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StreetStuff Daily June 6, 2017

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… Until then, the compensation and unit labor costs data as they currently stand are not telling the whole story.

Mon 6/5/2017 10:36 AM

Monday 10:00 Data Stephen Stanley Chief Economist

Mon 6/5/2017 8:53 AM

Q1 Revised Productivity Stephen Stanley Chief Economist

Nonfarm business productivity was revised from -0.6% to flat, in line with the upward adjustment to GDP reported late last month. Productivity growth was a little better in 2016 (+1.1%) than it had been in prior years, but not surprisingly (given the downward skew pattern to GDP in Q1), we stumbled out of the gate in 2017. In any case, the average productivity gain since the beginning of 2011 has been 0.6%, a depressing run. Hourly compensation was revised lower. The Q1 adjustment was minor, from +2.4% to +2.2%, but the Q4 reading was revised lower by a massive amount. As I discussed when the latest GDP data were released, there was a huge downward adjustment to Q4 wage and salary income, and that revision feeds through to the hourly compensation data. The problem here is that the likely reason for the downward revision to income has nothing to do with economic fundamentals and everything to do with tax avoidance strategies. After Trump’s election in November, there was considerable chatter about income tax rate cuts, so anyone who had the flexibility to manipulate the timing of when their income was realized had ample incentive to delay into 2017, in hopes of being taxed at a lower marginal rate. We have seen time after time in the past that those pesky rich people are far more clever at shifting things around when tax policy changes than the politicians in Washington give them credit for. Of course, we do not have the benchmark labor income data for Q1 yet, so we don’t have the offsetting bulge in income that I suspect will eventually show up, which means that the data as they currently stand are probably distorted downward to a significant degree. Thus, the fact that hourly compensation is running at a 2.3% pace over the past four quarters and that unit labor costs are running at only 1.1% over the past four quarters is unfortunately a mirage. Hopefully, this will be resolved in a quarter or so, when the benchmark data for Q1 are incorporated into these numbers.

The ISM non-manufacturing index eased, roughly as expected, from 57.5 to 56.9 in May. That level is still indicative of robust activity (the report notes that the 56.9 level has historically corresponded to a 3.1 percent increase in real GDP). To put the May reading into context, the 56.9 level is still slightly ahead of the year-to-date average (56.7) and well above the 2016 average of 54.9. The production component slipped but was still above the 60 mark. The new orders gauge came off pretty sharply to 57.7, which, believe it or not, is the worst reading since November. This is worth keeping an eye on, but 57.7 is still awfully strong. Ironically, after a lame payroll result Friday, the ISM nonmanufacturing employment measure surged by over 6 points to 57.8, the best reading since 2015 and the fifth-best in the 20-year history of the series. This report also underscores how tight the labor market is getting. Labor, construction labor, service labor, and skilled labor were the four commodities reported in short supply, while labor, construction labor, service labor, and temporary labor were all reported up in price. There continues to be a wide and widening gap between what the aggregate wage data show and what actual players in the real-life economy say is happening on the ground. When faced with such a dichotomy, I’ll side with the real-life reports and presume that the data will catch up at some point. Finally, the prices index sank by over 8 points in May to 49.2, sliding below the break-even mark for the first time in 15 months. This result seems a little strange considering that the list of commodities reported up in price outnumbered the list of those reported down in price by 20 to 5. Those 5 must have been big ones! All 5 were either food or energy products. If we pare the up in price and down in price lists to core items (i.e. exclude the food and energy commodities), the up column pitches a 12-to-0 shutout. So, it may be premature to herald a collapse in input cost pressures, though I would back up the prices index result by noting that I expect a negative outcome for the May PPI. Meanwhile, factory orders slipped by 0.2% in April, as expected.

6 June 2017

5 June 2017

April factory orders raise our Q2 US GDP tracking to 2.1%

The Blue Drum Playing the long game •

US factory orders declined by 0.2% m/m in April, a touch weaker than we anticipated (Barclays: -0.1% m/m) and in line with the consensus. However, upward revisions to March, on balance, suggest slightly stronger inventory accumulation relative to our assumptions, and improved momentum in equipment spending. After rounding, the tracking estimate for Q1 is unchanged and our Q2 GDP tracking estimate increased by one-tenth to 2.1%.

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5 June 2017

US productivity growth revised upward to show flat growth in Q1

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The rate of productivity growth for Q1 was revised upward to 0.0% q/q saar from the preliminary estimate of -0.6%. However, this remains a noticeable

slowdown compared with productivity growth in the previous two quarters (+1.8% in Q4 and +3.3% in Q3). The revision was driven by growth in nonfarm business output, which was revised up to 1.7% (+0.7 pp). On the other hand, real compensation per hour was revised a touch lower, to 0.9% (-0.1 pp), the second consecutive quarter of negative growth. Growth in unit labor costs (a measure of how much compensation is growing relative to output) was revised lower to 2.2% (from 3.0%)… Figure 1: Trend productivity remains weak

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The recent price downturn takes its cue from souring long term fundamentals, but the market risks being surprised to the upside this summer if it continues to play the long game. Though OPEC’s exit strategy is not clear today, all signs indicate the producer group will not exit market management mode overnight. Over the near term, demand growth is set to rebound and inventory draws will accelerate. The tight relationship between global S/D balances, OECD inventories, and prices, along with current positioning and flat price levels, skews risks to the upside this summer, in our view.

Yet we have lowered our estimates for Q4 17 from $54/b for Brent to $50, and for 1Q18 to $51 due to a weak fudnamental outlook for 2018, lingering concerns about Chinese economic growth, and US tight oil outperformance.

In our FAQ section, we show that small US producers are growing strongly, that North Sea output is enjoying a temporary resurgence, and that demand growth is likely to rebound after a weak Q1.

FIGURE 1 Despite the recent weakness in oil prices, timespreads continue to tighten, signaling healthy demand for crude oil ($/bbl)

5 June 2017

Globalisation, technology and how to deal with disruption Globalisation and technology raise incomes and living standards overall. However, the related structural changes can create significant adjustment costs (disruption) to certain groups. This has led to political resistance and the call to reverse globalization. However, protectionism is disruptive itself and means losing the gains from trade. Instead, focusing on facilitating the adjustment process for affected workers could a more effective response. This is even more important as future disruption is likely to be increasingly driven by labour-substituting technologies rather than international trade. In this context, investment in human capital must be at the centre of any strategy, with the aim that next to substituting workers, new technology also complement to human labour.

