Last Week

The most important thing that happened last week was that the June jobs report and the June ISM manufacturing and non-manufacturing PMIs further implied the US economy is close to achieving “escape velocity” (meaning ending the era of around 2% GDP growth).

Other than the obvious (that an accelerating economy is good for stocks), the strong data and implication that we’re finally breaking out of this slow-growth economy is key for two reasons:

First, the strong data of the past few weeks are helping to remove any worry about the economy being able to recover from the Q1 hole.  Second, the debate about whether the Fed is “behind the curve” (which is a term that just means the Fed may be too accommodative at this point, given what appears to be happening in the economy and with inflation) was reignited last Friday. If the market starts to believe the Fed is behind, look for inflation-linked assets/sectors to outperform going forward.

Turning to the data, ISM manufacturing and non-manufacturing PMIs actually slightly missed estimates last week. (Manufacturing:  55.3 vs. (E) 55.6, Non-Manufacturing: 56.0 vs. (E) 56.2.) Regardless, both were strong numbers and solidly above the 50 level that implies expansion.

And, the June jobs report was a blowout of 288K vs. (E) 213K.  And, beyond the June report, for the first six months of 2014 we’ve seen average monthly job gains of 231K—which is the best 6-month stretch since the crisis of 2008.  Additionally, the unemployment rate fell to 6.1% while the labor participation rate remained at 62.8% (meaning the unemployment rate likely declined because unemployed people found jobs, not because they dropped out of the labor force).

Bottom line is last week was an important week of data, and it implied that economic growth is accelerating. While last week’s data alone won’t result in a material change in Fed policy expectations, it does put some more pressure on the Fed to begin to explain their exit strategy.  For now, we remain in a sweet spot of an easy Fed and accelerating growth. But if things continue at this pace, Fed outlook will have to change—but that’s a problem for another day.

Last week wasn’t all about the U.S., though, as there were also a lot of global data.  The biggest positive surprise came from China, as both the private Markit and government June manufacturing PMI were above 50, while June service sector PMI in China surged to 53.1, up from 50.7 in May.  Bottom line is the PMIs, along with other recent data, confirm that the pace of growth of the Chinese economy has stabilized above 7%, which is a general tailwind for global markets and the economy.

Finally, turning to Europe, there were a ton of data last week (flash June HICP, June manufacturing and composite PMIs, retail sales and an ECB meeting).  Bottom line on all of it is that while there are some pockets of weakness (German data have been a bit soft the last few weeks, which is disconcerting), the consensus is that the slow recovery in Europe is continuing.  The ECB, as expected, made no changes to policy and will wait to see the effectiveness of the June measures before moving again.

This Week

It is a very quiet week economically for both the U.S. and the rest of the world.  Jobless claims (Thursday) is the only number to watch here in the U.S., while internationally the “highlight” will be Chinese CPI/PPI (tomorrow night) and trade balance (Thursday).  Inflation is always a concern in China, because an uptick in inflation will cause the government to pull back stimulus (which puts economic growth at risk). But no one is expecting a major uptick in inflation this week.

In Europe it’s also quiet (the biggest number of the week was German industrial production, which we got this morning).  The Bank of England meets Thursday, but there will be no change to policy. And, seeing as the BOE makes no statement at its rate meetings (unlike the Fed or ECB), this will be a non-event.  After a very busy holiday-shortened week, last week, we generally get a break economically over the next several days.

Most currencies were driven by economic data yesterday. The Dollar Index drifted slightly higher off the decent June ISM manufacturing PMI (up +0.06%) while the euro was slightly weaker (down -0.12%) after mixed manufacturing PMIs (they generally met expectations but the euro has seen a big rally lately).

The Aussie was the best performer vs. the dollar, rising +0.8%, breaking decisively through resistance at $0.94 and hitting a new high for the year.  The strength in the Aussie was due to short-covering as the currency rallied through $0.94 (which had been the high for the year) thanks to the improvement in Chinese PMIs and the lack of any dovish comments from the RBA during their rate meeting yesterday.

Markets were looking for the RBA to make some mention of the recent strength in the Aussie and attempt to “talk it down” as they did last year, but that didn’t happen.  It’s especially surprising given the fact that some bulk commodity prices (specifically iron ore) have collapsed 30% since April while the Aussie has rallied, causing a “double whammy” on the mining sector that continues to threaten the economy.  But, the RBA refrained from any Aussie-related commentary and instead said they continue to expect a “period of stability” in interest rates (meaning no more cuts).

Given the divergence in the Aussie vs. key commodity prices (high vs. low), a stabilizing but not accelerating Chinese economy, and the RBA’s reluctance to ease further, the picture isn’t very optimistic for the Aussie economy. Fundamentally, things are still bearish for the Aussie.  But, clearly the trend is higher for now, and next resistance is $0.9518.  And, until the RBA says something about the elevated Aussie, then this counter-trend rally will continue.

The pound continued its grind higher, hitting another multi-year high after the Great Britain June PMI beat estimates (57.5) Tuesday, and the trend remains clearly higher. (As long as the Fed is dovish and the UK economy continues to surge, the pound will continue to rally vs. the dollar.  We’ve not seen the highs yet in this trade, I believe.)

The yen weakened a bit vs. the dollar yesterday (down -0.25%), but it bounced off the intraday lows and dollar/yen remains below the 200-day moving average – and it needs to get back above that support level today or tomorrow; otherwise the outlook for the yen will continue to get stronger.

