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April 26, 27 2016 FOMC Meeting

In a Nutshell: “Moderating economic growth and consumer spending keep the Fed on hold.”

Rate Decision: Fed funds rate range maintained at 0.25% and 0.50%

The FOMC members came, they talked, and they didn’t do much other than signal that they will continue to do not much for a while.

Going into the latest Fed gathering, there was some uncertainty over what the Committee would signal. Was Chair Yellen’s dovish tone going to hold sway or would the members try to signal that a rate hike could be on the table in June? Well, those who were worried that interest rates could go up, shouldn’t have been concerned.

Right off the bat the statement noted that “growth in economic activity appears to have slowed” and “growth in household spending has moderated”. Yes, there were some comments about income gains holding up and consumer sentiment being high, but weakening growth and softening household demand are not generally considered circumstances where you would expect to see rate hikes.

There was also no statement that the risks to the forecast were equally balanced. I guess they just didn’t want to say that what the risks were, and that failure to discuss where the economy might likely go is another indication that the members are uncertain where the economy might go. And uncertainty about how strong the economy might be going forward doesn’t breed rate hikes.

Today’s statement was probably a little more dovish than most people expected. Chair Yellen has been yelling that she was willing to wait longer than others before raising rates and if anyone doubted it, it is now clear that she has the biggest voice in the room. There was only one dissent and that too was a bit of a surprise. She is doing a good job in herding the cats on the Committee.

Okay, what does this all mean? We still have two more jobs reports and a slew of other labor market, inflation and economic data coming out before the next meeting on June 16-17. But those reports, as well as data from Europe and Asia, will have to be really strong for the Fed to consider raising rates at that meeting. The opportunity after June would be July 26, 27. I actually believe that is a possibility despite the fact there is no press conference afterward. Chair Yellen has made it clear that all meetings are live meetings, whether or not there is a press conference scheduled. I suspect she will take the first chance to prove that point. July could be it, but we need a whole stream of solid economic and inflation numbers to make that happen.

(The next FOMC meeting is June 14-15, 2016.)

March Durable Goods Orders, April Consumer Confidence and Nonmanufacturing Activity and February Housing Prices

KEY DATA: Orders: +0.8%; Capital Spending: 0%/ Consumer Confidence: -1.9 points/ NonManufacturing Activity: -0.4 points/ Housing Prices: +0.4%

IN A NUTSHELL: “March went out like a lamb and April was baaad as well.”

WHAT IT MEANS: If the Fed was hoping for a spring rebound, it will have to wait a little longer. The recent data have hardly been great and today’s numbers continued that trend. Durable goods order rose solidly in March, but were up less than expected. Part of that may have been due to the oddity that Boeing reported a sharp increase in orders but the government had civilian aircraft demand falling. Don’t ask me why, I just don’t know. The rest of the report was mixed. Orders for machinery and communications equipment were up while demand for computers, electrical equipment and motor vehicles declined. Private sector non-aircraft capital goods orders were flat, which was disappointing given they had cratered in February and a bounce back had been expected. Order books are not filling, so don’t expect any great surge in production anytime soon.

The Philadelphia Fed reported that activity in the non-manufacturing portion of its regional economy expanded slightly slower in late March and early April.   Yet this was not a bad report. Hiring, the workweek and wages and benefits all were up solidly, indicating that activity is solid. It is also pointing to a growing labor shortage in the Mid-Atlantic area. In addition, expectations, especially about business activity, were up solidly, pointing to growing confidence that the region’s economy should do well in the months to come.

The Conference Board reported that consumers were a touch less optimistic in April. It was interesting to see that the current conditions index rose nicely, but expectations dropped even more. Maybe everyone is just depressed about the primaries. I don’t know.

Finally, home prices continued to rise, as the S&P/Case Shiller national home price index moved up solidly in February. Gains were across the nation, with Portland and Seattle posting double-digit increases over the year. Still, the rise is slowing, which is good news for potential buyers.

