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October Wholesale Prices and Mid-November Confidence

KEY DATA: PPI: +0.6%; Energy: +2.7%; Food: +1%/ Sentiment: -0.3 point

IN A NUTSHELL: “Despite the surge in producer prices, there are few indications that inflation will accelerate sharply.”

WHAT IT MEANS: Is inflation something the Fed should be concerned with? It doesn’t currently believe so and today’s Producer Price Index increase really doesn’t change things very much. First of all, the large rise was driven by jumps in energy and food. Petroleum costs have hit a downdraft and it isn’t clear that food prices will continue to rise sharply. Also, the change over the year in the index has decelerated over the past few months. That is not say the October report did not contain any potential issues. Transport costs are increasing and with growth strong, they are likely to continue putting pressure on distributors. Construction expenses are skyrocketing. And price pressures in the pipeline are picking up. Add to that rising labor expenses and firms will have to start determining if demand is strong enough to support faster increases in prices. I suspect that is what will happen, so look for consumer prices to begin accelerating slowly over the next few months.

Consumer confidence remains on the moon. That’s not quite Mars, but pretty close. The University of Michigan’s mid-month reading of consumer sentiment fell only modestly in November. Still, the index is on track to record the highest level since 2000. The dot.com bubble hadn’t burst yet and confidence did crater afterward. A similar result occurred when the housing bubble burst. If the economy tails off over the next year, as expected, look for confidence to start deteriorating.

MARKETS AND FED POLICY IMPLICATIONS: The Fed, as expected, made no change in rates yesterday, in part because the members were fairly sanguine about inflation. They noted that “On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.” In other words, the strong growth they see is not threatening. But that doesn’t mean there is no reason to raise rates in December and going forward. Remember, the Fed is simply trying to get back to neutral, which Chair Powell has stated is far from the current level. To the members, as long as there are no deflationary pressures at work, the need to move to neutral will dominate. And also remember that the Fed has a dual, not a triple mandate that would include the stock markets. So if increasing rates has a negative impact on equity prices, so be it, unless it sets off a major stock market correction. Why that would happen with an economy that is as strong as the current one and which is being propelled by massive fiscal stimulus is something I cannot figure out – and something that doesn’t seem to worry the Fed right now. So, look for further rate hikes in 2019, even if growth moderates, which it likely will.

September Consumer Confidence and August Home Prices

KEY DATA: Confidence: +2.6 points/ Home Prices (over-Year): +5.8%:

IN A NUTSHELL: “Consumers are so exuberant that even the limited income gains will not stop them from spending, at least for a while.”

WHAT IT MEANS: With income gains lagging badly, it is doubtful that consumers can keep spending at the pace they have been lately. But that doesn’t mean consumption will fall off the cliff, at least not right away. The Conference Board reported that household confidence rose in October to its highest level in eighteen years. The robust job market is underpinning the buoyant attitude about not only the present situation but also expectations. Indeed, the report noted “that consumers do not foresee the economy losing steam anytime soon. Rather, they expect the strong pace of growth to carry over into early 2019.Families may not have a lot more money to spend, but they will still go out and buy anyway.

As for the housing market, it is going the opposite direction of confidence. Though the S&P CoreLogic Case-Shiller national index rose solidly in August, the gain on a year-over-year basis fell below 6% for the first time in twelve months. Price gains had surged in the 2012 – 2013 period, but the increases were overdone. The rise in home costs then decelerated to more reasonable levels in late 2014. From then on, they steadily picked up steam until early this year. Now, we are likely in a slow deceleration phase that should not lead to a crash since sales are not faltering greatly.

MARKETS AND FED POLICY IMPLICATIONS: When people feel good about the future, they are more willing to spend and right now, they are really happy about current and future economic activity. They think that the current job market is really great, though they a bit more uncertain about the next six months. Still, there is not a lot of fear out there and that is good for the economy. And it is another reason that most economists don’t expect growth to fall off the cliff anytime soon. Even the problems in the housing market are more controlled than last decade, as sales remain at reasonable, not greatly elevated levels. Thus, we should not be saddled with lots of homes sitting vacant, as we were when the housing bubble burst. Taken together, today’s data are actually positive, since they point to a solid household outlook but only moderating, not collapsing housing prices. The Fed, which meets next Wednesday and Thursday may take note of the softening housing market, but not express any great concern. It will likely signal another rate hike is coming.

September Consumption and Income

KEY DATA: Consumption: +0.4%; Disposable Income: +0.2%; Prices: +0.1%; Ex-Food and Energy: +0.2%

IN A NUTSHELL: “The slow income growth may not be stopping consumers right now, but it is likely to start doing so very soon.”

