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September 16-17 ‘15 FOMC Meeting

In a Nutshell: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”

Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%

The Fed decided that all economic and financial issues in the world are its concern and given the uncertain global economic and financial conditions, the start of rate normalization would have to wait. Boy, what a difference seven weeks make. After the July FOMC meeting, conditions seemed to be in place for a September rate hike. Indeed, fifteen of seventeen participants indicated they expected rates to be increased this year. That number dropped to thirteen and one member even thinks rates will not be increased until 2017.

So, what changed? First, oil and other commodity prices fell. There was a concern that the labor market needed further improvement, though the rate is near the members’ long run rate of 4.9%. Fed Chair Yellen explained that there is some extra slack in the market because of the falling participation rate and the elevated level of part-time workers who want full-time jobs.

But the real shift was the central position of foreign issues. The recent instability in China, the rise in the dollar and the weakness in countries dependent on commodities for growth (e.g., Canada) caused the FOMC to rethink its timing of a rate hike. Adding these worries to the energy declines and supposedly labor market slack. The members’ lowered their inflation outlook for the next couple of years. And since inflation remains well below the Fed’s target, The Committee decided not to go for it on fourth and one, but instead punted.

So, when will the Fed start raising rates? While Chair Yellen said that October is a live meeting, it is unlikely the FOMC will get enough compelling information about China and the financial markets over the next six weeks to make an October hike possible. Indeed, we don’t even know what will constitute enough knowledge of what is happening in China, especially since the Chinese data are questionable, at best, and their policies are hardly transparent.

The Fed, by making China, the dollar and the world financial markets central to its decision process, has muddied the waters. Indeed, investors seem as confused as most economists. On the news, the Dow quickly dropped about 80 points, but then rallied sharply, rising over 200 points. However, once Yellen started explaining things, the index fell over 200 points.

The Fed will eventually start raising rates, but it is no longer clear what benchmarks will have to be met before that decision is made. It could be December, but it could be sometime in 2016 as well. Right now, I don’t think anyone, including Janet Yellen, has any idea.

(The next FOMC meeting is October 27-28, 2015.)

July Consumer Price Index and Real Earnings

KEY DATA: CPI: +0.1%; Excluding Food and Energy: +0.1%/ Real Hourly Earnings (Monthly): 0.1%; Real Weekly Earnings (Monthly): +0.4%

IN A NUTSHELL: “The Fed has to decide if modest inflation is good enough.”

WHAT IT MEANS: The slow water torture the Fed is putting us through continues unabated and it would be nice if the economic data helped stop the pain. No chance. The Fed has a dual mandate and while the economy is good enough to raise rates, inflation remains well below target levels. Today’s July Consumer Price Index report does nothing to change that picture. Prices rose minimally and that included energy and food. That is, you can exclude energy or food and energy, and there was just a modest rise in consumer costs. Interestingly, the Bureau of Labor Statistic has gasoline prices rising solidly in July but the Energy Information Agency has gasoline costs down a touch. What the government’s left hand is posting has little to do what the right hand is presenting. Regardless, there remains a clear demarcation between goods inflation and services inflation. Since July 2014, commodity prices, which are about 38% of the index, were down 3%. Energy commodity costs dropped over 22% over the year. Meanwhile, the services component, the larger portion of the index, was up 2.2%. Shelter, especially rent, is rising sharply. As for the specific categories, medical care costs, both services and commodities, is rising faster than most other areas. Food price pressures are increasing and it is not just eggs. New vehicle prices are up but used are down. The high demand for new vehicles is putting a lot of used vehicles on the market. Clothing prices rose in July, but that was probably an aberration as they are down over the year. Basically, consumer price pressures exist, but they are not great and are concentrated in services, where there is less volatility than in the commodities segment.

With prices up modestly but hourly and weekly earnings up more solidly, real earnings rose. Workers are seeing gains in pay, but more of it is coming from longer hours worked rather than higher hourly wages.

