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June Non-Manufacturing Activity, Private Sector Jobs, Layoffs and Weekly Jobless Claims

KEY DATA: ISM (NonManufacturing): +0.5 point; Activity: +2.6 points/ ADP Jobs: 177,000/ Layoffs: +37,202/ Claims: +3,000

IN A NUTSHELL: “With the economy booming, it is becoming harder and harder to find workers to hire.”

WHAT IT MEANS: Boy, are businesses in good shape. Earlier this week we saw that manufacturing activity rose again in June and today the Institute for Supply Management indicated that the nonmanufacturing portion of the economy might be in even better shape. Business activity surged and it was already strong. New orders were robust. But hiring eased a touch, though it is still quite strong. Despite soaring production, orders books are still filling at a pretty rapid pace. It is getting harder to meet the strong demand and that has led to deliveries slowing further. Will firms start allocating demand by raising prices? That might be coming.

Tomorrow is Employment Friday and it looks like job gains will be solid. ADP’s measure of private sector employment increases pointed to a very good but not great increase. There was limited hiring in the small business segment, which usually leads the way. If there is going to be problems hiring, it is likely to show up here as larger businesses can pay more and provide better benefits. That may be the case already.

Job layoffs remain low, even if they did pick up in June. Challenger, Gray and Christmas reported a jump in layoff notices and we are starting to see a rise from last year. The report noted that “in the wake of announced tariffs, we may be entering a period of increased cuts going forward”. Interestingly, retail is stabilizing and it was also pointed out the firms are already looking into creating a suitable workforce for the holiday shopping season. On the other hand, other sources indicate that firms have been scrambling to find any worker possible to fill positions and many are just not working out. That could be leading to more turnover.

Jobless claims increased last week and are running a touch higher than they had been. Still, the level remains pretty low.

MARKETS AND FED POLICY IMPLICATIONS: Tomorrow’s payroll number could be a head scratcher. Clearly, firms are looking for workers and have become somewhat desperate. But if they cannot find them, then job growth could be lower than the consensus of roughly 200,000. I would not be surprised if it is closer to 150,000, even if the labor force participation rate rises. A disappointing number would not be a sign of weakness, other than in labor supply. As I have argued all year, the key number is the hourly wage change. If we get the expected pop in wages, it will be taken as a warning that the labor market tightness is finally creating higher wages. This is a terrible measure, but it is closely watched nonetheless. I don’t like it because it is a weighted average, so it is possible that the average wage rate can fall even if all wages rise. In addition, it doesn’t include benefits and firms are upping their use of non-wage compensation packages in order to attract workers while not locking in higher salaries. Investors, though, seem to be willing to shrug off just about any and every hurdle placed in their way so a weak employment number may – or may not – affect the markets. Rationality is not the same thing as efficiency.

May Consumer Spending, Income and Prices and June Consumer Sentiment

KEY DATA: Consumption: +0.2%; Disposable Income: +0.4%; Prices (Over-Year): +2.3%; Excluding Food and Energy (Over-Year): +2.0%/ Sentiment: 98.2 (up 0.2 point)

IN A NUTSHELL: “Inflation to Fed: We have a liftoff.”

WHAT IT MEANS: There is a famous saying from the Apollo 11 mission, when we put the first people on the moon: “We have a liftoff!” Well, it looks like that is the case when it comes to inflation.   Consumer prices rose moderately in May, whether or not you include the more volatile food and energy components. But the real issue is that over the past year, both the headline number and so-called core numbers rose by at least 2%. The Fed’s target has been reached.

But we are just starting to see the impacts of the tax cuts hit. Indeed, consumer spending increased fairly modestly in May and when you adjust for inflation, it was flat. That is likely to change, hopefully, during the second half of the year. Moderate May weather kept utility spending down and that helped restrain consumption. Energy costs were up sharply, though. Meanwhile, household income expanded at a somewhat better pace. But even here, there are some warning signs. Wage and salary gains were fairly limited. What created the solid increase was a sharp rise in dividends. For the average household, if they hold stocks at all, their dividends wind up mostly in retirement accounts, so it is not going to be spent. That raises questions about how strong consumption will be going forward. So far this quarter, consumption is growing at a 2.3% pace, up quite nicely from the 0.9% rate posted in the first quarter. A likely decent gain in June could push the increase to the 3% range. That would point to much better second quarter growth.