WHAT IT MEANS: The issue facing us right now is whether the economy can sustain the strong growth we have seen for the past two quarters. The income data don’t seem to support that likelihood. Consumption expanded briskly in September, led by a surge in durable goods spending. But demand was solid across all categories and it has been strong for most of this year. So, what’s the problem? It’s all about sustainability and that comes from income. Personal income growth has tailed off with wage and salary gains moderating. Farm income fell sharply, likely the result of the trade battles. But the yin and yang of farm income is not my greatest worry. What is truly worrisome is the savings rate, which has declined consistently since February. The September rate was 6.2%. Using recent income distribution data, if the top 20% saved just 12% of their income, a very conservative estimate, the bottom 80% would have no savings. If the second highest income group had savings rate at the average, also conservative, the middle and bottom two income groups would have a negative savings rate of nearly 6%. In other words, to maintain the consumption levels we have been seeing, most households have to be dissaving and that is simply not sustainable. And while inflation remains fairly tame, any acceleration in price increases will simply put further pressure on consumption.

MARKETS AND FED POLICY IMPLICATIONS: While the tax cut-induced spending sugar high continues, the end is likely near. And the problem remains spending power. While some businesses have been announcing sharp increases in wages, especially the minimum wage, that attitude has not been adopted universally. Thus, we have yet to see any acceleration in wage and salary gains. Instead, the added spending seems to be coming from savings and there is simply no way that can continue much longer. It is also hard to imagine that inflation will not continue to accelerate, further reducing spending capacity. The year-over-year gains in real/inflation-adjusted earnings will start decelerating early next year, not only because of inflation but also because the impact of the tax cuts will already be in the income numbers. While investors and some stock market pundits and politicians rail at the Fed for raising rates, it’s the issue of worker compensation that is really the greatest concern. I know this sounds familiar, I write it several times a month, unless wages and salaries, not just benefits, start increasing faster, we are headed back by to a 2% to 2.5% economy. The Fed would actually love that growth pace as it is sustainable. That way, they can raise rates to the neutral level without having to start stepping on the brakes. Stronger growth, though, could force them to hike rates even more. Indeed, the members have already warned that is possible. So watch what you wish for as no good economy goes unpunished.

August Existing Home Sales and Leading Indicators, September Philadelphia Fed Manufacturing Index and Weekly Jobless Claims

KEY DATA: Sales: 0%; Prices: +4.6%/ LEI: +0.4%/ Phila. Fed (Manufacturing): +11 points: Claims: -3,000

IN A NUTSHELL: “The housing market looks to be the only soft-spot in a solid economy.”

WHAT IT MEANS: Second quarter growth was strong, it looks like the economy expanded solidly in the third quarter and if the measures of future growth have any validity, the good economy will continue into next year. But then there is housing. Housing sales are going nowhere, unless they are going down. Existing home demand was flat in August as increases in sales in the Northeast and Midwest were offset by weaker activity in the South and West. Both single-family and condo purchases were flat as well, which is really weird. I hope the National Association of Realtors didn’t mess up the data. As for prices, they are still rising moderately. However, the rate of gain is easing and it should continue decelerating.

Despite the issues with the housing market, the outlook for the next six months is very good. The Conference Board’s Leading Economic Index rose solidly in August after strong gains in June and July. Growth should remain at or possibly above 3% for the rest of the year. However, the report did provide a note of caution: “The US LEI’s growth trend has moderated since the start of the year.” But most economists have cautioned that the strong second quarter increase was not likely to be sustained.

Manufacturing was another sector that seemed to be on the brink of a slowdown. Output gains were slowing and the trade battles were helping. But the Philadelphia Federal Reserve Bank’s manufacturing Index popped back up in early September, as orders rebounded. Hiring picked up and shipments increased. Confidence, though still high, continues to fade, which is inline with national indicators about the sector.

Jobless claims fell again last week. The level is the lowest since November 1969. No more needs to be said.

