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April Philadelphia Fed Manufacturing Activity, March Leading Indicators and Weekly Jobless Claims

KEY DATA: Phil. Fed: -10.8 points; Orders: -11.2 points; Jobs: +2.4 points/ LEI: +0.4%/ Claims: +10,000

IN A NUTSHELL: “The economy continues to move forward even as the manufacturing sector slows.”

WHAT IT MEANS: The more data we get, the clearer it becomes that the slowdown in consumption and the cautious spending on capital goods is taking its toll on manufacturers. The Philadelphia Fed’s Business Outlook Survey, which looks at manufacturers in the Mid-Atlantic region, dropped sharply in early April. This number is extremely volatile, so don’t read too much into the decline. Indeed, the level of activity is still quite solid. But, as can be seen in the moderation in the growth of new orders, the manufacturing is no longer accelerating as fast as it had been. But there were some good numbers in this report. Hiring is improving and worker hours are expanding. Also, expectations on capital spending were quite strong, with much of the funds being directed toward non-computer equipment and software. Firms are taking a wait and see approach, though, as most of the new investment is expected to occur in the second half of the year.

Looking forward, we could see a pick up in activity. The Conference Board’s Leading Economic Index rose solidly in April after even bigger increases in February and March. The gains were in most components, another sign that conditions could be firming. But it will still take more consumer and business spending if we are to shake off the first quarter lethargy.

Jobless claims jumped last week but that was not the big news in the report. The number of people on unemployment insurance was the lowest in seventeen years. Adjusting for the size of the labor force, we are closing in on historic lows set in the 1960s, when benefits were much less generous and less long lasting. In other words, there just are not a lot of people in the reserve army of the unemployed.

MARKETS AND FED POLICY IMPLICATIONS: While there are lots of numbers to come out over the next two weeks, we really need to focus on just two: The first quarter GDP report, which will be released on Friday, April 28th, and the April jobs report, which will come on the following Friday, May 5th. A first quarter growth rate below 1% cannot be ruled out, though I think it will be closer to 1.5%. Regardless, a low increase would set us up for another year of trend growth, which is pretty mediocre. The April jobs report should be a good measure of what are sustainable job gains. The January and February increases were excessive and the soft March number moved the three-month average to a more normal level. If the April increase is in the 150,000 to 175,000 range, we should assume the economy is not likely to accelerate sharply. That is something that will play on the minds of the FOMC members when they meet May 2-3. Don’t expect much to come out of that meeting, though a hint on when the Fed might start shrinking its swollen balance sheet could create a stir. Today’s numbers shouldn’t move investors one way or the other. Investors do have earnings reports, which continue to dribble out, to mull over.

March Employment Report

KEY DATA: Payrolls: +98,000; Revisions: -38,000. Retail: -30,000; Unemployment Rate: 4.5% (down from 4.7%); Wages: +0.2%

IN A NUTSHELL: “Well, it turns out a sluggish economy really doesn’t create large numbers of new jobs.”

WHAT IT MEANS: I have been commenting this week that I was surprised by some of the high estimates for job gains. Economic growth was tepid in the first quarter yet the January and February payroll increases were robust. I warned that the jobs number would disappoint, but even my pessimism was not nearly as great as it should have been. Companies didn’t go out and hire lots of workers in March and the large increases reported for the previous two months were not as strong as initially thought. But before we get too worried, the economy added an average of 178,000 new workers each month during the first quarter and that is pretty good, especially since most firms are complaining they cannot find qualified workers. This was a rather nondescript report as there were no sectors where hiring was robust and only one that posted a truly disappointing one. Retailers continue to retrench, as we all know, and the growing number of store closings led to a large drop in payrolls. The cold March weather probably didn’t help much either. That was pretty much it.

On the unemployment front, the rate dropped and is now the lowest since May 2007. The so-called real (or really stupid) unemployment rate fell to 8.9%, the lowest since December 2007. In other words, we are back to before the Great Recession. The decline occurred for all the right reasons: Falling unemployment, rising employment and increasing labor force.

