’ll hear from Fed Chair Jerome Powell as he speaks to the Economic Club of New York so that will be an obvious focus of the market today. Fed Vice Chair Richard Clarida spoke yesterday and struck a rather balanced view that seemed to call for continued rate hikes, as long as economic and employment gains continued on trend. That’s obviously a big qualifier—and he did touch on the weakening in non-residential investment— so we discuss his policy views in more detail below. As for Powell it will be interesting to see if he tempers his recent economic enthusiasm given the recent market volatility and housing weakness.
|Economic News||RV Shipments Declining: Canary in the Coal Mine?||Agency Indications|
Federal Reserve Vice Chairman Richard Clarida spoke yesterday to the Bank Policy Institute with his speech on Data Dependence and U.S. Monetary Policy. This was his first opportunity to expound at length on his monetary policy views since October. And given his somewhat dovishly-interpreted comments from a CNBC interview a couple weeks ago, investors were eager to hear his views at more length. Alas, for those looking for additional dovish comments, Professor Clarida did not deliver. Instead, he struck a balanced view that implies continued quarterly rate hikes as long as economic and labor market growth remain strong with inflation near the 2% benchmark (i.e., data dependent). The full text of the speech can be found here.
Mr. Clarida did give his rationale for why, if growth in employment and the economy are above long-term potential, inflation continues to remain so docile. His answer was that recent trends in productivity and labor force growth were above trend as well and thus keeping inflationary forces at bay. His concern, however, was that spending on equipment and software (productivity-enhancing investments) declined in the third quarter and if that continued he would expect inflation to move higher if employment and GDP growth continued apace. He would view that development as a reason to continue with hikes.
Brandishing his professorial-command of the subject matter he also talked about the concept of the equilibrium unemployment rate (u*) and the neutral interest rate (r*). He admitted that accurately estimating both is a fools errand, and that they are constantly shifting, but an estimate nonetheless provides policymakers with hypothetical guideposts as to where the economy and monetary policy stand and where they may be headed. He noted that with the neutral rate estimated at 2.50%-3.00%, monetary policy is close to neutral, especially after the expected rate hike to 2.25-2.50% next month. He also noted that while the estimate of the equilibrium unemployment rate (think of it as the goldilocks rate for the economy, not too hot, not too cool), had moved down in recent years (currently estimated at 4.5%), it could continue to move lower as new information becomes available. From his speech, the essence of his policy approach seems to be, given expected economic and employment growth, gradual rate normalization (i.e., quarterly rate hikes) continues to be the appropriate policy path but that path will become increasingly subject to change if the incoming data changes. So while not a dovish take Clarida spelled out a pretty clear reaction function to policy that from this point forward will be adjusted based on incoming data and not the autopilot-like hikes of 2018.
Meanwhile, while the Fed has three hikes penciled in for next year from its September forecast, the market has been downgrading its estimates as more recent economic indicators point to some slowing, particularly in housing, and the increasingly problematic trade/tariff situation not to mention equity volatility. The latest market estimates have the Fed moving just over one time next year (30bps) and that is off from a 60bps estimate in early October. Despite Clarida’s policy clarification we think the 30bps hiking estimate for next year is too low. We feel the economy still carries enough momentum to get two hikes in 2019 but that third hike remains a real uncertainty.
Speaking of economic momentum, or the slowing thereof, the latest S&P CoreLogic CS 20-City Home Price Index joins a lengthening list of housing reports reflecting some softness. The September release revealed the slowest year-over-year gains in almost two years, adding to signs that buyer interest is waning amid higher mortgage rates and elevated property values. The 20-city index increased 5.1% YoY, the least since November 2016. The report marks the sixth straight month of decelerating price gains.
It’s the latest in a spate of housing reports indicating a broad slowdown, with sales and home-building also showing signs of weakness. This is undoubtedly one of the data points that Fed Vice Chair Clarida will be looking at and if the trend continues, it obviously could slow the expected pace of rate hikes next year. That’s what the market is betting on and it will be interesting to hear Chairman Powell’s views on the subject later today.
RV Shipments Declining: Canary in the Coal Mine?
One of the more esoteric data points the Fed may be looking at could be the shipment of RV’s. Recall that in the Great Recession RV sales plummeted in the wake of job losses as the nice-to-have items like RVs got axed in kitchen-table budget-cutting sessions. The graph illustrates the YoY percentage change in shipments of RVs and it reflects significant weakness since the summer. This decline is especially enlightening given the decrease in oil and gas prices that have occurred during that time (i.e., the decline in shipments can’t be blamed on increasing fuel costs). Looking at sales/shipments of such toys/luxuries can be an early indicator of gathering consumer concerns.
Agency Indications — FNMA / FHLMC Callable Rates