All posts by joel

December New Home Sales and 4th Quarter Workforce Vitality

KEY DATA: Sales: +10.8%; Year-over-Year: +14.5%; Prices (Year-over-Year): -4.3%/ Workforce Vitality (Year-over-Year): +4%

IN A NUTSHELL: “It was a great year for housing and workers didn’t do that badly either.”

WHAT IT MEANS: Looking at the two feet of snow in my backyard makes it hard to remember the December record warm weather, but today’s new home sales number brings that back into my mind. Builders ended the year on a major high as new home sales surged in December. While the wonderful conditions helped, another factor may have been at work: Consumer desires for more reasonably priced units were being matched by supply. Indeed, there was a sharp drop in median prices. The share of homes sold in the middle market, $200,000 to $500,000 jumped from 64% to 68%. In the $500,000 and up segment, the share fell from 16% to 13%. Basically, homebuyers seem to be losing a little of their desire to own the big, expensive McMansions. In December, the large increase was driven increases in all regions, though the gain in the South was modest. For all of 2015, sales were up sharply despite a double-digit drop in the Northeast. Roughly 20% increases in the South and West led the way, while new home purchases rose modestly in the Midwest.

I often note that the hourly wage data are confusing. They have not been around long enough to determine a trend. Worse, they are averages that are affected by the type of hiring that occurs. For example, a firm may be raising wages for their continuing workers but if turnover brings in new workers at lower wages, the math tells us that wages may not be rising much. So, how do we really determine what is happening? ADP’s Workforce Vitality report fills in some of the gaps. The overall index rose strongly over the year, but what was eye opening were the wage numbers. Though overall wages rose 2.1% over the year, wages for full-time workers who stayed in their positions jumped 4.1%. Full-time workers who switched positions saw their wages increase 4.7%. In other words, the headline number hides the extent to which wage pressures have built. And with the unemployment rate likely to fall to 4.5% or even lower by the end of the year, those wage pressures will only build further.

MARKETS AND FED POLICY IMPLICATIONS: The Fed is meeting today and will issue a statement soon. Those who worry about the equity markets expect the FOMC to back off their rate increase plan. But the economic data are okay. Yes, fourth quarter growth looks like it was soft, but let’s look at the composition when it comes out on Friday. Housing is solid, the consumer is buying lots of vehicles and the job market is strong. The U.S. economy is still solid and outside the energy sphere of influence, it is very good. Excluding energy, inflation is slowly accelerating even with the strong dollar. And the pressure on wages will only add to the belief that inflation will move back up to normal rates, especially when the oil price declines end. But the markets are focused on oil and to the extent that falling energy prices lead to falling stock prices, the Fed will have to decide how much the financial economy trumps the real economy. That will be true not just in today’s statement, but in comments the members will make going forward. I believe they should stay the course, but that is not a consensus view.

January Consumer Confidence, NonManufacturing Activity and November Home Prices

KEY DATA: Confidence: +1.8 points; Philadelphia Fed NonManufacturing Index: -21.6 points; Case-Shiller Home Prices (Year-over-Year): +5.3%

IN A NUTSHELL: “The stock market is falling and with it business confidence, but to households, it’s full speed ahead.”

WHAT IT MEANS: I remarked last week that Wall Street and Main Street were operating in parallel universes and nothing says that more than today’s data. The equity markets wild ride has hardly hurt consumer confidence. Actually, the Conference Board’s index rose nicely in January, led by a solid increase in expectations. I guess people have learned that markets go up, they go down and sometimes they just go. The days of the retail investor watching the indices and reacting look to be long gone. The details of the report also don’t show that the market volatility is having much of an impact, at least on households. Current conditions were flat and while jobs weren’t as easy to get, they didn’t get any harder to find. And respondents expect the labor market and business conditions to improve going forward.

