What the Market Overlooked in the Personal Consumption Expenditures Report

  • Most market analysts are pointing to the slight miss in May’s headline year-over-year PCE deflator reading of 1.4% vs. 1.5% expected and 1.7% previous.
  • What has been overlooked by most are the strong back-to-back personal income figures of 0.4% m/m in May and 0.3% m/m (revised from 0.4%) in April. While April was revised a tick lower, May’s rebound capped off an impressive two month gain of 0.7% in personal incomes.
  • This runs counter to the prevailing sentiment that the Phillips Curve is broken and wages are not picking up or at least holding their own.
  • The Fed has shifted focus recently, as they often do on a discretionary basis, to focus on financial stability after the epic run up in mega cap tech names, equity  valuations, and market complacency suggested market psychology was fostering an unhealthy rise in market bubble dynamics.
  • The core Fed FOMC members are now willing to overlook taming inflation for the time being as a 15% fall in the energy complex drags down PCE and CPI for the next few months. They still believe continued labor market tightening toward what is deemed to be “full employment” will eventually boost wages and keep inflation expectations on a steady projectory. Other central banks are following suit.
  • Assist FX sees the recent central bank turn toward slightly less dovish rhetoric as supportive of a more sustainable recovery. While asset valuations are still stretched and in bubble territory on a longer term basis as regularly discussed on this site, letting some pressure out of the “everything bubble” is actually productive overall.
  • Letting asset valuations and house price-to-income ratios skyrocket unchecked by a tightening reaction function in monetary policy would be one major catalyst capable of changing our S&P500 bias to negative as prices become increasingly stretched like pulling a thinning rubber band.
  • Assist FX sees moderate Fed action to trim asset purchase reinvestments in September with another 25 bp Fed Funds target increase in December.
  • Our equity, fixed income, and USD bias remains neutral.

Top 3 Takeaways From March FOMC Meeting

1.) Dovish hike of 25bp – As expected, the FOMC hiked the benchmark target rate by 25 bps to a range of 3/4 percent to 1 percent. The hike was paired with cautious and dovish commentary by Fed Chair Yellen, as she is known to do. The balance of risks is neutral. There was no “reassessment” in the economic outlook but things are progressing in line with the Committee’s expectations for meeting the dual mandate soon. I actually believe the mandate was effectively achieved last year if measured more realistically. There were no notable hawkish surprises. Gold roared higher, bond yields were clobbered, the dollar was slammed, equities surged–with each asset class moving by more than 1% on the day (for a change).

2.) Is the Fed all of a sudden paying attention to asset bubbles again? – The dovish Fed Chair did reiterate during the question and answer session that higher financial asset prices, particularly equities, impact the Fed’s monetary policy expectations. This is a soft admission to keeping an eye on the asset bubbles the Fed’s policies have likely already inflated. In other words, further stock melt ups similar to those experienced in the past few months could cause the pace of tightening to increase in order to put a lid on even larger asset bubbles. One could be forgiven for being skeptical of this materializing given the Fed’s recent history of ignoring asset bubbles until it is too late. But this suggests it is perhaps on the radar more than it has been. Beware of single direction stock moves northward precipitating increased expectations for tightening, thus muting the magnitude of said moves.

3.) 10y Treasury Note had a blow torch lit underneath the bid –  The 10y yield plummeted below 2.5% from above 2.62%. Per my post yesterday, long TLT and BLV cranked out impressive reversals higher from the recent base lows. The move happened so rapidly that I’m keen on taking profit and reassessing. This is a short term bull move in bond prices within what I view to be a longer term bond bear market on tap.

10y plummet 031417