The University of Michigan’s Index of Consumer Sentiment edged up in June, though it receded from its mid-month reading. Importantly, households are becoming more concerned about future economic activity. Respondents think the economy is in very good shape, but the trade issue is weighing on optimism. A growing share of people believe more trade is better than less.

MARKETS AND FED POLICY IMPLICATIONS: Right now, the extended period of strong growth that so many are predicting is just a wish and a hope. The numbers on wages continue to disappoint. In addition, households seem to taking their tax cuts and saving them, as the savings rate has risen recently. And while business capital spending is strong, it hardly matches the massive spending on dividends, stock buy-backs and mergers and acquisitions. I am not saying that the tax cuts are having no impact on growth, they are. But as of now, I think the added spending has been disappointing. That may or may not worry investors, but in a perverse way, should provide some comfort to the Fed. The members’ worse fear is a surge in growth that triggers even faster inflation. How long the Fed would be willing to allow the economy to “run hot” is not clear, but with backlogs building and labor shortages of critical workers, such as truckers, at crisis levels, the ability and need to raise prices is also increasing. Inflation may not be high yet, but the Fed has to be concerned that it will exceed its target by more and for longer than expected. It hard to think that we will not see another two rates hikes this year and the possibility we will get four more next year cannot be dismissed.

May Leading Economic Indicators, June Philadelphia Fed Manufacturing Survey and Weekly Jobless Claims

KEY DATA: LEI: +0.2%/ Phil. Fed: -14.5 points/ Claims: -3,000

IN A NUTSHELL: “Strong growth this quarter should be followed by another quarter of solid growth.”

WHAT IT MEANS: The economy is strong, but will it continue that way? It looks likely. While the Conference Board’s Leading Economic Index rose somewhat modestly in May, it is still pointing to better growth ahead. The gains were in most components of the index, which indicates the economic expansion remains broad based. Still, as the report states, “the current trend, which is moderating, indicates that economic activity is not likely to accelerate.”

Manufacturing activity in the MidAtlantic region moderated in early June, but that is really not a surprise. The index is wildly volatile and it soared in May. Orders continued to expand, but not as robustly. Hiring remained very strong and employees are being asked to work longer. Surging shipments led to a thinning of order books, which does need to be watched. Looking forward, optimism continues to fade. While it is still high, it is coming back to more normal levels. That said, the special question this month was on production and respondents indicated current output has been rising sharply and activity is expected to accelerate going forward. Hiring should be strong in the summer, if firms can find the workers.

Jobless claims fell modestly last week, indicating the labor market remains tight. Given how low there are, it would be hard to see them drop much more.

MARKETS AND FED POLICY IMPLICATIONS: There may be some headwinds forming. Clearly, the tax cuts have created a huge amount of stimulus that will carry us through the rest of the year and well into next, but what do we do once the impacts fade? That is when confidence about the future sets in and there is a lot of chaos in Washington that is causing optimism to moderate. Of course, that just means we are backing down from the exuberance that has gripped the consumer and business community since the passage of the tax changes. Nevertheless, issues regarding trade and immigration, which directly affect businesses, are not viewed as being helpful. Growth will likely come in above 3% this quarter and next, but to keep growing at that pace, firms have to invest and an uncertain world is not a desirable one to make big capital spending decisions.

May Industrial Production and June Consumer Sentiment

KEY DATA: IP: -0.1%; Manufacturing: -0.7%; Motor Vehicles: -6.5%/ Sentiment: +0.8 points

IN A NUTSHELL: “A fire may have disrupted vehicle production in May, but that has already turned around, so don’t worry about the drop in output.”

WHAT IT MEANS: I often mention that it is foolish to look at the headline number for one month and assume it tells what is going on. Nothing shows that more than the May industrial production number. The decline in overall output and the sharp drop in manufacturing activity were largely due to the fire in Ford’s main parts supplier. Vehicle and parts production cratered. That is already turning around, so while the May number was temporarily low, the June number should be temporarily high. Put the two together and you get the trend. That said, manufacturing output still declined mildly in June as most industries were down. Six of the eight non-durable goods industry groups posted falling output, while only three of the eleven durable goods industries were up. Why the sudden drop in output is unclear, so I think it is best to just file this report away and see what the next couple of months have to offer.