Economic data lately out of Japan has been a bit tepid, and given the lack of specifics from Shinzo Abe’s “3rd Arrow,” it appears the market is starting to lose some confidence in the PM (that’s why the yen is rallying – it’s not because of economics per se).  The Bank of Japan remains in the corner of the yen bears, and I believe they will act if the economy begins to falter – but that could be at a much lower level for dollar/yen.

Again this has been a trade that has worked for over 18 months, so I’m hesitant to abandon it now, but the dollar/yen needs to get back above the 200-day sooner than later.

Bonds were sharply weaker yesterday as the 30-year fell -0.65%, trading lower off of the global PMIs. This largely implied the global economic recovery is progressing (there was also a cautious article on junk bonds and credit spreads in the WSJ, although that didn’t really tell us anything new).

Bonds were weaker all day yesterday (the selling began overnight Tuesday once the Chinese PMIs hit), and the declines accelerated after the strong auto sales and ISM manufacturing PMI.  The yield curve steepened yesterday as the “belly” of the curve declined only modestly (down -0.27%), helped by the Fed purchasing $2.9 billion worth of 7-year bonds.

Bonds gave back a lot of last week’s rally yesterday, but still remain firmly in a solid uptrend until the 30-year breaks 135’18-ish, the uptrend will continue.

Last Week

There were three important economic takeaways last week:  First, housing appears to be finally bouncing from its winter dip.  Second, capital spending (businesses buying a new machine or some other high-cost investment) continues to not rebound like the rest of the economy has since the winter.  Third, inflation has clearly accelerated over the past three months, but economic growth doesn’t appear to be keeping pace with the recent acceleration in inflation.

Of the three, the final point is by far the most important. While it’s very early yet, if the economy can’t keep pace with accelerating inflation, then we risk stagflation, which is bad for most assets (bonds and stocks).  We aren’t anywhere close to stagflation, but after the data last week, it’s something we need to keep an eye on.

Looking at the actual data, the Personal Income and Outlays report was the most important release last week, and the main cause of the “stagflation” worries.  Core PCE, the Fed’s preferred measure of inflation, rose +0.2% in May and is now up +1.5% year-over-year (yoy), and that met expectations.  More importantly, though, Core PCE has gone from rising +1.1% yoy in February to +1.5% in May. If we annualize the last three months’ gains, we get an annual core PCE increase of +2.1%, basically at the Fed’s target.  This recent acceleration confirms what we’re seen recently in CPI.

At the same time, though, while the economy is continuing to recover, it’s not matching the gains in inflation over the past three months.  Case in point: May consumer spending slightly missed expectations, increasing +0.2% vs. (E) +0.4%, and real consumer spending (consumer spending less inflation) was actually negative in April and May.  So, the key here isn’t that the economic recovery has stalled—it has not.  But, over the last few months, the economy hasn’t grown as quickly as inflation has.

Capital spending, however, still isn’t seeing the rebound in activity that other sectors of the economy have enjoyed since April.  The May Durable Goods report headline declined, but the real number to watch (Non-Defense Capital Goods Excluding Aircraft) rose +0.7% and the three-month rolling average showed a +1.5% gain.  But, while it’s a positive number, it’s not strong growth.

With housing now showing clear signs of a rebound, capital spending (again, think investment by businesses in machines, etc.) is the one sector of the economy that still hasn’t gotten a bounce. This probably reflects continued caution by businesses on the future of the economy (i.e., things are getting better, but not enough to make large investments because people aren’t confident in revenue visibility).

Bottom line with last week: Nothing resulted in a material change in the outlook for the economy or Fed policy. But the recent acceleration in inflation/less than impressive consumer spending report (and extrapolating it out to potential stagflation) bears watching.

This Week

It is going to be a busy holiday-shortened week (the market closes at 1 p.m. EST Thursday and Friday is off).

Probably the most important number of the week has already been released, and it was the European flash HICP for June (their CPI).  The annual inflation rate ticked slightly higher to 0.8% vs. 0.7% in May (meeting expectations) so that’s slightly encouraging, but overall the deflation threat in Europe remains and this will keep the ECB fully “engaged” in the deflation fight.

Turning back to the future data, it’s “jobs week” this week, although be aware the May jobs report will be released Thursday at 8:30, at the same time as weekly claims.  Prior to that we get ADP on Wednesday.  The jobs report isn’t as critical as it has been in recent months, but it still is important.  In the context of our “stagflation” point earlier, markets will be watching for jobs growth in line with recent reports (so around 200K). If there is an increase in wages and hours worked, this will imply tightening in the labor market (which is both inflationary and positive for consumer spending).

Tomorrow we get global official June manufacturing PMIs, which should continue to confirm the consensus that: The pace of economic growth in China has stabilized, Europe’s economy continues to slowly recover, and the manufacturing sector of the U.S. economy is seeing the recovery accelerate.

The biggest risk of disappointment in this report is in Europe, as France’s flash PMI was pretty bad (47.8) while the overall EMU was stagnant.

Finally, as if all that wasn’t enough, Fed Chair Janet Yellen speaks Wednesday (we can expect similarly “Dovish” remarks like the last FOMC meeting) and there is an ECB meeting.  But, after their attempt to “shock and awe” the market last month, this meeting should be a non-event.