While households are shrugging off the market changes, business owners are worried. The Philadelphia Fed’s index of nonmanufacturing activity in the region cratered in January. But when respondents were asked about their own business, they didn’t think conditions had declined very much. Sales, orders and hiring all were up, though at a slower pace than in December. But looking forward, business owners were really concerned. Expectations fell sharply. Let’s see: Current firm business conditions were largely stable, orders kept growing and hiring continued yet respondents became fearful. Hmm. That seems likes an emotional not a business conditions change reaction.

As for the housing market, The S&P/Case-Shiller national home price index rose solidly in November and the increase over the year accelerated. Using the seasonally adjusted data, every one of the twenty markets shown posted an increase in prices between October and November. There remain wide variations in price increases. Washington, Chicago and Cleveland were in the 2% range but Portland, San Francisco and Denver were up double-digits. Basically, the housing market, as measured by prices, is in good shape and the more prices rise, the more homeowners have the equity to make a move. That is good news.  

MARKETS AND FED POLICY IMPLICATIONS: Hey market commentators: It isn’t all about stock prices! If consumers are becoming more confident while stock prices fall, guess what will happen when they start rising again? Households aren’t worried about the labor market so they will continue to spend and in an economy that is two-thirds consumer based, it is hard to see how growth will slow significantly. The decline in the equity markets will not change Fed policy if the real economy, led by the consumer, keeps expanding. Fourth quarter growth was probably disappointing, but the largest part of the negative effects of the decline in oil prices has likely been felt already. How much more can investment be cut back when it was cut to the bone in 2015? Meanwhile, consumers are beginning to believe the low energy prices might be here for a while and they should start spending that windfall. Going forward, the positive effects of low energy costs will start overwhelming the diminishing negative effects and the economy should do just fine. Barring a meltdown in either China or the equity markets, don’t expect much change in the Fed’s rate hike strategy. I don’t.

December Consumer Prices, Housing Starts and Real Earnings

KEY DATA: CPI: -0.1%; Excluding Energy: +0.1%/ Starts: -2.5%; 1-Family: -3.3%; Permits: -3.9%; 1-Family: +1.8%/ Real Earnings: +0.1%

IN A NUTSHELL: “The restraining influence from collapsing oil prices may continue for a while, but otherwise, inflation is increasing at a moderate pace.”

WHAT IT MEANS: While the equity markets focus intently on the ever-declining price of oil, the economy continues to move forward. Indeed, though the drop in energy costs has helped households but businesses, it has not slowed the rise in inflation. Consumer prices declined in December, but excluding energy, they were up once again. Over the year, household expenses, either just excluding energy or excluding food and energy, rose pretty much at the Fed’s target of 2%. Commodity prices remain soft but services, which are over 60% of consumer costs, are still on the rise. In December, it was cheaper to buy food in the stores, but eating out continued to cost more. And in a very surprising outcome, medical commodity expenses declined while medical services costs were up minimally. Even health insurance price increases were modest, though don’t tell that to either businesses or households.

Workers hourly earnings, adjusted for inflation, rose in December, largely due to the fall in inflation. The gain over the year was somewhat less than we had been seeing.

On the housing front, new construction activity moderated in December. This was a surprise since the warm weather was expected to provide a boost to housing starts. Even the details of the report were disappointing as the only gain was in multi-family activity in the Northeast. Single-family starts were down in every region. That said, housing permit requests have been outstripping starts for the past three months. We should see a pick up in construction going forward. For all of 2015, both housing starts and permit requests surged by double-digits. That clearly indicates the housing sector ramped up activity last year.

