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By HaleStewart September 25, 2016 8:16 am
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US Bond Market Week in Review: The Fed Faces a Modestly Growing Economy

     Currently, the NY and Atlanta Fed are predicting 3Q GDP growth of 2.3% and 2.9%, respectively.  At Wednesday’s meeting, the Fed released their latest GDP predictions, which projected 1.8% growth in 2016.  This is .2% below their June projections.  An analysis of the long leading, leading and coincident indicators shows that the Fed is probably closer to being right.    

Long Leading Indicators

Baa yields

Baa yields are risky enough so that if investors see a recession on the distant horizon, they’ll sell this particular credit class, sending yields higher.  But the latest move for this bond credit is down.  Investors search for yield in a low rate environment offers a partial explanation.  But if investors were truly concerned about the long-run environment, they’d avoid this particular credit altogether.

Corporate Profits

Corporate profits are the purest indicator of corporate health.  They’re also a good predictor of employment gains, which are the most important coincidental economic indicator.  Profits declined in 4 of the last 5 quarters.  While the energy sector started this trend, it has spread out to other business sectors.  The latest predictions for the 3Q16 are more of the same.

M2 Money Growth

Money lubricates the economy.  More money will not only put downward pressure on interest rates, it will also (hopefully) increase activity. 

Building Permits

Edward Leamer has convincingly argued that housing is the economic cycle.  A new home not only requires labor (increasing employment) but a large number of raw materials (lumber, concrete), durable goods (home appliances) and strong consumer confidence (people only buy houses when they’re confident in future prospects).  Building permits are the earliest signal of the housing industry’s perception of future prospects. 

Long-Leading Indicators Conclusion: Two indicators – Baa yields and money supply – indicate growth.  But these are financial indicators, implying we should give them slightly less weight (just because money is plentiful doesn’t mean people will take out more loans).  While the two activity indicators are positive, they are less so than the financial indicators.  Building permits are moving sideways, which is slightly positive.  There is sufficient confidence to continue requesting permits at current levels, but there is insufficient demand to increase this metric.  Finally, corporate profits are negative; they’ve been declining for most of the last year and will most likely continue that trend into the 3Q.     

Leading Indicators and Coincident

Thankfully, the Conference Board compiles this data and releases it every month.  Here is the latest release:

Save for April’s .5% M/M increase in the LEIS, the LEIs and CEIs have been fairly weak for the last 7 months.  And while the 6-month rolling LEI average increased in the last 2 readings, there is insufficient information to conclude that the trend is strengthening.  The following graph and table from Doug Short places the latest CEI data in perspective:

Industrial production contracted in 8 of the last 12 months, which retail sales fell in 6 of the last 12.  Overall, the above data points supports the Conference Board’s assessment of the LEIs and CEIs:

The Conference Board LEI for the U.S. decreased in August, after two consecutive monthly gains. Despite the decline, the LEI’s six-month growth remains positive. Meanwhile, The Conference Board CEI for the U.S. continues rising at a slow and steady pace. Taken together, the current behavior of the composite indexes and their components suggest that the expansion in economic activity should continue, but underlying weaknesses in the LEI may pose a risk to growth in the months ahead.

Add to the above a spate of slightly weaker economic numbers over the last 4 weeks:

  • The ISM manufacturing and service indexes, while still positive, dropped sharply with weak internal developments.
  • The latest industrial production figure contracted
  • The latest retail sales figure contracted

and you get yet another potential growth slowdown.  This means the drop in the Fed's median projected GDP growth rate is probably correct.






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