KEY DATA: CPI: +0.4%; Less Food and Energy: +0.2%/ Starts: +6.6%; Permits: +3.6%/ IP: +0.7%; Manufacturing: +0.3%
IN A NUTSHELL: “With inflation accelerating slowly, housing rebounding slowly and manufacturing activity improving slowly, it is clear the economy is picking up steam slowly.”
WHAT IT MEANS: The Fed’s dual mandate means it has to target maximum employment at stable prices i.e., an unemployment rate in the 4.75% to 5% range and inflation at about 2%. We have pretty much been at the full employment target for several months and now inflation is making its way to the 2% rate. Consumer prices rose sharply in April led by a jump in energy costs. With oil prices steadily increasing, we should be in for some additional solid gains for a while. The rise in inflation was not just gasoline. Prices for food, medical care, shelter and transportation services rose as well. There were also a number of categories, though, where costs did decline, such as clothing, vehicles and, most importantly, cupcakes. In other words, there is an upward trend in inflation, but it is not across all categories.
On the housing front, conditions did improve nicely in April. Housing starts surged and permit requests rose solidly. But the level of construction is still well below the recent peak recorded in June 2015. Strangely, the problem has been in multi-family activity. With the rental market so strong, it was expected this segment would lead the way – and it did in April. But for the first four months of the year, multi-family starts were below the same period last year. And that was true for permit requests, so this segment seems to have stalled a bit. Looking forward, starts exceeded permits for the past three months, so don’t expect any major acceleration in building.
Manufacturing production rebounded in April as well, but the story is the same here. We get one negative month, one flat month and one positive month, and the cycle repeats. This sector is not showing a major upturn, though it does look like the declines could be over. The summer driving season is projected to be really strong and that could lead to additional output of gasoline. As for energy production, prices probably need to rise a little more before wells start coming back on line, but maybe the shut downs will cease.
MARKETS AND FED POLICY IMPLICATIONS: Inflation is accelerating, but not at a rapid rate. Over the year, headline consumer costs were up 1.1%, which is still below target. However, one year ago, prices were falling. Excluding energy, though, prices were up 2%. At current levels, energy turns positive in September and the yearly rise accelerates for six months. In other words, by the fall, even the headline number should be above the Fed’s target. Excluding food and energy, the more common comparison, prices were up 2.1% over the year, marking the six consecutive months that core consumer inflation was at or above the Fed’s 2% goal. In other words, the Fed’s dual mandate is within its grasp. But Fed Chair Yellen is likely to hang on to the mediocre growth in housing and manufacturing to argue that a rate hike is not yet needed. And given that real earnings actually declined in April, as prices rose faster than wages, she can also say that wage pressures are not yet critical. So, these reports may hint that the Fed will have to do something in a few months, but the data don’t require that a rate hike occur in June.