Regional Fed Indexes Signal An Incoming Weak ISM Report

Regional Fed Indexes - Stocks Fall Slightly

When the S&P 500 was down, the headlines blamed worries about tariffs. When stocks were up, the Fed got the credit as their Minutes were released Thursday.

Clearly, this is the wrong way to look at the market because the tariff news won’t come out until Friday and Saturday. Also, the content of the Minutes doesn’t change based on how the market does.

You can’t claim the Minutes were hawkish if stocks fall and dovish if stocks rise. Traders love a dovish Fed and hate a hawkish one, but they don’t always analyze the statements correctly. The larger point here is the tariffs and the Fed aren’t the only factors affecting stocks.

The S&P 500 fell 0.22% which pushed the CNN fear and greed index down from 23 to 22. I think stocks will rally sharply if Presidents Trump and Xi come to an agreement.

It’s tough to say precisely when a deal will be made, but it should happen soon. The best 2 sectors were energy and materials which increased 0.59% and 0.55%. The worst 2 sectors were technology and the financials which fell 0.95% and 0.88%.

Regional Fed Indexes - 10 Year Yield Comes Close To 3%

Many have been calling for the 10 year yield to fall below 3% ever since it went above 3% in September.

It has fallen from its high of 3.26% in early November to just 3.02%. Also, It has fallen below its recent range. The economic data never suggested the rate should go above 3% to begin with since growth is slowing.

A catalyst for this decline has been weak data and falling commodity prices.

The latest increase in real yields has caused investors to come up with points to justify the move. They blame central banks tapering, pension funds not buying treasuries, emerging markets selling treasuries to defend their currencies, and Japanese and Europeans not buying treasuries because of high hedging costs.

They say QT, the trade war, and increased U.S. issuances justify these high real rates. A key point here is that since growth and inflation are falling, real rates need to keep rising, not just maintain their increase, to keep the 10 year yield above 3%. I don’t see that happening.

The 3% level on the 10 year is the most important level out of all markets because the Fed plans to raise rates above 3% in 2019. I don’t think the Fed will get to 3%, but a couple more rate hikes will invert the curve if the 10 year yield is below 3%.

Currently, the 2 year yield is 2.80% which means the difference between the 10 year yield and the 2 year yield is only 22 basis points.

The Fed fund futures don’t expect the Fed to hike rates as much as it projects in 2019, but the Fed fund futures are often wrong on intermediate term projections. This is why I focus the most on the odds for a December hike.

With stocks not near their correction lows and the meeting coming closer, the odds for a hike have increased. They’re now at 82.7%. I think the hike is a lock.

Regional Fed Indexes - Fed Minutes

As you can tell by the updated Fed odds, the treasuries market, and the stock market, the Minutes from the November meeting, where the Fed didn’t change rates, didn’t cause as much of a reaction in the markets as the Powell speech on Wednesday. I’ll quickly summarize the Minutes since they didn’t affect markets.

Fed said a rate hike is warranted “fairly soon” which means it will hike rates in December. The Fed is transitioning away from the language where it says “further gradual” hikes are warranted because it is about to be at the low end of the estimates for the neutral rate.

Fed emphasized incoming data. The Fed always claims it is data dependent, but we know it is estimate dependent. Since it’s estimates can be anything, it’s policy can be anything. You can always justify both sides of policy debates.

The Fed stated the downside risks to the economy include tariffs, the strong dollar, non-financial corporate debt, rising inflation, and financial conditions tightening. It’s interesting because the Fed is the cause of financial conditions tightening which means it named itself as a risk.

Also, the idea of inflation being a risk is outdated as inflation is starting to fall. Upside risks are the fiscal stimulus surprising to the upside and excessive consumer confidence. I don’t see the fiscal stimulus surprising to the upside since business investment growth has already started to slow.

Regional Fed Indexes - Decent Richmond Fed Report

We’ve seen a couple weak November regional Fed reports. This has caused the average to sink. As you can see from the chart below, the average suggests the ISM manufacturing PMI will fall. If it does, I think stocks will decline as it will confirm that the manufacturing sector is slowing.

Richmond Fed survey wasn’t one of the weak ones as it came it at 14 which missed the consensus and last month’s report which were 15.

Shipments index increased from 7 to 12 and the volume of new orders index fell from 20 to 17. Local business conditions index fell from 8 to 5 and capex fell from 21 to 17. Equipment and software spending increased from 16 to 19.

Inflation readings fell as the prices paid index fell from 5.68 to 4.7 and the prices received index fell from 2.84 to 2.13.

The weakest part of this report was the expectations data. Expected shipments fell from 49 to 30 and the expected volume of new orders fell from 43 to 27.

Furthermore, expectations for local business conditions fell from 37 to 16. Backlog of new orders index fell from 21 to 1.

If the index follows expectations, it will join the chorus of indicators that suggest the economy is weakening. I’m more focused on the ISM reading than this regional Fed report since the ISM seems to impact stocks.

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