MARKETS AND FED POLICY IMPLICATIONS: The battle between the Fed’s growth mandate and the inflation mandate continues unabated. Under normal circumstances, the Fed would simply wait until inflation starts approaching its target rate before raising rates. But this is not a normal situation. Rates are well below “normal” levels and it is no longer clear that the low level of rates is doing more good than harm. The argument du jour against a rate hike, which is likely to be just ¼ percentage point, is that it would cause the dollar to skyrocket, killing tourism and wrecking the junk bond market. Huh? I guess since people have thrown just about everything else against the wall, those worried that a Fed mini-move would cause the world as we know it to collapse, have to come up with even more bizarre rationalizations to argue against a rate hike. All these excuses are the best arguments to raise rates. Perceptions of what are high rates have been so totally warped that the Fed is playing catch up. It’s time to act, if only to bring some semblance of normalcy back into the fixed income markets.

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

KEY DATA: Sales: +0.6%; Excluding Vehicles: +0.4%/ Imports: -0.9%; Nonfuel: -0.3%; Exports: -0.2%; Farm: +0.8%/ Claims: +5,000

IN A NUTSHELL: “With consumers spending and the labor market really tight, the only thing that could keep the Fed from raising rates is the weakness in prices.”

WHAT IT MEANS: If all the Fed worried about was the domestic economy, there would be no worries at all. Retail sales were strong in July, led by robust vehicle demand. There were also decent gains for firms that sold furniture, building supplies, health care products, sporting goods, clothing and gasoline. The gasoline sales rise occurred despite a modest price decline, indicating people are driving more. People also ate out more and shopped online heavily. However, electronic and appliance purchases were off and people didn’t do much buying at department stores. So-called “core” sales, which better mirror the GDP consumption number, were up a solid 0.3%. There was also a sharp upward revision to June retail activity. Second quarter consumption looks like it was better than initially believed.

As for the labor market, the rise in unemployment claims was really modest. More importantly, the level remains extremely low, implying that firms are simply not laying off workers.

While the economy and labor markets are strong, the Fed’s other mandate, inflation, looks like it is not going in the right direction. It may seem strange that the Fed wants higher inflation, but that is because it is well below its target. The July import price report indicates inflation pressures are limited. Declining energy costs played a role in the fall in import costs but there was also a drop in consumer and capital goods prices. Vehicle costs were stable. Export prices fell, but the reeling farm sector was able to push through some price increases.

MARKETS AND FED POLICY IMPLICATIONS: The economy is strong enough to absorb a rate hike, especially since the increase is expected to be modest. Why anyone thinks a quarter point rise in short-term interest rates would hurt the economy is beyond my understanding. But there is inflation, which the Fed continues to argue will get back to normal rates over the next year or two. The Chinese currency devaluation should put downward pressure on prices. Let’s face it, the Chinese want to dump cheap goods onto the U.S. market to keep their economy from failing. The U.S. consumer is the target in this trade war. It is uncertain, though, who is hurt by the Chinese actions. U.S. consumers get lower cost goods but that might displace goods made in either the U.S. or other countries. To the extent that the Chinese action hurts other countries that export to the U.S., those countries will depreciate their currencies so they can remain competitive. But domestic firms cannot change their currency so there is a possibility of slower U.S. growth. Will the Fed put off raising rates because the Chinese action may lower inflation? I said this before and I will say it again: If the Fed doesn’t hike rates because the dollar may rise in value because of currency manipulation, the message sent is that the Fed can also be manipulated.

June Job Openings and Labor Turnover

KEY DATA: Openings: -108,000; Hires: +117,000; Quits: +18,000

IN A NUTSHELL: “Hiring is improving and that is cutting into job openings.

WHAT IT MEANS: The JOLTS report is one of the most closely watched releases that we get each month as it provides insights into the availability of positions and the willingness of firms to fill those openings. In June, firms picked up the pace of hiring, which is good news. Indeed, there was a 7.4% rise over the year, which is robust. That pace was rarely seen in the last expansion and is a clear indication the labor market is solid. With payroll gains improving, the number of job openings eased. Smoothing the monthly ups and downs out, though, the second quarter level of job openings remained at record highs. Firms may be eating into their open job requisitions a little, but they have a long way to go. The one negative in the report was the modest rise in the number of people quitting. The level remains well below what we saw in the 2000s and we will not be able to say that the labor market is in good shape until people feel comfortable to simply tell their employers to take their jobs and you know what. We are not there yet.

