Thursday, July 5, 2018

Markets remain higher after release of Fed minutes

Dow shot up 181, advancers over decliners about 3-1 & NAZ rose 83.  The MLP index gained 1+ to the 262s & the REIT index added a big 4+ to the 357s (nearing last year's record in the 360s).  Junk bond funds crawled higher & Treasuries were steady again.  Oil retreated over 1+ to the high 72s (more below) & gold inched up 3 to 1256.

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Oil futures erased their earlier session gains, with losses accelerating after the US Energy Information Administration released its weekly inventory update.  US weekly crude oil stocks increased by 1.2M barrels, versus forecasts for a 3.5M barrel draw.  Before the reversal, US crude oil  futures were hovering at their highest price in about 3-1/2 years with supply disruptions continuing to support the market.  Also, Pres Trump once again took to Twitter to call out OPEC for the high oil prices.  The oil market has been supported by a fall in output from Venezuela & the potential for a halt of Iranian oil exports due to US sanctions.  OPEC reached an agreement in Jun to increase output, but this did little to stop the rise in oil prices.  A supply outage in Libya is adding extra upside support.

US oil producers doing what OPEC won't: Boost output to cut prices

The possibility of a full-blown trade war has forced some companies to pause investment plans, the Federal Reserve said.  In minutes of its Jun meeting, the central bank's FOMC noted that contacts across 12 districts have “expressed concern” that tariffs & other proposed trade restrictions would have adverse effects on their businesses.  Some business contacts said capital spending plans were scaled back or postponed given uncertainty over global trade policy.  “Most [FOMC] participants noted that uncertainty and risks associated with trade policy had intensified and were concerned that such uncertainty and risks eventually could have negative effects on business sentiment and investment spending,” the minutes said.  Contacts in the steel & aluminum industries said they already expect higher prices due to import tariffs imposed by the Trump administration.  Those contacts did not report any plans to increase domestic capacity.  Concerns over a tariff spat between the US & trade partners, including China, Canada & the EU, could dampen expectations for a 4th rate hike in 2018.  In Jun, the Fed raised short-term interest rates for the 2nd time this year & expects to increase rates twice more before the end of the 2018.  Beyond trade worries, “a number of participants” in the FOMC also said it would be premature to conclude that inflation has reached the Fed's 2% target — a milestone that would encourage policymakers to raise interest rates.

Businesses hit pause on spending amid trade uncertainty: Fed minutes

America's labor shortage is approaching epidemic proportions & it could be employers who end up paying.  A report from ADP & Moody's Analytics cast an even brighter light on what is becoming one of the most important economic stories of 2018: the difficulty employers are having in finding qualified employees to fill a record 6.7M job openings.  Truck drivers are in perilously low supply, Silicon Valley continues to struggle to fill vacancies & employers across the grid are coping with a skills mismatch as the economy edges ever closer to full employment.  “Business’ number one problem is finding qualified workers. At the current pace of job growth, if sustained, this problem is set to get much worse,” Mark Zandi, chief economist at Moody's Analytics, said.  “These labor shortages will only intensify across all industries and company sizes.”  Private payrolls grew by 177K in Jun, a respectable number but below market expectations.  It was the 4th month in a row that the ADP/Moody's count fell short of 200K after 4 months at or above that level.  The reason for the tick down in hiring certainly isn't because there aren't enough jobs.  The Bureau of Labor Statistics reported that Apr closed with 6.7M job openings.  May ended with just over 6M the BLS classifies as unemployed, continuing a trend this year that has seen openings eclipse the labor pool for the first time.  At some point that gap will have to close.  Employers are expected to have to start doing more to entice workers, likely thru pay raises, training & other incentives.   As employers face the pressure, the costs likely will end up getting passed on.  Most inflation measures are at 2% or more now & are likely to continue rising.  Companies are reporting record profits, but could find themselves constrained by a double-short of inflation, both from wages & rising costs due to escalating trade tensions & tariffs between the US & its trading partners.  Those are all issues the Federal Reserve will have to weigh as well.  The central bank has been raising interest rates as it sees the economy growing & inflation meeting the Fed's 2% target.  Fed officials have indicated they will be raising rates 2 more times in 2018, but the market has been skeptical, with traders assigning just a 51% chance of that happening.

