Market Insight Monthly | November 2018


Economy: Economic Data Improves, Trade Weighs on Businesses

Economic Data
Economic trends generally improved in November, even after strong gross domestic product (GDP) growth over the last two quarters. The Conference Board’s Leading Economic Index (LEI), an aggregate of ten leading indicators, increased 0.1% in October and 5.9% year over year. While LEI growth slowed, positive momentum signaled low odds of recession in the coming year.
Nonfarm payrolls grew solidly in October, while the unemployment rate stayed at a 48-year low. Average hourly earnings grew 3.1% year over year last month, the first time that measure of wage growth has eclipsed 3% since April 2009. While investors have recently been sensitive to the uptick in wage growth, we think the current pace is sustainable and healthy for the U.S. economy, especially as labor costs remain relatively low [Figure 1 . Wages represent up to 70% of business costs, so current wage growth shows inflation has yet to reach levels that could weigh on output.

Modestly accelerating wages and fiscal stimulus were a boon to consumer’s wallets last month as the quarter of holiday spending commenced. Personal incomes grew year over year in October, near the fastest pace in three years, while personal spending rose near its fastest such pace in four years. Consumer confidence in November fell month over month, but it essentially remained at an 18-year high, signaling strong consumer activity will continue to boost output.
Reports last month showed pricing increases slowed, contrary to expectations that economic growth and tariffs may fuel higher inflation. The core Producer Price Index (PPI), which excludes the volatility in pricing of food and energy components, rose 2.2% year over year in October, slowing from a multiyear-high pace reached in September. Year-over-year growth in the core CPI cooled for a third straight month. Year-over-year growth in Core Personal Consumption Expenditures (PCE), the Federal Reserve’s (Fed) preferred gauge of inflation, fell to 1.8% in October, below the Fed’s 2% target. Overall, we believe wage and pricing data show inflation remains relatively contained, and inflationary pressures will likely continue at these levels into next year.
However, negative impacts from the U.S.-China trade dispute seeped into leading indicators for business health. Business spending growth continued to cool, concerning investors that trade tensions may be outweighing the benefits of fiscal stimulus for U.S. corporations. New orders for nondefense capital goods (excluding aircraft), our best proxy for future capital expenditures (capex), increased 4.8% year over year in October. The Institute for Supply Management’s (ISM) gauge of new business orders fell to the lowest level since April 2017 in October, hampered by steep declines in export orders as overseas manufacturers cut production in preparation for lower demand. Even though recent data on business spending have been discouraging, we see trade tensions as the primary roadblock to capital investment.
Still, U.S. manufacturing health remained solid, even as demand from U.S. businesses waned. ISM’s Purchasing Managers’ Index (PMI), a gauge of manufacturing activity, rose in October to just below a 14-year high (reached in August). Markit’s PMI, which assigns different weights to its survey components, jumped to a fresh five-month high. We are encouraged by U.S. manufacturing strength, especially as global manufacturing activity slows, and we expect fiscal tailwinds and economic momentum to fuel further growth in the sector. The trade dispute has been difficult to navigate for U.S. corporations, and many have opted to put future expansions on hold until there is more clarity on the tangible and intangible effects of tariffs on demand and profits.
U.S. housing demand continued to decline as consumers became more apprehensive about big-ticket purchases and homes became less affordable. While existing home sales grew 1.4% month over month, they fell 5.1% year over year, the biggest decline since August 2014. New home sales dropped 12% year over year, matching one of the biggest drops since 2011. Year-over-year growth in housing prices, represented by the S&P CoreLogic Case-Shiller 20-City Composite, continued to slow.
Fed Keeps Rates Unchanged, Expectations Drop
Fed policymakers reconvened in November and announced November 8 that they would leave rates unchanged. Since then, markets have struggled with reconciling the Fed’s rhetoric around interest rates and where the neutral rate is with strengthening global economic headwinds. Market-based forecasts of the Fed’s policy rate dropped significantly in November as markets increasingly positioned for a slower path of rate hikes [Figure 2].

Fed funds futures’ implied probability of at least three 25 basis points (0.25%) rate hikes before the end of next year—including a likely hike in December—slipped to 30% at the end of November (from about 65% on November 8). Futures are pricing in an 80% probability of a rate hike at the December meeting, and a year-end 2019 upper-bound fed funds rate of 2.7%, compared with 2.25% today. The Fed’s next rate announcement is scheduled for December 19.
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