MARKETS AND FED POLICY IMPLICATIONS: Another down day for oil, another down day for stocks. So it goes. Except in the energy and energy-associated segments, the potentially negative economic implications of the falling oil prices have yet to be seen in the general economy. Housing may not be booming, but it is doing okay. Inflation hasn’t collapsed, at least if you exclude the energy price declines. So, what are we to make of things? Clearly, the Fed has to be concerned about the extent of the drop in equity prices. But the members have to separate the impacts that are related to sectoral or largely foreign issues from fundamental domestic growth concerns. The simple fact is that non-energy inflation is at the Fed’s target rate when you look at the Consumer Price Index. Also, the rate has been rising for the past year, during which oil prices have been cratering. The Fed’s preferred measure, the Personal Consumption Expenditure Index, is still running a below target, though. Until that changes – and the craziness in the oil market settles down – the members will continue to worry about inflation and growth. Still, though today’s reports don’t tell us the economy is booming along, they support the view that conditions are still good and inflation is not falling. That should put things in perspective, even if the equity markets’ wild mouse ride continues.

December Import and Export Prices and Weekly Jobless Claims

KEY DATA: Imports: -1.2%; Nonfuel: -0.3%; Exports: -1.1%; Farm: -1%/ Claims: +7,000

IN A NUTSHELL: “Falling energy costs and the rising dollar are combining to keep the prices of imported goods and overall inflation down.”

WHAT IT MEANS: So much for inflation. The cost of imported goods fell again and declined even when fuel was excluded. Indeed, the nonfuel index has been either flat or down for the past seventeen months. Searching the details, it was hard to find any major or even sub-category that was up. Fish and beverages were about it. Since December 2014, nonfuel import prices have dropped 3.4%, while fuel is off a whopping 40.5%.

On the labor market front, unemployment claims rose last week, but the government has had trouble seasonably adjusting the weekly data early in the year. Regardless, the level, especially when using the smoothed, 4-week moving average, is still quite low, pointing to further tightening in the market.

MARKETS AND FED POLICY IMPLICATIONS: I guess if you do things long enough, you get to see just about everything. That is the case with inflation. It is amazing that I am sitting here writing about inflation being too low in the United States. But there it is. Clearly, part of the problem is the war going on in the energy sector, where the Saudi’s are trying to drive out U.S. competitors by keeping the production tap wide open and prices way down. That has not worked particularly well for the producers, but it has saved consumers hundreds of billions of dollars. That money is being used to bolster household and business balance sheets and is adding to demand for all types of products. But it has also caused energy-related companies to slash spending on just about everything. The net result has been lower prices and slower growth. The teensy weensy step the Fed took to raise rates, coupled with the U.S. economy being the strongest in the industrialized world, have led to a rising dollar that is also keeping prices down. That would not be a worry unless the price declines become entrenched in the system and inflation expectations fall. Reasonably well-anchored expectations have been the Fed’s security blanket, so any movement downward on perceptions would create concerns. A couple of months ago, before the latest down draft in oil prices, I commented that the inflation rate could move back toward the Fed’s target early this year. I was expecting oil prices to slowly filter upward, not crash and burn. That is likely what many Fed members projected as well. But now we have to wonder when energy prices will turn up. Until they do, the Fed will not have the comfort of accelerating inflation to go along with a tightening labor market. That could cause the members to become even more cautious. I still have a March hike in my forecast, but further declines in prices could push back the next increase.

December Employment Report

KEY DATA: Payrolls: +292,000; Revisions: +50,000; Unemployment Rate: 5.0% (unchanged); Hourly Wages: -$0.01

IN A NUTSHELL: “With firms hiring like crazy, it is hard to believe the economy is not also growing solidly.”

WHAT IT MEANS: Wow! That is best word to describe the job growth during the last few months of the year. In December, the gain was huge, but it didn’t even match the 307,000 new positions added in October. Over the past three months, an average of 284,000 jobs were created. For the year, total payrolls rose by 2.65 million, the second best increase in the last fifteen years. Only last year’s 3.1 million gain was greater. In December, the hiring was widespread. Construction was up sharply, though warm weather probably hyped the increase a bit.   Manufacturers added workers, though there were cut backs in machinery and strangely, motor vehicles. We set a record for vehicle sales in 2015 so it is doubtful the cut backs were demand related. And, of course, the oil patch continued to shrink. It is amazing that we had such strong growth overall despite a huge 130,000 decline in mining. Where there was real strength in December and for most of 2015, was the services sector. Health care is booming again, restaurants are adding workers like crazy, professional and business services, especially temp help firms, are bulking up, financial firms are feeling good enough to expand and transportation firms are moving in a lot of new people. Interestingly, the large overall increase was not the result of holiday hiring as retail and wholesale were up modestly.