Mon 6/5/2017 3:16 PM

Lyngen/Kohli BMO Close: A 200-day Break (attached) Treasuries are in the process of consolidating near the bottom of the yield-range – it’s not an exciting narrative for the market, but it’s nonetheless the most apt description of Monday’s trade. The bulk of the price action was achieved overnight and while we saw 10-year yields as high as 2.189% intraday, the 200-day moving-average at 2.176% proved an important focal point. Last week’s price action was range-defining and it also offered a couple of key technical events. First, the complete filling of the post-election opening-gap in 10-year yields has reset the bottom of the yield-range to 2.143%. That said, it was somewhat smaller than the dramatic type of rangebreak that we would intuitively have anticipated given the shift in sentiment seen in the wake of NFP (at least as it relates to the chances of a Sept ratehike). To be fair, the now-filled opening-gap had been a particularly stubborn resistance level,

holding twice before finally giving way on the jobs report. The second technical shift of note was the breaching of the 200-day moving-averages across several benchmarks – most importantly the 10-year. That said, the 7-year also broke under 1.99%, as did the long-bond at 2.835%. We’re not particularly surprised to see that 2s, 3s, and 5s, are still a distance away from their respective 200-day MAs and will suggest this reflects the Fed’s insistence on following-through with additional tightening – at least in the near-term. As for the longer-end of the curve, while the 200-day MAs were broken and confirmed with a weekly close, Monday’s weakness has put those levels back into play. This begs the question, why do we care about breaking the 200-day? It’s certainly rare and it is also typically followed by an extension of the breakout. For context, the last bullish break of the 200-day moving-averages was in January 2016 and saw rallies in 7s, 10s, and 30s, of 66 bp, 65 bp, and 55 bp, respectively. The bullish implications were played out over the course of 4-5 weeks – which in this case would take us past the Fed and well into the mid-summer seasonals that favor lower yields. This could prove especially timely as the Committee hikes during an otherwise uncertain economic backdrop. Activity in the Treasury market on Monday was uninspired at best, with cash taking just 67% of the 10-day moving-average. 5s and 10s were tied as the most active issues, with each taking 27% marketshares. 2s and 3s were also tied, each with 15%. The long-bond was particularly active with a 7% marketshare – a fact that was certainly a function of the sector’s underperformance. Tactical Bias:

…The improving sentiment for 30s strikes us, not

because 30s haven’t outperformed 10s (and 5s as well for that matter) – because they have, but rather because as the long-bond pushes deeper into overextended territory, we could more easily envision a bullish steepening of 5s/30s and 10s/30s – presumably driven by pricing out/lower the Fed’s likely path of rate-hikes. But that’s more likely a

next-week trade that will aided by long-end supply and of course the FOMC’s SEP forecasts.

Chart 3: US investment grade credit appears overvalued “US credit returns have been larger than would be expected given broader market moves”

Global Daily Macro Monitor

6 June 2017 • •

Eurozone: A likely modest increase in retail sales in April belies a firm trend in indicators of consumer spending. Mexico: The ruling party held on to governorship of a key state, pointing to continued uncertainty around next year’s presidential election.

BNP Paribas MarFA™: Risk premia too low for some assets? 

BNP Paribas MarFA™ is our cross-asset correlation framework which identifies market factors and trading opportunities.

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There are only a few assets that appear mispriced vs the broader market. Global, Korean and Japanese equities, France 2y government bond, US IG credit and EURUSD appear overvalued.

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Given the rising political risk in Italy and the UK, we would expect to see some idiosyncratic risk premium priced into Italian and UK assets. MarFA™ indicates, however, that there is very little risk premium priced. MarFA™ identifies that the main Macro factors that explain asset moves are US 10y real rates, economic activity data and commodity prices.

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Chart 1: Global equities appear overvalued

US Rates at the Bell June 5th, 2017

Recap & Discussion: US 10yr rates maintained a lazy 3bp range after last Friday’s short-covering rally (~4mn dv01 taken off short-base), closing modestly weaker as developed equity markets tread water (S&Ps ~6pt range). With most trading activity relegated to idiosyncratic re-pricing of EM risk-assets after the Saudi-led alliance of Gulf Arab states announced they had severed ties and closed borders with Qatar (now former member of the GCC), US rates and stock index futures traded approx. ~45% of Friday’s volume.

CitiFX | 5 June 2017 US Surprise Index: Another Day, Another Dip On slightly disappointing numbers in ISM NonManufacturing (-0.1-sd) and Durable Goods (also 0.1-sd), the US Economic Surprise Index (ESI) dropped to a 1-year low of -44.7 on Monday. As shown in the chart here, the recent negative surprises have been due to decreasing data momentum (as shown by the red line), while expectations (in light blue) remain elevated. Although data has been slowing down, it remains still well above its 1-year average, as the Data Change Index is positive.

employment growth following the soft May payrolls report. The fall in the prices paid component mirrors the similar decline observed in the manufacturing report. As we have written previously, these subcomponents largely reflect changes in already-known commodity prices. The marginal revisions to April core capital goods orders and shipments are not large enough to significantly alter GDP tracking or the outlook for business investment. Growth in business equipment investment has moderated following a strong first quarter (Figure 2).

Q2 GDP growth continues to track a touch above 3%, and while growth is likely to slow in Q3, continued strong ISM readings raise conviction that growth will remain at or above 2%. 05 Jun 2017 15:43:35 ET

Energy Weekly Sizeable Inventory Draws Should Lift the Oil Price; OPEC Communication on Inventory Targeting Would Also Help •

To break this down further, we can look at data surprises in terms of their individual sectors. You can see in the chart below that the bulk of the disappointing data has come from prices, real estate, and the Industrial sector, while the labor market continues to beat expectations, although less so than earlier in the year….

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05 Jun 2017 11:05:32 ET

US Economics Flash ISM Nonmanufacturing falls slightly to still strong level …

Citi’s view

Although slightly below consensus, this is a relatively solid ISM report. Taken together, both ISM indexes point to an economy that has perhaps slightly decelerated from earlier this year but where underlying growth remains fairly robust. The sharp pickup in the employment subcomponent should help dispel fears of a rapid slowdown in

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Despite a string of positive data points last week that indicated further tightening of the oil market, spot Brent closed the week 4.4% lower w/w at $49.95/bbl. Since early March oil prices have struggled to sustain a rally as bullish investor sentiment has dropped noticeably even though high frequency inventory data are now coming in materially constructive. The persistent reversals in oil rallies this year appear to have fatigued oil bulls A continuation of inventory declines (which Citi expects) should only be a positive for oil prices. Curve structure remains relatively strong, particularly in WTI, despite the sliding oil flat price and further crude inventory draws into summer should strengthen timespreads further. This is likely to happen in short-order and the resultant up-turn in market expectations and the oil price should follow. Our global oil balance indicates that oil inventories are likely to draw-down by 1-m b/d+ through 2017.