MARKETS AND FED POLICY IMPLICATIONS: The FOMC begins its two-day meeting today and none of the numbers released today should change anyone’s thinking about the condition of the economy or whether rates should be increased. The really interesting reports come out later this week. It is very likely that Thursday’s GDP report will show that there was tepid economic growth in the first quarter. However, on Friday, the Employment Cost Index release could indicate there was a sharp acceleration in wages and salaries. We saw a hint of that in the Philadelphia Fed’s survey. Chair Yellen is watching labor costs as a key indicator of labor market tightness and the Employment Cost Index is one of the better measures of those pressures. Labor costs had cooled, surprisingly, during the second half of 2015, but I think that was not the case early this year. If that forecast is accurate, eyes will turn to next week’s jobs report and wages. While I think the hourly wage number is largely meaningless, it is viewed by the markets as containing some information. That too could be show accelerating wage pressures. But until we see that labor costs are indeed on the rise, Chair Yellen will be able to say that there is still a lot of room for the Fed to stand pat – which is what I expect tomorrow’s statement to indicate.

March Leading Indicators, April Philadelphia Fed Manufacturing Index and Weekly Jobless Claims

KEY DATA: Leading Indicators: +0.2%/ Phila. Fed: -14 points: Expectations: +13.4 points/ Claims: down 6,000

IN A NUTSHELL: “The economy is continuing to expand slowly and the labor market is tightening, but the manufacturing sector remains weak.”

WHAT IT MEANS: Next week the Fed meets and will evaluate what is going on. So, what is going on? Not much. The Conference Board’s Index of Leading Indicators rose in March after having declined the previous two months. On net, this report points to a continued expansion in the months to come, but hardly a break out into strong growth.

On the manufacturing front, the Philadelphia Federal Reserve’s survey of manufacturers took a steep dive in April. Just about every component was down sharply from its March level. Normally, that would be a warning sign that something not so great was going on in the manufacturing sector. However, that might not be the case. While current conditions cratered, optimism improved sharply. Respondents were more optimistic about future demand and as a consequence, expect to hire more people and work them longer. This improving outlook for the future seems to indicate that the current slowdown may not last long.

On the labor front, we have a totally different picture. Unemployment claims dropped to their lowest level in nearly 43 years. Adjusting for the size of the labor force, it was the lowest level ever. Firms are holding on to their workers as tightly as they ever have, a clear sign of growing labor shortages.

 MARKETS AND FED POLICY IMPLICATIONS: Yes, the economy is expanding. Yes, manufacturing seems to be lagging. But can we really say that economic activity is faltering if the labor market is still tightening? Probably not. I say probably because unemployment tends to be a lagging indicator, though more recently the length of the lag has likely shortened. The economy starts to turn before firms figure it out, both on the upside and the downside. Regardless, next week’s FOMC meeting will not be interesting as far as its outcome: There will not be any change in rates. But the statement will matter. Since there is no press conference or dot chart or forecast estimates, the parsing of the words in the statement will be all we have to go on. I don’t expect any major change from the previous statement, since the economy has not rebounded sharply enough to cause anyone to say growth is accelerating. Thus, the members could save some money by phoning it in. Okay, I am kidding. There will be some dissent as some members are still leaning toward moving sooner rather than later, but we will not know about their views until the minutes come out a three weeks later. As for the markets, today’s reports, other than the surprisingly low claims number, should not have a major impact on investor thinking. We are still in earnings season and oil and Europe and just about everything other than fundamental economic data should drive decisions.

March Existing Home Sales

KEY DATA: Sales: +5.1%; 1-Familly: +5.5%; Condo: +1.8%; Prices (Year-over-Year): +5.7%

IN A NUTSHELL: “Home sales rebounded in March, but the lack of inventory is likely to keep gains down for some time to come.”

WHAT IT MEANS: Housing is dominating the data this week and the mixed results don’t point to a vibrant market. Yesterday, we saw that housing starts were soft, which came on top of a stagnant homebuilders’ confidence. Today’s existing home sales numbers were better than expected, but really not that great. Sales rose in March quite solidly, rebounding from a down February. Single-family activity was somewhat stronger than the condo market. The increases were across the nation, with every region reported a rise in closings. Still, we are below the sales pace posted in December and January and the rise from March 2015 was a modest 1.5%. Condo sales were actually down from last March, though it is not clear why. The big problem remains the supply of homes on the market. There are only about a 4.5 months supply at the current sales pace. That is way too low. With supply low, it is not surprising that price gains remain quite strong.

