There was little to dampen risk appetite, with the outlook for inflation improving and US growth revised higher. Markets have now priced the first Fed cut by May, with a roughly 50% probability by March, pulling front-end yields lower and steepening the yield curve once again. The dollar hit a three-month low before finding support while an early strong rally for equities faded and reversed into the close.
European gloom lifting as inflation eases
European economic releases were better than expected, with German and Spanish inflation below expectations, while measures of economic and consumer sentiment appear to be turning the corner.
The German Harmonised Index of Consumer Prices fell .7% in November, pulling the annual rate of inflation down from 3% to 2.3%, two tenths lower than expected and inching closer to the ECB target. This preliminary HICP release shows none of the details, but the national measure of CPI inflation slowed from 3.8% to 3.2% with services inflation falling from 3.9% to 3.4%.
The Spanish HICP fell .6% on the month – a much steeper fall than the .1% decline expected - bringing the year over year rate of HICP inflation down from 3.5% to 3.2%. Consensus estimates pointed to an acceleration in annual inflation, but base effects from government energy subsidies and VAT cuts may have added a layer of volatility. Encouragingly, the national core rate that excludes energy and fresh food also fell steeply, from 5.2% to 4.5%.
With both German and Spanish rates of headline inflation undershooting forecasts alongside steep declines in their national core measures, markets are strongly expecting today’s eurozone inflation readings to print lower than indicated, giving a further boost to rate cut hopes.
Italian consumer confidence recovered in November with increases in each of the component indices leading to a rise of 2 points in the headline index to 103.6. Confidence also improved in the eurozone, but the .3 increase in the headline Economic Sentiment Indicator to 93.8 concealed mixed readings from its components and was still some way from its long-term average of 100. Consumer confidence improved but confidence in industry, retail and services was little changed. More concerning was a further decline in the Employment Expectations Indicator, which slid .7 points to 102.1, although it remains above its long-term average of 100.
Better balance of US Q3 growth
Revisions to third quarter US GDP showed an even faster pace of annualised growth than originally reported and a better balance of spending, with growth at a 5.2% annualised rate in Q3. Upward revisions to nonresidential fixed investment and state and local government spending were partly offset by a downward revision to consumer spending, which grew at a 3.6% rate rather than 4% originally estimated.
Among the notable changes, growth in nonresidential structures investment was revised from 1.6% to 6.9%, while growth in services imports was revised 4.8% to 1.9%. PCE inflation was revised lower, with Q3 growth in the headline PCE revised from a 2.9% annualised rate to 2.8% and the core PCE from 2.4% to 2.3%. Stronger growth in private fixed investment, weaker import growth and weaker price pressures reinforced the perception of a goldilocks economy, giving a further boost to risk appetite. Other revisions showed stronger growth in private sector wages and salaries and higher real disposable income, raising the estimated savings rate by two tenths to 4% and suggesting consumers may have more gas in the tank for Q4 spending than previously estimated.
Home buyers respond to lower mortgage rates
The MBA average 30-year mortgage rate fell another 4bps last week to 7.37% and mortgage applications for home purchases climbed 4.7%, rising 16% above the low of four weeks earlier but remaining 20% below the level this time last year. This modest recovery is unlikely to do much for the existing home sales market, with affordability even more stretched by recent price increases.
Richmond Fed President Thomas Barkin later poured a little cooler water on the risk rally by reiterating his doubts that inflation is on a definite downward path. He pointed to lingering price pressures in services and said that if inflation flares up again, the Fed should “have the option of doing more on rates”.
Dull reading in Fed Beige Book
The Fed’s Beige Book has shown most districts concerned about slowing growth for the past year, and this latest update was little changed. Regional businesses pointed to mixed consumer spending and weaker demand for workers, with comments that suggested the economy continues to lose momentum.
UK housing demand also pick up
Mortgage approvals in the UK for house purchases unexpectedly climbed to 47.4K in November from 43.7K the prior month, exceeding estimates and pointing to further signs of surprising resilience in the housing market.
Portfolio update
Our stop on the balance of short Schatz futures was triggered at 105.30, and we are completely out of the trade now. As the late Charlie Munger said, “You're not learning anything if you're not making mistakes”.
Markets
Fixed income
The yield on the two-year treasury fell another 9bps to 4.65% for a total decline of 30bps this week while the ten-year note struggled to break below 4.25% and closed at 4.26% (-7bps).
Equities
China’s equity markets extended this week’s slide and closed just above October’s year to date low.
Commodities
Enthusiasm for precious metals continues to mount, but the rally struggled once the dollar turned around, and gold closed at $2044.24/oz (+.2%) with silver unchanged at $25.02/oz.
Today’s macro agenda
China official PMIs November
Japan retail sales October, industrial production October
Eurozone, France and Italy CPI November, Germany retail sales October
US personal income/spending and PCE deflator October, Chicago PMI November, pending home sales October, weekly initial and continuing claims
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