Wages rose moderately and they are up a solid 2.7% over the year. However, with inflation increasing at a similar pace, household spending power continues to go nowhere and that is likely to restrain consumption going forward.

MARKETS AND FED POLICY IMPLICATIONS: As I visit clients and try to explain that there are limitations to growth even if corporate taxes are cut, I keep getting push back. But the reality is that you have to do the math. Businesses cannot find qualified workers – without bidding them away from competitors and driving up costs – because most of them are already working. Even if you add in discouraged workers and those working part-time for economic reasons, the labor supply is limited because many of those are either in seasonal industries, don’t live where the demand exists, don’t meet hiring profiles because of drug or background checks, are too old or simply don’t have the skills. You can argue all you want that the welfare system is too generous and is keeping people out of the workforce, but the research on the subject doesn’t support the view that the participation rate is significantly low. Indeed, the Bureau of Labor Statistics and private sector researchers forecast furthers decline in the participation rate due to demographic forces. So going forward, it may be hard to match the job gain monthly average posted during the first quarter. But anything over 125,000 or so should be enough to slowly drive down unemployment, making it even harder to hire and expand. And if you are assuming robots will solve the labor problem, the Republicans are now say a tax bill may not be in place until the end of the year. Given the lag between orders and the time it takes to make them operational, labor-saving capital investment will do little to ease the labor shortage before the end of next year – if it does at all. What am I saying? The economy is likely to expand a little faster this year than last and with tax cuts, somewhat faster in 2018. But it is hard to see how we get to robust growth with labor shortages that will only intensify going forward.  

March Consumer Confidence and January Home Prices

KEY DATA: Confidence: +9.5 points/ National Home Prices (Monthly): 0.6%; Home Prices (Over-Year): 5.9%

IN A NUTSHELL: “I guess people think that chaos in Washington is good as consumer confidence is soaring.”

WHAT IT MEANS: The politicians in Washington may have made a fine mess of health care reform, but that didn’t seem to bother too many people, at least not in the latest survey of confidence. Or, maybe people really didn’t like the reforms and they were happy they weren’t passed. Or, maybe the survey was done too early to capture the impact of the failure to repeal and replace Obamacare. Who knows, but the latest report on household attitudes by the Conference Board was incredibly strong. The Consumer Confidence Index hit its highest level since December 2000. Forget the housing bubble, things are even better now. Every component was up solidly as people thought that current conditions were a lot better, jobs were more available and they were easier to get. The future looks brighter as well and respondents are hopeful their incomes will rise.

The national S&P CoreLogic Case-Shiller Home Price Index rose solidly in January and over the year as well. The gains are accelerating and given the paucity of supply, they should continue to do so even as mortgage rates increase. Looking across the nation, only Cleveland posted a decline in January, and that was minimal. Over the year, the increases ranged from a low of 3.2% in New York to 11.3% in Seattle. Of the twenty large metro areas shown, twelve had year-over-year gains that were faster this January than a year ago. In other words, prices are rising, they are rising faster and they are doing so across the nation.

MARKETS AND FED POLICY IMPLICATIONS: “Happy days are here again, the skies above are clear again, so let’s sing a song of cheer again, happy days are here again.” I just don’t get this confidence report. Okay, maybe not as we need to see what people think now that the AHCA has gone down in flames. Economic growth looks like it will once again be lackluster, in the 1% to at most 2% range. Yes, the last two job numbers were strong, but with labor shortages growing, it is hard to believe we can sustain gains above 200,000 (the next report is April 7th). So, what is making people so happy? Got me, especially since about a third of the nation think we are on the right track, a third think Washington is a disaster and the final third are flipping coins. But at least we can say that home prices are rising. That is good because higher values are reducing the number of people who cannot sell because they don’t have enough equity. I don’t worry about first time home buyers and will not until the “churn” in the market, which comes from owners selling their current units and then buying different ones, returns to a normal pace. Absent that, supply will be limited and prices will rise, but the market will not be normal. As for investors, these reports hold out hope that consumer spending will prop up the economy until the government decides whether it is going to give us more money to spend and will spend more money itself. The Republican leadership is hoping to get a tax reform bill done by August. Given the CBO is likely to show that as usual, the tax cuts will explode the deficit, it should be interesting to see how the politics play out on that bill. And those numbers might not even include money for infrastructure spending. Will Rogers said he didn’t belong to any organized political party, he was a Democrat. I wonder if Republicans will start behaving like Democrats this year. And can Democrats keep their discipline and start behaving like Republicans? It just may turn out that 2017 is even wilder than 2016.

