Beige Book - Fed Shows Rate Cuts Incoming

Beige Book - Redbook Sales Growth Falls

Before getting into the Fed's Beige Book let's review Redbook Sales. In the week of July 13th, Redbook sales growth fell sharply from 6.2% to 4.7%. Keep in mind, this is yearly growth, so the strong growth in the previous week had nothing to do with this weakness. This comes on the heels of the very strong June retail sales report.

There’s not much we can make of this week to week volatility. If growth stays in this range for the rest of the month, there might be some sequential weakness in the July retail sales report. I expect real wage growth to be strong though because inflation is falling quicker than wage growth.

Headline inflation depends a lot on energy inflation. We are on the precipice of the back to school shopping season which is the 2nd biggest shopping season of the year. The weekly Redbook sales reports are about to be very important. August retail sales will be more important than July retail sales.

Slight Improvement In Housing Market Index

Beige Book - The housing market index measures homebuilder sentiment. It has partially rebounded from the weakness late last year, but isn’t at its cycle high. That makes sense because housing became unaffordable last year and hasn’t fully rebounded yet.

We could be pretty close to a rebound because real wage growth is solid and house price growth has fallen. Some think this weakness is an early warning sign of a recession. While the housing market is a leading indicator, it’s not impossible for there to be a mini-correction without a recession.

Housing starts haven’t had a real recovery this cycle. So I don’t see housing causing a recession.

Beige Book - Prices getting in line with reality is a good thing.

Most of the decline in price growth has occurred if the labor market stays strong. We will see positive yearly growth in many housing stats in late 2019 because of how weak the comps are.

As you can see from the chart below, the July housing market index increased from 64 to 65 which matched estimates. This is one of the first July housing related reports. It didn’t show much of a change from June.

Current sales index was up 1 point to 72. Future sales index was also up 1 point to 71. Traffic was weak again as the index increased 1 point to 48. It’s still in contraction territory.

West was the strongest region as its index was up 6 points to 75. South increased 1 point to 69; it is the largest housing region. Northeast was 57 and the Midwest was 54. Midwest has the most affordable housing and the Northeast is by far the smallest housing market.  

Fed’s Beige Book Shows It Will Cut Rates

Beige Book - July Fed Beige Book told us what we already know. Namely that growth is modest. And that the Fed will cut rates due to worries about the global economy, low inflation, and the trade war.

Specifically, the Fed wrote “Labor markets remained tight, with contacts across the country experiencing difficulties filling open positions. The outlook generally was positive for the coming months, with expectations of continued modest growth, despite widespread concerns about the possible negative impact of trade-related uncertainty.” In a Dallas Fed survey of 360 firms, 28% were hurt by the tariffs and 5% were helped.

As you can see from the chart below, the IFR Markets Beige Book diffusion index fell from -39.5 to -44. Which means pessimism increased. Number of uses of the words strong and strength fell from 58 and 11 to 34 and 8.

Beige Book - This all amounts to the Fed being very likely to cut rates despite the relatively solid economy.

These are insurance cuts. After the retail sales report, Wells Fargo raised its estimate for personal consumption growth in Q2 to 3.4% from 2.9%. That’s much higher than the Q1 reading of 0.9%.

Headline GDP growth decline from Q1 won’t mean much. Underlying data in Q2 will improve unless the report misses estimates by a lot. I don’t use the Fed’s opinion for my economic analysis. But it doesn’t hurt to see the Fed agreeing with my point.

We look at Fed statements to see what it will do to interest rates and where its guidance will likely be. Because of the Beige Book, the odds of a double cut later this month increased from 27.1% to 39%. Personally, I would be shocked to see the odds get to 40%. We are close.

With these odds, a 50 basis point cut is on the table.

Beige Book - Investors don’t expect great economic data to push the odds of a double cut down. Powell already stated the Fed didn’t change its mind after the solid June labor report.

Only thing that matters to the Fed funds futures market between now and the next meeting is what the Fed says. It can talk up the odds of a double cut if it wants.

Fed knows what it is doing. Any dovish statement will make investors more convinced a 50 basis point cut is coming. On Friday, Bullard will be speaking. I expect him to call for a 50 basis point cut because he is a dove. If he doesn’t call for that, the odds will fall again.

Action in stocks is confusing because we have seen stocks falling on good news. That would make sense if good news made the Fed less likely to cut twice. But the odds of 2 cuts are increasing. My only explanations are investors are worried about trade and stocks are overbought.

Beige Book - Conclusion

Quantitative analysis of the Fed’s Beige Book tells us the Fed will be very dovish at its July meeting. Even though retail sales growth beat estimates.

Fed seems very worried about global growth and trade. I’m not sure if a double cut would push stocks higher. It seems to be overkill based on the current economy.

If President Trump is waiting for the Fed to cut rates before doing a deal, then this meeting could catalyze a trade deal. That would send stocks higher.  

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