MARKETS AND FED POLICY IMPLICATIONS: The labor market is in very good shape. Yes, the monthly job gains have been less than they were last year but they are still strong enough to keep the unemployment rate coming down. The JOLTS data raise some questions about the monthly job gain slowdown. Is it due to a moderation in demand or supply? Think about the housing market. Few debate the idea that a dearth of inventory is keeping home sales depressed. If you cannot find the right home, you don’t buy. But when you do find it, you have to pay the price or risk losing the home. Well, why don’t people think the same thing should be going on in the labor market? The low unemployment rate is making it difficult to dip into the shrinking “reserve army of the unemployed and underemployed”. But just like homebuyers who refuse to pay more for the home they like – and thus lose the homes – employers who refuse to pay up for workers are not getting the workers they need. Very simply, firms are behaving as if there isn’t a labor supply curve, just a labor demand curve. If you keep wages below the market-clearing wage by refusing to increase compensation, in a growing economy, demand will exceed supply. That is precisely what is going on in the labor market right now. Firms say they cannot find qualified workers but they will not pay up to attract qualified workers. The result: Slower job gains and modest wage increases. Interestingly – and in contrast to traditional economic thinking – higher wages could induce workers who are skilled and willing to move, to actually move! That would allow for a more dynamic labor market where people move up the ladder, creating openings for people at all skill levels. In other words, if wages increase faster, job gains could accelerate! Extending this logic to the housing market, higher home prices could induce more homeowners to list their homes, especially those with minimal equity, expanding inventory and increasing sales. When it comes to markets, if you don’t think about both supply and demand, you don’t get the analysis right.

June Existing Home Sales

KEY DATA: Sales: +3.2%; Prices: +6.5%

IN A NUTSHELL: “Dear Janet: The housing and labor markets are in great shape, so what are you waiting for? Your friend. –Joel”

WHAT IT MEANS: Well, so much for issues with the housing market. Yes, conditions weakened early this year but are there any doubts left that the problems were weather related? I don’t think so. Housing starts and permits jumped in June and existing home sales did the same. The National Association of Realtors reported that home sales hit its highest annualized rate since early 2007. All parts of the country took part in the party. Since June, demand is up by nearly 10%, with every region posting an increase of 7% or more over the year.   While sales are rising, inventories are barely budging and that mismatch is having the expected impact: Prices are soaring. Indeed, the median cost of an existing home hit its highest level on record. And with mortgage applications up solidly over the year, it looks like the housing market surge will be sustained.

MARKETS AND FED POLICY IMPLICATIONS: The FOMC meets next Tuesday and Wednesday and while there is almost no chance (I never say never when it comes to the Fed) that a rate hike will be announced, that doesn’t mean some serious signals that the Fed will finally pull the trigger will not be sent. We do get two more jobs reports and the second quarter GDP numbers before the September 16-17 meeting, so there is still some uncertainty about a move, but the odds of an increase continue to rise. If we see payroll increases in the 225,000 to 250,000 range in July and August, even just one downtick in the unemployment rate and any acceleration in wages, it will be hard for the Fed to say they need to see more good news. What would they be waiting for? Not a recovery in housing. That is here and indeed the issue is rising prices, not weak demand. Consumer spending? If wages keep rising, can retail spending be far behind? We may not have robust growth, but it is clearly solid enough to absorb a rise in short-term rates from 0% to 0.25%. I mean, seriously people, would that really crash the economy? A rate hike in September looks more and more likely.

July Home Builders Index, Philadelphia Fed Manufacturing Survey and Weekly Jobless Claims

KEY DATA: NAHB: 60 (unchanged)/ Phil. Fed: -9.5 points/ Claims: down 15,000

IN A NUTSHELL: “The housing sector is moving to the forefront and if manufacturing can ever get its act back together, this economy could really accelerate.”

