Economics trends somewhat better, but a June hike is unlikely

23 May 2016

Key takeaways

  • In a week with several economic data releases, it was actually the Fed’s minutes which created the most stir in financial markets.
  • Consumer prices, as measured by the CPI index, increased 0.4%, roughly in line with consensus forecasts and grew at the fastest pace in almost two years, due primarily to higher energy prices.
  • The housing data from the past week continue to reflect the strength of the U.S. market.

Full commentary

In a week with several economic data releases, it was actually the Fed’s minutes which created the most stir in financial markets. The minutes pointed to a potential for a rate hike in June, if economic conditions warranted. First quarter economic growth was sub-par and Fed officials, while cautious about the data, may be hoping for an improvement from U.S. consumers. Despite repeatedly mentioning a possibility of a June hike in the minutes, markets are still skeptical. Fed funds futures are pricing in a less than 30% chance of a June hike, and the 2-year treasury yield is at 0.89%, below December 2015 levels when the Fed raised rates for the first time since 2006. A June timing is also questionable, given uncertainties created by the June 23rd British referendum.

Consumer prices, as measured by the CPI index, increased 0.4%, roughly in line with consensus forecasts and grew at the fastest pace in almost two years, due primarily to higher energy prices. Excluding food and energy, core CPI rose 0.2%. The increase in headline inflation may boost the inflation outlook at the Fed, as the two deflationary forces of 2015, namely the rise of the U.S. dollar and lower commodity prices, are less of an issue this year. Industrial production also increased in April, for the first time in three months, with gains in utilities and manufacturing, which resulted from higher output of consumer goods, especially autos. The consumer data is showing some improvement as evidenced by the stronger retail sales, although there are signs that consumers are cutting back on non-essential purchases. Recent credit card data has also shown an increase in consumers’ willingness to carry more debt. Overall, consumer spending trends remain uneven, and areas to watch are the increased credit card lines and auto loans to subprime borrowers.

The housing sector is fluctuating, but still appears to have some headroom to improve, supported by affordable financing and resilient labor conditions. The housing data from the past week continue to reflect the strength of the U.S. market. Housing starts rebounded in April, after a sharp decline in March, and Friday’s data on existing home sales for April showed better than expected 1.7% growth, after a strong 5.7% increase in March, bringing the annual pace to $5.45 million. The median price of an existing home increased 6.3% year on year to $232 thousand the highest level since June 2015. Additionally, inventory of available properties dropped 3.6% in April to $2.14 million units. Despite signs of stricter mortgage underwriting standards, we do not envision this tempering the demand for housing. An area of strength is the gradual demand shift towards first-time homebuyers. Homebuilders, observing this trend, are readjusting offerings to target the entry level segment.

Homebuilding and related home markets are contributing to GDP growth. We expect further strengthening over the medium term, driven by an improving labor market, along with the potential for income growth, rising home equity, and low borrowing costs. As the chart of the week shows, new home starts remain below historical averages, even after a steady increase since 2009, and household formations have recently surpassed 15 year average levels, a trend we expect to continue, driven primarily by the rental economy. As such, we do not believe that the housing sector is overheated and it does not pose the risk of pulling the economy into a recession.

Economic data from this past week largely beat consensus estimates. While growth momentum continues in the U.S., global uncertainties persist and the Fed is telling the markets to prepare for a rate hike in June. With the fed fund futures pricing in only a 26% probability of an interest rate increase in June, market participants appear to be challenging the Fed’s posture.

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