March 14-15 2017 FOMC Meeting

In a Nutshell: “The Fed raises rates and reiterates it will continue to increase them gradually.”

Rate Decision: Fed funds rate range increased to between 0.75% and 1.00%

As expected, the Fed raised rates by ¼ percent today. Was this a ho-hum meeting? Not really. Yes, the FOMC made it clear it intends to follow up with two more hikes this year and three next year, but that doesn’t constitute aggressive behavior. It still leaves the Fed well below its projected long-term rate of roughly 3%. In other words, if people were worried that that rates were going to rise faster than expected, the Committee’s statement and Chair Yellen’s answers to questions at her press conference were all constructed to calm those fears.

There was also some important information in the dot charts that describe the members thinking on inflation, growth and interest rates. The nation’s central bankers and their staffs of hundreds of Ph.D. economists expect GDP to expand at an average of maybe 2% over the next few years. That is in line with their long-term growth forecast, but it is about half as fast as the Trump administration’s growth projections.

That sluggish growth outlook has some enormous implications for fiscal policy. Cutting taxes and increasing spending widen the budget deficit. The administration argues that the deficit increases will not be as large as most private sector economists forecast because they believe growth could reach 4%. If we only get 2% growth, the deficit would skyrocket. Indeed, if the Congressional Budget Office scores the proposed tax and spending changes using growth rates similar to the Fed’s, which they are expected to do, the deficit projections could be really ugly.

One final point when it comes to fiscal policy. Chair Yellen encouraged Congress to pass policies that increase the economy’s growth potential. That means promoting investment not spending. The tax cuts the Trump voters are hoping for don’t fall into the category of capital investment. They are on the consumer spending side and would be more inflationary.

So, what should we expect going forward? Today’s economic data support the view that the Fed will move cautiously but consistently. Consumer inflation, as measured by the Consumer Price Index, is at the Fed’s target. However, the Fed’s preferred measure, the Personal Consumption Expenditure deflator, remains just below target. With energy prices falling, at least temporarily, inflation should not accelerate sharply. Also, February retail sales were soft, indicating that consumer confidence may be up but spending isn’t. Growth this quarter could be disappointing.

At least two more rate hikes this year are expected. If we get a huge fiscal stimulus package, especially one directed at consumers, the increase could total one percentage point.

(The next FOMC meeting is May 2-3, 2017.)

January Trade Deficit and Housing Prices

KEY DATA: Deficit: $4.2 billion wider; Imports: +2.3%; Exports: +0.6%/ Home Prices (Over-Year): +6.9%

IN A NUTSHELL: “The strengthening economy is sucking in foreign products and that could depress first quarter growth.”

WHAT IT MEANS: The stock markets may be hitting new record highs and consumer confidence soaring, but don’t look for a huge increase in economic growth. Yes, first quarter growth should be better than the tepid pace posted at the end of last year, but if the trade deficit keeps widening, it will not be anything great. Indeed, the January deficit was the largest in almost five years, led by a surge in demand for foreign products. We bought a lot more oil, cell phones, vehicles and capital goods. On the export side, farmers did well as did the vehicle sector, and we did sell a lot of energy to the rest of the world. But a slowdown in aircraft related shipments depressed the export total. That could change quickly, so don’t assume the deficit will keep rising.