WHAT IT MEANS: The economy continues to expand at a moderate pace even as we would like to see it grow more rapidly. One of the factors in this decent but not great expansion has been a rotation in sector leadership rather than broad based growth. Housing has been a laggard, but that looks like it is changing rapidly. The National Association of Home Builders/Wells Fargo Housing Market Index is now at a level not seen since November 2005. From January 2001 to December 2005, the housing bubble period, the index averaged 63. Given that the current reading is 60, it appears that builders are getting bulled up once again. We are not talking a new bubble here, but we are looking at significant gains in activity, especially in the single-family segment. Also, it looks like the long-suffering Northeast will be seeing a lot more construction as that region’s index has finally broke into the black.

While housing is coming back, manufacturing continues to decelerate. The Philadelphia Fed’s manufacturing index dropped sharply in July. The sector is still growing, but not strongly. And with backlogs going nowhere and payrolls largely flat, it doesn’t look as if manufacturers in the Philadelphia region will be ramping up production soon. Confidence about the future is picking up, but it is still below recent high levels.

On the labor market front, last week new unemployment claims jumped, raising questions about future job gains. Well, never mind. This week, most of the rise was wiped out. While the level is still a touch higher than it had been for much of the past year, it is now back to where solid job gains should be expected.

MARKETS AND FED POLICY IMPLICATIONS: Fed Chair Yellen keeps repeating that a rate hike is coming, probably this year. She also keeps warning that the first one doesn’t matter: It is the pathway going forward that is critical. But markets keep focusing on hike number one and the data keep telling us that it is unclear which meeting this year it will occur. I have not ruled out September, as I believe the labor market data, including compensation gains, will be strong enough to convince the members that the economy can absorb a rate hike. In particular, follow the compensation numbers reported in the quarterly Employment Cost Index. Second quarter data will be released on July 31st. These data are much more comprehensive than the monthly hourly wage numbers and have been accelerating.   If that pick-up continues, and the unemployment rate falls even a little over the next two months preceding the September 16-17 FOMC meeting, the Fed could consider making its first move then. As for investors, when you get divergent economic numbers, the best thing is to punt, especially since earnings are coming out.

June Retail Sales, Import and Export Prices and Small Business Optimism

KEY DATA: Sales: -0.3%; Excluding Vehicles: -0.1%/ Import Prices: -0.1%; Nonfuel: -0.2%; Export Prices: -0.2%; Farm: -1.5%/ NFIB: -4.2 points

IN A NUTSHELL: “With consumers not buying, inflation decelerating and small businesses worried, the greatly expected second half boom may turn out to be a little less robust.”

WHAT IT MEANS: While not all economic indicators were showing a rapid recovery, there were many signs that the economy was really picking up some speed. Well, it might be time to sit back and rethink this a bit. May retail sales were robust and while June vehicle demand was strong, it was below the huge May sales pace. So most economists, including myself, expected consumer spending to grow minimally in June. Well, it didn’t. Instead, demand declined, even when vehicles were excluded. Sales at electronics, appliances and general merchandise stores were pretty solid, but demand for furniture, clothing, building materials was off, we didn’t buy anything online and we didn’t go out to eat. Weird. Worse, gasoline purchases rose and that was likely due to a rise in prices. In other words, this was not a very good report.

The gap between the Fed’s inflation target and the inflation rate has been widening slowly and today’s import price report indicates that trend could continue. Import prices fell in spite of an increase in energy costs. Food costs dropped sharply, while consumer and capital goods as well as vehicle prices were flat. Only energy related products showed a rise. On the export side, prices fell as well and the long-suffering agricultural sector continued to see its prices drop.

As for small businesses, confidence took a major hit last month. It had risen back to normal levels in May, but it seems June was a bummer, reflecting the lack of consumer spending we saw in the retail sales report. Firms didn’t hire anybody and kept wages stable.