05 Jun 2017 09:57:15 ET

RPM Daily Short Covering Post Payrolls In US, short covering drove yields lower as the NFP disappointed. Around $4m DV01 was taken off the short base. Meanwhile Eurodollar ED extended

longs as investors pushed back the timing of the FED, with the red pack now at max longs (and large accrued PnL at 2.4). However selling by hedge funds post payrolls maintained a net short bias in cash resulting in overall neutral positioning. 05 Jun 2017 22:45:55 ET

Municipal Weekly Pennsylvania Weekly yield recap and near term outlook Municipals, with the exception of the 5YR tenor, outperformed Treasuries again over last week. Over the last few weeks, this kind of outperformance by municipals seems to have become the norm and we see the effect on ratios which continue to improve. Issuance is expected to be robust next week but we expect ratios for most tenors to richen further driven primarily by the positive supply demand technicals over the summer months. Specifically, we expect the 2YR, 5YR, 10YR and 30YR ratios to end July 2017 around 65%, 68%, 82% and 92% respectively. Thus, while the 2YR and 5YR ratios seem to be reaching their support levels (i.e. further richening will face resistance), the 10YR and 30YR ratios have more room to improve (richen). We must admit that we were surprised at the negative print for municipal fund flows last week but we see it as a flash in the pan. At present, the only legitimate threat to municipal ratios stems from sharp moves in the Treasury market and we believe that the near term risks of such an event are minimal.

Evaluating Pennsylvania credit After last week’s gloomy developments regarding Illinois, this week, we wanted to focus on a more sanguine credit story. We turn our attention to Pennsylvania as we are enthused by the state’s increasingly dominant status as a natural gas producer and exporter. With the commercial development of the Marcellus and Utica Shale formations in the northeastern United States, much of that growth has occurred in Pennsylvania, a traditionally coal-producing state. In fact, if the two shale plays were a country, they would be the third largest natural gas producing region globally behind

the US and Russia! We believe that the direct and indirect benefits to the state’s finances as a result of the developments in Pennsylvania’s energy sector are quite undervalued. While the state has its share of problems including political gridlocks and pension underfunding, we believe the long term outlook for Pennsylvania credit is propitious and we discuss.

CitiFX | 05 June 2017 CFTC/Dealer Positions -- Multiyear Highs in Real Money Longs and Dealer Balance Sheets See below charts and tables summarizing the latest CFTC Commitment of Traders (COT), Traders in Financial Futures (TFF) reports based on positions for COB 05/30 (i.e. last Tuesday), the most recent NY Fed Primary Dealer (PD) Positions report as of 5/24 as well as the Liquidity Premium Index produced by the Citi Treasuries Desk. During the week prior to the latest CFTC 10yr duration rallied 7bp (10y yield 2.28% -> 2.21%) on the back of soft Home Sales data. US Treasuries: • In Long maturities, Asset Manager longs continued rising, reaching 5-year highs, while both Leveraged Funds and Dealers increased shorts. The old format COT data confirms increasing Speculative shorts, although significantly less extreme than the TFF data. • In Short maturities, the picture is similar, with AM longs Lev shorts increasing, albeit to less exceptional levels. Dealers and COT Speculative positions, on the other hand, ticked marginally lower. • In terms of specific contracts it’s especially worth noting a large Dealer Net Short in FV’s (5y z-score = -2.3) and significant AM net long in WN’s (5y z-score = 3.0).

Chart 1

05 June 2017

Rates Strategy Commentary Thursday trifecta

Chart 2

05 Jun 2017 20:03:58 ET

Global Economics View US Protectionism Round-Up: Mech. tubing, Sugar, TTIP, Steel •

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We highlight several impending trade measures as decisions are due on mechanical tubing (July 13) and steel imports (end of June). However, hawkish comments on trade and investigations may in part reflect a negotiation strategy to improve the US trade position. We continue to expect NAFTA to be renegotiated in its trilateral format. Officials aim for the renegotiations to do 'no harm' and appear inclined to narrow the scope of negotiations to potentially fit the ambitious schedule for the talks (to finish by December/January). The upcoming Trade Deficit Report (June 28), the steel investigations (end of June) and the NAFTA objectives letter (July 17) could provide further clarity on the US trade policy stance.

■ Friday’s disappointing payrolls data are unlikely to delay the Fed’s largely priced in June hike, though it is likely to intensify concerns around a tight labor market that hasn’t been accompanied by commensurate wage growth. Headline payrolls fell well short of expectations and included substantial downward revisions, even as the unemployment rate dropped yet again (albeit amid a decline in labor force participation). Aggregate payroll income rose just 0.2% on the month. Looking ahead, we’ll be very attentive to any shifts in the Fed’s characterization of the outlook on inflation and balance of risks—we believe markets are already excessively priced for a “lowflation” outcome. ■ This upcoming Thursday could prove eventful, with an ECB meeting, former FBI director Comey’s Senate testimony, and the UK general election. While we can't say whether Comey’s testimony will reveal new “bombshells,” past market behavior suggests any sharp moves, if they occur, may prove to be short-lived. On the UK election, while there has been some poll tightening (discussed last week), polling averages suggest a 7-8% lead for Tories, though next to no polling data are available since the London Bridge terrorist attack on Saturday evening. We maintain our base case for a Tory majority. An exit poll will be released at 10 p.m. local with actual results to come a few hours later.

