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FOMC Preview and Projections plus the Wildcard to Watch, July 25, 2017

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Tomorrow’s FOMC meeting is important to markets for multiple reasons, because it will give us additional color on when the Fed will begin to reduce its balance sheet, and whether a December rate hike is still on the table.

Those revelations will be the latest catalyst for the ongoing battle between “reflation” (which means cyclical sectors like banks, industrials and small caps outperform) or “stagnation” (super-cap tech and defensive sector out-performance).

Given the latter sectors have been the key to outperforming the markets in 2017, understanding what the Fed means for these sectors is critically important. Remember, it was the Fed’s “hawkish” June statement that saw Treasury yields rise and banks and small caps outperform from June through mid-July. And, it was Yellen’s “dovish” Humphrey-Hawkins testimony that reversed the rise in yields and resulted in the two-week outperformance of super-cap tech (FDN) and defensive sectors such as utilities. So again, while not dominating the headlines, the Fed is still an important influence over the markets, just on more of a micro-economic level.

What’s Expected: No Change to Interest Rates or Balance Sheet Policy. The Fed is not expected to make any change to rates (so no hike) or begin the reduction of the balance sheet. However, and this is important, the Fed is expected to clearly signal that balance sheet reduction will begin in September by altering the fifth paragraph to state that balance sheet normalization will begin “soon” or “at the next meeting.” Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Hawkish If: The Fed Reduces the Balance Sheet. This would be a legitimate hawkish shock, as everyone expects the Fed to start balance sheet reduction in September. Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Dovish If: No Hint At Balance Sheet Reduction. If the Fed leaves the language in paragraph five unchanged (and says balance sheet reduction will happen “this year”) markets will react dovishly, as balance sheet reduction likely won’t start until after September, and that means no more rate hikes in 2017. Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Wild Card to Watch: Inflation Language.

So far, the Fed has been pretty dismissive regarding the undershoot of inflation, but that may change in tomorrow’s statement. If the Fed reduces its outlook on inflation (implying low inflation isn’t just temporary) or, more significantly, implies the risks are no longer “roughly balanced” (which is Fed speak for we can hike at any meeting), then a December rate hike will be off the table, and that will result in a likely significantly dovish move. If made, that change will come at the end of the second paragraph.

Bottom Line

To the casual observer, this Fed meeting might look like a non-event, but there are a lot of potential changes that could have significant implications on sector performance over the next few months. So, again, getting this Fed meeting “right” will be important from an asset allocation standpoint.

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Weekly Market Cheat Sheet, May 22, 2017

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Economic and Investing Cheat Sheet - May 22

Last Week in Review:

There weren’t many economic reports last week, and the data we did get was mixed. In sum the data did nothing to remove the growing feeling that the US economy is losing momentum.

First, the initial look at May data in the form of the Empire State Manufacturing Index badly missed at -1.0 vs. (E) 8.0, but the Philly Fed Business Outlook Survey on Thursday contrarily blew away expectations (38.8 vs. E: 19.6). The net effect is that it put more focus on this week’s flash manufacturing PMI to give us a true look at the pace of manufacturing activity in May.

In the US housing market, the Housing Market Index beat expectations on Monday (70 vs. E: 68), but Housing Starts data on Tuesday whiffed (1.172M vs. E: 1.256M).

The most encouraging report last week was Industrial Production, which beat estimates of 0.4% with a headline print of 1.0%. But, a lot of that “beat” came from auto manufacturing, and activity in that sector has almost certainly peaked (remember Ford is cutting employees amidst more challenging sales environments). Point being, the Industrial Production beat is likely a one off, not the start of a trend.

Rounding things out with the labor market, weekly jobless claims fell 4K to 232K, as the general trend lower remains very well defined. Continuing claims fell to a 29-year low while its four-week moving average fell to a 43-year low. This encouraging report was especially notable because the data was collected from the week corresponding with the survey week for the May jobs report, and the strong print suggests that May could be another very strong month for the labor market. Bottom line, economic data last week did not materially change our outlook for the markets.

This Week’s Preview:

This will actually be a relatively busy week of economic data, as we get the flash manufacturing PMIs, Fed minutes from the May meeting, and other important economic reports.

