Out of Step

One Step

Data dependency seems to be a trendy topic, one that is currently playing out as the market lurches from one economic data point to the next. Investors are ignoring the saying that “one data point does not make a trend” and that, against a backdrop of Zero Days to Expiration Options, prices reverse dramatically when there is a surprisingly strong or weak economic release. The Federal Reserve says it is data dependent, and at least in its June meeting last Wednesday, it communicated that it is bucking the trend of latching on to the latest data point. The encouraging inflation news from the Consumer Price Index (CPI) that came out hours before their statement did not seem to sway their outlook. The Fed moved from expecting three rate cuts this year to communicating to the market that their median forecast is now just one step down in rates.

Every quarter the central bank releases their Summary of Economic Projections, and for June, they increased their collective forecast for yearend core inflation to 2.8% from 2.6%. In March, their central tendency inflation forecast (which removes the top 3 and bottom 3 of the 19 individual forecasts) ranged from 2.5% - 2.8%, so the median forecast in June moved to the top of that range, which is a significant, albeit subtle, shift.

Stocks jumped on the CPI news but have yet to regain that high after the Federal Open Market Committee meeting, and Chairman Powell’s subsequent press conference did not give the market the all-clear signal it was hoping for. In fact, Powell gave a warning to the markets: “You don’t want to be too motivated by any single data point.” Investors may start to pay attention to the fact that the Fed may be moving toward a less accommodative monetary policy just as there are signs of economic weakness, as shown by last week’s initial claims data.

Stepping Up

Initial jobless claims are a reliable forecasting tool for inflection points in the labor market, and they are increasing. There is a reason why average weekly initial claims for unemployment insurance are one of the ten inputs for the Leading Economic Index. Jobless claims always turn up ahead of recessions and give a warning sign about employment before the more widely followed Nonfarm Payroll Report. Ironically, investors track nonfarm payrolls every month for clues about the direction of the economy, but that report normally peaks at the start of a recession, giving no warning at all about a downturn. The clear uptrend in initial claims is becoming undeniable. Most economists prefer to use a 4-week moving average on the weekly claims data because it can be a bit noisy. The 4-week average just hit its highest level in 9 months, and is up 13% from the low hit in January.

The number of new claims for insurance benefits is one thing, but the report also tracks the total number of unemployed collecting benefits, which rose to its third highest level in a year. We have listed many other leading employment indicators that have deteriorated, from the National Federation of Independent Business Jobs Report and Challenger job cut announcements, to name just two, but the Initial Claims data is what will get investor’s attention…finally.  High interest rates are an overhang on the economy, and if companies accelerate firings, that can create dramatic reversals in consumption that not many expect. This series is out every Thursday morning and is rising in importance.

A Step to the Right

Markets do not like change, and the sudden step toward populism in Europe has caught many investors off-balance. Nationalism and anti-immigration right-wing advocates had a great week as European elections yielded gains to them at the expense of pro-business liberal parties and politicians aligned with green initiatives. Mainstream politicians will still dominate in the European Parliament, but the far-right gains have caused investors to become concerned about major leadership changes, particularly in France with President Macron calling for a snap election. Immigration and heavy regulation have frustrated much of the Continent and they are voting for change.

Investors now have to deal with a lack of visibility on a macro scale that has caused massive drops in stock valuation after the election result in Mexico and the upcoming snap elections in the UK and France. The success of the anti-European Alternative for Germany (AfD) party has clouded the political equilibrium that had been formed between the two mainstream parties in Germany since the 1990 reunification. Prime Ministers Trudeau of Canada and Kishida of Japan are suffering extremely low approval ratings in part due to frustration over their inability to balance their respective budgets. As of now, the U.S. has been impervious to any capital outflow emanating from political uncertainty. One has to wonder when that will change as we approach the presidential debates, the party conventions, and, of course, the November election.

What to Look for This Week

1. Wednesday, June 19 10:00 am E.S.T. National Association of Home Builders’ Housing Market Index. Taken from a survey of 900 home builders who rate market conditions. A reading above 50 is a favorable outlook. The index moved above 50 in March and April this year before a 45 reading in May. June will be important to watch because lumber prices have fallen precipitously, normally a negative sign for housing demand. Housing Permits follow the next day.

2. Thursday, June 20 8:30 am E.S.T. Initial Jobless Claims. The Fed has said they would begin to ease on any sign of labor market weakness, so any further acceleration in claims and we will begin to see headlines in the financial press. The equity markets have cheered bad news because softer data translated to a higher chance of Fed cuts, but a growth slowdown led by higher joblessness is not a positive scenario for stock markets.

3. Friday, June 21 10:00 am E.S.T. Conference Board Leading Economic Index for May. The last two months have gone back to negative month-over-month readings, so the May data could be pivotal. The Conference Board calculates a six-month growth rate in the index as a recession signal, and the last two months did not signal a recession after an incorrect signal that lasted for almost two years. It is normally extremely accurate. If the May data is weak, it could push the indicator to signal a recession again.