Daily Insight

U.S. stocks bounced around as offsetting economic reports and a fairly dramatic turnaround in crude prices left traders unsure of the position to take during the session.

Stocks began the day lower as oil per barrel shot up $5, coming just 20 cents shy of the $140 mark and the two economic releases of the day canceled one another out – New York-area manufacturing posted a weak reading, but foreign security purchases show there is plenty of appetite for U.S. securities. But energy traders, after brushing off the Saudi announcement to increase production by 550,000 (formerly 300,000, boosting that by 250,000 this weekend) per day beginning next month, shifted their positions. As a result, crude dropped $6 and stocks rebounded to the highs of the day before closing flat. The chart below illustrates the day’s activity.

Of the 10 major S&P 500 industry groups, financials were the best-performing area, adding 1.05%. Energy and information technology shares also gained some ground, while consumer staple and health-care shares led the laggards lower. By the close, six of the 10 ended in the red.

On the economic front, the Empire Manufacturing survey showed New York-area factory activity contracted in June – this marked the second-straight month of decline and the fourth in the past five. Fortunately, the New York region is not a terribly significant portion of total U.S. factory activity, as one might expect. The national reading is hovering right at the expansion/contraction mark of 50 and has shown mild improvement over the past couple of months.

But regarding the Empire number, clearly financial-sector woes are hurting activity in the region. Businesses have to contend with both higher costs and increased layoffs/smaller bonuses at the large brokerage firms. This doesn’t affect manufacturing in a direct sense, but does flow through to orders as the weakness trickles down.

A couple of the key sub-indices within the report were ugly as new orders came in at -5.5, shipments posted a -6.5 reading and unfilled orders posted -10.5 – all lower from the previous month. On the bright side, the index that measures the outlook for the next six months jumped to the highest level this year, coming in at 32.3 from 23.9 in May and 19.5 in April.

Note, on the Empire Index, a number above zero marks expansion; the national factory index – the ISM reading we talk about each month – marks expansion by anything above 50.

In other news, the Treasury Department reported that foreign security purchases jumped $115 billion in April – there’s a pretty large lag to this data as it takes times to compile. We’ve heard a lot about how the trade deficits are the reason for the falling dollar, but the value of the greenback in actually driven more by Fed policy than anything else, especially in the relative short term.

If perhaps, most of the dollars foreigners held via trade were converted into other currencies to buy assets outside of the U.S. then, yes, trade deficits would lead the dollar lower. However, so long as these governments and investors return most of these dollars to the U.S. via security purchases then the old Keynesian argument doesn’t hold up. For instance, the U.S. trade gap over the past 12 months has run about $692 billion, while foreign security purchases over this period have registered $772 billion. The trend is true for the past few years.

Moving along to the Fed, it appears the press – the WSJ, FT and Washington Post – are attempting to walk the market down from their fed funds expectations. Fed funds futures were showing a pretty good indication that the FOMC would begin to gently raise rates by the August meeting – holding steady at next week’s get together. But some comments from Richmond Fed President Lacker seem to have confused some people. He did mention that the Fed may hold pat, but I believe he was referring to the June 25 meeting. He also raised serious concerns regarding inflation and it seemed fairly clear to me he was signaling a hike in August. The press saw it differently, and the possibility of the FOMC holding off for an indefinite period led the headlines last night.

As a result, expectations of some tightening have come off a bit. The bar chart shows expectations for the June 25 meeting, and no change in policy is largely expected. But notice how things have changed from the “1 day ago” reading, as shown in the table (top table to the left). And importantly, notice how expectations for a hike in August have come off (second table). There was a 68.5% chance of at least a 25 basis point hike in August yesterday. Today that expectation has dropped to 56.5%.

I think the view regarding some tightening will increase again this morning after the producer price index for May is releases at 7:30CDT. This number is trending 6-7% year-over-year and unless it returns to the 4-5% range, the Fed will feel pressure to do something – at least I hope they will for the dollar’s sake and the price of oil.

Have a great day!

Brent Vondera, Senior Analyst