The most important report this week will be Wednesday’s May flash manufacturing PMI. This will be the first major data point for May and it needs to show stabilization and, better yet, acceleration for stocks to rally.

Second in importance this week will be the FOMC minutes. Markets have priced in a slightly more dovish Fed given the soft inflation data recently, but markets have overestimated the Fed’s dovishness throughout 2017. If the minutes are hawkish, that could push yields and the dollar higher (which would be stock positive).

Meanwhile, there are two reports on housing data, New Home Sales and Existing Home Sales due out on Tuesday and Wednesday, respectively. Investors would welcome a rebound after last week’s soft Housing Starts report.

Finally, both the second look at Q1 GDP and Durable Goods Orders will be released Friday morning. The latter will be closely watched as the gap between soft and hard data remains a concern, and a strong revision to GDP and a good Durable Goods number will help close that gap. Bottom line, economic data remains the key to reigniting the reflation trade (remember, it’s #1 in my list of four events needed to restart the rally). So, the market needs good data and a confident/hawkish Fed for stocks to again test recent highs.

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Weekly Market Cheat Sheet: May 8, 2017

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Weekly Market Cheat Sheet

Last Week in Review:

Economic data last week, highlighted by the strong jobs report, helped to somewhat narrow the gap between soft sentiment surveys and hard economic data… although it’s fair to say that gap remains open and is still a headwind on stocks, just a slightly less strong one. It was not all positive last week, though, as we got several signs of potential loss of momentum in China, which was an underreported but potentially important development last week. Finally, the Fed meeting proved to be a non-event, except in that it reaffirmed a June rate hike is likely (but that’s already mostly expected from the markets).

Starting with the jobs report, it met our “just right” scenario. The overall job adds were strong at 211k vs. (E) 185k, but revisions to the March report were negative 19k, so the net number was more in line. The unemployment rate dropped to 4.4%, but that was in part due to a decline in the participation rate. Meanwhile, year-over-year wage increases declined to 2.5% from 2.7%. Bottom line, this number was “fine,” but it wasn’t massively reflationary (in part due to the wage number) and that’s why we didn’t see the strong headline jobs report ignite an immediate reflation rally in stocks (again, the wage number undermined the strong job adds).

Looking at other economic data last week, there were more positives than negatives, highlighted by the ISM Non-Manufacturing PMI, which hit 57.5 vs. (E) 55.8. That strong Non-Manufacturing PMI helped to offset the soft April Manufacturing PMI, which dipped to 54.8 vs. (E) 56.5 while the New Order component dropped below 60 for the first time in five months. While disappointing vs. expectations, it’s important to remember that the absolute level activity remains strong.

Turning to the Fed, the key takeaway from last week’s Fed meeting was that the Fed viewed the loss of economic momentum in Q1 as “transitory,” and still said risks to growth were “roughly balanced.” Both terms are Fed speak for, “We’re going to hike in June despite the soft Q1 GDP.” The market largely expects that (Fed Fund futures have a hike priced at 83% (which is close to a universal conclusion).

Finally, I want to take a moment and focus on Chinese economic data from last week, as the numbers were universally disappointing. Official April Manufacturing PMI dropped to 51.2 vs. (E) 51.7 while composite PMI declined to 51.2 vs. previous 52.1. Additionally, iron ore went into quasi freefall this week, as iron ore futures ended limit down on the Dalian Commodities Exchange on Wednesday night. The drop came after the Chinese steel industry PMI dropped below 50, signaling contraction. Oversupply has something to do with the price drop as well (exports are surging out of Australia) but the bottom line is that base metal prices are a coincident indicator of economic activity. The declines in iron ore, steel and copper last week, combined with the under-whelming Chinese data, definitely caught our attention. We now are officially watching this closely for everyone, and will keep you updated.

This Week’s Cheat Sheet:

This week, April CPI and April Retail Sales (both Friday) are the important reports to watch. The latter is more important for markets at this point than the former, as we need to see a rebound from Q1’s paltry consumer spending. If retail sales fail to show progress and beat expectations, it’ll widen the gap between soft data and hard economic numbers. With CPI, we should see some mild cooling of the recent uptick in inflation, but overall inflation pressures continue to slowly build.