MARKETS AND FED POLICY IMPLICATIONS: The housing market is doing okay, and I mean just okay. There is some hope that sales may accelerate. Demand for high-priced units was soft in March. That may reflect the uncertainty created by the stock market volatility we saw in January and early February. Since these data reflect closings, it may be a few more months before upscale demand rebounds. With the equity markets coming back nicely, an upturn in the upper end of the market is likely. Until then, we can only forecast a better market and that is something many Fed members are unwilling to bet on. As for the markets, stronger than expected economic data are usually not viewed positively by traders, and this report was a little higher than projected. But it was mixed, so I don’t expect any major reaction to these numbers, especially give it is earnings season.

March Retail Sales and Producer Prices

KEY DATA: Sales: -0.3%; Excluding Vehicles: +0.2%/ Producer Price: -0.1%; Goods: +0.2%; Services: -0.2%

IN A NUTSHELL: “The consumer seems to have decided that visits to the mall are passé.”

WHAT IT MEANS: Consumers have been the broad shoulders of the economy, but carrying the load seems to tiring them out. Retail sales faded in March, which was not a major surprise given that vehicle demand was off fairly sharply. Indeed, excluding vehicles, which were due for a slump after having been strong for so long, demand for retail products rose. Unfortunately, the gain was not very strong. The details of the report were mixed. Clothing was down but building supplies were up. Restaurant demand fell, a real eye opener since this was a leading sector, but furniture and appliances inched upward. We didn’t do a lot of online shopping but we did visit general merchandise stores. Gasoline sales jumped, but there was also a rise in gasoline prices. Basically, we bought some goods here and there but not a lot of things in general.

On the inflation front, business costs remain under control as the Producer Price Index fell in March. This was a strange report as goods prices actually rose while services costs declined. That was a reversal of past reports. The decline in services costs was pretty widespread. It is unclear why there was a sudden downdraft in services prices, so we should not take this report as an indicator that we could see weak pricing in the largest component of the economy. On the goods side, food costs decline but energy prices were up. Excluding food and energy, wholesale prices rose modestly, a sign that any further acceleration in inflation should be limited.

 MARKETS AND FED POLICY IMPLICATIONS: The first quarter of this year looks like it was a total downer. We knew business investment was going to be soft because of the continuing problems in the oil complex and that exports were likely to be modest due to the strong dollar. But there was some hope that the consumer would make up for those other sectors. Those prayers seem to have been dashed. GDP growth could come in around 1% or even less, depending on inventories. That would make it two consecutive quarters below 2%, which in itself is nothing great. So, why has the consumer left the field of battle? It isn’t because households don’t have the money to spend, they do. It’s not as if confidence is faltering, it is not. So, is this the pause that refreshes or the pause that depresses? My view is that the long, slow recovery has caused people to fundamentally change their buying habits. Is the trip to the mall really something that is high on the priority list? I am not so sure. Parents don’t have to drop their kids off at the mall to get rid of them for a few hours anymore. They just have to pay for data. And the recession taught us that the things we once thought we needed, we really didn’t need.   Consumers will continue to consume, but the rate of consumption may have shifted downward, at least for a while.

March Non-Manufacturing Activity and February Trade Deficit and Job Openings

KEY DATA: ISM (NonMan.): +1.1 points; Orders: +1.2 points /Trade Deficit: $1.2 billion wider/ Openings: -159,000; Hirings: +297,000

IN A NUTSHELL: “Politicians and market experts keep saying the economy is trouble, but the data keep telling us that is just not the case.”

WHAT IT MEANS: All portions of the economy look like they are coming back. Last Friday, the Institute for Supply Management reported that manufacturing grew solidly in March as orders surged. Today they reported that the non-manufacturing portion of the economy improved as well, also because of rising demand. Exports were solid, a story repeated in the trade data. In addition, hiring picked up, which we saw in the March employment report. Backlogs are building, though not rapidly. With orders and business activity up and order books filling, it is likely we should see solid job gains in the months to come.