It’s always nice when economic theory actually works and that is the case with the housing sector. The limited supply of homes on the market is driving up prices sharply. CoreLogic’s Home Price Index jumped in January and over-the-year. Improving wage gains, confidence and credit scores are allowing more families to enter the market and they are bidding high for the limited inventory. We are in another leg up of price gains. With the Fed likely embarking on what could turn out to be a fairly consistent pattern of rate hikes, we could see prices rise even faster if buyers try to beat the rising mortgage rates. Of the ten major metro areas CoreLogic charts, four were rated as “overvalued”. The rest were considered to be fairly valued.

Two other reports were released today. The Paychex/IHS Small Business Jobs Index rose for the third consecutive month and the gains were across the nation and across almost every sector. The IBD/TIPP Economic Optimism index fell for the first time since the election and the expectations index posted its second consecutive decline. Still, both indices remain well above where they were before the election.

MARKETS AND FED POLICY IMPLICATIONS: Employment Friday is this week, so most data will take a back seat to that report. I don’t expect the jobs gain number to be great, but good enough that the FOMC members will have little reason to faint at the prospect of raising rates. Regardless of the number of positions added or the unemployment rate, a sharp rise in wages would do the job and that is a distinct possibility. The economy is not booming, but that may actually be working to the Fed’s advantage. Fed Chair Yellen has said the members estimate that we are at an unemployment rate consistent with full employment. A strongly growing economy would tax the tight labor market, making it difficult for firms to continue expanding rapidly without bidding up wages to attract the workers they need. Inflation would rise and that could lead to the Fed to increasing rates more often than expected. A rate hike at next week’s FOMC meeting is likely, especially since the markets expect one. But that opens up the possibility of an increase each quarter. And a major fiscal stimulus package would only add to the belief that people are underestimating how much rates could rise this year.  

January Consumer Prices, Retail Sales and Industrial Production

KEY DATA: CPI: +0.6%; Excluding Energy: +0.3%/ Retail Sales: +0.4%; Excluding Vehicles: +0.8%/ IP: -0.3%; Manufacturing: +0.2%

IN A NUTSHELL: “Another inflation number, another reason to for the Fed to hike rates.”

WHAT IT MEANS: Yesterday I noted that any number that shows that inflation is rising is a warning that the Fed is going to raise rates soon. Well, the sharp rise in the Consumer Price Index in January is one of those numbers. Yes, energy costs did surge, but in her testimony, Chair Yellen said that inflation including food and energy matters. Over the year, top line inflation was 2.5% and even excluding food and energy, the so-called core, it was above the Fed’s 2% target. The gains in January were across the board with only a decline in used-vehicle prices keeping the index from rising even faster. Food at home was flat but if you went out to eat, you paid a lot more. Thankfully, fresh donut prices were down.

Rising prices is not keeping consumers from spending. Despite a slowdown in vehicle demand, retail sales rose solidly in January. People hit almost every type of store as sales of clothing, appliances and electronics, building supplies, sporting goods, food and health care products rose solidly. We didn’t buy a whole lot of furniture and interestingly, online sales were flat. That may have been due to the fact that we were eating out like crazy.

Industrial production eased in January, but as usual, the headline number didn’t tell the whole story. We had one of the warmest January’s on record, at least where I live, and utility production tanked as a consequence. But manufacturing output increased moderately and the petroleum sector continues to rebound, with output up significantly. The vehicle sector continued its wild up and down swings as assembly rates tanked after having increased in December. With new models coming out randomly, I suspect it has become hard to seasonally adjust these data.

So far, February hasn’t been a particularly good month for builders. The National Association for Home Builders index slid as traffic declined. That led to a pullback in expectations.