As for the unemployment rate, it was stuck on 5.0% for the third consecutive month. The labor force grew strongly and that caused the participation rate to rise. The labor force participation rate has basically stabilized, declining an insignificant 0.1 percentage point over the year. I think it is time to put that made up problem to bed. For the year, the number of people unemployed fell sharply and we are back to April 2008 levels.

There was one very disappointing number in the report, though. The average hourly wage fell a penny, which was a major surprise. It is hard to see how the labor market can be this strong without wages increasing consistently, but that is what the Bureau of Labor Statistics is claiming. Over the year, wages are up a 2.5%. While that is a solid acceleration from the 1.8% increase posted last December, it is still less than hoped for.

MARKETS AND FED POLICY IMPLICATIONS: This was a strong report, though without any wage increase, it was not as great as it could have been. Still, it clearly shows that the domestic economy is in very good shape. The report should buoy investors’ confidence, which has been battered by the China Syndrome fears. Since the U.S. economy is not greatly dependent on exports to China, it should continue to do well. Where problems arise is for those companies dependent on China for sales and especially earnings. But that is an equity market problem for some firms, not a fundamental economic issue for the U.S. economy. Therefore, while the Fed may worry about China, the strong U.S. economy is what should determine future policy. Indeed, without the China overhang, this report would likely have cemented a March rate hike, which I still believe will happen. The Chinese situation shows how the Fed has left itself without any policy options. Right now, because rates are so low and the Fed has been so cautious in raising rates, the only policy option available is to not raise rates further! What can the Fed do if China is in real trouble? More QE? Enough said.

December ADP Jobs, ISM NonManufacturing Activity, Help Wanted Online and November Trade Deficit

KEY DATA: ADP Jobs: +257,000/ ISM (NonManufacturing): -0.6 point/ HWOL: -276,800/ Trade Deficit: down $2.2 billion

IN A NUTSHELL: “The markets may be worrying about China but investors have little cause to be concerned about the U.S. economy.”

WHAT IT MEANS: Tons of data were released today and they generally told a similar story: The U.S economy is just fine. Since on Friday we get the “all-important” jobs report, we should probably start with some estimates of what that number may look like. If ADP is anywhere close to the government’s number, the December jobs report be really good. The payroll services firm’s estimates of private sector growth have trended over time with the BLS data, but have been off quite a bit on a monthly basis. Regardless, the payroll gains were spread reasonably evenly across all sizes of companies. It was good to see large firms hiring again. This component had been pretty moribund during most of 2015. There was a surge in construction, but that may have been the result of the unseasonably warm weather.

Most people concentrate on manufacturing, but the real action is in the services sector, which is the biggest portion of the economy. Watching what happens there is critical to understanding the direction of the economy. The Institute for Supply Management’s December Non-Manufacturing Index declined to its lowest level in twenty months, but the details tell a different story. The measure of activity and production rose, as new orders, especially exports, grew faster and firms increased hiring. Firms got their products out the door faster and that drove down the index. In other words, the largest portion of the economy is doing just fine.

As for hiring, The Conference Board’s measure of help wanted online ads fell sharply in December. The data are volatile and smoothing them out, the trend is still up. Still, firms seem to have become a little more cautious as the number of new ads has pretty much stabilized.

On the trade front, the deficit shrank in November as both exports and imports fell. Interestingly, oil imports soared. Imports of cell phones fell by nearly 20%, but they have been bouncing around like crazy. On the export side, we sold less of most products except aircraft. Still, it looks like the trade deficit could narrow in the fourth quarter, boosting growth.