…■ While we don’t expect an actual tapering announcement until at least September, the prospect of tapering and weakening of forward guidance should both mean increased term premia. The 1y1y/2y1y EONIA curve could steepen at least 15-20bp, keeping well above mid-2014 levels, before the global deflation scare took hold, and Schatz yields could increase ~20-30bp once we are past the German and Italian elections. We also expect there will be at least 3040bp repricing higher of 10y German yields on these expected ECB actions, likely over the course of 2H17. We discuss the impact of ECB actions on German yields in greater detail here. ■ In addition to Randal Quarles, Trump is reportedly expected to nominate Marvin Goodfriend, a former Fed research economist, to the Board of Governors. Goodfriend has in the past expressed a preference for “pre-emptive” hiking and a view that the Fed is “behind the curve”—and that a “small campaign of hikes” to get to 2% was appropriate. This would indicate a hawkish

addition to the board, and a particularly weighty one if he were appointed the Chair. Thus far however, there’s been no indication as to whether the administration has a leadership role in mind for him. Goodfriend also has also previously expressed skepticism regarding the efficacy of balance sheet policy, and instead voicing his preference for negative interest rates as a means of adding accommodation—this view does not currently have much support in the FOMC. …■ Sluggish inflation, looming political risk and delays in fiscal policy have continued to pressure US term premia lower and, consequently, flattened the 2s10s curve back to pre-election levels. While curve flattening may continue in the medium term, particularly if balance sheet normalization is very gradual, we prefer to position for a near-term reversal. Rather than outright steepeners, we prefer to enter zero premium conditional 2s10s bear steepeners. The 3m2y/3m10y implied vol ratio is at its highest since mid-September, having risen substantially over the last month. Also, an analysis of the implied versus realized beta suggests that the options market is implying less than 0.3bp of steepening for every 1bp sell-off in 10y swaps, whereas the 2s10s swap curve over the last three months has actually steepened over 0.5bp for each 1bp rise in 10y swap yields. Positioning also looks somewhat favorable with specs’ strong curve flattening bias (see here) possibly indicating some vulnerability to a reversal.

06 June 2017

UK Economics: UK general election: A guide to the night The UK is going to the polls on 8th June 2017. Polls suggest that the Tories are likely to win by a bigger majority than they currently have (17), though recently we have seen a narrowing in the polls, with the lead as low as 1 point in one poll and some even predicting a hung parliament. The lead of the Tories has dropped from 20 points to 8 points on average (Figure 1).

Our base-case scenario is for a Tory majority. Based on Electoral Calculus and our current polling averages, the size of the Tory majority is likely to be 58 seats, which is less than the 100+ predicted when the election was called. Polling booths will be open between 7 a.m. and 10 p.m. and counting of votes will begin when the polls close. The exit poll will be released immediately after voting closes at 10 p.m. on BBC News. First results are typically released just before midnight. In this note we list the estimated time when the results are likely to be announced in each constituency, the vote share of the largest two parties in the 2015 general election and the margin between them. We have also highlighted in yellow the constituencies where the margin between the two largest parties is less than 10% (i.e., marginal seat). Along with that we have also noted

down the estimated leave share in each constituency in the EU referendum using academic Chris Henretty’s estimates of how constituencies voted in the referendum. There are 118 constituencies where the margin between the largest 2 parties is less than 10%.

Deutsche Bank 06 June 2017

The Flow Whisperer - TAARSS 3Y Anniversary, lessons learned, and more Europe for June Tactical Asset Allocation Relative Strength Signal (TAARSS) Monthly Update Top recommendations for June: Europe Eq, EM Asia Eq., Corp. IG , US Technology Eq., and EM Debt. TAARSS turns 3 years old After 3 years of live performance history we learned that quarterly rotation strategies performed better relative to their benchmarks compared to the monthly rotation strategies. In addition, we also found that multi asset strategies were more stable, less prone to take unintended risks due to unconstrained allocations, and less likely to remain uninvested. We also noted that Year 3 was better for the majority of the TAARSS-based strategies. Overall we see quarterly strategies as more appropriate for a signal-based portfolio, while the monthly signals should be analyzed more carefully to assess the potential presence of noise. Furthermore, monthly signals may be better utilized as a monthly relative strength tactical indicator rather than as a blind signalbased rotation portfolio. EFRoM portfolios which use monthly TAARSS seek to improve some of the monthly rotation strategies shortcomings, and seem like a better alternative for tactical monthly portfolios. Tactical positioning for June based on TAARSS and EFRoM  Investor sentiment rose more clearly during last month, moving back into risk-on territory. Based on this positive change we recommend to add risk in June. We believe that Corporate IG, EM Debt, US Dom. Cyclicals, US Large Cap, and DM Intl equities seem sensible alternatives for increasing risk in June. Furthermore, according to our TAARSS model we continue to be positive towards Global Equities, and we still prefer DM Intl and EM over the US in June. In Intl

DM we prefer Europe as a regional or Eurozone-country exposure such as Spain, France, or Germany, while we continue to prefer Asia in EM, particularly Malaysia. In the US we stay neutral and prefer market weighting, Domestic Cyclicals ex Financials, or Technology tilt. For Fixed income we prefer Corp IG, EM Debt, and Intl DM Debt. While for commodities we continue to recommend staying on the sidelines altogether. 

05 June 2017

US Daily Economic Notes Looking for a cyclical lift in productivity …Companies may need to operate more efficiently in an environment of dwindling excess labor slack. In the chart below, we can see that the unemployment rate fell below 5% in Q3 1997 (4.9%) and continued to decline for the next several years. The unemployment rate reached a cyclical low in Q4 2000 (3.9%) and rose to only 4.2% in Q1 2001, right before the economy entered what was a very mild recession in the following quarter. Over the fourteen quarters between Q3 1997 and Q1 2001, nonfarm productivity expanded at a 2.8% annualized pace. This was nearly one full percentage point faster than the 1.9% annualized growth rate between Q1 1991, when the previous recession ended, and Q3 1997, when the unemployment rate first breached 5%.

first likely coming at next week's June FOMC meeting – and a reduction in the balance sheet are still likely by year-end. One reason the Fed has remained on message is that financial conditions have persistently eased despite two rate hikes since December. In fact, our financial conditions index has recently neared the loosest (i.e., most supportive of growth) levels since 2014. The magnitude of the easing in financial conditions since the December 2016 FOMC meeting is material. In terms of its impact on real GDP growth, this easing is roughly equivalent to one 25bp rate cut, even though the Fed has raised rates twice over this period. The evolution of financial conditions as the Fed continues to raise rates and also begins to unwind its balance sheet will be an important factor determining whether the market or the Fed view proves correct about monetary policy in 2018.

Figure 1: Financial conditions have eased considerably in recent months, sending a positive near-term growth signal

Figure 1: With the unemployment rate so low, firms may have to boost Productivity Figure 2: Alternative FCIs confirm easing in financial conditions

05 June 2017

Fed Notes - Loose financial conditions helping to keep the Fed on track 

Despite another weak Q1 for US growth and several soft inflation prints in recent months, the Fed has for the most part stuck to the script for policy over the remainder of the year: recent communication has continued to signal that at least one rate hike – the

05 June 2017

Fed Notes - Interesting developments regarding potential Yellen replacement

Among the most important appointments the Trump Administration will make in its first year are those of Federal Reserve Board membership, and in particular, the filling of Janet Yellen’s position as chair. Events in recent days have reduced the odds that the next Fed chair will be a name out of left field with little background in monetary policy. Indeed they have raised the odds that (1) Yellen will either be asked to stay on or will have significant say over who replaces her, (2) Jay Powell will be named chair, or (3) Marvin Goodfriend is being groomed to be the Chair.