As for the nation’s trade situation, there was good news and bad news in the February report. First, the deficit widened, which means more money is flowing out of the country to buy foreign products. But while imports were up, so were exports. Foreign purchases of our products are coming back. The manufacturing sector had been battered by low energy prices and the rising dollar, but at least those companies that sell their products overseas may be coming out of the dark tunnel. We sold more computer products, telecommunications equipment, engines, motor vehicles and consumer products. However, we bought lots of consumer products and capital goods. That points to improving household and business activity.

As for the labor market, there was mixed news in the February Job Openings and Labor Turnover Survey (JOLTS). This is a favorite of Chair Yellen and who knows how she will react to it as openings fell but hirings jumped. The new hires were the highest since November 2006, which is impressive. It just might be the firms have finally figured out how to fill all those open recs, which may explain the decline in openings. There was also a rebound in quits. There had been a sharp drop in January, which was strange. As it turns out, it looks like the decline was just a blip in the trend toward more people leaving their jobs to find other positions. That only happens in a solid labor market.

 MARKETS AND FED POLICY IMPLICATIONS: For the most part, today’s reports point to a domestic economy that is in good shape. First quarter growth looks like it may be a little less solid than hoped for, but the underlying data indicate all is still well. That means the battle for the hearts and minds of Fed members will continue. The Chair will continue doing all she can to rein in those who want to make moves sooner and more often than she does, while the opposition uses the latest data as ammunition to return fire. I don’t expect either side of the hike/don’t hike debate to back down until the inflation data demand that one side capitulate. With states passing increased minimum wage laws and companies raising their wages to match competitors’ moves, I just don’t understand how the compensation data have stayed so tame for so long. But I have argued that wages are set to jump for over a year now, so maybe I never will get it. Anyway, investors should see these reports as supporting the hawks at the Fed. But the markets haven’t delinked from oil, so who knows where they will go given the wishy-washy nature of the petroleum markets.

March Employment Trends and February Factory Orders

KEY DATA: Trends Index: -1.06 points; Orders: -1.7%; Durables: -3%

IN A NUTSHELL: “Job gains have been holding up but unless growth improves, the monthly payroll increases could slow as we move toward the summer.”

WHAT IT MEANS: With Fed Chair Yellen focusing more on wage pressures rather than the domestic economy, which she thinks is good, the labor market data are the ones to watch. The Conference Board’s Employment Trends Index eased in March after a smaller decline in February. The year-over-year increase has slowed markedly in the last six months and since this is a forward-looking indicator, it is pointing to slower job gains ahead. That should not come as a surprise, as the sluggish growth over the past six months didn’t put as much of a damper on hiring as would be expected. Ultimately, either growth has to accelerate or payroll increases are likely to decelerate.

One sector where jobs have been hemorrhaging is manufacturing and there still isn’t any really good news that would point to a recovery. Factory orders fell in February as durable goods demand was off even more than the preliminary estimate. Nondurable goods orders were also down, but more modestly. Most of the decline in factory orders came from slippage in two sectors, mining and aircraft. We can gloss over the aircraft cut backs, as they are hugely volatile and don’t create much near-term impacts. The oil-sector, though, continues to restrain overall economic growth.

 MARKETS AND FED POLICY IMPLICATIONS: While the Conference Board’s Employment Trends Index moderation is a warning sign that hiring could ease, it is not yet signaling a major downturn in job gains and clearly not a drop in total employment. But any easing in job creation would slow the decline in the unemployment rate, especially given the recent rise in the participation rate. That would provide Chair Yellen with more ammo as she defends her “slow as she goes” rate hike policy. But too much is being made of the monthly data on wages. They can be biased by changes in the distribution of jobs and not reflect what is actually happening. It’s simple math: If there lots of jobs being created in the relatively lower paying retail and hospitality industries but losses in the relatively higher paying manufacturing and energy sectors, the weighted average would go down – or the rise would be restrained. But that is just a distributional issue. Let’s see what other, better measures, such as the first quarter Employment Cost and the Productivity and Costs reports say when they are released at the end of the month and early May. Until then, Chair Yellen has a strong argument that wage pressures are modest and are indicating there still is slack in the labor markets, as she fights against those at the Fed who want to raise rates sooner and more rapidly than she does.