Outside of those two numbers, focus will be on the Chinese CPI and PPI, as again data there suddenly turned lower last week. Bottom line, it should be a quiet week, but retail sales and CPI are important as the “gap” between soft sentiment surveys and hard economic data remains… and it needs to close further if we are going to see a breakout in stocks.

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Last Week and This Week in Economics, May 1, 2017

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Economic data continued to underwhelm last week and the gap between soft sentiment surveys and actual, hard economic data remains wide, and that gap remains a medium term risk on the markets.

The Sevens Report - This week and last week

Last week in Economics – 4.24.17

Looking at the headliner from last week, Q1 GDP, it was underwhelming, as expected. Headline GDP was just 0.7% vs. (E) 1.1%, and consumer spending (known as Personal Consumption Expenditures or PCE) rose a mea-sly 0.3%. But, the 0.7% headline met the soft whisper number and that’s why stocks didn’t fall hard on Friday.

That GDP report came on the heels of another underwhelming Durable Goods number. The headline missed estimates but the more importantly, New Orders for Non-Defense Capital Goods ex-Aircraft rose just 0.2% vs. (E) 0.4%, although revisions to the February data were positive.

Meanwhile, inflation metrics firmed up last week. First, the PCE Price Index in Friday’s GDP report rose 2.2% vs. (E) 2.0%, while the Employment Cost Index, a quarterly gauge of compensation expenses, rose 0.8% in Q1 vs. (E) 0.4%. Those higher inflation readings were why you saw the dollar rally pre-open Friday despite the disappointing GDP report.

Bottom line, the economic data over the past several weeks hasn’t been “bad” and it’s not like anyone is worried about a recession. But, the pace of gains has clearly slowed, and until we see a resumption of the economic acceleration many analysts were expecting at the start of 2017, any material stock rally from here will not be economically or fundamentally supported (and remember, it was the turn in economic data back in August/September that ignited the late 2016 rally. Yes, the election helped, but the momentum was positive before that event, so economics do matter).

This Week in Economics – 5.1.17

Economic data this week could go a long way towards helping to resolve the large gap between soft sentiment surveys and hard economic data, given the large volume of economic reports looming this week.

First, it’s jobs week, so we get the ADP Employment Report on Wednesday and the official jobs report on Friday. We’ll do our typical “Goldilocks Jobs Report Preview” on Thursday, but after March’s disappointing jobs number, the risks to this report are more balanced (it could easily be too hot if the number is strong and there are positive revisions, or it could be too cold and further fuel worries about the pace of growth).

Second in importance this week is the Fed meeting on Wednesday. The reason this is second in importance is because it’s widely assumed the Fed won’t hike rates at this meeting (June is the next most likely date for a rate hike), although the Fed has turned slightly more hawkish so there’s always the possibility. We’ll send our FOMC Preview in Wednesday’s report but the wildcard for this meeting is whether the Fed gives us any more color into how it plans to reduce its balance sheet. If the Fed does reference or start to explain how its plans to reduce its balance sheet, that could be a hawkish surprise for markets.

Finally, we get the global manufacturing and composite PMIs this week. Most of Europe is closed today for May Day so just the US ISM Manufacturing PMI comes today, with the European and Japanese numbers out tomorrow. Then, on Wednesday, we get the US Service Sector PMI and global composite PMIs on Thursday. The global numbers should be fine but the focus will be on the US data. In March we saw a loss of positive momentum in these indices but the absolute levels of activity remained healthy. If we see more moderation and declines in the ISM Manufacturing and Non-Manufacturing PMIs in April, that will stoke worries about the overall pace of growth in the economy and that will be a headwind on stocks.

Bottom line, this a pretty pivotal week for the markets. On one hand, if economic data is strong and the Fed a non-event, the S&P 500 could push and potentially break-through 2400. Conversely, if economic data is underwhelming and the Fed mildly hawkish, we could easily see last week’s earnings/French election rally given back, and the S&P 500 could fall back into the middle of the 2300-2400 two months long trading range.

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Last Week and This Week in Economics, April 24, 2017

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Last Week in Economics – 4.17.17

April economic data started with a bit of a thud as all three April reports missed estimates last week. And while on an absolute level the numbers imply economic activity remains “fine,” the lack of additional progress is contributing to growing doubts about the strength of expected economic reflation (and that’s why bond yields are lower than most expect).