Household confidence picked up during the first half of June. The University of Michigan’s Consumer Sentiment Index increased modestly, led by a sharp increase in the view about current conditions. However, and maybe more importantly, respondents were more pessimistic about the future. And they are beginning to notice the pick up in inflation. Anchored inflation expectations are something the Fed had often noted as being important and if they are becoming unmoored, that is a real concern.

MARKETS AND FED POLICY IMPLICATIONS: There have been so many strong economic numbers that one weak one shouldn’t indicate the start of a slowdown. Very simply, the economy is in very good shape. Looking forward, though, we need to be concerned about inflation. Pressure is building at every level for both producer and consumer goods. Households are noticing that, especially since it is eating into purchasing power, which has flatlined again. It is not enough to simply say growth is strong and conclude everything is fine. Too much of a good thing can be a bad thing as well. And investors are not very happy with the imposition of tariffs. While it is hard to argue that Canada is an unfair trader, especially given the U.S. runs a trade surplus with our Northern neighbors when both goods and services are considered, it is not unfair to say that China is an unfair trading partner. The issue is how you reduce the barriers. It is doubtful that the U.S. can cut greatly into the trade deficit with China without massive, wide-ranging tariffs and restrictions. Those would raise costs for consumers and businesses, reducing spending power, consumption and making U.S. firms less competitive internationally. About the best thing that has come from the talk of tariffs and trade wars is that people are finally recognizing that there is a thing called fair trade. Decades ago when that issue was raised, the free-traders of the world considered that approach nothing short of protectionism. Those same free-traders seem to have become tongue-tied when it comes to the ultimate protectionism, tariffs. Maybe now a rational, well thought out approach toward trade will be discussed, where trade barriers are reduced through trade agreements with our trading partners.    

May Retail Sales, Import and Export Prices and Weekly Jobless Claims

KEY DATA: Retail Sales: +0.8%; Ex-Vehicles: +0.9%/ Import Prices: +0.6%; Nonfuel: +0.2%; Export Prices: +0.6%; Farm: +1.6%; Claims: -4,000

IN A NUTSHELL: “Strong consumer demand and higher prices, perfect (or not) together.”

WHAT IT MEANS: How good is the economy? Very. Retail sales rose strongly in May. Even if you remove vehicles or gasoline or any of the other categories that can be volatile or are heavily impacted by price changes, this was still a really good report. Indeed, the numbers were so good that even department store sales surged! Only two categories, furniture and sporting goods, were down. Furniture demand was strong in April, weak in May but decent over the year. As for sporting goods, sales have been soft all year. I guess kids just don’t play outside anymore. And most impressively, the increase in retail sales was robust despite soft online demand. That is not likely to continue.

On the inflation front, conditions are heating up as well. Import prices surged in May, led by a jump in energy costs. Excluding energy, the cost of imported products rose more moderately. Consumer goods prices are not rising sharply, but the increases over the year have been consistently accelerating and have turned positive after being negative for several years. Imported food prices also increased. This is important because food has been a stabilizing factor in the consumer inflation measures. On the export side, the agricultural sector has been able to push through a lot of price hikes this year. This is again a concern if countervailing tariffs hit this sector, as has been threatened.

That the labor market is tight is hardly in doubt and the decline in jobless claims reinforces the view that the unemployment rate is heading downward.

MARKETS AND FED POLICY IMPLICATIONS: The Fed raised the funds rate yesterday and made it clear they are going up more this year and next. But there is every reason to think the projections in yesterday’s report will be the lower, not the upper bound of the rate hikes. As I have noted many times, we are in the midst of a Great Experiment: Can the economy survive massive tax cuts and huge government spending increases when it is already growing solidly and the labor market is at or near full-employment? The concern is that inflation will accelerate sharply because growth could become too strong. Yes, as I like to say, there is no such thing as a free robust economy. Right now, few economists really have a good handle on how to forecast inflation. Wages are simply not behaving as most models expected. The extensive nature of global trade has helped keep down both wages and prices. But tariffs add to the possibility that inflation will be higher than expected. The economic data are great, but can the growth be sustained if price gains move well above the Fed’s 2% target, forcing the FOMC to hike the funds rate more than currently projected? I think that outcome has a higher probability than the one where inflation is restrained and the Fed raises rates moderately.

