Signs Indicate the Current Economic Cycle Could be in its Latter Stages

economic Data - bond news
There have been several signs indicating the current economic cycle could be in its latter stages. Auto sales and auto lending have been at the forefront of indicators auguring for late cycle. Today we have news that April SAAR Ford  vehicle sales were down 7.1% versus an expected Street consensus estimate of -4.7%. GM  reported SAAR auto sales of -5.8% versus a Street consensus estimate of -2.0%. According to Bloomberg, total vehicle sales are estimated at a seasonally adjusted annual rate of 17.10 million. That would be up from the 16.53 million pace recorded in March, but down year-over-year. This does not mean that a recession is approaching, but it probably means that the cyclical peak of economic activity is in our rearview mirrors, fiscal policies and monetary policy renormalization notwithstanding.
            Inflation, ISM and Personal Income/Personal Spending data are not pointing to a surge in economic activity, nor do they point to recession. Personal Income rose 0.2% in March, on a monthly basis. This was down from a downwardly-revised 0.3% in February (from 0.4%). Personal Spending flat-lined in March, unchanged from a revised print of 0.0%, in February, down from 0.1%. Real Personal Spending (adjusted for inflation) rose 0.3%, in March. This was up from a prior -0.1%. Why was real Personal Spending stronger in March? Because inflation pressures subsided.
PCE MoM printed at -0.2%, in March. This was down from a prior print of 0.1% and in line with the Street consensus estimate. On an annual basis Headline PCE fell to 1.8% from a prior 2.1%. Core PCE YoY (the Fed’s favored measure of inflation) fell to 1.6% from 1.8%. A reduction of year-over-year oil price comps were partially responsible for the softening of inflation pressures, but services prices also softened. For example: Communications prices fell 3.2%. Rising real incomes and slowing consumer spending caused the savings rate to rise from 5.7% to 5.9%, the highest since the 6.0% print in August 2016. The consensus opinion among economists is that the savings rate should fall into the low 5.00%s, in the coming months. That remains to be seen.
I would also point out that Headline PCE fell 0.3% while Core PCE fell 0.2%, on an annual basis. Readers may remember that I have written, on numerous occasions, that when oil/energy prices rise, headline and core inflation converge, when headline is running below core but, diverge with rising oil/energy prices, when headline is running above core. This relationship held true again. Unless we see a spike in oil prices, headline U.S. inflation (PCE and CPI) readings should moderate through June, rise again over the summer and moderate again in the fall, monetary and fiscal policies notwithstanding.
The ISM Manufacturing Index fell to 54.8 from a prior 57.2. Markit Manufacturing PMI was unchanged at 52.8. Prints over 50, for both ISM and Markit indices indicate improving conditions. ISM New Orders remained positive at 57.5, but slowed significantly from a prior 64.5. ISM Employment remained positive, but less so, falling to 52.0 from a prior 58.9. I am not trying to be alarmist, but the slowing in the auto sector, which I think is cyclical in nature and not a short-lived soft patch, could weigh on manufacturing data in the months ahead. Yes, we should see a second-quarter rebound in economic activity and GDP, but I do not believe that it augurs for economic activity reaching so-called escape velocity.
Economic Cycle
Yesterday, we saw long-dated UST yields climb higher on talk of very long-dated UST issuance, by Treasury Secretary Mnuchin. Today we are seeing the long end of the UST curve mainly unchanged ahead of tomorrow’s FOMC meeting. Although few market participants believe the Fed will tighten tomorrow, the Street is awaiting the FOMC statement for clues as to whether the Fed plans on raising the Fed Funds Rate at the June meeting and for signs of when and how the Fed might shrink its balance sheet. I do not expect tomorrow’s FOMC statement to be particularly enlightening.
In my opinion, the Fed will raise the Fed Funds Rate 25 basis points at the June 2017 FOMC meeting. Depending on inflation, growth and fiscal policies (in that order of importance), I expect the Fed to tighten, again, at the September 2017 FOMC meeting and/or at the December 2017 FOMC meeting. I do not expect the Fed to announce balance sheet reduction prior to the December 2017 FOMC meeting, with reinvesting slowing or ceasing beginning January 2018.
I have received questions regarding TIPS, again. After reaching a near-term low of 1.857, on 4/21/17, the 10-year U.S. TIPS breakeven has risen to 1.90. This is in spite of fading inflation pressures and sliding oil prices. At the present time and at current breakevens, I do not view TIPS as a very attractive asset class. Depending on client goals, objectives and risk tolerance, TIPS could be appropriate from an inflation hedging perspective, but I do not believe inflation will be strong enough, in the foreseeable future, to make TIPS, priced at current breakevens, an outperforming area of the fixed income markets. I would need to see the 10-year TIPS breakeven below 1.80 before my ears would perk up.
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Thomas Byrne serves ad the Director of Fixed Income for Wealth Strategies Management LLC. Thomas brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets. High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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