Weekly Economic Cheat Sheet 12.21.15

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Last Week

Last week was historic as the Fed hiked rates for the first time in nearly a decade, but it wasn’t fully the “Dovish hike” investors were hoping for. So, between new uncertainty surrounding the path of future rate hikes and worsening manufacturing indices, the economic outlook for the market did not materially improve.

Starting with the Fed decision, for a two-hour period it looked like the Fed perfectly threaded the needle between hiking rates for the first time in nearly 10 years, and providing enough dovish guidance to comfort markets that the next rate hike won’t come for a long time.

Unfortunately, once investors looked past the dovish tone, they focused on what we were all focused on—the “dots.” The fact that the Fed didn’t reduce the median dots for 2016 (which shows where the Fed thinks the Fed Funds rate will be at year end) was taken as modestly “hawkish,” and that was largely responsible for the dollar surge Thursday and the plunge in stocks.

The main takeaway from the Fed hike is that there remains a large and substantial gap between where the FOMC thinks rates will end 2016 (at 1.375%) and where the market (via Fed Fund futures) thinks rates finish 2016 (0.875%). Bottom line, there is a two-meeting discrepancy and that needs to be resolved. Whether the Fed needs to get more hawkish or the economy prevents another timely hike, either scenario is at least a temporary headwind on stocks. Going forward, the proper framework to view what the next Fed rate hike means for stocks is this: June=“Good,” March=“Bad”, After June=“Ugly.”

Looking at the rest of the data from last week, the December manufacturing PMIs were disappointing, and disconcertingly imply we are not yet seeing stabilization in the manufacturing sector, which continues to be plagued by excess inventory and a strong dollar.

December flash manufacturing PMI missed estimates at 51.3 vs. (E) 52.8, as did December Philly Fed, which turned negative again. Empire Manufacturing Survey actually slightly beat estimates, but it remained in negative territory and New Orders in both Empire and Philly plunged (New Orders are the leading indicators in the manufacturing PMIs).

Bottom line, the recent manufacturing data does not imply stabilization, as we said last week. While soft manufacturing won’t derail the US economy, stable manufacturing is needed if the economy is ever going to achieve “escape velocity” of 3.5%-plus growth (and that matters because we need that for stocks to materially break out from current levels).

Bottom line, last week brought closure on the drama surrounding the first rate hike in nearly 10 years, but beyond that it didn’t provide a lot of additional clarity on the economy, so the economic outlook for the US remains unclear, despite the events of last week.

This Week

Even if Christmas wasn’t this week the economic calendar would be pretty light, but the holiday (1/2 day Thursday, off Friday) will make the data this week even less impactful. The only real, notable economic event this week comes Wednesday with the release of the November Personal Income and Outlays Report.

As you likely know by now, this report is important every month not because of the headline but instead because of the Core PCE Price Index contained in the report, which is the Fed’s preferred measure of inflation.

Inflation was highlighted by the Fed even more than normal in last week’s statement, so it’s not an oversimplification to say that what inflation does over the next two months will decide whether the Fed hikes in March (very unlikely given current inflation levels) or June.

Remember inflation pressures continue to firm (Core CPI last week rose 2.0% yoy) so if the Core PCE Price Index begins to reflect any upward pressure, that will be hawkish (and not good for stocks). It likely won’t happen this week, but following last week’s FOMC statement Core PCE Price Index is an even more important indicator to watch.

The other notable reports this week include Durable Goods, which has been strong lately and bodes well (potentially) for Q4 growth as business spending and investment has been a positive surprise economically.

There are also several more housing numbers (November Existing Home Sales on Tuesday and New Home Sales on Wednesday). These reports were disappointing in October and more soft numbers are expected given the decline in Pending Home Sales (which lead existing home sales), but as long as the disappointments are supply based (lack of homes for sale) and price is generally steady, they shouldn’t elicit too much of a reaction from markets.

Final Q3 GDP comes Tuesday, but at this point the data is so old it’s virtually inconsequential, while jobless claims finish the week on Thursday. Overall, it should be a quiet week barring any shocks from the Core PCE.