June 12-13 2018 FOMC Meeting

In a Nutshell: “…the labor market has continued to strengthen and economic activity has been rising at a solid rate.” 

Decision: Fed funds rate target range raised to 1.75% to 2.00%.

The Fed did what the Fed was expected to do, raise the federal funds rate by one-quarter percentage point. But that is not the whole story. The members indicated the FOMC would continue raising rates and we should expect to see two more increases this year, bringing the total number of moves to four and the increase to a total of one percentage point. And there will be a lot more over the next two years.

As for the economy, the Committee is really optimistic. Growth is solid, not moderate. Household spending is picking up as against moderating. And the unemployment rate is declining, rather than just low. Put that all together and you see that the Fed believes the economy is doing very well, which Chair Powell said in his press conference.

Given the positive view about the economy and the belief that inflation will run at, if not above, the Fed’s target of 2% for at least the next two years, the rate hike was logical. Looking at 2019 and 2020, the Committee expects the funds rate to top out somewhere in the 3.5% range. So there are a lot more moves to come.

Finally, the so-called “dot-plot”, which shows the individual forecasts, pointed to the unemployment rate starting to rise in 2020, even as inflation continues to accelerate. By 2020, the funds rate is projected to rise above what the Fed members consider to be the long-term or neutral rate. This time frame coincides with what many economists think could be the first likely start date for the next recession. Just something to keep in mind.

So, what are the takeaways from today’s Fed action, statement and the Chair’s press conference? This was a fairly hawkish report. Look for rates to rise consistently over the next two years, with the funds rate topping out at around 3.5%. Last, the Fed Chair will be holding press conferences after every meeting rather than every other meeting, so rate hikes at any meeting becomes more likely.

(The next FOMC meeting is July 31-August 1, 2018.)

May Producer Prices

KEY DATA: PPI: +0.5%; Over-Year: 3.1%; Ex-Food and Energy: +0.3%; Goods: 1%; Services: +0.3%

IN A NUTSHELL: “Energy matters and right now the surge in prices is driving up businesses costs and making the Fed’s decision to raise rates, if that happens, easy.”

WHAT IT MEANS: As the Fed finishes its meeting and decides what to do with interest rates, the data on inflation makes it clear that its target rate has largely been reached. Yesterday’s Consumer Price Index showed that inflation is rising and today’s Producer Price Index reinforced that view. Wholesale costs jumped in May led by a surge in energy prices. That should ease in the June report, but businesses are still paying a lot more this year for energy than they did last year. Even excluding energy, producer prices were up solidly. Indeed, if you look at the detailed chart of price changes by industry, there were few areas where prices actually fell. And the major reason that wholesale costs didn’t jump even more was that food prices were up minimally. Fish and shellfish prices were down sharply, though I haven’t seen that in the markets I frequent, and I eat fish all the time. As for my beloved bakery products, their prices rose moderately, though they were up more at the consumer level. Oh, well. There isn’t a great schism between goods and services inflation, at least when you remove energy. That indicates the inflationary pressures have become widespread. Looking into the future, there are similar warning signs as intermediate costs were up solidly, especially for processed products.

MARKETS AND FED POLICY IMPLICATIONS: The Federal Reserve likes to look at prices that exclude volatile components such as energy and food. The resulting index is called the “core” and that is the case whether they look at wholesale or consumer prices. It does that, in part, because large movements in food or energy can overstate the trend in inflation. That was the case in May. At the consumer level, the core is a better indicator of future inflation than the overall index. But the reality is that businesses and consumers pay food and energy costs and if you look at price changes over the year, you get a good picture of what is happening. In the business sector, costs are rising sharply, which I would expect the FOMC will take seriously as they make not only their decision on whether to raise rates now but over the next year or two. Expect the Fed to announce a rate hike later today. Whether the members will signal they are concerned about inflation is the real issue and that might be made clearer in either the statement, Chair Powell’s press conference or the charts on inflation, growth and interest rates. We will know soon enough.