MARKETS AND FED POLICY IMPLICATIONS: Today’s data may not have been uniformly strong, but they do point to a very solid economy. That seems to matter little to investors as worries about China and Korea and oil prices are overwhelming indications that the domestic economy is growing at a pace that will allow the unemployment rate to keep falling, and labor shortages to continue expanding. A year from now, the unemployment rate should be at or more likely below 4.5% and many parts of the country will be dealing with rates below 3%. A year ago I expected that 2015 would be the year of “take this job and shove it”. I was a year early. Turnover rates in some industries are rising already and should be increasing across most industries and occupations by the summer. Firms will have to make decisions about how to deal with increasing demand and a shrinking employment pool. That is the issue on which most U.S. firms should focus, not a slowing China or low energy prices.

December Supply Managers’ Survey and November Construction

KEY DATA: ISM (Manufacturing): -0.4 point: Orders: +0.3 point; Employment: -3.2 points/ Construction: -0.4%; Private: -0.2%

IN A NUTSHELL: “The manufacturing sector continues to wander aimlessly and firms have slowed hiring as a result.”

WHAT IT MEANS: The first major number of the year, the Institute for Supply Management’s Manufacturing Index, fell in December. The sluggish industrial portion of the economy remains just that – sluggish. Actually, activity contracted for the second consecutive month and that is causing firms to rethink their hiring practices. Employment declined for the second time in three months. If there was any good news in this report, and there wasn’t much, it was that the drop in new orders decelerated and the production reduction that we saw in November largely disappeared. That does not mean the sector is positioned to start growing strongly, but maybe it can get back to a slow expansion.

Construction activity fell in November, the first decrease since June 2014. But the data were far from showing a major problem in this sector. The residential component rose decently but commercial building was off sharply. The public sector didn’t help at all. The federal government decided not to spend very much at all and state and local governments slowed their construction activity as well. Government construction spending can be very volatile, especially in these days of tight budgets. Even with the November decline, total construction was still up a strong 10.5% over November 2014 levels and private activity soared a robust 12.1%.

MARKETS AND FED POLICY IMPLICATIONS: Today’s economic data, even if they were strong, would likely have done little to take investors minds off of the economic issues in China. Having soft numbers, though, didn’t help. Still, the market reaction to weak Chinese economic data, while not a surprise, is hardly comforting. I don’t know how many times I have noted that if anyone believes the Chinese data, I have a bridge I am willing to sell them. While our economic numbers bounce around like crazy, theirs move in steady patterns. Does anyone think that China has smooth changes in their economic performance on a monthly or even yearly basis? I have frequently noted that the markets might be efficient, but not necessarily rational. That has drawn a lot of criticism from fellow economists. Well, the data are disseminated rapidly and effectively, but garbage in gets you garbage out. The Chinese economy has been slowing and will likely continue to do so as it transforms into a more consumer-dependent economy. Just as it is wrong to say that lower energy prices is bad for the U.S. economy in the long run because in the short run, the energy companies adjust faster than consumers, it is wrong to argue that the transformation in China implies major problems for the country because exporters are forced to adjust faster than consumers can make up for the decline. Assuming that a group of central planners can manage the transition seamlessly was not rational, which is why I have my view of the rational nature of investment activity. The Chinese economy will be fine, just not right away.

November Leading Indicators, December Philadelphia Fed’s Manufacturing Survey and Weekly Jobless Claims

KEY DATA: LEI: +0.4%/ Phila. Fed: -7.8 points/ Claims: down 11,000

IN A NUTSHELL: “Except for the manufacturing sector, the economy is in good shape, but that is a significant but.”

WHAT IT MEANS: With the rate hike behind us, it is time to start focusing on the economy and inflation. Inflation outside the energy sector is slowly accelerating, a reality the Fed has accepted, if not embraced. It gives them some breathing room to move gradually. But as long as that acceleration continues, the rate hikes will follow. As for the economy, its strength will ultimately determine how fast labor shortages appear, wages rise and firms are forced to start raising prices. The Conference Board’s Leading Economic Index is pointing to very solid growth ahead. After jumping in October, it rose strongly in November. These back-to-back large gains are hinting that growth should accelerate going forward. I hope so, since my forecast has that. Current conditions are not that strong and that supports most economists’ views that fourth quarter growth will be good but not great.

