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Atlanta Fed Business Inflation Expectations

• YOY Business Inflation Expectations increased to 2.0% from 1.9% in October

Takeaway

Around 10 AM yesterday, the Dollar Index rallied and bonds sold off (a typically “hawkish” reaction). The reason was a slight uptick in the little-followed Atlanta Fed Business Inflation Expectations Survey.

What made the report “hawkish” wasn’t the fact that expectations for year-over-year inflation rose to 2.0% (they were at 2.1% earlier this year). Instead it was that the percent of business executives who saw inflation as starting to trend higher over the next 12 months jumped from 54% in May (the last time the questions was asked) to 63% in November, which is a multi-year high.

Declining inflation expectations as measured by the bond market have been a big topic of discussion and are partially responsible for the “dis-inflation” talk here in the U.S. But actual expectations by business owners for inflation pressures over the coming 12 months are trending materially higher—not lower.

Combine that with the uptick in the Fed’s quarterly wage inflation data, and there are growing signs that wage inflation has bottomed and is finally trending upward. (This is anecdotally confirmed by the U-6 underemployment index dropping to multi year lows at 11.5% in last week’s jobs report.)

Bottom line, I’m pointing this out because there are very few people prepared for inflation. From a portfolio standpoint, while it isn’t something we need to position for today, it is something we need to watch for. That’s because there are signs emerging that inflation has bottomed, and is starting to (slowly) gain some upward momentum, led by wage gains.

This is something we will continue to watch over the coming months/quarter, because if we do see inflation, that’s a major trend change few people are properly positioned for at this time.

This was an excerpt from today’s Sevens Report. To continue reading today’s Report, simply sign up for a Free Trial on the right hand side of this page.

Last Week

Global economic data were again mildly disappointing last week, but they didn’t turn negative. Against the backdrop of global central banks becoming “more” accommodative, the data were good enough not to change the current outlook that the global recovery is (barely) continuing—but that outlook is enough to hold stocks up at current levels.

From a stock standpoint, global data are more important than U.S. data in the near term because everyone is comfortable the U.S. economy is getting better. How much better can be debated, but there’s ample evidence to show it’s gaining momentum.

The same can’t be said for the global economy. Last week’s manufacturing and composite PMIs from China and Europe were slightly disappointing in that they missed expectations. No global readings were above 52 (keep in mind 50 means no growth; even 52 represents slow growth), so none of the numbers were “good.”

But, they did stay above 50 and the important distinction is that the global economy is still recovering (albeit slowly). The sell-off in late September/early October was partially predicated on the idea the global recovery was failing. Last week’s numbers further refuted this concern; that’s the important takeaway (stocks can hold these levels as long as the global recovery isn’t failing).

Here in the U.S., manufacturing data and jobs were in focus. The October PMIs were generally fine, in that they showed the manufacturing and service sector continuing to expand at a good pace (both were above 57).

Turning to the jobs report, it was also generally in-line, with 212K job adds. This missed expectations of 240K but closely tracked the rolling 12-month average of 222K. So, it was in the middle of our “just right” range.

But, I do want to point out that the jobs report was a bit more “hawkish” than the market reaction. Importantly, the unemployment rate fell to 5.8%, which is not very close to the 5.5% “normal” unemployment rate. Also, U-6, which considers underemployment, dropped to 11.5% from 11.8%—the lowest levels in several years.

The “dovish” reaction came from the wage data, as wages rose 2.0% yoy (above 2.2% is “hawkish.”) But, keep in mind wages always lag an improving jobs market. While this report won’t cause expectations of the first rate hike to be pulled forward, it does solidify June as a target date for the first hike, and I’m not sure the bond market accurately reflected that on Friday.

Finally, the Fed and BOJ were quiet last week while the BOE made no changes to rates or policies (as expected). The ECB was the highlight of the week, and while it didn’t change any policies, Draghi did as good a job as possible of “talking” dovish. He refuted various accounts of infighting at the ECB, explicitly saying economic risks were to the downside. He added that ECB staff are now researching alternative ways to stimulate the economy (which means corporate bond purchases and QE).

