July Durable Goods Orders and Fed Chair Powell’s Comments

KEY DATA: Orders: -1.7%; Excluding Aircraft: +1.3%; Capital Spending: +1.4%

IN A NUTSHELL: “The Fed Chair expects more rate hikes because of the strong economy and strong business investment supports that view.”

WHAT IT MEANS: The tax cut provided created huge increases in profits and it looks likes firms are starting to spend their earnings on capital goods. Durable goods orders seemingly cratered in July but forget the headline number: The drop was due to large declines in both private and defense aircraft orders, which bounce around like super balls. Excluding aircraft, demand for big ticket items surged, led by sharp increases in machinery, computers and vehicles. The gains, though, were not universal. Demand for communications and electrical equipment was off. Still, private sector capital spending jumped and is up over 7% since July 2017. That indicates firms are finally using at least some of their newfound largesse to bolster production and productivity. That bodes well for continued solid growth this year.

The annual Jackson Hole Fed conference is underway and Fed Chair Powell talked today. It is easiest to summarize his views on future rate hikes by presenting his own words: “… if the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will likely be appropriate. … The economy is strong. Inflation is near our 2 percent objective, and most people who want a job are finding one. My colleagues and I are carefully monitoring incoming data, and we are setting policy to do what monetary policy can do to support continued growth, a strong labor market, and inflation near 2 percent.” In other words, it will take a clear and significant slowdown to cause the Fed to slow or stop the rate hikes.

MARKETS AND FED POLICY IMPLICATIONS: With businesses finally starting to invest heavily, the second leg of the tax cut-induced strong growth is taking place. The expansion is likely to moderate as consumer spending settles down, but it should still be quite solid. That is why most economists, including myself, have said we still have one year – or more – of really good growth before the sugar high wears off. If that is the case, then there is no reason for the Fed to stop normalizing rates and shrinking its balance sheet. Next summer, conditions might be different and a slowdown in the process might be possible. Thus, it is likely that a minimum of four more rate hikes will occur over the next year. And if growth does not decelerate significantly, if inflation creeps upward and stays above the Fed’s target, then additional rate hikes should be expected. What that does to investors’ thinking is anyone’s guess. But they might want to focus on something the Fed Chair said: “I would also note briefly that the U.S. economy faces a number of longer-term structural challenges that are mostly beyond the reach of monetary policy. For example, real wages, particularly for medium- and low-income workers, have grown quite slowly in recent decades. Economic mobility in the United States has declined and is now lower than in most other advanced economies. Addressing the federal budget deficit, which has long been on an unsustainable path, becomes increasingly important as a larger share of the population retires.”