March Private Sector Jobs and Help Wanted Online

KEY DATA: ADP: 200,000/ Online Ads: -31,500

IN A NUTSHELL: “Businesses may be buying ads less but they are enjoying it more as hiring remains strong.”

WHAT IT MEANS: It’s Employment Friday week and that means the ADP estimate of private sector job gains comes out on Wednesday. Once again, the ADP report is pointing to a solid rise in nonfarm payrolls when the March numbers are released on Friday. This was as good a report as you can get as the increases were spread across all industries and firm sizes. Every sector, including manufacturing posted a decent rise in payrolls. While the industrial heartland is still feeling the pain of the strong dollar, the negative effects are dissipating and that bodes well for job gains and economic growth. Looking across firm size, there were increases in every segment. About the only soft spot was large corporate (1000 or more employees) hiring. That portion added workers, but not at as solid a pace as the small and mid-sized companies.

While hiring is strong, firms seem to be cutting back on advertising. The Conference Board’s Help Wanted Online measure fell in March. This trend has been going on, in fits and starts, since the peak last November. The weakness was not universal as ad activity rose in the West and South but fell in the Northeast and Midwest. Only 17 of the 51 metro areas posted gains.

MARKETS AND FED POLICY IMPLICATIONS: Janet Yellen is still waiting for the labor market to tighten and the rest of the world to catch up with the U.S. Yet the job market looks pretty good. The ADP report points to another job gain of about 200,000 to 225,000 in March. That is my guess and I also expect the unemployment rate to edge down to 4.8%, the Fed’s rough full-employment number. Is the moderation in want ads indicating a future softening in job gains? Not necessarily. Despite the claims that firms cannot find qualified workers, they seem to be doing so and payroll gains have been robust. Firms may simply be doing a better job of calibrating hiring activity with advertising activity. They could also be realizing that some of the open recs are not going to be filled and it doesn’t make sense to keep advertising the positions. Of course, it could be that growth has slowed and there just isn’t as much of a need for workers. I guess we will see soon enough if that is the case. As for the markets, Chair Yellen’s dovish comments yesterday were just the tonic that equity investors needed. Nothing helps equities more than a Fed Chair who is worried about the economy and wants to go slowly when it comes to raising rates. I only wish that investors would actually want strong growth and better earnings rather than just low rates, but I have been saying that for so long that even I am bored of repeating that lament. Yellen basically told the hawks that they could bleat all they want, she has no intention of raising rates in April and she is unwilling to even venture a hint at when the next move might occur. She is watching wages and the number of part-timers who want full-time jobs. I expect wage gains to reaccelerate and part-timers to fall, but I also don’t expect that Friday’s report will really make much of a difference unless it is much strong than expected. A soft report would only reinforce the view that the Fed is on hold for a while.

February Consumer Spending, Income and Pending Home Sales

KEY DATA: Consumption: +0.1%; Disposable Income: +0.2%; Prices: -0.1%; Excluding Food and Energy: +0.1%/ Pending Sales: +3.5%

IN A NUTSHELL: “Despite having the money to spend, households seem to be dispensing it using an eye-dropper.”

WHAT IT MEANS: To spend or not to spend, that is the question and it doesn’t seem that consumers are coming down on the side of spending with any gusto. Consumption rose modestly in February and the huge gain initially estimated for January disappeared into a similarly modest rise. The problem area was nondurable goods, which includes gasoline. Adjusting for inflation, spending was up more moderately, though not spectacularly. Purchases of services were strong, which is good news since that segment comprises about two-thirds of consumption. Households are not hurting for cash, though the February income report was odd. There was a very decent increase in income, adjusted for taxes and inflation. However, wages and salaries declined. That happened despite robust job gains. An exceptionally strong increase in January was probably followed by a more normal February and the seasonal adjustments didn’t like that. Don’t be surprised if wages and salaries rebound solidly in March. As for inflation, prices were tame. Excluding food and energy the increase also seemed to be modest. The core index actually rose 0.1494%, which was reported as up just 0.1%. Had it risen by another 0.0006% (six ten-thousandth of a percent), the headline would have read up 0.2%, which would have been viewed as another solid gain. Understanding the data requires a lot more than looking at the headline number. For the year, overall prices rose a modest 1% but the “core” was up 1.7%, which isn’t that far from the Fed’s 2% target.

