This week’s economic calendar can best be defined as manufacturing-centric. Away from the FOMC minutes, scheduled for release on Wednesday afternoon, and Chair Jerome Powell’s scheduled talk on Friday morning, investors will be keeping a close eye on a sector of the economy that many had given up on — at least until November 2016.
Today we got the Chicago Fed National Manufacturing Index, which surprised to the upside with a big revision to the prior month. The index, released monthly, tracks overall economic activity and inflationary pressure nationally. The Richmond Fed Manufacturing index, released Tuesday morning, focuses on the Richmond Fed regional economy and tracks orders, shipments and employment indices. Consensus for May is calling for 10 versus the prior reading of -3. On Thursday at 11:00 a.m., we receive the Kansas City Fed Manufacturing Index. Consensus is calling for 22 versus April’s 26. A resurgent manufacturing sector has been an unexpected and stunningly successful hallmark of President Trump’s first term.
Naturally, given the robust gains, we have seen in the manufacturing sector over the past 18 months and with weekly jobless claims at 45-year lows, the official unemployment rate below 4%, at 3.9%, and consumer and business confidence at multi-year highs, inflation pressure or the prospect of it has investors on edge. It is a natural order for inflation pressure to manifest in an economy that is firing on all cylinders particularly after years of dormancy. The recent move high in energy prices, crude oil specifically, has added a degree of urgency to the narrative.
The U.S. 10-year Treasury has been the focal point of this attention for investors. The Federal reserve’s posture on monetary policy has also played a central role in this narrative. Last week the 10-year yield again pierced the 3% level and remained above it to close with a yield of 3.06% on Friday. The odds of the FOMC raising rates at the next meeting are nearly 100%. That meeting is June 13 and 14, followed by FOMC forecasts and the Fed Chair press conference.
The trepidation of rising rates aside, as I discussed last week, equity prices have proven to be quite resilient as a result of solid economic data from employment to industrial production, durable goods orders, business and consumer confidence and interest rates that have remained at the low end of their historical range. Largely better-than-expected Q1 earnings have also provided rotating buoyancy to equity markets on a sector-by-sector basis. Last week, equity markets lost fractional ground after gaining ground in eight of the nine previous sessions.
Additionally, a subtle degree of “risk-on” in investor appetite has come from an unexpected place — geopolitics. Though there’s still no certainty, the prospect of a denuclearized Korean Peninsula and the official end to the Korean War is a potential eventuality of enormous consequence. News over the weekend of a massive shift in the trade imbalance posted annually between China and the United States is something that was inconceivable until very recently. NAFTA negotiations continue but with clear signs of momentum at the backs of U.S. negotiators. All three themes have the potential of removing perceived risk in markets —globally. More specifically, they could all also add momentum to US growth in a meaningful way.
The Volatility Index (^VIX) has reflected that shift rather efficiently. On April 4, the VIX was trading at 18.02 – down dramatically from February’s high tick of 37.32. Friday’s close at 13.42 speaks directly to receding geopolitical, and interest rate fueled fears.
US equity markets (^DJI, ^GSPC, ^IXIC) look to be on the increasingly solid ground for a long list of reasons, laid out above, as we head into the trading week. The variables investors may need to price in this week involve any dramatically negative shift on the geopolitical front, the FOMC minutes on Wednesday or any unexpected verbiage from Fed Chair Powell on Friday.
Commentary by Sam Stovall, CFRA chief investment strategist
The 10-year yield again trades above 3.0%, causing consternation with investors that the direction of the 10-year versus 2-year yield curve, which traditionally has been a harbinger of impending economic recession, will flatten or invert. We currently see the yield curve remaining positively sloped and even widening slightly in the quarters ahead, as we project the 10-year yield to rise to an average of 3.20% by Q4, versus a 2-year yield that averages 2.65% in Q4. Even though we expect U.S. real GDP to rise 3.6% in Q2, we see this growth moderating in a stair-step fashion to 3.2% by the final quarter of the year, which should help ease inflationary pressures. As a result, we forecast the year-over-year change in core CPI to hover at or below 2.3% through Q2 of 2019.