Fed Minutes Suggest No Change In Rates Soon

Another Good MBA Applications Report

MBA Applications report from the week of November 15th was strong again. Composite index was down 2.2% weekly after it rose 9.6%. This weakness was because of the refinance index which was down 8% after rising 13%. It’s not surprising refinancing is down because rates are off their lows. Even really low rates won’t encourage refinancing if rates were previously lower. Almost all the refinancing already occurred when rates were lower.

Good news is the purchase index was up 7% after rising 5%. Even though weekly growth was strong and increased from the prior week, yearly purchase applications growth fell from 15% to 7%. That’s all about tougher comps. It would have been interesting to see what could have happened to yearly growth if this was a weak report. Growth might have been near the flatline. 

As you can see from the chart below, mortgage purchase applications growth has mostly been in line with new home sales growth. This shows why strong purchase applications growth is good news. Existing home sales report comes out on Thursday and the new home sales report comes out next Tuesday. Investors are expecting good results from both reports.

Update On Earnings Season

Q3 earnings season is almost over, but some results from retailers have been coming out lately. There are still about 32 companies that haven’t reported yet. The table below reviews the near finalized results. With 468 firms reporting, 74% beat EPS estimates and 56% beat sales estimates. Margins have fallen just like overall corporate margins as sales growth is 4.75% which is below every measurement of profit growth. NIPA margins have been falling for 4.5 years which is the longest decline since WWII.

As you can see, non-GAAP EPS growth was 3.45%. If you look at non-GAAP EPS, then there hasn’t been an earnings recession. Best way to frame the discussion if you want to call something a recession is to say there has been a profit recession as both non-GAAP and GAAP earnings are down from last year. 

Without buybacks, there would have been a mild EPS recession. Prior profits allowed for big buybacks. Eventually if profits keep falling, there will be a sharp decline in buybacks. Because shares get issued in recessions and buybacks occur in expansions (sometimes with borrowed money) critics of buybacks say they increase the cyclicality of the economy.

Fed’s October Minutes

Keep in mind the Fed’s statements are from the October 30th meeting where it cut rates 25 basis points. Some conspiracy theorists claim the Fed changes what’s in the Minutes to fit current policy objectives, but I don’t buy that. If the market doesn’t like what was said at the meeting, the Fed can simply come out and say those are old opinions and the new opinions are different. There’s little point to tamper with the Minutes.

This report is from 3 weeks ago, and since then there have been worse economic reports and the trade discussions have gone poorly. It being old explains why the Fed stated the economy is in a good position and the trade discussions seem to be going well. Trade negotiations haven’t been going well as it looks less likely that there will be a phase 1 deal this year. Some GDP estimates have growth coming in below 1% in Q4. That’s not a strong economy!

Is The Economy In A Good Position?

Now let’s get into the details and quotes from the Minutes. “Most” Fed members see the recent rate cuts as enough “to support the outlook of moderate growth, a strong labor market, and inflation near the Committee’s symmetric 2 percent objective.” Current policy “likely would remain as long as incoming information about the economy did not result in a material reassessment of the economic outlook.” 

In other words, the Fed doesn’t see the need to cut more with the current backdrop. Since then, the economic data has gotten worse and stocks have rallied. If the Fed just follow stocks, it will do nothing. It’s not insane to follow markets because they could be correct about the economy improving in 2020. A scary aspect for the Fed is if stocks are wrong and expectations are too high.

Fed stated policy isn’t on a pre-set course because of Powell’s mistake late last year when he said the balance sheet unwind was on autopilot. It’s amazing how much that one statement impacted markets and future policy. To be clear, the economy was headed for a slowdown and rate cuts were needed. Rate hikes last year certainly weren’t the best idea. Without the autopilot comment and the hike in December, the 20% decline in the S&P 500 could have been avoided.

Also, Fed stated the economy was in a fairly strong position. Fed will have egg on its face if Q4 GDP growth is below 1.5%. And, Fed cited the strong consumer and the healthy labor market. It must not be looking at the weakness in the Bloomberg consumer comfort index and the decline in demand for temporary workers. 

Personally, I agree that the consumer is in good shape and I think GDP growth will be closer to 2% than the flatline. It just looks bad given the recent weak data.

Risk Factors

Finally, on risk factors, the Fed sees, “the downside risks surrounding the economic outlook as elevated, further underscoring the case for a rate cut.” It stated, weak business investment and exports came from “weakness in global growth and elevated uncertainty regarding trade developments.” Then it said, both issues have “eased somewhat.” 

This explains how the Fed was somewhat bullish on the prospects of a trade dea. Even though in the past few weeks negotiations have gone south. On October 11th, President Trump stated the phase 1 deal was done in principal. 

Now it doesn’t look nearly as close to being done. To be clear, there’s still a chance something gets done in the next 3 weeks. Odds have just fallen. This issue hasn’t eased somewhat. It has gotten worse. 

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