On the housing front, the National Association of Realtors Pending Home Sales index, which reflects signed contracts, rose strongly in February. It was down in January. The Midwest led the way with the South and West also posting increases. There was a modest decline in the Northeast. Still, the minimal increase over the year points to a sluggish housing market.

MARKETS AND FED POLICY IMPLICATIONS: Recent Fed member comments are driving home the message that the U.S. economy is in decent shape but the world economy is uncertain and inflation remains too low. Today’s reports will not change that view. The Fed is in a bind. The economy is solid enough that looking at it on its own, and the trend in inflation, conditions have been largely met to raise rates further. But negative world interest rates are driving capital into the U.S., keeping mid and long-term rates down and putting upward pressure on the dollar. Increasing rates could exacerbate those trends. So what would force the Fed’s hand? Rising Inflation. Chair Yellen believes the recent acceleration in core prices was driven by temporary factors. There are two more reports before the June FOMC meeting and if her expectations were wrong, then she might have to modify her stand. As for the markets, the pathway forward is even more confusing. Investors have to consider Fed speeches, job growth, wage and price gains, the dollar, oil, world growth, terrorism and whether Villanova can actually win it all. (Okay, maybe not the last one as they can win it all.) In other words, look for choppy markets going forward.


February Consumer Prices, Housing Starts and Industrial Production

KEY DATA: CPI: -0.2%; Excluding Food and Energy: +0.3%/ Starts: +5.2%; Permits: -3.1%/ IP: -0.5%; Manufacturing +0.2%

IN A NUTSHELL: “With the manufacturing and housing sectors improving and inflation on the rise, the Fed could easily signal that rate hikes are coming, possibly sooner than most think.”

WHAT IT MEANS: It was a good day for the U.S. economic data, at least if you like growth and a continued pick up in inflation. Consumer prices fell in February. So what else is new? Well, how about the broadening of price pressures outside the energy sector? Excluding energy, prices rose solidly. The core, which also excludes food, rose by the fastest pace in nearly four years. Looking at the details, there were few categories where prices actually declined. While it was good to see that cookie prices were down, that was offset by a rise in donut costs. Oh, well. There was one major outlier that may have artificially upped the price increase: Apparel prices surged 1.6%. That makes no sense at all since most of our clothes are imported and I don’t see that kind of increase in the import price data.

On the housing front, builders look like they are getting those shovels back into the ground. Housing starts jumped in February despite a massive, likely snow-induced, 50% drop in the Northeast. The Midwest, South and West were all up solidly. There were also increases in both the single-family and multi-family segments of the market. Looking forward, permit requests did fall. However, they had been running well ahead of starts. Even after the February decline, the three-month average for permits is still above the average for construction, so I don’t look at the drop as indicating a future slowdown in activity.

Industrial production fell sharply in February. Not to worry as utility output was down big-time. That’s weather. Meanwhile, manufacturing output increased decently, adding to a strong gain posted in January. The industrial heartland is coming back and is no longer the weakest link.

 MARKETS AND FED POLICY IMPLICATIONS: While yesterday’s data came down on the side of the Fed taking the cautious route at its meeting, today’s numbers, especially the inflation report, is a warning that the days of no price pressures are behind us. The FOMC cannot slough off the idea that inflation is not an issue, despite the headline declines in the reports. There is a broadening in the price pressures and while it is not high yet, it is no longer below the Fed’s target, when you remove energy. Because of the recent drop in petroleum prices, it may take until the fall before the year-over-year energy price decline is largely wiped out. But when that happens, the overall index will also exceed the Fed’s target and the Fed members have to start planning now for that eventuality. With the Fed’s statement and Janet Yellen’s press conference coming soon, investors are likely to remain cautious. But while the Fed is likely to keep rates steady, I think the members are willing to hint that rates could be going up. Investors may not be fully prepared for that.