April Consumer Prices, Inflation-Adjusted Earnings and May Small Business Optimism

KEY DATA: CPI: +0.2%; Over-Year: +2.8%, Ex-Food and Energy: +0.2%; Over-Year: +2.2%/ Real Hourly Wages: +0.1%; Over-Year: 0%/ NFIB: +3 points

IN A NUTSHELL: “Inflation is accelerating and eating into household spending power.”

WHAT IT MEANS: The Fed is meeting today, with inflation will be a major topic of discussion. The members have very good reason to raise rates. The Consumer Price Index rose moderately in April, though much of that came from a surge in energy costs. Removing the more volatile food and energy components, inflation was also up moderately. Food costs were flat, though they rose solidly in March. Indeed, that seems to have been the pattern over the past few months. One month, prices rise; the next month they go nowhere. That was true for medical commodities, apparel and transportation services. Shelter costs, though, just keep going up. Since April 2017, the cost of all goods and services was up sharply and that is what we need to watch, since that is what consumers actually buy.

If this economy is to grow solidly for an extended period, consumers will have to lead the way, but that looks doubtful. Hourly wages are rising, but when you factor in the cost of goods and services, they are going nowhere. Yes, nowhere. Real (inflation-adjusted) hourly wages, which is another way of saying spending power, were flat over the past year. Unless workers increased their hours worked, they had no increase in their ability to buy more. But even then, the rise in total spending power was modest. With savings levels near record lows, that does not bode well for future consumer spending.

Meanwhile, the small business sector has reached a state of euphoria. The National Federation of Independent Business’ rose to its second highest level in its 45-year history. Views on expansion, earnings and sales hit record highs. But there is a warning in the report for the Fed: Actual and planned price increases are soaring. It looks like small businesses feel that demand is strong enough that they finally have some real pricing power. That may bode well for earnings, but not for inflation.

MARKETS AND FED POLICY IMPLICATIONS: There were limited categories where pries increased in April, so, why should the monetary authorities worry? Simple. The month to month changes in consumer prices have been up and down lately, but the year-over-year changes have moved in a pretty clear pattern: Up. And when you add to that the actual and expected price increases of small businesses, it is hard to argue that inflation expectations are still “well anchored”, a favorite Fed phrase. The FOMC is likely to announce another rate hike tomorrow. But it is the press conference and the chart of projected economic growth, inflation and funds rates that should dominate the discussion about future Fed moves. I would be surprised if all of those variables don’t show higher levels than in the last report that came out in March. But the Fed could allow inflation run above trend for a while. Some members would not be uncomfortable with that given how long inflation has been below target. That is where the press conference comes in. There has been a lot of discussion about whether the Fed should change its approach to inflation, including whether the target it has set makes any sense. Hopefully, Chair Powell will shed some light on that, though Fed Chairs rarely are forthcoming. As for investors, the summit seems to have been largely a non-event for the markets as prices are not doing much. Hopefully, investors will now start focusing on economic fundamentals, at least until the next “crisis” hits.

May Employment Report and Manufacturing Activity and April Construction

KEY DATA: Jobs: +223,000, Private: 218,000; Revisions: +15,000; Unemployment Rate: 3.8% (down 0.1 percentage point); Wages (Over-Year): +2.7%/ ISM (Manufacturing): +1.4 points; Orders: +2.5 points/ Construction: +1.8%

IN A NUTSHELL: “Manufacturing is strong, construction is soaring and firms are hiring: What more is there to say?”

WHAT IT MEANS: Another Employment Friday, another good jobs report. Payroll gains in May were greater than expected and the revisions added even more jobs to the previous two months total. So this was a really good report. The job increases were across the board with nearly 68% of the private sector industries hiring more workers. That is just about as good as it gets. A decline in temporary help may be a signal that firms are moving part-timers to full-time status in order to fill open positions and retain workers. On the unemployment front, the rate declined to a level seen only once since December 1969. While the labor force barely increased, it is up sharply over the year, indicating that people are flocking back into the market. Strong wage gains are helping. Wages rose solidly over the month and over the year, the increase is starting to approach 3%, which would signal wage inflation is becoming an issue.

The ISM manufacturing report also was up more than expected and the details were all really good. Orders are soaring, backlogs are building and production and hiring are expanding to meet the growing demand. The only concern in the report was that a large percentage of the firms are paying more for their goods.