MARKETS AND FED POLICY IMPLICATIONS: The economic data are taking a back seat to the political/economic issues, in particular, trade concerns. You know things are crazy when investors say that the new tariffs are not as bad as was feared so let’s party hardy. Really, new tariffs and counter measures are something to celebrate rather than fear? The Chinese are masters at the non-tariff tariff and those are being imposed. Also, saying that the stimulus package will overcome the tariffs only implies that the tariffs will slow the economy from what we could have had without them. Regardless, today’s numbers were mixed. It was nice to see the economy should expand solidly over the next six months, but that is a surprise to no one. The housing market’s blues will likely only get worse as the Fed will be continuing to raise rates, starting next week. Oil prices are slowly increasing, which is further impinging on the purchasing power of the average household. So yes, the markets are booming and that is great, but unless that wealth is spent, it means little. And the average household is not spending those gains, as they are either not getting much of them or they are in their retirement accounts. So, I continue to warn that as we move through next year, conditions should deteriorate and if the trade skirmishes (my phrase, I used it months before Jamie Dimon) heat up and Chinese growth slows, the world and yes, U.S. economy will feel the pain.

July Trade Deficit and August Help Wanted OnLine

KEY DATA: Deficit: $50.1 bil. ($4.3 bil. wider); Exports: -1%; Imports: +0.9%/ HWOL: -46,300

IN A NUTSHELL: “The widening trade deficit will restrain growth in the third quarter.”

WHAT IT MEANS: We shall see if all the machinations going on over tariffs and trade deals ultimately lead to a narrowing of the trade deficit, but for now, the shortfall seems to be rebounding after an initial decline. The July trade deficit surged, which was expected, though the widening was larger than expected. A decline in imports was not a surprise as the rush to export soybeans led to a temporary jump in agricultural shipments. That unwound in July. However, exports of aircraft and consumer goods also declined. Overseas sales of vehicles and industrial products were up. On the import side, demand for just about everything except pharmaceutical products increased. Energy was not a major factor in the results.

Online want ads faded a touch in August. The Conference Board’s measure was down and a chart of the last year looks like a very scary roller coaster. But it starts and ends at roughly the same point, so it looks like the level is stuck in a range. Unfortunately, that range is well below the highs put in at the end of 2015. What does that mean for job growth? Probably little as it is doubtful that firms have cut back because they are looking for fewer workers. More likely, there is recognition that they can fill only so many open positions at a time, so the decline in ads probably reflects the supply of workers not the demand for workers.  

MARKETS AND FED POLICY IMPLICATIONS: The large widening of the trade deficit in July is likely to be sustained and trade will probably restrain growth this quarter. This is important because the narrowing in the trade deficit added 1.2 percentage points to growth in the second quarter. My best guess as of now is that trade may reduce third quarter growth by between one-quarter and one-half a percentage point. That is a swing of roughly 1.5 percentage points, meaning if everything else stays the same, GDP growth would be in the 2.5% to 2.75% range. But everything is not equal. Vehicle sales were soft again in August. Vehicles boosted growth in the second quarter. A decline in the third quarter would restrain overall growth by about 0.25 percentage point compared to the second quarter. To get to three percent, we need stronger government spending and much faster business investment. That is why I have been warning that third quarter growth could come in lower than many expect. While investors should take heed, Friday we get the August jobs report. I suspect that will be the focus of attention, at least when it comes to hard economic data. The consensus is for a rebound from the more moderate July number but still below the roughly 215,000 monthly average seen so far this year. But it is the wage number that is really important, as wage gains remain limited. It could run hot, which would be just another reason for the Fed to hike rates.

July Income and Spending and Weekly Jobless Claims

KEY DATA: Consumption: +0.4%; Income: +0.3%; Prices: +0.1%; Ex-Food and Energy: +0.2%/ Claims: +3,000

IN A NUTSHELL: “Continued spending should keep growth at a solid pace.”

WHAT IT MEANS: Third quarter growth looks like it will be solid, but how strong is a different question. We got a hint as consumer spending held up solidly in July. Most of that came from growing demand for services. It is unclear from the report precisely what was bought, but given that July’s temperatures were well above average (according to NOAA) much of the spending may have been on utilities. Softening of vehicle sales led to a decline in big-ticket item purchases. On the income side, wage and salary gains remain solid but the rise over the year continues to decelerate. Inflation-adjusted wage increase was the smallest in eighteen months. In other words, purchasing power of workers is improving, but at a declining pace, which raises questions about the sustainability of strong spending. The savings rate declined a little more than expected. Households may be maintaining their spending levels by pulling from savings. As for inflation, it increased moderately, excluding food and energy, and was at the Fed’s 2% target.

Jobless claims rose modestly last week and remain around historic lows when adjusted for labor force size. So, I will repeat what has been said for this entire year and most of last year: The labor market is incredibly tight, despite what the limited wage increases imply.