The U.S. labor shortage is reaching a critical point

The Federal Reserve’s efforts to unwind its mammoth portfolio of bonds continues to run into hitches.  Central bank officials at their Jun meeting discussed another issue, this one relating to the mortgage-backed securities (MBS) on the Fed's balance sheet.  According to the minutes from the Jun 12-13 gathering, proceeds the central bank is getting from the MBS it holds are running below the capped level of payments it has targeted for runoff later this year.  Anything above the cap is supposed to be reinvested.  Essentially, that means that the Fed will be letting all of those proceeds run off & not reinvesting anything.  That likely means that the balance sheet reduction may not be as much as planned each month.  The Fed originally had intended to be running off $20B a month, along with another $30B in proceeds from Treasuries it is holding.  The Fed accumulated the bonds during its economic stimulus program that began in late 2008 during the financial crisis.  The balance sheet had hit more than $4.5T at one point, while the runoff program has resulted in a reduction of more than $100B so far.  Fed officials noted that the MBS market is sensitive to long-term rates, so higher yields later could result in the need to reinvest again.  The MBS discussion came as the FOMC approved an adjustment in the rate it pays on excess reserves that banks hold with the Fed.  While it approved a qtr-point rate increase in the funds rate, it raised the interest on excess reserves rate only 0.2 percentage point.  The funds rate had been moving to the top end of its range & getting close to the IOER rate.  The Fed uses IOER as a guidepost for its benchmark funds rate.  Since that move was approved, the funds rate again has jumped to the top of its range & most recently was within 0.04 point of the IOER.  Fed officials in Jun said the reason the funds rate was moving higher could be due to higher rates in the overnight repo market

Fed balance sheet runoff hits another snag

Germany's chancellor said she's willing to back lower tariffs on US auto imports as a potential EU concession to the Trump administration – just one day after CEOs of Germany's biggest carmakers reportedly voiced support for eliminating such tariffs entirely.  Angela Merkel said she would be ready to support lowering the tariffs, though the measure couldn't just apply to the US.  "I would be ready to support negotiations on reducing tariffs but we would not be able to do this only with the U.S.," she said, adding that singling out one country would violate World Trade Organization rules.  Yesterday, the CEOs of prominent German auto companies – including Daimler, BMW & Volkswagen – “liked” a Trump administration proposal for both sides to reduce those tariffs to zero, according to reports.  The proposal was said to have been made by US Ambassador to Germany Richard Grenell during a meeting at the US embassy.  The EU tariff rate on all US car imports is 10% while the US tariff on imported European cars is 2.5%.  Last week, Pres Trump threatened to impose a 20% tariff on imports of all vehicles assembled in the EU, though he is reportedly willing to scrap those plans if the EU reduces its levies.  The potential tariff would hit Germany particularly hard as cars are one of their key exports: manufacturers in the country exported more than 4.3M vehicles in 2017.  European Commission President Jean-Claude Juncker is expected to meet with Pres Trump later this month to discuss trade concerns.  Trump has been vocal about the need for automakers to manufacture vehicles in the US & has said there are too many German cars on the roads.  The Commerce Dept is currently investigating whether foreign auto imports pose a risk to national security.  Meanwhile, while tensions appear to be easing with the EU, another round of US tariffs on Chinese goods are due to go into effect tomorrow.  The levies would be placed on $34B worth of goods.

Angela Merkel supports cut in EU tariffs on US cars

Oil prices fell after weekly gov data showed a surprise rise in US crude stockpiles last week as refineries cut output, while gasoline stocks decreased & distillate fuel inventories rose.  Crude inventories rose 1.2M barrels in the latest week, the Energy Information Administration said, compared with expectations for a decrease of 3.5M barrels.  West Texas Intermediate (WTI) crude futures ended the session down $1.20 (1.6%) at $72.94 & Brent crude futures fell 79¢ (1%) to $77.45 per barrel.  Oil earlier traded near its highest in 3½ years earlier, boosted by potential disruptions to flows from Iran & the Middle East despite a fresh demand from Pres Trump that OPEC cut prices.  Trump again yesterday accused OPEC of driving up fuel prices.  "The OPEC Monopoly must remember that gas prices are up & they are doing little to help," Trump Tweeted.  "If anything, they are driving prices higher as the United States defends many of their members for very little $'s.This must be a two way street. REDUCE PRICING NOW!"  OPEC together with a group of non-OPEC producers led by Russia started to withhold output in 2017 to prop up the market.

Oil drops 1.6%, settling at $72.94, after surprise rise in US crude stockpiles

Stocks were back on another rocky road today, then traders liked what they heard.  The "sort of" victory with Germany on car tariffs sounded good.  However China is a much larger trading partner & that relationship remains unsettled.  The Jun jobs data will move stocks in the AM.  Then trade issues will be the main driver for stock prices.  Today the Dow closed near its highs, something the bulls always like to see.

Dow Jones Industrials

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