05 June 2017

Global Financial Strategy Low interest rates and low volatility hit financial institutions again Global Financial Services Conference update: FICC revenues deteriorating FICC revenues, which had been recovering since AprJun 2016, have been slowing down due to falling interest rates and volatility (Figures 5-6), and a lack of market themes. The Deutsche Bank Group held its Global Financial Services Conference in New York on 30-31 May. During a presentation, JPMorgan CFO, Marianne Lake, said that 2Q (Apr-Jun) markets revenue was down 15% YoY so far. Bank of America CEO, Brian Moynihan, said that he projects a 10-12% YoY decline. Morgan Stanley and Citigroup CEOs also stated that they expect similar declines. Goldman Sachs underperformed in 1Q (JanMar), and commented that conditions are comparable. We have summarized the statements from each company on page 2. Update on Japanese brokerages On a 27 April results conference call, and at a 26 May investor day, Nomura holdings said that 1Q (Apr-Jun) is shaping up to be a slow start to this quarter. On a 28 April conference call, Daiwa Securities Group said that bond trading conditions in Japan and the US have become harsh due to falling volatility. US financial stocks drop After 2Q updates via outlets such as our conference, US financial stocks dropped on 31 May, with Goldman Sachs falling by 3.3%, Bank of America by 2.2%, and JPMorgan Chase by 2.1%. US financial stocks’ relative performance can be mostly explained by interest rates (Figure 6). They have been underperforming due to long-term interest rates falling while stock indexes rise (Figure 7). Since the most recent interest rate peak on 13 March, information technology sector stocks have risen 9% and utilities 6%, but financials and telecommunication services are down 6%, and energy stock are down 7%.

Figure 6: Interest rate and bank stock index

Japanese financial stocks: from the US presidential election until 15 December 2016 (Figure 9) UST 10y yields rose by 74bp after the US presidential election through to 15 December, which widened the gap between Japanese and US interest rates and led to the JPY depreciating by up to ¥14 versus the USD. This resulted in a 13% rise in TOPIX over the same period, which exceeded the 6% rise in the S&P 500 (Figure 9). Thanks to a considerably weaker JPY and a 23bp rise in 20y JGB yields, Japanese financial stocks significantly outperformed TOPIX (Figures 8-9). Japanese financial stocks since 15 December (Figure 10) However, 10y UST yields have fallen by 44bp since 15 December. The difference between Japanese and US interest rates has narrowed, and the JPY has appreciated by as much as ¥8 versus the USD. The S&P 500 rose by 8% over the same period, as falling interest rates accelerated the search for yield, but TOPIX only rose by 5%, due to yen appreciation (Figure 10). Japanese financial stocks (particularly banks and brokerages) have been underperforming TOPIX due to considerable JPY appreciation and a 4bp dip in 20y JGB yields (Figures 8, 10).

Going forward, we think that the major driver for Japanese stocks, including Japanese financials, will also be 10y UST yields.

June 05, 2017 @ 10:26 AM

Monday Morning Outlook Long Housing, Short Autos Late last week automakers reported selling cars and light trucks at an annual rate of 16.7 million units in May, down 3% from May 2016. If you look at a twelve-month moving average, sales peaked back in April 2016 and have been trending lower, ever since. Meanwhile, the twelve-month averages for home construction, prices, and sales are still hitting new highs for the current economic expansion.

…The problem is that limits on land use, including some environmental rules, are impeding the housing recovery. In particular, these rules tend to suppress the construction of "affordable" housing as the costs of the rules don't vary based on the "price point" the builder is focused on and adding a fixed cost has a larger percentage impact on lower-priced homes. As a result, we may keep seeing more rapid gains in home prices around the country, not because of some sort of "market failure," or "greed," but because of the government's failure to clear a path for the free market to work. One key issue to watch will be whether the growth in home prices continues to outstrip the growth in rents. That's been true the past several years, but now home prices have finally come back to fair value on a national average basis. This is good news. With home prices recovering, builders will become more active and housing will follow the path of vehicle sales...with a lag, helped along by too much government.

… 8. The June 14 press conference should provide some clarity on the order of these two moves, but we have made a tactical switch in our own thinking. We now expect balance sheet adjustment to start in September and the funds rate to rise in December. Our analysis shows that the start of balance sheet adjustment is a smaller tightening step than a 25bp rate hike, and this finding is consistent with the extremely muted bond market reaction to the committee’s signals of an earlier move toward runoff. This means that announcing the start of balance sheet adjustment in September and keeping open the option of foregoing the third 2017 hike might be viewed as the more prudent course of action given the mixed recent data and the potential for fiscal turmoil in Washington in Q3 related to the need for a debt ceiling hike and an extension of spending authority. … 9. According to press reports, President Trump intends to appoint Randal Quarles to the Fed vice chairmanship for supervision and Marvin Goodfriend to another governorship. Quarles was floated several months ago, but Goodfriend represents new information. He is well-qualified as a monetary economist, with views that have leaned hawkish historically but have been more eclectic recently; two that stand out are a strong focus on the importance of anchoring inflation at 2% and a preference for negative interest rates over QE as an easing tool. 5 June 2017 | 10:55AM EDT

5 June 2017 | 8:24AM EDT

US Views: A Tactical Switch (Hatzius) … 2. Further declines in labor market slack are likely, as output growth remains above potential. On a 3-month average basis—a reasonable benchmark given the apparent noise in some of the employment measures that play an outsized role in the CAI at this point in the data calendar—our current activity indicator (CAI) stands at 3.1% through May. Real GDP continues to send a slightly less upbeat signal, but our latest Q2 tracking estimate of 2.5% is nevertheless consistent with ongoing above-trend growth. … 4. In any case, the more important reason why growth should stay firm is the easing in financial conditions. Our FCI is now at the easiest level since early 2015, with lower 10-year yields, a weaker dollar, and gains in the S&P 500 all contributing to the recent move. Based on the recent history of the index, we estimate that the FCI impulse to growth looks set to pick up to +¾pp year-onyear by late 2017, an improvement of 2pp from early 2016. These numbers are significantly bigger than the potential effects of a fiscal package on growth, which we would peg in the 0.3pp range for late 2018.

