Hard Data Finally Closes the Gap!

  • Tim Duy’s Fed Watch – Will Growth Slow In 2018? And Why?
    In short, the Fed has already done a lot, growth likely to slow, and inflation is a mystery, so why hike now? But if your answer is the third option then you believe that the necessary (at least in the Fed’s view) tempering of economic activity will only occur after additional monetary tightening. In either case you eventually get a slowing of economic activity. But the path of short term rates looks very different. I think the majority of Fed policy makers fall into the third category, and thus are more likely than not to see the solid growth of the past three quarters as a signal that the economy will overheat without the projected additional rate hikes in December (25 basis points) and next year (75 basis points). Which is why I expect that as long as the economy looks likely to drive unemployment rate lower, the Fed will remain biased toward hiking rates.
  • Summary

    Hard economic data has finally joined the giddy chorus of soft, survey-based data. But, is this cycle of realized economic gains reaching a point of exhaustion? History suggests U.S. Treasury yields find little upside after extremes in hard data surprises.

    Comment

    Yellen and gang have reason to feel encouraged with hard economic data finally catching up to rosy soft, survey-based data. The chart below shows U.S. hard (blue) and soft (pink) economic data changes, which measure releases in relation to one-year averages.

    Hard data like industrial production and durable goods orders are supporting the euphoria found in consumer and small business sentiment witnessed post-election. The under-performance of hard data had been a major theme over the year.

     

     

    The next chart shows economic data surprises for U.S. hard (blue) and soft (red) data. Data beats by hard data series are occurring at their greatest rate since January 2014. We had all grown accustomed to realized economic growth measures coming in at or slightly below economists’ estimates. This condition ended in late October 2017, helping propel short-end U.S. Treasury yields and the S&P 500 higher. 

     

     

    But, can hard economic data keep up these realized improvements and upside surprises? We query for instances when the Citigroup Hard Economic Surprise Index exceeds an extreme reading of 70 like accomplished earlier this week.

    The chart below shows the changes in U.S. 10 year note yields during the trading days after these instances of extreme hard data surprises. All in all, the upside potential for longer-end yields has been very modest with most instances ultimately falling in yield over the course of the ensuing one to two months.

    The continued flattening in the U.S. yield curve (2y10y 52.6 bps) remains a vote of no confidence in the Fed’s expected path for inflation. Past cycles in economic data suggest recent improvements are probably not sustainable. Could this create a mirage for Yellen, and soon, Powell et al to maintain their inflation outlook and believe tightening is needed to stave off over-heating.

     

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