MARKETS AND FED POLICY IMPLICATIONS: The data are becoming clear as to both growth and inflation. Consumers are spending money at a very solid pace and that is putting a floor under growth. But inflation is accelerating. The Consumer Price Index has moved above the Fed’s target, as have a variety of other special measures that a number of Federal Reserve Banks have created. But the Board considers the Personal Consumption Expenditure price index the gold standard and we will not get that until we get the income and consumption numbers on March 1st. I expect that measure to also show inflation over the year rising by 2% or more. So, does that bring the March FOMC meeting into play for a rate hike? I think that is too soon, especially since Chair Yellen commented that fiscal policy will play a role in the Fed’s decisions. We are months away from any clear indication what those tax cuts may look like. I think the May meeting holds out great possibilities and if not then, I would be surprised if they don’t do something in June. So, we are looking at a move in the next three to five months. If that is the case and a decent sized fiscal stimulus package is passed, I expect the Fed to hike again in September and at least one other time before the end of the year. A December half-point increase would not be out of the question if the economy picks up steam and inflation continues to accelerate. I don’t believe equity investors have priced that in and the bond market seems to be just starting the process – but not with a lot of conviction.

January Wholesale Prices, Small Business Optimism and Fed Chair Yellen’s Comments

KEY DATA: PPI: +0.6%; Goods: +1%; Services: +0.3%; Ex-Food and Energy: +0.2%/ NFIB: +0.1 point

IN A NUTSHELL: “With top line inflation driving the Fed’s decision, any increase in costs moves the FOMC closer to its next rate hike.”

WHAT IT MEANS: The Fed intends to raise rates this year and more than likely several times. That much was made clear by Chair Yellen, who commented thatWaiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession“. She also noted that the Fed looks at top line inflation, which they are confident is moving toward its 2% target and that the unemployment rate is already at the level members believe is full employment. In other words, the Fed is ready to go and the only thing stopping it is below-target inflation. That is why the sharp rise in the January Producer Price Index is important. Much of the increase came from another jump in energy costs, but it wasn’t limited to petroleum. Services prices bounced back and the only thing keeping the index from rising faster were flat food costs. There is also some pressure building in the pipeline.

The National Federation of Independent Businesses reported that small business confidence edged up in January, solidifying the gains made since the election. Firms have a large number of job openings and hopefully they will be able to fill them. Owners seem willing to invest, even though the index eased a touch in January, it remains at a high level.

MARKETS AND FED POLICY IMPLICATIONS: There are great expectations that the president and Congress will come through with tax cuts and regulatory changes that will “unleash the beast” in the corporate sector. But that has to happen and lines are being drawn in the sand – and not just by Democrats. A Republican member of the House Ways and Means Committee said that there would be no tax reform without a border adjustment tax, which subsidizes exports and penalizes those that import. He is basically arguing it is time to move to a consumption tax structure. That would create a large number of winners and losers and consumers could see higher prices. Indeed, a border tax, previously known as a tariff, might be necessary as well to offset the revenue losses of tax reform. So, let the battles begin and one of the groups who may be involved is the Fed. Higher consumer costs and aggressive fiscal policy will be the green light to move rates back up to more normal levels. And the Chair noted that currently, the estimate of a “normal” rate is low because of a number of factors. If those conditions change with stronger growth, the Fed would be chasing an upward moving target. Change isn’t simple and if it is going to happen, the many moving parts have to be considered. But too many in Congress don’t have a clue that there are consequences to making the changes they are proposing. The next year should be lots of fun, with tax reform, regulatory changes, Dodd-Frank, Obamacare and rate hikes all entering into the mix. For an economist, this could be the best of times.

January Import and Export Prices and February Consumer Confidence

KEY DATA: Imports: +0.4%; Nonfuel: -0.2%; Exports: +0.1%; Farm: -0.1%/ Confidence: -2.8 points

IN A NUTSHELL: “The strong dollar is keeping everything but energy costs under control.”