Last week’s headline economic report, flash April Manufacturing PMI, missed expectations at 52.8 vs. (E) 53.9, and declined from the March reading. Likewise, April Empire Manufacturing and Philly Fed also missed expectations and declined from very high readings in March.

Now, to be clear, on an absolute level all three readings show continued economic growth, but again it’s the pace that matters. Stocks have priced in reflation, but the loss of momentum in economic data undermines that thesis, and that’s why stocks have grinded sideways now for six weeks.

Meanwhile, the gap between soft sentiment surveys and hard economic data remained wide. March Industrial Production beat estimates but that was only because of strong utility production given the March blizzard. The manufacturing sub-component declined and badly missed estimates, again providing non-confirmation for the still high (in absolutely terms) manufacturing PMIs.

Bottom line, economic data wasn’t outright “bad” last week, but it didn’t help reinforce the expected reflation trade, and that did at least partially stoke concerns about the pace of growth. Meanwhile, economic data didn’t help close the gap between hard and soft.

This Week in Economics – 4.24.17

The slow drip of economic data continues this week (next week is the big one), although given the precarious nature of the bond market (10-year yields signaling a potential slowdown) all economic data is at least partially important.

With that in mind, the most important number will be Friday’s Employment Cost Index. Inflation is a key component of the reflation trade, and any broader uptick in inflation has to come from increased wages. In Q1, wage data in the government jobs report wasn’t particularly strong. So, if the Employment Cost Index shows no real uptick in wage pressures, that will further undermine the reflation trade.

Other important data next week includes the first look at Q1 GDP (which will be lucky to hit 1%) and Durable Goods. Starting with GDP, it’s not going to be a strong report, but if consumer spending (PCE) is stronger than expected that will be a silver lining. Meanwhile, Durable Goods offers yet another opportunity for hard economic data to meet surging sentiment surveys, and in doing so close the gap between strong soft data and lackluster actual data. Other notable data points this week include Pending Home Sales and Existing Home Sales, both of which will be under more scrutiny following the disappointing Housing Market Index and Housing Starts numbers from last week.

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Tom Essaye on “The Bell” Podcast with Kenneth Polcari and Adam Johnson

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I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk about the reality of tax reform, tax trade, geopolitics, and the bond market, straight from the NYSE Floor. We were also joined by Kenneth Polcari, Director, O’Neil Securities, director of NYSE Floor.

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Last Week and This Week in Economics, April 17, 2017

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Week of April 17th and April 10th in Economics

Last Week in Economics – 4.10.17

The two important economic numbers came out Friday when markets were closed, so they didn’t receive much attention, although they should have. Both numbers (CPI and Retail Sales) further eroded the reflation trade thesis and will increase worries the economy is losing momentum.

Starting with retail sales, the headline on this number was plain ugly. March retail sales declined 0.2% vs. (E) 0.0%. Almost as importantly, February retail sales were revised down to -0.3% from the previous 0.1%. As longer-term readers know, we generally disregard the headline and instead look at the “control” group retail sales, which is retail sales ex autos, gasoline and building materials. That control group gives us a better read on truly discretionary spending.

Here the numbers are a bit better. Control retail sales rose 0.5% in March vs. (E) 0.3%, but February was revised lower from 0.1% to -0.2%. So, considering revisions, the March number wasn’t a beat.

Bottom line, this number is not good for stocks. Consumer spending was the engine powering the Q3/Q4 2016 economic acceleration, and the sluggishness in consumer spending now is extending beyond what we would consider normal slack following a big acceleration. These are not the kind of numbers we would see if a bigger economic acceleration is looming.

Turning to CPI, it also undermined the “reflation” trade in the near term. Headline CPI dropped -0.3% vs. (E) 0.0% while core CPI declined -0.1% vs. (E) 0.2%. Additionally, the year-over-year core CPI reading dipped from 2.3% in Feb. to 2.0% in March. This soft CPI reading isn’t a damning number, and clearly the trend of inflation is higher. Yet markets need modestly higher inflation and better growth to power stocks higher, and last week’s numbers did not suggest that’s happening.

Bottom line, this week now is very important, as it will go a long way to resolving the now-glaring discrepancy between still sluggish “hard” economic data and surging “soft” economic sentiment surveys.

