KEY DATA: Starts: -2.6%; Permits: +4.6%/ Phila. Fed (Manufacturing): +19.7 points; Orders: +12 points/ Claims: +5,000
IN A NUTSHELL: “There is not much to complain about the economy as housing and manufacturing are improving and the labor market remains tight.”
WHAT IT MEANS: We know that inflation is on the rise and while energy is a factor in the acceleration of price gains, it is not the only one. The economy is getting stronger and that has major implications for future inflationary pressures. In January, housing starts edged downward, but that came after an upward revision to the December numbers. Single-family construction rose but the volatile multi-family sector fell sharply. More importantly, the level of construction was 10.5% above the January 2016 pace and 6% above the 2016 average. In other words, builders started off the year in good shape. Permit requests jumped, moving back above starts. That points to greater home construction in the months ahead. Regional activity varied widely. Construction soared in the Northeast and South but cratered in the West and Midwest. Weather matters. The number of home under construction continues to rise, though it would be nice if it increased faster. Inventory remains too low.
The Philadelphia Federal Reserve Bank’s survey of manufacturers rose sharply in February. General business activity soared, helped along by a surge in demand. Only 6% of the respondents said new orders fell, indicating that the improving economy is lifting most boats. Hiring was a little slower than it had been. Firms seem to meeting the new demand by working their current employees longer. That makes sense given the labor shortage. This month’s special question had one result that should open Janet Yellen’s eyes. Manufacturers expect inflation to run at a 3% pace over the next ten years compared to a 2.7% average in the fourth quarter 2016 survey. The FOMC keeps noting that “most survey-based measures of longer-term inflation expectations are little changed”. If inflation expectations are rising, the Fed will have to act sooner rather than later.
Unemployment claims rose last week but remain near historic lows. There just aren’t a lot of people who have skills, are between 21 and 55 and can pass a drug and background check who are sitting at home watching The Price is Right. As a result, firms holding onto their employees tightly. I expect they will start moving part-timers into full-time positions, even if that raises costs. It is better than going without and could reduce turnover and improve productivity.
MARKETS AND FED POLICY IMPLICATIONS: While the economy is in good shape, the administration is not. The chaos is raising questions about the ability to push through significant tax cuts and spending increases. Unless revenue increases are found, the proposals will cause the deficit to soar. The political pressure a $1 trillion deficit forecast would put on the Republicans would be hard enough to deal with without political problems. With those issues, action could be either pushed into later this year or only showpieces would be passed. That would not be good news to all those investors who believe that happy days are here again. As for the Fed, the unmooring of inflation expectations that we saw in the Philadelphia Fed survey is a clear warning that the days of doing nothing are over. A large increase in both jobs and wages in the February employment report could put the March FOMC meeting into play. At the minimum, it would support my view that the next hike could come in May. Hey bond market people, are you looking at the inflation numbers?