WHAT IT MEANS: Import prices jumped again in January, propelled by energy. Energy prices surged by nearly 6%, after having jumped by even more in December. Over the year, the cost of imported fuel is up a whopping 58%. In January 2016, fuel costs were down nearly 40% from the previous year. So it is no wonder that overall import prices are up nearly 4% from the previous year. In just one year, the headline number has gone from a yearly change of -6.5% to a rise of 3.7%, a greater than ten percentage points swing. As for the details, imported food prices dropped sharply, though my Mexican avocados seemed to cost more. Has a border tax been implemented already? Consumer and capital goods prices eased a touch, while automotive import prices dropped sharply. In other words, there aren’t any broad-based inflationary pressures coming from the import sector. As for exports, the two-month rise in farm product prices was halted in January, but the drop was modest. Consumer export prices fell sharply and capital goods exports costs were off modestly, but vehicle makers did see a sharp rise in their prices.

The surge in consumer confidence since the election faded a touch in early February. The University of Michigan’s Consumer Sentiment Index dropped, led by a solid decline in expectations. Still, the level remains quite high. Both positive and negative reactions to the Trump actions are major factors in respondents’ attitudes and they are split pretty much down the middle between positive and negative. As I have said many times, changes in confidence driven by political factors rarely have sustained impacts on spending, so let’s wait a while before we make any judgment on how the rise – or any subsequent fall if it happens – will play out in the marketplace.

MARKETS AND FED POLICY IMPLICATIONS: Import costs, which had restrained inflation, are now rising. Should the Fed be worried about this? Yes and no. The increases are not widespread, so we cannot assume that we will be seeing consumer inflation surge. But the Fed shifted to headline inflation from core and energy is driving up that rate. Don’t be surprised if inflation tops the Fed’s 2% target in the new few months. That would mean the Fed has met both its inflation and unemployment targets, so there would be little to stop it from raising rates – if it wants to and follows its own guidelines. Still, even if inflation tops 2% before the March 14-15 FOMC meeting, the Committee is not likely to raise rates then. They will want to see what the tax cut plan, which is supposed to be “phenomenal”, looks like. (Someone should take the thesaurus away from the White House.) I have the next increase in April, which is a non-press conference meeting. I think Chair Yellen wants to prove that all meetings are live and raising rates then, especially if it comes after a major tax cut proposal, would be the easiest time to make that point.

January Employment Report and Non-Manufacturing Activity

KEY DATA: Payrolls: +227,000; Unemployment Rate: 4.8% (up 0.1 percentage point); Wages: +0.1%/ ISM (NonMan.): -0.1point; Employment: +2 points

IN A NUTSHELL: “The labor market is still a solid job machine but workers are not seeing wages grow solidly.”

WHAT IT MEANS: The jobs machine keeps on humming along. The nation’s businesses added jobs at a very strong pace in January and the gains were spread across most of the economy. Construction workers were hired like crazy, manufacturers added to their payrolls, retailers kept expanding (or maybe they just haven’t shut the stores yet), finance and real estate companies grew, firms started hiring temps again and the health care and hospitality sectors continued to demand more workers like crazy. Only the government showed restraint. But there are some warnings in the numbers. The acceleration in job gains from December’s moderate 157,000 increase came largely from two places: Construction and temporary employment services. Weather probably played a major role in the construction swing (it was warm in January), while the decline in temp positions was likely an aberration, making for an outsized rise in January. Don’t be surprised if job gains retreat back to the 150,000 to 175,000 going forward.

The unemployment rate inched upward in January as the labor force surged, lifting the participation rate as well. All this angst about the falling participation rate is simply misplaced. The rate has been in a fairly tight range for over three years, as the demographic forces driving it down are being offset by the expected return of frustrated workers. Still, there doesn’t seem to be enough pressure on companies to bid more for workers. Wages rose minimally over the month and are up only 2.5% over the year – before inflation is factored in. That is just not good enough.

The Institute for Supply Management reported that the Non-Manufacturing sector continued to expand solidly in January. The overall index was off minimally and the details were solid. Most importantly, hiring is picking up, as order books are no longer thinning. Order growth is still strong, though a touch less than it had been, largely due to weakening in export demand.

