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August Consumption, Income and Pending Home Sales

KEY DATA: Consumption: +0.4%; Disposable Income: +0.4%; Prices: 0%; Excluding Food and Energy: 0.1%/ Pending Sales: -1.4%

IN A NUTSHELL: “Consumers are spending their growing incomes and that should help the confused members of the Fed make up their minds about raising rates.”

WHAT IT MEANS: If the Fed members need data that show the economy is in good shape, all they have to do is look at the consumer spending and income numbers. Consumption jumped in August after rising solidly in July, indicating the households are out there doing their part to make sure that the economy is strong. We knew that vehicles were flying out of showrooms, but people also spent heavily on nondurable goods and services. Services, which are two-thirds of spending, had been lagging until this year and the rise we have seen continues unabated. So far this quarter, adjusting for inflation, consumption is growing at a very respectable 3% pace. Can this pace be sustained? Given the income numbers, absolutely. Disposable income, which is what we actually have to spend, not what we earn, rose strongly for the fifth consecutive month. Even adjusting for inflation, household earnings are rising solidly. The key has been a rebound in wages and salaries. They are now growing decently and given largely nonexistent inflation, consumer spending power is up a robust 3.7% since August 2014.

On the housing front, the National Association of Realtors reported that pending home sales fell in August, which was unexpected. Only in the West did contract signings rise. Demand is up solidly over they year, but the rate of increase is slowing, in part because of higher prices but also because there is not much inventory to choose from. Black Knight Financial reported that their National Home Price Index rose moderately in July and is up 5.3% over the year. The Index is only 5.5% below the peak reached during the housing bubble.

MARKETS AND FED POLICY IMPLICATIONS: Fed members, including Chair Yellen and NY Fed President Dudley, are trying to ease the confusion created after the last FOMC meeting. While that may have be an heroic task given the Tower of Babble that the Fed has become, today’s talk by Mr. Dudley did reinforce Chair Yellen’s Thursday’s comments that the suddenly critical international events were really not that important, so never mind. Mr. Dudley also reiterated that he thought rates would rise this year and inflation could actually reach the Fed’s 2% target next year. This is the person who warned that a rate hike was “less compelling” just before the last meeting, so listen carefully to his words. The Fed members, at least those in favor of raising rates soon, look like they got the message to talk with a unified voice. That voice says rates will be increased this year, so maybe we should believe them. Maybe. Clearly, the U.S. economy is growing solidly and if you believe the Blue Chip Forecasters panel, of which I am a part, we should get above-trend growth once again in the third quarter as well as next year. Panelists also expect inflation to exceed 2% soon. Conditions are either already in place, or are expected to be in place in the foreseeable future, for the Fed’s growth and inflation targets to be met. Whether the members act or not this year, though, remains anyone’s guess.

Revised Second Quarter GDP, September Consumer Confidence and Fed Chair Yellen’s Comments

KEY DATA: GDP: +3.9% (from 3.7%)/ Confidence: down 4.7 points

IN A NUTSHELL: “With the economy in good shape, Chair Yellen’s strong hints that hike this year is likely have to be heeded.”

WHAT IT MEANS: Second quarter GDP was revised up again. Consumers spent even more than thought and business construction was actually decent. On the other hand, the inventory build was a little less. There was also an upward revision to profits, which grew a little faster than initial estimated. Overall, this report reminds us that the U.S. Economy is in good shape.

Consumer confidence faded in September as the University of Michigan’s Consumer sentiment index fell fairly solidly. However, this was likely due to the wild volatility in the equity markets early in the month. Indeed, confidence rose from the mid-month reading.

