May 26 – A cautious optimism lifted values for both the broader commodity and equity sectors overnight, with traders encouraged by reports that negotiators are close to a deal to raise the U.S. debt ceiling, although this morning’s economic data took some of the bloom off of overnight gains. The markets will be closed Monday for the Memorial Day holiday, adding a little more intrigue for traders as the news cycle continues. The VIX is trading below 19 this morning, while the dollar index is trading near 104.1. Yields on 10-year Treasuries are trading near 3.83% this morning, after posting fresh 11-week highs, while yields on 2-year Treasuries are trading near 4.58%, which is also an 11-week high. Yields rose following the release of this morning’s economic data, but they were already going up as people left the Treasury market due to worries over the looming debt ceiling deadline. Crude oil prices are 1% higher in early trade ahead of next week’s OPEC+ meeting, while the grain and oilseed markets were mostly higher as well.
Durable goods orders rose 1.1% month-on-month in April, which is the exact opposite of what analysts expected. That follows a 3.3% gain in durable goods orders for March. But the details tell a more intriguing story. Durable goods orders minus transportation fell 0.2% month-on-month in April, versus analyst expectations of a 0.1% decline and versus 0.3% gains the previous month. But core durable goods orders, which is an indicator of business sentiment, rose 1.4% month-on-month, which is an improvement from the 0.6% decline the previous month.
But the bigger surprise to traders came in the PCE numbers released this morning. Personal income came in at 0.4% month-on-month gains in April as expected, although that is up from 0.3% the previous month. However, the headline personal consumption expenditures rose 0.8% month-on-month in April, which was twice the 0.4% expected, and up from 0.1% in March. The PCE price index therefore rose 0.4% month-on-month in April, up from analyst expectations of 0.3% and up from 0.1% in March. The headline PCE price index rose 4.4% year-on-year in April, up from analyst expectations of 4.3% and up from 4.2% the previous month. The core PCE price index that excludes the more volatile food and energy sectors also rose 0.4% month-on-month in April, up from analyst expectations of 0.3% and up from 0.3% gains the previous month. The core PCE price index was up 4.7% year-on-year in April, beating analyst estimates that it would be unchanged at 4.6%. The bottom line is that consumer spending rose at twice the expected pace in April, driving prices higher and reigniting inflation concerns once again. Today’s data provides another indicator of the stickiness of inflation in our economy. That pushed Fed fund futures trading this morning to price in 57% odds of another rate hike at the Fed’s June meeting, up from just 17% a week ago. Traders now put 58% odds that the Fed’s benchmark rate will be at 5% or higher at the end of this year, which is up from just 8% odds a week ago.
China’s economic numbers continue to slide. Auto production in China fell 17.5% month-on-month in April, while sales fell 11.9% month-on-month. Other data this week showed new home sales through the first 22 days of this month were down 13% month-on-month, adding to calls for stimulus for the Chinese economy. However, the ability of China’s government to provide that stimulus may be limited. First, implementing stimulus while the United States and other major economies are tightening could devalue the yuan at a time when China wants the world to see its currency as a strong alternative to the greenback. Second, many government units within China are rumored to have debt problems of their own, limiting their ability to stimulate the economy. A circulating social media note in China this week stirred widespread concerns that the capital city of southern China, Yunnan Province, Kunming was unable to pay its debts. Local authorities denied the rumor, but it stirred concerns about a potential debt crisis for local governments. Much of the revenue for local governments comes from land sale revenues in China, but those sales have been sluggish for the past two years. We obviously can’t confirm the financial status of these government units in China, but it’s interesting to note that many rating agencies have downgraded credit ratings on a number of Chinese local governments. This suggests that the government’s ability to stimulate the economy is limited, even if they’re not facing a “crisis” situation. This suggests declining demand for construction and metals amid lower investments in government led infrastructure projects.
This weekend marks the beginning of the Northern Hemisphere summer growing season, with the markets adding some weather risk premium into the grain and oilseed markets ahead of the three-day holiday weekend. It’s quite dry in the spring wheat belt of Russia and Kazakhstan, although local analysts are still pushing total wheat production estimates upward. It’s also quite dry across the U.S. Midwest Corn Belt, with little rain in the forecast over the next 10 days to two weeks. The first corn condition ratings are expected to come from USDA on Tuesday of next week, but traders may want to add some risk premium going into the weekend. Forecasters continue to see changes in the atmosphere suggesting that the pattern will start to turn more favorable sometime around the 8th or 9th of June, but the key will be to get crops to that point unharmed in the meantime. Beyond that, the pattern looks favorable if we continue on the current path.