USA: ISM Non-Manufacturing and Factory Orders Edge Lower, Q2 GDP Tracking Down to 2.4% BOTTOM LINE: The ISM non-manufacturing index edged lower in May, a bit below consensus expectations. Component details were mixed, reflecting decreases in the orders and business activity components but a large increase in the employment subindex. Factory orders declined in line with expectations in April. Growth in durable goods orders was revised down modestly, while growth in core capital goods shipments was revised up. Following today’s reports, our May Current Activity Indicator (CAI) increased by two tenths to +3.0%, but we revised down our Q2 GDP tracking estimate by one tenth to 2.4% (qoq ar). 5 June 2017 | 9:08AM EDT

USA: Q1 Productivity Revised Higher but Compensation Revised Down BOTTOM LINE: Nonfarm productivity growth was revised up in Q1, somewhat better than expected.

Unit labor costs and compensation per hour were revised down substantially on a year-over-year basis. Our wage tracker now stands at +2.6% for Q1 vs. +3.0% previously, reflecting the downward revision to compensation per hour. 5 June 2017 | 7:01PM EDT

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declined from its preliminary estimate by one tenth to +2.9%. The May EM CAI stands at +6.2% (vs. +5.7% in April); the EM CAI does not have a preliminary estimate. The global MAP declined over the past week, mainly driven by weaker-than-expected data releases in LATAM and Asia ex-Japan.

USA: GS Economic Indicators Update Over the last week, the GS US Financial Conditions Index decreased by 10.5bp to 99.3, the easiest level since early 2015. The easing in financial conditions was primarily driven by a lower 10-year Treasury yield and higher equity prices:

June 5, 2017

JEF Economics

Monday Morning Recon …Fed Whisperings: June Rate Hike on Track… Vague Balance Sheet Communication …We do NOT think that the May employment report will dissuade the FOMC from raising rate on June 14, but we do think that the doves will raise the decibel levels of their objections to rate normalization and that Neel Kashkari will again dissent at the upcoming FOMC meeting.

5 June 2017 | 1:29PM EDT

Global: GS Economic Indicators Update 

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The GS US FCI eased by 11bp last week to 99.29, mainly driven by a lower 10-year Treasury yield and higher equity prices. The Euro area FCI tightened by 2bp last week to 99.70, primarily due to a stronger trade-weighted EUR. The Japan FCI eased by 2bp last week to 99.82, mostly as a result of higher equity prices. The UK FCI tightened by 1bp last week to 99.67, driven by a higher 10-year Gilt yield. The May global CAI increased from its preliminary estimate by one tenth to +4.7%. The DM CAI

…While most policymakers continue to promote a preferred path for two more rate hikes –most likely June and September—and the first stage in changes in balance sheet reinvestment policy before the end of the year, there are many details and issues that the FOMC needs to make public before the markets can get a handle on how the Fed will proceed with balance sheet normalization. At this point, we know very little beyond the Fed’s desire to reduce the size of the balance sheet in “a gradual and predictable manner.” One of the most important issues is how the FOMC intends to communicate the details and logistics of balance sheet normalization. That is not remotely clear at this juncture. …One of the consequences of providing such vague guidance on how the FOMC intends to

provide guidance on details of balance sheet normalization is that we must always be prepared for the possibility of an unexpected announcement. …Treasury This Week Coupons: Treasury will announce next week’s 3year notes, 10-year note reopening, and 30-year bond reopening at 11:00AM on Thursday. We expect that the sizes of the auctions will be unchanged from the last package of reopenings at $24 bln, $20 bln, and $12 bln, respectively. The $56 bln package will combine to raise $28 bln in cash when the auctions settle on June 15th. There will be no SOMA add-ons for any of the auctions.

June 5, 2017 Treasury Market Commentary Daily Commentary, 6/5 … At 3:00, benchmark Treasury yields were 1.5 to 3 bp higher and the curve slightly steeper after the 1 to 6 bp bull flattening rally Friday to post-election lows for long-end yields. The 2-year yield rose 1.5 bp to 1.30%, 3-year 2 bp to 1.44%, 5-year 2 bp to 1.74%, 7year 2.5 bp to 1.99%, 10-year 2 bp to 2.18%, and 30year 3 bp to 2.84%. Our

desk actually saw better domestic real money buying in good volumes and was surprised the market managed to sell off even as modestly as it did. While underperforming outright, TIPS relative performance Friday compared to the size of the long-end nominal gains was good. That didn't last Monday, however, with the rise in nominal yields more than accounted for by higher real yields and TIPS inflation breakevens falling slightly more, extending a gradual but persistent weakening trend since the end of January. The 5-year/5-year forward inflation swap was down another 1 bp to 2.21%, back to where it was on election day in November after pulling back from a post-election high of 2.50% in December.

June 6, 2017

FX Morning Daily Commentary, 6/06 …FX reserves are on the rise again: Changes within the Fed’s custody holdings work as the barometer for the evolution of currency reserves, and this barometer is now flashing a green light, underpinning the EM asset class outlook. Previously, we highlighted parallels with the 2004-2006 Fed tightening cycle. Then higher US Fed funds rates were unable to tighten financial conditions. Here, too, it was sharply rising currency reserves indicating excess of USD liquidity. Currency reserve managers recycling these excess reserves into DM sovereign asset holdings helped keep the USD offered and US bond yields remarkably low. Understanding the impact of the cross-currency basis: Nonetheless, there is one difference to the 200406 episode and that is the cross-currency basis swap spreads. Nowadays, cross-currency basis is significantly wider, suggesting better offshore USD liquidity conditions will convince investors to monetise basis spreads. On the front end of the basis swap curve, the monetisation effect is almost complete, but it is now the 5-12 year tenor of the curve which is seeing investor interest. The USDJPY basis still offers more than 70 bp within the 5-12 year maturity spectrum. Investors buying adequate JGB maturities and swapping holdings back into USDs has become more favourable compared to holding the equivalent USD sovereign bond. The JPY impact: With foreign investors buying 5-12y JGBs, the BoJ needs to intervene less to keep JGB yield near its envisaged zero yield. Hence, the BoJ’s balance sheets may grow by less than the JPY80trn the BoJ has been aiming for. Latest BoJ communication suggests the balance sheet growing now at around JPY60trn, which has lent JPY support. In addition, the tightened USDJPY basis reduces hedging costs. Sure, most hedges are done via short-dated swaps not exceeding one year maturities, but on the margin the basis swap spread tightening now focusing on the middle of the curve may have added to JPY strength. A side effect of this development, where basis swap spreads are tightening due to strong USD liquidity conditions, is that the JPY increasingly decorrelates from the global risk perception. As long as the monetisation of the basis is not complete, strong financial conditions could suggest higher risk appetite and rising share prices working alongside a higher JPY

reverse. July Fed funds futures don't have their thinking caps on this morning, and are unchanged at 1.125% which implies an 86% chance they hike rates on June 14.