Chair Yellen’s Comments and Fed Policy: Last night, Fed Chair Yellen gave a speech that should be reviewed closely. Yes, she reiterated a lot of what had been said, but there were some clear messages that she was sending. First, She once again stated that she and most other Fed members expect to raise rates this year. As today’s data show, the economy can absorb a rate hike. As for the Chinese wrench that was thrown into the rate hike gears, she noted that “we do not currently anticipate that the effects of these recent developments on the U.S. economy will prove to be large enough to have a significant effect on the path for policy.” In other words, never mind. On the inflation front, she is sticking to her view that “inflation will return to 2 percent over the next few years as the temporary factors that are currently weighing on inflation wane”. We now know that the “medium term”, the phrase used in the FOMC statements, refers to a “few years”.   As for those who argue we should wait until all the uncertainties have dissipated, she noted that “monetary policy affects real activity and inflation with a substantial lag. If the FOMC were to delay the start of the policy normalization process for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession.”   Finally, she quashed the “one and done” rate hike theory when she noted that after the first increase, there would be a “gradual pace of tightening thereafter.” The Fed is not going to simply stop, look and listen. Once started, the members expect to move in a restrained, but consistent pattern.

With only two meetings left before the end of the year, October 27-28 and December 15-16, it seems that it will take disappointing data to prevent a rate hike. If by December, the unemployment rate is at or below 5% (not a heroic assumption since it is currently 5.1%), job gains are strong enough to point to further unemployment rate declines and there are indications that wage inflation is accelerating even modestly, the FOMC should finally pull the trigger. With only one employment report and no Employment Cost Index number before the October meeting, it looks like December 16 could be H-Day, the day the long-awaited hike occurs.

August Existing Home Sales

KEY DATA: Sales: -4.8%; Prices (Year-over-Year): +4.7%

IN A NUTSHELL: “Home sales are still solid, even if they did come off their 8½ year high.”

WHAT IT MEANS: The housing market is being watched closely as it has been a key driver of growth and we know that the Fed is locked into the domestic economy. Okay, I will stop being snarky about the Fed. No, I will not! Anyway, the National Association of Realtors reported that existing home sales dropped more than expected in August. After having reached in July a level not seen since February 2007, a slight come down was forecast, and we got it. Still, let’s not get carried away here. This was the third year in a row that sales fell in August. Is there a seasonal adjustment issue here? Probably not, but it is worth noting. If you chart the monthly difference in existing home sales, there do not appear to be any trends you can find on a monthly basis. Looking at the details, sales were down sharply in the South and West, they fell relatively modestly in the Midwest and were flat in the Northeast. On the costs side, prices rose moderately, but the gain over the year was the smallest in a year. The South and the West continue to post price increases of 6% or more, the Midwest was up 4% while there was a modest 2.4% rise in the Northeast. As for inventories, they rose from July’s level but were still down over the year. The supply of homes remains fairly low.

MARKETS AND FED POLICY IMPLICATIONS: The world is trying to figure out what the FOMC members were thinking when they met last week and decided not to raise rates. Some of the Fed members were out trying to provide some perspective. St. Louis Fed President Bullard, who didn’t vote, said he would have dissented as he is in favor of raising rates, while San Francisco Fed President Williams, who voted, said the decision was close. Chair Yellen speaks on Thursday at UMass Amherst on “Inflation Dynamics and Monetary Policy” and hopefully that will provide some perspective on what she is looking at. We will likely get a lot more comments over the next couple of weeks. But it is still unclear what the key factors are that will shift the close decision from no move to let’s get going, so we really need to wait and listen to the comments from more of the Fed membership. As for the markets, the housing report may be viewed as negative, but I think we can dismiss the decline as being a normal down after several ups. Also, third quarter sales are averaging 2.8% above the second quarter and that translates into a nearly 12% annualized quarterly increase. And that is happening despite the relative dearth of homes on the market. It is likely supply, not demand, that is creating the slowdown in sales, as buyers cannot find that “perfect” home. Fed member comments, economic issues around the world and trends in oil prices will likely overwhelm the economic numbers this week. Next week we get consumer spending on Monday and the September jobs report on Friday, at which point we can start thinking about the domestic economy again.

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.