The one sector that has been under pressure lately is manufacturing and that softness doesn’t look like it is going away. The Philadelphia Federal Reserve’s December Manufacturing Index plunged into negative territory after having crawled out of the red in November. Falling orders, shrinking backlogs and declining prices don’t indicate any strength in this sector. Interestingly, though, hiring and the workweek picked up. That seems to show that the slowdown may be viewed as temporary. The labor numbers need to be watched carefully as I believe that will be the source of cost pressures and ultimately price pressures. There were questions asked about 2016 cost projections and the respondents expect wages and benefits to rise by about 3.5%. Those that expect costs to rise faster next year and those that expect them to rise at the same pace they did this year were evenly split. Very few firms expect labor costs to rise slower in 2016.

Speaking of the labor markets, weekly unemployment claims dropped back to what is now the “usual” level last week. Of course usual is not normal as the level is consistent with further tightening in what is already a tight labor market.

MARKETS AND FED POLICY IMPLICATIONS: The Fed cleared easily the first hurdle in the process of moving back toward normal interest rates. The pathway, however, is hardly clear. The members, in their forecasts, point to moves every other meeting. The markets don’t quite agree and think there will be fewer increases. I don’t agree either, but I think there will be five, not four increases. The key, as I mentioned in my commentary yesterday, is inflation. Through most of 2015, the year-over-decline in oil prices had hovered between 40% and 50% down. Before the latest downdraft in prices, I had expected those drops to largely disappear in the first quarter of next year and the top line inflation number to move above 2%. If we stay below $40/barrel, that will take longer. I expect the core rate to hit 2% by the fall part and stay there. So, will the Fed worry about oil? Probably not. But what may concern them is the downward pressure created by declining import prices. If the dollar keeps strengthening, it will take even longer for the headline inflation number to get to 2%. That said, I would be surprised if it didn’t happen during the second half of 2016, which is why I have five moves next year.

December 15-16 ‘15 FOMC Meeting

In a Nutshell: “That’s one small step for the Fed, one giant move toward normal financial markets.”

Rate Decision: Fed funds rate range increased to between 0.25% and 0.50%

Well, they finally did it. After hinting and backing off, The FOMC raised the fed funds target range by one-quarter percent. This is the first move of any type since December 16, 2008, when the 0% lower bound was hit, and the first increase since June 26, 2006, when the 25 basis point increase brought the rate to 5.25%. In between we had the housing bubble bursting, the financial system in near collapse and a recovery that is still scarred by the excesses of the last decade.

Very simply, it is good to get this finally out of the way. History will determine whether this was the right time to make a move, but it had to be made and in my mind, this was as good a time as any. Actually, I think if they had gone in June or September, that would have been fine as well, but I don’t want to be critical – at least not right now.

Most importantly, we can now focus on the next stage of the move back to normal bond and stock markets. There are lots of additional actions that must to be taken: We need a funds rate that reflects normal conditions, the Fed’s balance sheet needs to be shrunk and assets need to be shed, and the markets’ obsession with Fed future actions, or lack thereof, must be reduced.

So, where do we go from here? There is little doubt that “the data” will drive Fed decisions – they just keep telling us that. So let’s project out one year from now. The unemployment rate is likely to be at or even below 4.5% and labor shortages will be common, wages will probably be rising at a solid pace, the restraining impacts of declining energy costs should be behind us and businesses will be needing to make up for lost ground due to all the uncertainties they have faced. In addition, Europe will have another year of quantitative easing and China will be another year into its transition to a more balanced, consumer-driven economy. In other words, the economic environment is setting up for a very solid 2016 that should support moves at roughly every other meeting to begin with but maybe more frequently by the end of next year.