Finally, to make this a bit more real, Friday’s numbers resulted in the GDP Now for Q1 dropping to just 0.5%. That type of economic growth simply cannot support stocks at these levels, and as such we should expect Friday’s data to further pressure bond yields and the dollar, which will increase stock headwinds.

This Week in Economics – 4.17.17

This week is important for markets because we will get a much more definitive answer to the question of whether the pace of economic growth is losing momentum. How that question is answered will go a long way to determining whether the S&P 500 takes out the March low of 2322, or if stocks can bounce.

To that point, the most important economic releases this week all contain March data, and the most important report will be the flash manufacturing PMIs out Friday, followed (in importance) by Empire Manufacturing (today) and Philly Fed (Thursday). The reason those numbers are so important is because it’s April data, so they will give us the most current view of the pace of economic activity in the US. If they further imply there is a loss of momentum, that will further undermine the reflation trade and hit stocks. Conversely, markets need strong data this week to help reinvigorate the reflation trade thesis.

Looking beyond those March data points, the next most important report this week is March Industrial Production. This number is important because a wide gulf still exists between “soft” sentiment -based data, and “hard” economic numbers. Industrial production is the next opportunity for some of that “hard” economic data to move higher and begin to close that gap.

Bottom line, we’re coming to a head on the debate over soft vs. hard economic data, and whether the recent economic acceleration can last. While there aren’t a lot of numbers this week, what data we do get is important to resolving that debate… and that will move markets.

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Fed Balance Sheet Primer, April 11, 2016

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Fed Balance Sheet Primer

An excerpt below from today’s subscriber edition of Sevens Report.

Fed Balance Sheet Primer

Markets remain consumed by politics and geopolitics, but really the biggest macro surprise so far for 2017 came from the Fed last week, with the realization that they could begin to shrink their balance sheet in 2017. That event has potentially hawkish implications for bonds (bonds lower, yields higher), the dollar (higher) and stocks (increased headwind).

We initially warned about this possibility back in mid-March in our FOMC Preview. And, as we said back then, you’re going to be reading a lot more about this in the coming weeks, so I want to cover this topic more fully so that everyone has proper context.

Why Is The Fed Balance Sheet Important? The Fed balance sheet has ballooned over the past eight years given all the bonds it has purchased through the various QE programs. Unwinding that balance sheet without up-setting asset markets is quickly becoming the Fed’s highest priority.

To get specific, right now the Fed reinvests all the proceeds from a matured bond on its balance sheet—but that’s going to change. If the Fed gets $100 million in short-term Treasuries redeemed, right now it simply buys $100 million worth of new Treasuries. But when the Fed stops that reinvestment, that $100 million wouldn’t go back into the bond market, removing a source of demand.

The point is that when the Fed stops reinvesting principal, that will be potentially bond negative/yield positive, and that process needs to be managed very carefully considering the size of the balance sheet ($2.4 trillion in Treasuries, $1.7 trillion in mortgage backed securities).

When Will the Fed Stop Reinvesting All Bond Proceeds? Until last Wednesday, the unanimous answer would have been “2018.” But, following the Minutes, it’s looking more likely that the Fed could begin to end reinvestment of proceeds in December 2017.

Very Hawkish If:… Hawkish If:… Neutral If:… Dovish If:…

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What Will the Fed Stop Buying? Right now, the Fed rein-vests proceeds from both Treasuries and Mortgage-Backed Securities (MBS), so the question facing markets is whether the Fed will stop reinvestments in just one of these two securities, or whether it will stop reinvestments in both. Until the Minutes, it was assumed the Fed would only begin halting reinvestments in MBS (that way they could further support Treasuries, the more critically important market).

Hawkish If: … Neutral If: …

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How Will the Fed Stop Reinvesting Proceeds? The major question here is whether the Fed will slowly reduce the amount of reinvestment gradually, or whether it will just halt reinvestments all together. To illustrate the point, if one week the Fed has $100 million in bonds paying off, will they reinvest $50 of the $100 and reduce that number gradually over time, or will they just not reinvest any of the $100?

Given Fed history, a gradual reduction is what everyone expects; however, in the Minutes they talked about zero reinvestment, and it seems like the Fed is getting a bit antsy to get policy closer to normal.