Bottom line, the ECB continues to slouch toward QE and more stimulus. While “euro bulls” wish they would hurry, the important thing is they are headed in the right direction. The ECB this week reinforced my bullish Europe thesis.

This Week

This week will be very quiet. First, keep in mind bonds and banks are closed Tuesday for Veterans Day. Second, there is really only one economic report of note this week domestically, and that’s Retail Sales (Friday). There is now a month-plus of lower oil prices in the economy, so it’ll be important to see retail sales (ex gasoline) increase if the U.S. consumer is really starting to come out of his/her shell.

Internationally, the latest round of Chinese economic data Thursday night (retail sales/industrial production) is obviously important from a global growth standpoint (these numbers need to continue to show incremental progress).

In Europe, the Bank of England’s inflation report Wednesday is the highlight, but that really will only affect the pound. And, given the precipitous decline in the pound the last few weeks (it hit new 52-week lows vs. the dollar last week) there is the chance for a “hawkish” surprise. But that won’t be a reason to be enthusiastically long the pound unless it’s a real shocker.

Finally, the flash estimates for Q3 European GDP come Friday morning, and like the Chinese data earlier this week, it’s important from a “Is the global recovery ongoing?” standpoint.

Bottom line, while there are numbers to watch this week (again, the Chinese data is the uncontested highlight) nothing this week should make anyone’s outlook on the global economy materially worse or better, even with some big surprises.

This was a look at the economic section of today’s Sevens Report. To continue reading today’s sevens report, simply sign up for a Free Trial on the right hand side of this page.

Jobs Report Preview

The importance of these jobs reports from a Fed policy standpoint is on the rise, and the risk to stocks is for the numbers to run too “hot” and pull forward Fed interest rate increases.

The “Too Hot” Scenario: >300K job gains. A jobs number this strong would likely result in a pulling forward of rate increase expectations, and the markets would react hawkishly: Stocks, bonds and commodities would all decline, the U.S. dollar would continue to rally.

The “Just Right” Scenario: 180K – 290K job gains. This is the “sweet spot” for this report, as it implies a still-healing labor market but not one that’s so strong it would pull forward the date of the first rate hike. A number in this range shouldn’t elicit too much of a market reaction as it’s mostly priced in.

The “Too Cold” Scenario: <180k job gains. Given all the other employment metrics released in October, the chances of this number being a big miss are very remote.

If we get a number below 180K, expect a mildly “dovish” reaction—stocks and the dollar will decline, while bonds and commodities will rally. But, even if this is a big miss, don’t expect markets to move too much as it’ll probably be discounted as a statistical aberration.

Wage Increases and the Unemployment Rate: >2.2% and <5.9% will be taken as “hawkish.”

Given the risk is skewed to the “hawkish” side of things for this meeting, changes in the year-over-year wage gains and unemployment rate are equally as important as the headline jobs number.

An annual wage increase over 2.2% would be considered “hawkish” and elicit a “hawkish” reaction from markets, while a drop in the unemployment rate below 5.9% would also be “hawkish.”

 To read more of today’s Sevens Report simply sign up for a free trial on the right hand side of this page.

ISM Non-Manufacturing  PMI

• October ISM Non-Manufacturing PMI was 57.1 vs. (E) 58.0.

Takeaway

The non-manufacturing (or service sector) October PMI was a slight disappointment as it declined from a 58.6 reading in September, and the details were also a bit underwhelming. New orders (the leading indicator of the report) fell 1.9 points to 59.1, the lowest reading since April. And, this weakness was confirmed by the private firm Markit’s service sector PMI, which also fell to 57.1. The one bright spot was the employment component, which rose to 59.6 from 58.5 in September, a multi-month high (which bodes well for the jobs number Friday).

But, while a slight moderation, the bottom line here is the absolute level of activity of the service sector (which is by far the larger portion of the economy compared to manufacturing) remains strong and comfortably above 50. There is some slight evidence that, on the margin, the pace of activity in the U.S. economy is moderating slightly, but the recovery remains very much intact, and the economy remains generally supportive of stock prices.