The bond market has taken on a very summer-like feel and it is not because temperatures could top 90 degrees here in the Northeast, later this week. The mixed data and the Fed’s commitment to a gradual, but historically moderate, monetary policy renormalization has left bond market participants with little to do. Add to this the unlikeliness of seeing meaningful fiscal policy reforms and the bond market feels a little sleepy. Summer may have indeed come early, this year.
Seasonality affects more than just market behavior. It can also influence business activity in various sectors of the economy. Few, if any, sectors are more influenced by the seasons than housing. Thus, market participants were eagerly awaiting April Housing Starts and Building Permits data. Economists were expecting a sharp rebound from soft weather-influenced March data. The rebound left economists disappointed. This was mainly because there was no rebound.
April Housing Starts fell 2.6%. The Street had expected an increase of 3.8%. This follows a March print of -6.6%, revised slightly higher from -6.8%. An April print of -2.6% might be swallowed by economists more easily, if there was a surge in Building Permits, as that would augur for stronger future construction. Hopes for a future surge in new home construction were dashed when April Building Permits printed at -2.5%. The data indicated that it was multi-family starts and permits which were responsible for much of the contraction. This is important as multi-family home construction has been the bright spot of the residential construction sector.
This is not to say that single-family starts rebounded. They did not. Single-family starts fell to 784,000 in April from 821,000 in March. Multi-family starts fell to 322,000 in April from 389,000 in March, on an annualized basis. Industry economists expect single-family construction to increase as the year progresses, as the number of owner-occupied homes in the first-quarter rose faster than renter-occupied housing for the first time since 2006. This may prove true, but there is the possibility that, with the economy apparently in late cycle, demand for credit, including building loans, is waning. Time will tell.
Some economists believe that Industrial Production and Capacity Utilization data can be useful in forecasting inflation. The theory suggests that stronger consumer demand is responsible for both higher prices and an increase of Industrial Production and Capacity Utilization. Thus, if Industrial Production and Capacity Utilization rise, it must be due to greater consumer demand and, therefore, stronger inflation (Why do I feel like I am in the Witch scene from Monty Python and the Holy Grail?).
April Industrial Production rose 1.0%, in April. This was up from a prior revised increase of 0.4% (down from 0.5%), higher than the Street consensus of 0.4% and was the strongest gain in more than three years. Capacity Utilization increased to 76.7% from a prior reading of 76.1%. This was higher than the Street consensus estimate of 76.3%. Although the increase was encouraging, Capacity Utilization remains well below the cyclical peak of 79.16%, seen in November 2014 and far below the readings above 80% which have been typical of economic expansions.
The gains in Industrial Production and Capacity Utilization were broadly-based, but there were some flags in the data. One flag was the rise in automobile production at a time that auto credit appears to be rolling over and new vehicle demand is waning. Could automakers be cranking out vehicles and ramming them down the throats of dealers? Dealer inventory data which indicate that the supply of vehicles on dealer lots, which is approaching three months, would bear this out.
The production of consumer goods also surged, in spite of softer consumer spending data. It appears that business leaders have put much faith in soft data, such as consumer optimism measures, which have been quite strong, as of late. I would remind readers that consumer confidence and employment tend to peak at or near the end of expansions. If consumer spending does not surge in May and June, we could see Industrial Production and Capacity Utilization come back to earth. If consumer spending does surge, it could be game on for GDP and inflation.
The bond market is voicing the opinion that it is not likely to be “game on,” in the near future. At the time of this writing, the 10-year UST yield stood at 2.315%. Weak Housing Starts and Building Permits data are behind the cautious tone in the bond market. Few bond market participants are placing confidence on the stronger Industrial Production and Capacity Utilization data.
One reason for the tepid response to Industrial Production and Capacity Utilization, other than a lack of confidence in the sustainability of auto and consumer goods production, is that energy production (mining and drilling) also boosted Industrial Production and Capacity Utilization data. Greater energy production, particularly oil and natural gas, can be disinflationary or anti-inflationary, effectively countering OPEC/Russian production cuts. Thus, while higher rates of Industrial Production and Capacity Utilization augured for stronger inflation pressures, in the past, the increase in U.S. energy production may have made this correlation less reliable. This is why we must understand the “why” when we analyze correlations.
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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.
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