Hawkish If:… Neutral If:…

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Bottom Line

This topic isn’t exactly exciting, and it won’t grab the headlines, but it is shaping up to be one of the bigger market influences in 2017. The reason why is simple: No one knows what’s going to happen to the bond market once the Fed begins to remove itself. On a percentage basis, it’s not like the Fed dominates the daily trading in Treasury markets. Yet sentiment is a funny thing, and the Fed needs to manage the unwind of a $4.1 trillion balance sheet successfully, because the potential for some sort of a market dislocation (especially in the age of algorithms and HFTs) isn’t insignificant. So, please keep this primer as a reference point, because I would be shocked if the Fed balance sheet doesn’t cause some sort of volatility in 2017 (beyond just the Wednesday reversal the news caused last week).

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Tom Essaye on “The Bell” Podcast with Dan Wiener and Adam Johnson

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I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk auto sales, free tuition, and a lot more.

We were also joined by Dan Wiener, editor of the The Independent Adviser for Vanguard Investors, who shares his 5 favorite funds and most “liquid” investment.

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Last Week and This Week in Economics, April 10, 2017

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Last Week in Economics – 4.3.17

Signs of a slight loss of economic momentum continued last week, and while on an absolute level growth remains “fine,” stocks need consistently better data to off-set lack of action in Washington, and that’s simply not happening right now. As a result, stocks are “stuck” at the current levels and downside pressures are building.

Looking at the notable data releases last week, the jobs report was the headliner and it was “Too Cold” according to our preview. March job adds were 98k vs. (E) 175k while wages grew just 0.2% vs. (E) 0.3%. But, the unemployment rate dropped to 4.5%, which tempered the negative fallout and helped stocks shrug off the soft data.

The other two important numbers from last week were mixed. March ISM Manufacturing PMI slightly beat estimates at 57.2 vs. (E) 57.1. However, it declined from the February 57.7. Additionally, new orders, the leading indicator in the report, dipped to 64.5 vs. (E) 65.1.

March Non-Manufacturing PMI missed estimates at 55.2 vs. (E) 57.0, surprisingly hitting a five-month low. New Orders also dropped to 58.9 from 61.2 and employment plunged to a seven-month low at 51.6.

Looking at these PMIs, they’re a great reflection of the current economic data/market dynamic. On an absolute level, the data is strong (remember any-thing above 50 is expansion). But, incrementally we are not seeing improvement, and as such these data points are not helping power stocks higher like they were in Jan/Feb.

Finally, the most disappointing economic data point from last week was March auto sales, which dropped to 16.6M (seasonally adjusted annual rate, or saar) vs. (E) 17.4M saar. That number weighed on stocks last Monday, as worries about the car market and industry continue to quietly grow.

Turning to the Fed, there was a hawkish surprise in the FOMC Minutes last week, as they revealed the Fed may begin to decrease its balance sheet (i.e. buy less mortgage-back securities and Treasuries) later in 2017. Markets reacted hawkishly when this news hit on Wednesday (dollar up, bond yields up, stocks down) as this was a legitimate surprise (no one expected the balance sheet to start to shrink until 2018).

This is a potentially significant event, and it’s something we’re going to be detailing more this week, as any balance sheet reduction will increase upward pressure on bond yields. As we said last week, this was the first true surprise of 2017.

This Week in Economics – 4.10.17

As is usually the case following a jobs report week, the economic calendar is pretty sparse, with the three key reports all coming Friday (which is Good Friday, and markets will be closed).

March retail sales and March CPI will be released Friday morning. Retail sales is important because it’s the first opportunity for “hard” March data to move higher and meet surging sentiment indicators. A beat by retail sales would be a positive for the market and imply actual economic activity is starting to close the gap on sentiment surveys.

CPI is important because of the reflation trade. The market is pricing in rising inflation and better growth, so this CPI number needs to be Goldilocks. It has to be strong enough to show that inflation is consistent, but at the same time it can’t surge so much that it makes the Fed hawkish (an unlikely scenario).

Bottom line, if Retail Sales and CPI can show 1) Better growth and 2) Steady but not accelerating inflation, it’ll help offset the recent mild data disappointments and be a net positive for stocks.