The Economy: A Look Back and What’s Ahead (1.21.14)

Last Week

Economic data last week was almost universally better than expected. This gave the market a needed “confidence boost” about the current state and trajectory of the economy following the disappointing December jobs report.

First, with regard to the current state of the economy, the first two January economic data points, Empire State manufacturing and Philly Fed, both beat expectations.  Importantly, given the context of the jobs report, the employment indices in both reports saw strong gains from December to January (Philly jumped 5.6 points to 10.0 while Empire jumped from zero to 12).

Turning to the trajectory of the economy, several pieces of December data helped remind the market that we are seeing economic growth accelerate.

First, there was good news on the consumer front, which came amidst seemingly daily “blow ups” of retail stocks.  December retail sales beat estimates, rising 0.2%. But more importantly, “control” retail sales—which exclude automobiles, gasoline and building materials, and serve as a better gauge of consumers’ willingness to spend discretionary income—jumped 0.7%.  This reading helped solidify the belief that Q4 GDP will be stronger than originally thought, and the terrible retail stock results are not due mainly to a sluggish consumer.

There was also some positive reinforcement in the housing market, after the December Housing Market Index and December Housing Starts largely met pretty high expectations, echoing recent data that implies that the housing market recovery is stabilizing after seeing it slow in the face of higher rates earlier in 2013.  The key in housing now isn’t so much that the market is accelerating, but instead that it’s maintaining, and that’s what the data said last week.

Bottom line is the December jobs report “spooked” markets, despite the fact that it was initially disregarded as a statistical anomaly.  The 120-point drop in stocks last Monday proved that.

But, serendipitously, the data last week gave the market renewed confidence in the economy, and  reinforced the belief that the December jobs report was just an anomaly that will be revised higher.

And, from an expectations standpoint, the market is still pricing in: 1) Another $10 billion taper of QE at the January meeting next week; 2) That QE ends completely in November; and 3) A minimum of 3% GDP growth in 2014, with risks to the upside.

This Week

The January global flash manufacturing PMIs, which are released Wednesday night (China) and Thursday morning (Europe and the U.S.) are the big (and pretty much only) numbers to watch this week.  These PMIs remain very important because a continuation of the global economic recovery is a key pillar to a continued rally in risk assets, and the global PMIs give us the best “look” at the state of the global economy.  China will be especially in focus, as concerns remain about whether economic growth is stable in that country (there are lingering concerns we will see economic growth slow further).

Domestically, we get more housing data (Existing Home Sales) on Thursday, and between that report and weekly jobless claims, that’s pretty much it for domestic economic data, as it’s a quiet week.

Finally, there are two central bank events worth watching.  First, the Bank of Canada will have an interest rate meeting, and given the recent slowdown in their economic data, there is speculation that the BOC will cut interest rates.  The market has already priced a cut in, to a point, as the “Loonie” is basically at a four-year low versus the dollar.  The reason I point this out is because it could set up a “buy the news” bounce. Unless the BOC cuts rates and is very “dovish” in their commentary, we might see an oversold bounce in the “Loonie.”  If we do get that bounce, it may be a decent entry point for a short position via futures or the CurrencyShares Canadian Dollar Trust (FXC), as regardless the trend in CAD will remain lower.

The other central bank event to watch this week is the release of the Bank of England minutes from the December meeting.  As I’ve detailed in this Report, the Bank of England may be a key leading indicator for how well “Forward Guidance” works as a policy tool for the Fed.

That’s because the BOE’s guidance, that it won’t raise interest rates until well into the future, is being undermined by strong economic data out of the UK.  And, it’ll be very interesting to see how the BOE addresses this erosion of confidence in its “Forward Guidance,” and very well could provide a blueprint for what will happen to the Fed, should our markets begin to lose confidence in their “Forward Guidance” and anticipate a sooner-than-expected increase in interest rates as the economy improves.

The market losing faith in the Fed’s “Forward Guidance” because economic data is substantially improving remains the greatest peripheral risk to stocks and other risk assets. That’s because, if that happens, we’ll see interest rates embark on an unruly rise.  The BOE is ahead of us on this path, though, so it’s important to watch what they say, and more importantly, how the market reacts.