But reading the Fed’s statement, while the members seem to be comfortable with current and future economic conditions, there appears to be some unease about the inflation prospects. The Committee mentioned that some surveys indicate that inflation expectations have “edged down” and there was an added statement that inflation would be monitored closely. Since inflation is still an outlier, the pace of future hikes may be linked more to progress on reaching the Fed’s 2% inflation target than on the strength of economic growth. The problem, of course, is that inflation tends to be a lagging indicator. As economists used to note, “If the Fed waits until it sees the whites of inflation’s eyes, it has waited too long”.   It is not clear what the Fed will use as a leading indicator of inflation.

Looking longer-term, since the Fed has to get to a “neutral” funds rate before inflation heats up, and that rate is assumed to be about 3.5%, the FOMC has a lot of work to do. Unless the economy slows, energy prices keep falling and the dollar keeps rising, it is doubtful it will take three years to get there.

Finally, unless we have a perfect economy and inflation stabilizes close to the Fed’s 2% target, the FOMC will not stop at neutral. It hasn’t in the past and there is little reason to believe it will now. So when you start thinking about the terminal rate, it is prudent to assume that it is above the 3.4% long-term rate the members indicated in their “dot chart”. Don’t be surprised if we get to 4.00%. But for the next nine to twelve months, expect only gradual increases in rates.

(The next FOMC meeting is January 26-27, 2016.)

November Consumer Prices and Real Earnings

KEY DATA: CPI: 0%; Excluding Food and Energy: +0.2%; Excluding Energy: +0.1%/ Real Earnings: +0.1%

IN A NUTSHELL: “The steady rise back to normal inflation continues, adding ammunition to the Fed’s view that it is just a matter of time before its target is reached.”

WHAT IT MEANS: Inflation remains the one issue, or non-issue, when it comes to raising interest rates. But that concern is starting to fade, at least when you take out energy. Consumer prices were flat in November, led by another decline in gasoline costs. That downward pressure on the index by energy is continuing, though it is hardly clear that lower energy costs are a problem. Yes, they hurt the energy sector and all the companies that feed into it, but over time, the economy will be better off with the lower energy costs. Sometimes it just takes some pain to get some real gain. Excluding energy, consumer prices were up minimally. But more importantly, over the year, they are right at the Fed’s 2% target. However, all prices, including volatile food and energy, have risen only modestly since November 2014. While commodity prices keep falling, services, which are 63% of the index, keep accelerating. They rose solidly in November and are up by 2.5% over the year. It is unclear how much further energy prices will fall and if or when they will start to rise again, but the huge declines we saw in 2015 will dissipate as we go through 2016. And when that happens, even the headline number will move back toward and likely above the Fed’s target.

Wage gains seem to have eased once again. Hourly earnings increased moderately in November but when inflation is factored in, the gain was modest. We may still be a few months away from when firms feel so stressed by the lack of available workers that they actually have to start paying for new employees. But unless the law of supply and demand in the labor market has been repealed, the lack of workers and the growing number of job openings will have to lead to rising costs – no matter how hard and long businesses fight it.

MARKETS AND FED POLICY IMPLICATIONS: The FOMC meeting starts today and will likely end with tomorrow’s announcement that for the first time since June 29, 2006, the fed funds rate has been increased. The consumer price data only add to the confidence of those at the Fed who believe it is prudent to start the process of raising rates back toward more normal levels. The Fed has a lot of work to do. We are at least three percentage points below where we should be if the economy was growing solidly and inflation was at a reasonable level. The modest inflation pressures allow the Fed to move back to where they should be at a conservative pace. But with inflation, excluding energy, at the Fed’s target and with the annual declines fading, any price pressure that rising wages may create would move the inflation rate above target. Don’t be surprised if that happens sometime during the first half of next year. The Fed will argue that it will stop, look and listen before crossing the street to the next move, but that is likely to happen in March and every other FOMC meeting until late fall. Regardless, we are just one day away so let’s just sit back and wait.