 MARKETS AND FED POLICY IMPLICATIONS: Boy, what a difference eight years make. When Barack Obama became president in January 2009, the economy lost 793,000 jobs. The swing between then and now was over one million positions. The tasks facing the two of them are totally different. Eight years ago, it was stop the bleeding. Today, it is keep things going so wages can rise faster. Tax cuts, regulatory changes and infrastructure spending increases all could help, but they are not likely to significantly affect the economy until well into the second half of the year. That makes the Fed’s calculus more difficult. The unemployment rate is pretty much at its target and the inflation target is within sight. That seems to argue for a near-term rate hike. But Fed Chair Yellen has indicated she would be willing to let the economy run hot for a while and the modest wage gains provide her with some cover to do so. That said, monetary policy works with a lag and if the Trump fiscal policies are implemented, the Fed cannot fall too far behind the curve or it will have to raise rates faster than anyone would like. This increases uncertainty about the course of Fed policy. As for the equity markets, solid job gains and low wage pressures seem to be the recipe for a renewal of the exuberance we have seen since the election. How long that will last is anyone’s guess.

Fourth Quarter Productivity, Weekly Jobless Claims and Yesterday’s FOMC Statement

KEY DATA: Productivity (2016): +0.2%; Labor Costs (2016): +2.6%; Real Earnings (2016): +1.5%/ Claims: -14,000/ FOMC: “Steady as she goes.”

IN A NUTSHELL: “The Fed thinks the economy is okay and the data seems to support the view that the economy is okay, if you think okay is okay.”

WHAT IT MEANS: Tomorrow we get the January jobs report and if the huge increase in private sector jobs that ADP reported for the month is any indicator, it should be a good one. And it looks like firms will have to keep hiring if they want to expand output, as productivity is barely growing. In the second half of last year, firms did manage to squeeze out more output from their workforce, but for the year, the gain was miniscule. Only twice over the past thirty years has productivity growth been weaker. As a consequence, labor costs continued to accelerate, reaching its highest pace since 2007. Workers didn’t see their inflation-adjusted income increase very quickly, which is one reason so many voters were ticked off.

Businesses are going to have to make due with their workforces as the labor market continues to tighten. Jobless claims fell and are once again back to record lows. Challenger, Gray and Christmas reported that layoff notices, while up from December, were down nearly 40% from January 2016. Firms are holding onto their workers because they cannot find replacements. The Conference Board’s Help Wanted On Line measure rose in January. It had been declining for much of last year but starting in early fall, it stabilized and is now rising. And the Institute for Supply Management’s manufacturing employment index jumped in January. It is pointing to strong job gains, which supports the numbers that ADP reported. In other words, all the employment data released over the past few days point to a strengthening labor market.

MARKETS AND FED POLICY IMPLICATIONS: As expected, the Fed did not change the funds rate at the FOMC meeting that ended yesterday afternoon. The statement, though largely unremarkable, did make it clear that the members thought the economy was in decent shape. More importantly, instead of saying that inflation “was expected” to rise to 2% in the medium term, the members now believe that inflation “will” rise to that level. That may seem small but it shows that the Fed is now confident that their inflation target is in sight. If both the inflation and unemployment targets pretty much at hand, there is little reason for the Fed to continue standing pat for much longer. I have them raising rates in May, barring some unforeseen craziness that would upset the growth trend, such as a tariff.

So, where do we stand going into tomorrow’s employment report? The labor market is tight, the economy is solid but productivity is moribund. The productivity weakness is major threat to the hopes that the economy can grow at even a 3% pace let alone the hugely optimistic 4% rate that so many in the administration need to make their numbers work. With the labor force expected to expand at less than 1%, productivity would have to increase by 3% or more to get to that upper level. But this far into an expansion, that rarely happens. While you never can say never, basing economic and tax plans on a number that has a low likelihood of occurrence is not a particularly responsible thing to do. But I guess using the word responsible in reference to anything in Washington doesn’t make much sense either.