MARKETS AND FED POLICY IMPLICATIONS: Today’s reports were disturbing as they point to an economy that may not be picking up as much steam as seemed to be the case. Why the downturn in consumption occurred is baffling. Plenty of jobs are being created and confidence picked up, so why households stayed home is unclear. With the FOMC meeting in two weeks, reports that show modest consumer spending and moderating inflation play into the hands of those who want to push off hiking rates. No one expects the Fed to do anything at the July meeting, but there was the possibility that the Committee would signal that the economy was strong enough to absorb increases in rates. That may not occur. Even if it doesn’t, a September rate hike cannot be ruled out as we get two more jobs report before then, but they will have to be strong. As for the markets, who knows what will drive activity today. The weak reports would normally be taken as a positive for stocks as they could delay the inevitable. There is also the Iran agreement and that would point toward lower energy costs. Regardless, we need the consumer to get back into the game and soon.

May Durable Goods Orders and New Home Sales

KEY DATA: Orders: -1.8%; Excluding Aircraft: +0.7%; Capital Spending: +0.4%/ Home Sales: +2.2%

IN A NUTSHELL: “Businesses are investing again and the housing market is shifting gears, so why is the Fed so unsure about the economy?”

WHAT IT MEANS: And the hits keep coming, except in this case, it’s the good kind – the ones that make lots of money. The data seem to be moving to the top of the charts and while all the songs are not that great, they are making sweet music. Today, we saw that durable goods orders improved in May, though the April gain disappeared. Still, when you exclude aircraft, the rise in demand for big-ticket items was strong and the increases were pretty much across the board. Primary and fabricated metals, communications and machinery were up solidly. There was a decline in computers and appliances and electrical equipment, while vehicles were flat. Importantly, business capital spending, excluding defense and aircraft, was up solidly for the second time in three months. Still, there was a warning sign in the report: Order books are thinning. That does not bode well for a strong improvement in production.

Housing is getting better, no if, ands or buts about it. Yesterday we saw that existing home sales rose solidly in May and that result was duplicated in the new home market. While the percentage increase was not huge, it came on top of a sharply upward revised April sales pace. The level was the highest since February 2008, so we are starting to claw our way back toward more normal levels. We still have a long way to go, though. The long-suffering Northeast finally showed some strength. While total sales for the first five months of this year compared to last year are up by 24%, they are down by 23% in the Northeast. The West was also strong in May but there were declines in the South and Midwest. Interestingly – or strangely – median prices declined even though inventory is largely nonexistent. These data are volatile and given the existing home price increases, the decline will likely turn around next month.

Two other reports indicate that the economy is running strongly. The Richmond Fed’s June manufacturing index jumped while the Philadelphia Fed’s June non-manufacturing index eased but remained at a very high level. Both surveys point to strong job and wage gains.

MARKETS AND FED POLICY IMPLICATIONS: I love to poke fun at the Fed’s inability to forecast and right now, the monetary authorities are easy targets. The economy may not be soaring, but it is hard to say that conditions haven’t rebounded strongly from the winter downturn. I will wait until Thursday when the consumer spending numbers come out before I say the central bankers are clueless. We aren’t certain what households are thinking right now and while they are clearly buying big-ticket items such as homes and vehicles, they also have to doing something other than borrow money. If Thursday’s consumption report is as strong as I expect, and if the inflation data point to a continued move upward toward the Fed’s target, then there is every reason to think that at the July 28-29 meeting, the FOMC will start to signal a rate hike is near.

June 16-17 ‘15 FOMC Meeting

In a Nutshell: “Conditions for the first rate hike have not yet been met.”

Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%

The FOMC concluded its two-day meeting this afternoon and the statement basically told us nothing we didn’t already know. The economy picked up from the winter downdraft but there is still a way to go before we get back to strong growth. Yes, 2015 growth was downgraded from the March forecasts, but few expected a negative first quarter at that time. It was just math. Otherwise, there was little change in the comments as the Committee kept the funds rate range the same and there was no change in its investment policy.