MARKETS AND FED POLICY IMPLICATIONS: July was hot and if this past week is any indicator, August may have been hotter. Households are probably burning through their utility budgets to keep cool. While that is likely to mean the August spending number will be good, it is the rest of the consumption gains that will determine the real meaning of the data. Right now, it looks like third quarter consumer spending will be solid but significantly slower than the robust rise posted in the second quarter. It is likely the trade deficit will widen given the wild swings in things such as soy exports. It will take a huge increase in business investment to get growth anywhere near the 4.2% second quarter number. Going forward, the impact of the tax cuts on household spending growth will wear off. I doubt that investors will look that far into the future. Earnings are strong and pricing power is growing. If that power is used, inflation will accelerate. But until we actually see that happen, few will likely worry. The few who will be concerned make up the Federal Reserve. The next FOMC meeting is September 25-26. I still expect a rate hike at that meeting and another one in December.

July Consumer Prices and Inflation-Adjusted Wages

KEY DATA: CPI: +0.2%; Over-Year: +2.9%; Less Food and Energy: +0.2%; Over-Year: 2.4%/ Real Hourly Wages (Over-Year): -0.2%; Real Weekly Earnings (Over-Year): +0.1%

IN A NUTSHELL: “Consumer inflation is accelerating faster than wages, limiting household spending power.”

WHAT IT MEANS: With trade issues swirling, Turkey’s currency collapsing and uncertainty about the state of the world economy rising, it would be nice to see some comforting U.S. economic numbers. I am not sure we got that today. The Consumer Price Index rose moderately in July, but it wasn’t the monthly change that really made people take notice, it was the year-over-year gain that is of concern. The rise from July 2017 was the largest since July 2011, right after the surge in energy costs. Energy has rebounded recently as well, but not nearly as much as it did earlier in the decade. Excluding food and energy, the so-called core index, prices were up the fastest in a decade. So, it is hard to say that inflation is now tame.

As usual, the details of the report contained some oddities. Energy prices fell, but oil costs jumped. Gasoline price declines kept the gains down. Transportation prices jumped and shelter costs continue to rise sharply. The surge in home prices is leading the way. In addition, vehicle prices, which had been restraining consumer costs, are now driving them up. On the other hand, there was a large decline in drug costs. Really? I wonder what kind of medicinal drugs they are smoking in Washington (hehe). It looks like restaurants are pushing up prices more slowly than they had been.

With inflation approaching the magic 3% (not that it means a whole lot), consumers are becoming pressured to continue buying more goods. Real (inflation-adjusted) wages went nowhere in July and over-the-year, they were down. That is, household purchasing power is declining. Even when you add in rising hours worked, income was up minimally since July 2017.  

MARKETS AND FED POLICY IMPLICATIONS: The economy boomed in the spring, fed by rising after-tax income for both businesses and households. And that sugar high should continue for a while. But stronger demand is causing consumer prices to rise faster. While the Consumer Price Index is not the best measure of inflation (the Fed prefers the PCE, the Personal Consumption Expenditure deflator), it is one way of looking at costs. What is worrisome is that the potential inflationary impacts from the tariffs have not had a chance to move through the system. The combination of strong consumer demand, tight labor markets and tariff-induced cost increases points to even higher inflation over the second half of the year. The next reading of the PCE comes out on August 30th. If that index shows faster inflation as well, which I expect, it could lock in not just a rate hike in September but also one in December. As for investors, inflation is just one concern they are trying to deal with. Turkey’s currency implosion and its potential impact on European banks is another. And there continues to be a slow but steady ramping up of the trade skirmishes, especially with China. So the best thing to say is that uncertainty is likely to reign for quite some time and that means we are in for some bumpy days ahead.

July Employment Situation and NonManufacturing Activity and June Trade Deficit

KEY DATA: Payrolls: +157,000, Private: 170,000; Revisions: +59,000; Unemployment Rate: 3.9% (down from 4.0%; wages: +0.3%/ ISM (NonMan.): -3.4 points; Orders: -6.2 points/ Trade Deficit: $46.3 billion (7.3% wider)

IN A NUTSHELL: “Despite a disappointing jobs number, the labor market remains strong.”

WHAT IT MEANS: It was a big day for data and the numbers were mixed. The July jobs gain was well below expectations but as I always say, don’t assume one employment report is a good indicator of anything. First, the previous two months job increases were revised upward sharply. Taken together, job growth was actually strong. Indeed, the three-month average, which is a better way of looking at the situation, was a robust 224,000. In addition, Toys-R-Us’ closing reduced retail jobs sharply. So, don’t even look at the headline number, especially since the details were really good. Manufacturers and restaurants keep adding workers like crazy and construction and health care are hiring strongly. Government was down, but that was in education, which the government just cannot figure out how to seasonally adjust. On the unemployment side, the rate fell and is likely to continue declining. The labor force grew and the participation rate was stable. The one disturbing number was the wage increase. It was decent, but over the year, the 2.7% gain means that real wages are up less than 1% over the year. That is pathetic.  