Construction activity jumped in April, powered by robust a residential construction segment. Nonresidential was up more moderately. The increase would have been greater if commercial activity hadn’t slowed. I suspect that will pick up as firms start using at least some of their tax breaks to fund expansion.

MARKETS AND FED POLICY IMPLICATIONS: The volatility in the employment report sometimes creates outsized numbers that are not supported by other data. Today, we got a strong employment report that was supported by the other data. The economy is in great shape and it is hard to find any weakness. But there is no such thing as a free strong economy: Inflation looks like it is finally starting to show up. Wage gains are rising, despite the fact that the hourly wage number in the report is a terrible measure of inflation. It’s a weighted average and it is actually possible that the average wage could fall even if every individual industry’s wage rose. That is the wonders of the math. So, looking at the weighted average tells us very little, though everyone seems to want to use it. That said, wage pressures are building. In addition, consumer price increases are accelerating and measures, such as the ISM price index, show that firms are paying more for their inputs. I point this out because while investors may be jubilant, the Fed is meeting in less than two weeks and the members may not be as exuberant. The monetary policymakers are facing an economy that is strong and supportive of the rising wage and price pressures we are seeing. Thus, expect another rate hike to be announced on June 13th. I would be surprised and disappointed if, given the solid economic and inflation data, hints are not given that four rate increases this year are likely.

April Housing Starts, Permits and Industrial Production

KEY DATA: Starts: -3.7%; 1-Family: +0.1%; Permits: -1.8%; 1-Family: +0.9%/ IP: +0.7%; Manufacturing: +0.5%

IN A NUTSHELL: “Manufacturing continues to expand solidly, but the housing sector seems to be flattening.”

WHAT IT MEANS: With both short and long-term interest rates on the rise, it is time to look at the interest sensitive sectors to see if they will be sensitive to a rise in rates. Housing is the sector always highlighted when the argument is made that rising rates would slow growth. So, what is happening? It is not clear. Housing starts did fall in April, but the decline came from a drop in the always-volatile multi-family segment. Construction of single-family units was essentially flat. Between April 2017 and April 2018, starts were up over 10% and for the first five months of this year compared to last year, they are up over 9%, so it is hard to say that the sector is not doing well. Looking across the nation, there were sharp declines in housing starts in all regions except the South. As for the future, permit requests were also down, again due to a drop in multi-family segment. But the level of permits continues to run above starts, so builders will likely be using those permits in the near future.

The manufacturing sector is in great shape. Industrial production jumped in April as the three major components, Manufacturing, utilities and mining posted solid gains. On a monthly basis, manufacturing output has been up, down and all around over the past six months and over the year, it is up only moderately. While vehicle assembly rates moderated and that led to a slowing in related sectors such as metals. But there was a solid increase in the production of all types of business equipment, led by a surge computer output. It looks like the hoped-for increase in investment spending is happening.   Rising prices are generating a large jump in energy production.

MARKETS AND FED POLICY IMPLICATIONS: How high can mortgage rates go without affecting home purchases and construction? Probably a lot higher than they are currently. In the 1980s, 30-year mortgage rates were around 10%, in the 1990s they were in the 8% range and in the 2000s the rate hovered around 6%, yet housing starts were about 25% higher in each of those periods than their current level. In other words, mortgage rates could move from the near 4.5% rate to 5.5% or 6% before we discern any measureable impact. A better indicator of housing starts is housing price appreciation. When prices rise, builders build, but when they fall, watch out. Of course, home prices are reflective of demand, which is driven by the condition of the economy and income, but we are talking about indicators, not explainers. Nevertheless, prices are up sharply so we should expect home construction to continue to increase, especially since economic growth should be solid over the next year. That is the point that investors should consider when they start to panic about rising interest rates. The Fed is tightening because the economy is solid and inflation is back to where it should be. Thus, short-term interest rates, which are still historically low, should be moving back to more normal levels. Longer-term rates are increasing because stronger growth is triggering the rise in inflation back to more normal levels, so long rates should be higher as well. The point is, “it’s the economy, stupid!” A strong economy means the economy, including the housing sector, can support inflation in 2s and mortgage rates around 6%. Historically low interest rates and inflation are not birthrights and until we stop believing that, we will continue to fear the normal. We shouldn’t.