So, does that mean there was nothing to be gleaned from today’s news? Absolutely not. First, and maybe most importantly, most members expect there to be at least two rate hikes this year. According to the “dot chart” of forecasts, the “central tendency” is for the funds rate to be at 0.625% at year’s end. The only way to get there is if the rate hikes start in either September or October. Since there is no press conference in October (it’s that dumb press conference calendar issue again), the target month looks like September.

Chair Yellen’s press conference also provided some good information. First, she made it clear, time after time, that the conditions for a rate hike had not yet been met – but they could be soon. While the labor market has gotten a lot better, there is still some slack that needs to be taken up. A reduction in the number of people working part-time but wanting full time jobs needs to fall while wage gains and the participation rate need to rise. She seemed to think the participation concern is less of an issue now that it has stabilized.   Stronger growth, which most members expect, would resolve the labor slack issue.

Chair Yellen noted often that almost all members expect rates to rise this year. However, she tried to persuade everyone that there was no set pathway once the first rate hike occurred. She pointed out that most members expect something on the order of 100 basis points rise each year. Even with my challenged mathematical abilities, I can figure that to be a 25 basis point rate hike every other meeting. She is trying to dissuade people from assuming there had to be 25 basis point moves every meeting. I don’t believe it because at that pace, a neutral fed funds rate of 3.75% will not be reached until sometime in 2018. If it takes that long, I fear for the economy.

Okay, what is the takeaway here? Barring some negative international event, such as Greece hurting European growth, the Fed remains on track for a September rate hike. I suspect that most market participants don’t believe that. People still want to see it before they believe it. So, don’t be surprised if there is some real volatility if the Fed does what it says it will likely do.

(The next FOMC meeting is July 28-29, 2015.)

May Challenger Layoff Estimates and Weekly jobless Claims

KEY DATA: Layoffs: down 20,548/ Claims: down 8,000

IN A NUTSHELL: “The turnaround in oil prices is also turning around the labor market data as layoffs are declining.”

WHAT IT MEANS: Tomorrow is Employment Friday, so any labor market data will be swamped once the numbers are released, but you can get some insight into the pressures that are developing by looking at things other than the unemployment rate. The latest employment numbers point to further tightening in the labor market. Layoff announcements had been soaring as the oil patch started drying up. To put things in perspective, Challenger, Gray and Christmas reported that for the first four months of this year, layoff notices rose by a little over 28,000 from the same period last year. Meanwhile, the energy sector’s announcements rose by nearly 57,000. About 30% of all layoffs were in Texas. In other words, except for the energy firms have been holding tightly to their workers. With the rise in oil prices, energy sector layoffs have largely stopped – and so have overall layoff announcements.

Despite the weaknesses in energy and related industries, jobless claims have been low and they stayed down. Keep in mind, layoff announcements don’t necessarily become layoffs. The rise in energy prices may reduce actual payroll cut backs. Jobless claims declined last week and the level remains so low that payroll gains are highly likely to accelerate as we go forward.

MARKETS AND FED POLICY IMPLICATIONS: Payroll cuts in mining and machinery (support industry for the energy sector) totaled 20,000 in April and there still was a 223,000 rise in total employment. Don’t be surprised if in tomorrow’s employment report, we see a lot smaller job loss in those two industries. That should help drive the total gain to well above what we saw last month. The Fed will be watching the employment report closely, not just when it comes to employment but also what is happening with wages. But the hourly wage number doesn’t account for lots of other, more imaginative ways businesses are compensating employees. When you consider total compensation, it is clear that the upward trend is accelerating. In today’s revised first quarter productivity report, inflation-adjusted compensation per hour soared at a 6.5% rate over the quarter and was up a decent 2.2% over they year. Labor costs are reflecting the tight labor market and if hourly wages in the employment report doesn’t reflect that yet, we should be asking if we should even follow that number. For businesses, it’s all about total compensation and that is what we need to watch. If investors are focusing on the right numbers, they will have to start thinking that Fed has all the ammunition needed to start doing what the members really want to do: Raise rates.