NonManufacturing activity slipped pretty sharply in July. The Institute for Supply Management’s index dropped led by major decline in new orders. Backlogs grew a lot less rapidly, which is a concern. Business activity was off significantly and that is something the needs to be watched as it may be the first sign that the bloom is coming off the economy.

The trade deficit widened sharply in June as exports declined while imports rose. The drop in foreign sales was not surprising, given the trade war issues, but not in the categories we saw. Agricultural exports rose but there were sharp declines in capital goods, vehicles and consumer products. That does not bode well for future exports. We also exported more petroleum products. On the import side, we bought a lot more consumer goods, petroleum products and vehicles, but a lot less capital goods.

MARKETS AND FED POLICY IMPLICATIONS: The economy is in very good shape and the labor market is mirroring the gains. The July payroll increase is likely to be revised upward, if the previous months upward revisions are any indicator, and Toys-R-Us is not shutting down again. But wages are just not rising fast enough to improve spending power. The soft July vehicle sales number may be a trend as consumers are becoming tapped out. That does not bode well for future spending. In addition, we may be starting to see that trade wars can create significant negatives for economies. The decline in exports must be watched carefully. And while the Supply Managers’ index drop was just one number, if it is the start of a trend, it could be worrisome. The Fed will not be swayed by the headline jobs number but instead will look at the details. The lack of significant wage pressure is helpful, at least on the inflation front, but the trend in job growth is still above labor force growth and that implies a further tightening in the labor markets. The weak consumer spending power growth and the first crack in the economy that could be indicated by the slowdown in the nonmanufacturing segment may not change policy in the short run. But they are now likely on the Fed members’ radar.

July Private Sector Jobs, Help Wanted OnLine, Manufacturing Activity and June Construction Spending

KEY DATA: ISM (Manufacturing): -2.1 points, Orders: -3.3 points/ ADP Jobs: +219,000/ HWOL: +170,800/ Construction: -1.1%

IN A NUTSHELL: “The job market continues to be on fire even as manufacturing and construction start settling down into more sustainable levels.”

WHAT IT MEANS: Friday we get the government’s take on the number of jobs created in July and it looks like that could be a pretty good one. The ADP estimate of July private sector payroll increase came in well above expectations. While this measure does have periodic large misses, lately it has done a pretty good job of signaling whether the report would beat expectations. Driving the large gain was a surge in employment in mid-sized companies. The increases in small and large companies were somewhat disappointing. There also continues to be large numbers of workers being hired in manufacturing as well as a rebound in health care employment.

Regardless of the size of the July job increase, whether payroll gains will remain strong is a bit of a question mark. The Conference Board’s Help Wanted OnLine measure rose solidly in July. However, the number of ads peaked in November 2015, has been generally falling since then. It is down nearly 20% from the high and is at the level seen in mid-2012. Firms did ramp up their search for new workers and the increases were pretty much across the board, ranging from healthcare practitioners and management to sales and food preparation.

Manufacturing has been leading the way in this economy and it should continue to do so. The Institute for Supply Management’s Index did ease in July, but the level is still pretty high. New orders continued to grow but at a little less robust a pace. Production also expanded at a somewhat more moderate pace and as a result, backlogs built more slowly. Still, all of those components were at levels that indicate a very solid sector. Indeed, hiring actually picked up, which bodes well for Friday’s employment report.

The one weak report today was construction spending, which fell sharply in June. This was the largest decline in over a year and was driven but cut backs in public and private activity. There was weakness in the residential and nonresidential components. Manufacturers are starting to expand, another sign of strength in that sector.

MARKETS AND FED POLICY IMPLICATIONS: Friday we get the jobs report and today a statement from the Fed. Today’s reports generally paint a picture of a strong, expanding economy, though one that may be easing back to levels that can be sustained. Continued growth in excess of 4% is not likely and actually not desirable. It would create the likelihood of bubbles forming and recessions tend to follow the bursting of bubbles. But first, inflation would accelerate, though why it hasn’t yet is anyone’s guess. So consider a strong employment a double-edged sword: It would mean we have a great economy but it would also raise the risk of much higher inflation and interest rates. That is what the Fed and the markets have to balance as they look toward the future.

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.