2 June 2017

Financial Market Weekly SLOW JOBS REPORT AS ECONOMY RUNS SMACK INTO THE FULL EMPLOYMENT WALL Breaking economy news. May employment data, payroll jobs up just 138K with 66K of downward revisions to March and April. The unemployment rate incredibly dropped another tenth lower to 4.3% in May which provides some evidence that jobs growth is slowing as the economy hits the wall of full employment where there simply are not enough people out of work to put back to work. Yes, average hourly earnings have not risen any higher, 2.5% year-to-year for May the same annual gain as in April, but wages do not go up immediately once the economy reaches the full employment stage. The best economic theory can say is that wages will move up over the next 12 to 18 months. We would be surprised if wages were still running under 3% for example when we get to the end of 2018. Modest wage gains and continued income inequality do not take Fed rate hikes off the table. We hope.

MARKETS OUTLOOK Bonds yields fell from 2.20% on the weaker than expected jobs report on Friday. The market normally favors the payroll jobs count over the movement in the unemployment rate. Payroll jobs in May rose 138K and the consensus forecast was +182K, end of story. The 10-yr Treasury yield was 2.16% fifteen minutes after the report and closed at 2.16%, touching as low as 2.14% before 12 noon. The 2.16% 10-yr yield is mispriced of course if the Fed funds rate median forecast of 2.25% is reached as Fed officials think at the end of 2018. We guess bonds think the Fed will never get the funds rate that high for some reason if the bond market is capable of thinking. On the other hand, maybe fixed income investors are not expecting the Fed to push rates higher than 2.25%. There is no real yield pickup for savers starved for investment income either with CPI inflation of 2.2 percent the last 12 months. Not a great America time to retire and dine out on your nest egg.

Slowest three-month total payroll jobs yet will test Fed beliefs. Rockbottom 4.3% unemployment rate (lagging indicator) versus payroll jobs (coincident indicator). Some might argue that sure the labor market got to its best full employment level, but now it has hit a soft patch. Wait to see if it is temporary.

…The early market reaction was subdued in the first fifteen minutes post-release time with 10-yr Treasury yields falling 4 bps from 2.20 to 2.16 percent. Dow stock futures were up 71 points and now up just 25 points. The S&P 500 just closed last night at record levels up 8.5% year-to-date. Stocks investors are certainly not panicking that the economy's growth engines are about to go into

Bonds are in a technical uptrend with a new yield low made on Friday for 2017. It has filled a gap in the charts left a few nights after Trump’s surprise victory. Yields closed at 2.06% the day of the election results on

November 9. With the Fed announcement of a rate hike on June 14 dead-ahead, it would be surprising to see the rally continue. Maybe geopolitical risks could carry it further, but 2.00 percent seems to be quite a barrier technically. Before the last two Fed rate hikes in December and then in March yields were above 2.50%. The only thing moving up in yield is 3-month Libor closing at 1.22% this week, yet the market still has an intense desire to pay this lower floating rate yield. 3month Libor is moving up while 3-month Libor in December 2019 [Eurodollar futures; when the Fed says the funds rate will be 3%) is moving down closing at 1.92% on Friday. Two and a half years from now and only 70 bps higher than where 3-month Libor is today. Hard to explain rationally. Meanwhile, July Fed funds futures closed Friday at 1.13% or rate hike odds of 88% at the June meeting despite the softer employment report. At least someone is certain about the future in the markets. Fed funds futures say a rate hike is coming on June 14. Bet on it.

OTHER ECONOMIC NEWS THIS WEEK Inflation goal elusive, slip sliding away, but consumers are back spending it

Graph 1. Range trading kills USD implied rates volatility

JUNE 6, 2017

FX DAILY TESTING THE LIMITS OF THE TRUMP RANGE The correlation between USD/JPY and US Treasury yields remains stupidly strong. The causation seems clear enough - the BOJ is anchoring Japanese yields and the relative appeal of the yen is a function of yields overseas, encapsulated by the global bellwether. The last year can be divided into two ranges. Pre-Trump, USD/JPY traded in a 98-108 range and 10s in a 1.3-1.8% range. Since midNovember, USD/JPY has traded in a 108-119 range, 10s in a 2.15-2.70 range. We are at the bottom of that range, in both FX and bond markets.

From here, I'd rather be short yen than short Treasuries, but I wouldn't like to be long either. Is this week's move caused by the soft JUNE 6, 2017

FIXED INCOME DAILY THE LONG UNWINDING ROAD Market Update Our semi-annual Fixed Income Outlook ‘The long unwinding road’ is out. It reflects on the painfully slow exit from central banks, and the equally quiet stance in global bond markets. 10yT has been is a range of less than 50bp over the past six months – it is no surprise in this context that implied vols have crashed (Graph 1).

US data on Friday 9adn soft Ism prices paid yesterday) or by risk aversion (Comey testimony, UK election, Qatar)? Both play a part, obviously, but the pound's ignoring the polls, and glancing through equity markets and commodity market moves, there's no evidence of wider risk aversion. Oil prices have dropped back, partly on the grounds that there are not yet any economic sanctions being imposed on Qatar. I'm more inclined to see this fall in US yields as the last leg of the rally which started when huge bearish positions were squeezed at the end of Q1. Now that we've see a sizeable long position build-up in CFTC data, I'm more inclined to view this latest move as the last hurrah of the bond bulls, and fade it by staying long EUR/JPY and going long USD/JPY.

USD/JPY and 10year Treasury yields

trailing EPS is up 7% YTD in the US, and 17%, 16% and 1% higher in Japan, UK and the Eurozone, largely driven by the oil price slump dropping out of all but Japan's figures.

JUNE 6, 2017 JUNE 5, 2017

GLOBAL EQUITY MARKET ARITHMETIC ANALYSTS' EPS MOMENTUM IS STRONG, BUT THE ECONOMIC REALITY IS MORE SANGUINE (35P) Global equity markets continue to power ahead, rising a further 1.2% last week to leave MSCI World up 10.5% year-to-date. Japan was the biggest weekly winner with the Topix 500 rising 2.7% or 3.5% in US dollar terms. Sector-wise it was a week for the cyclical sectors with Autos, Electronics and Electrical Equipment and Travel & Leisure leading the way. However the commodity driven sectors were all negative last week along with Banks. Global earnings momentum, as measured by the percentage of analyst upgrades, is increasingly polarised (see page 13) with US and Eurozone momentum having surged towards 60%. Meanwhile UK, Japan, Emerging Markets and Asia Pacific ex Japan EPS momentum are heading in the opposite direction. An upgrade or a downgrade is a binary event, it has no economic value and this is why upgrades/downgrades are treated as sentiment indices. They are effectively a diffusion index of good and bad news in a similar vein to purchasing manager surveys (which are increasing bracketed as soft data). However when viewed through the lens of what has happened to actual EPS forecasts you see a very different picture. When it comes to the progression of estimates, Japan comes out on top, with 2017 earnings forecasts 5% higher than where they stood at the start of the year. Eurozone and UK EPS forecasts are just 2% higher, and the US, despite 75% of companies beating Q1 EPS estimates according to Thomson Reuters I/B/E/S, is about 1% lower. A different picture emerges again when you observe actual reported profits, where according to MSCI, 12m

ECONOMIC THEMES NEW EMPEROR OF JAPAN COULD FURTHER LIFT ECONOMIC SENTIMENT The government has finalised and submitted to the Diet the bills necessary to allow the Emperor to abdicate from the throne. With strong public support, and the support of both the ruling coalition and opposition parties, the bills will likely pass through both houses of the Diet without major delay. Once the legal framework is changed, the Emperor will be able to abdicate from the throne, an event that has not occurred for 200 years. The ascension of the new emperor to the throne and the start of a new imperial era could further lift economic sentiment.

June 6, 2017

Market Musings ECB TO SEE BALANCED GROWTH RISKS BUT KEEP UNBALANCED GUIDANCE  

We look for the ECB to keep rates and the planned pace and duration of QE unchanged at this week’s meeting. What will be watched more closely is the ECB’s language around the risks to growth and the easing bias and forward guidance around rates and QE. Here we look for the risks to the growth outlook to be upgraded to broadly balanced, in line with 90% of other analysts surveyed, but we look for the easing bias on

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rates and QE to remain in place, whereas about half of all analysts are looking for the ECB to drop the easing bias on rates. We also look for the ECB to stick with the forward guidance on sequencing as previously laid out, that rates will not rise until “well past the horizon of asset purchases.” This should leave a dovish tone as markets remove some of the rate rises that are priced in for 2018. While positioning suggests rates would have an easier time responding to a hawkish message, we think a lack of change to rate guidance should send bund yields back to the lower end of the range. EURUSD looks notably vulnerable to a near-term correction lower as it heads into this week’s ECB meeting. Valuations look stretched and some indicators are pointing to overbought conditions. We see downside risks of up to 2%, but we remain mediumterm bulls on the EUR overall.

June 5, 2017

Rate Strategy Rates Express

SSA Heading into Friendly Seasonals Yield pickup and diversification amidst fully valued markets; issuance drop-off supports spreads

5 June 2017

First Read

US Economic Comment ISM hints that payroll slowing was transitory ISM down slightly to still high level, but the employment index bounced back The nonmanufacturing ISM index slipped to 56.9 in May (consensus 57.1, UBSe 57.5) from 57.5 in April. The level so far in Q2 is consistent with some growth acceleration: Q1 averaged a slightly lower 56.4, and 2016 averaged 54.9. Perhaps more importantly after the soft May payrolls figure, the employment index rebounded from two weak readings to its highest level since mid-2015. Our allemployment ISM index, which combines the manufacturing and nonmanufacturing measures, had fallen to levels in March and April that historically had been consistent with < 150k per month in payroll gains, but its May level reversed that weakness (see chart). On net, smoothing through some monthly volatility, the ISM employment indexes suggest little change in the trend in employment growth: the slowing in payrolls in May could be transitory. Apr factory orders -0.2%, capex orders and shipments revised up

Healthy new supply from core SSA names in 2017 The “usual suspects” came back to tap the bond market for funding in 2017. Figure 1 presents the new “institutional size” USD-denominated supply by the nine large issuers broadly popular among investors.1 The two prolific European issuers – EIB and KFW – appear on track to match or exceed previous years’ supply with nearly $20 billion of new issuance in 2017 thus far. Even more impressive, the Asian Development Bank’s 2017 $15 billion in the new USD issuance has already nearly matched the entire 2016 total. Similarly, EBRD has also already exceeded the entire 2016 USD-denominated fundraising with about $4.5 billion of new issuance in 2017.

June 5, 2017

Economics Group ISM Non-Manufacturing Activity Softens in May The ISM non-manufacturing composite index slipped 0.6 points to 56.9 in May, as the sector continues to expand but at a slower pace. The prices paid index dropped significantly while the employment index jumped. June 5, 2017

Economics Group Special Commentary

Housing Chartbook: June 2017 Are Soft Home Sales Due to a Lack of Supply, or a Lack of Demand? Low inventories and the calendar took most of the blame for April’s disappointing reports on new and existing home sales. New homes sales plunged 11.4 percent in April, while an upward revision to the prior three months data by a cumulative 55,000 units certainly takes some of the sting out of April’s decline. However, the unusually large headline drop along with a less dramatic 2.3 percent drop in existing home sales and declines in both pending home sales and mortgage purchase applications raises the prospect that something else may also being going on. This past month’s soft spot in sales was somewhat surprising given the recent strength in builder confidence (Figure 1). The Wells Fargo/NAHB Homebuilder Sentiment Index rose 2.0 points to 70 in May, as both present and future sales indices rose during the month. Builder confidence is near its highest point of the cycle and buyer traffic is said to be solid. A lack of homes available for sale is certainly part of the equation. Unseasonably mild winter weather likely allowed the spring home

buying season to get off to an earlier start than usual, leaving fewer homes for potential buyers to choose from in April. Easter also came in midApril, which likely negatively impacted sales that month. The impact of these two twists was magnified by the seasonal adjustment process, which looks for a big increase in sales each April, and thus made the smaller-than-usual rise look much weaker than it actually was. Even with April’s soft patch, housing is still on track for its best year this decade. Sales of new homes through the first four months of this year are running 11.3 percent ahead of sales for the same period last year and sales of existing homes are up 2.1 percent for the comparable period. Housing starts also declined in April, although the entire drop was in multifamily units. Starts of new single-family homes rose 0.4 percent and are running 7.0 percent ahead of their yearago pace through the first four months of this year. Builders are selling virtually everything they build and a rising share of new home sales are for homes that builders have not yet started.