KEY DATA: ISM (Manufacturing): -0.4 points; Orders: -2.7 points; Employment: +0.8 points/ Construction: -0.8%; Private: -0.7%; Residential: -0.6%

IN A NUTSHELL:  “The manufacturing slowdown continues and it is being mirrored by moderating construction activity.”

WHAT IT MEANS:  The trade battles are supposed to create a more level playing field for manufacturers and lead to a faster growing sector, but for now, the opposite is occurring.  Manufacturing activity continues to fade.  The Institute for Supply Management’s Manufacturing index eased again in June, dropping to its lowest level since October 2016.  That is not to say the sector is not expanding, it is, but the pace has decelerated fairly consistently over the past year.  In June, the decline was led by faltering orders, which were flat.  This was the first time in nearly 3½ years that demand was not expanding.  With output increasing faster, order books continued to shrink, which is not good news for future production.  There was one good number in the report: Employment expanded faster.  Manufacturing payrolls may not restrain job gains in Friday’s June employment report, though I still think we could see a negative manufacturing number.

Construction, the other major non-service sector, also looks to be weakening.  Activity dropped in May as both public and private sector and the softness was pretty much across the board.  Both residential and nonresidential spending were down.  Compared to May 2018 levels, private sector construction activity dropped over 6% as residential fell by double-digits.  Non-residential was off minimally.  MARKETS AND FED POLICY IMPLICATIONS:Now that we have cease-fire in the U.S./China trade war – which should have surprised approximately no one – it is time to focus on the economic fundamentals.  Well, maybe we shouldn’t.  There have not been a whole lot of good reports recently and today’s numbers continue to paint a picture of an economy continuing to moderate. Manufacturing has been battered by the trade war fears and the weekend’s news wasn’t particularly helpful.  The reality is that nothing changed other than the hope that additional tariffs will not be put in place in the near term.  The Chinese got what they wanted and the U.S. put off imposing tariffs that could drive the economy into recession.  I guess you can say that is good but future tariffs have not been ruled out and thus there really is no reason for anyone to feel that this situation is close to being resolved.  It was said that an agreement was 90% complete, which is downright scary.  Anyone who has been involved with major negotiations knows that the last few percentage points are the toughest ones and ten percent is a large number.  So, don’t expect an agreement anytime soon, which means that ultimately, the threats of new tariffs will likely rear their ugly heads.  As for the Fed, the focus is on Friday’s jobs report (yes, there is a jobs report on Friday!), which should be decent but hardly great.  I categorize 150,000-175,000 as decent.  Don’t be surprised if the unemployment ticks up.  Until we get that number, even with additional data being released before then, the best thing that can be said is that the economy is expanding, but at a more trend-like manner, which is somewhere in the 2% range. 

KEY DATA: Consumption: +0.4%; Income: +0.5%; Prices: +0.2%; Ex-Food and Energy: +0.2%/ Sentiment: -1.8 points

IN A NUTSHELL:  “Decent income gains are supporting continued consumer spending, but weakness in wage increases remains a threat to growth.”

WHAT IT MEANS:  Until the trade wars are resolved, businesses will remain under pressure, so we have to look at consumers to keep things going.  And it looks like that is happening.  Household spending jumped in May, led by a surge in vehicle sales.  Services demand also was up solidly, which overcame weakness in soft goods purchases.  Still, the increase in spending, when added to the rise in April, means that second quarter consumption should be solid if not strong.  Of course, that depends upon June vehicle sales and we will not know them until next week.  Can households continue to spend?  That is a good question.  On the surface, the answer is yes, as disposable (after tax) income rose strongly.  But wage and salary gains were tepid, at best.  Workers did not see a whole lot of increase in their paychecks and that is worrisome.  Proprietors’ income jumped and interest payments surged (don’t ask me why, I have no idea), creating the strong income increase.  The savings rate was up again, possibly indicating that households are becoming more conservative in their spending patterns.  As for inflation, it rose moderately even when the volatile food and energy components (the core rate) were removed.  Over the year, price gains remain below the Fed’s 2% target.

Consumer confidence continues to fade, but by no means can it be said that people are depressed.  The University of Michigan’s Consumer Sentiment Index eased in June less than expected.  The overall measure remains quite high as do the current conditions and expectations indices.  The report noted that: “June’s small overall decline was entirely due to households with incomes in the top third of the distribution, who more frequently mentioned the negative impact of tariffs”.  That is not likely to lead to much of a change in overall spending.MARKETS AND FED POLICY IMPLICATIONS:We are on Fed Watch.  Will the FOMC cut rates at the next meeting, that end July 31st?   The markets still seem totally convinced that it will happen, but I am not.  Consumer spending is holding up and that means second quarter growth could come in at around 2%.  The Fed raised rates when the economy was expanding not much more than 2%, so why should 2% growth require a rate cut?  Keep in mind, most economists believed and still do that 3% growth is not sustainable and we would ease back to trend, which is in the 2% range.  As for inflation, which seems to worry the Fed as much or more than growth, it too is not really falling apart.  On a quarter-over-quarter annualized basis, top line inflation is running at a 2.3% annualized pace while core inflation is more muted, at 1.7%.  While the year-over-year numbers are both below 2%, the Fed should also be looking at the recent pattern.  If the quarter-over-quarter rates are near the Fed’s target, wouldn’t it be reasonable to remain patient and see what happens?  Growth around 2% and inflation just below 2% are not data points that demand a rate cut.  If we get one, my conclusion would be that it’s the equity markets that matter the most right now.  That would imply the Fed has a triple mandate that includes maximizing equity values, not just maximizing employment and stabilizing inflation.  Ugh!

KEY DATA: Starts: -0.9%; 1- Family: -6.4%; Permits: +0.3%; 1-Family: +3.7%

IN A NUTSHELL:  “Housing continues to wander along, not doing much better but not weakening a whole lot.”

WHAT IT MEANS:  If the housing sector was the canary in the mine, it would not be falling over nor would it be singing away.  It would just be sitting there.  Housing starts faded a touch in May, led by a sharp decline in the key single-family segment.  Multi-family activity was up double-digits, but not enough to stop the bleeding.  Three of the four regions posted declines, with only the South keeping things from looking really ugly.  On the other hand, permit requests rose a touch.  Single-family permit demand increased, but that may have due to an unusually low April level.  The May number was similar to what we saw during the first three months of the year.  Permit requests are still running above actual starts, so there is some room for construction activity to improve.  The backlog of homes to be built is thinning as the number of homes permitted but not started is falling.  If construction increases, the rise should not be that great.

Supporting the view that housing has likely entered a stable stage was yesterday’s National Association of Home Builders Housing Market Index report.  The overall index eased as all three components – present and future conditions and traffic – were down.  The Northeast and West were off sharply, but there was a rise in the Midwest and the South was flat.

MARKETS AND FED POLICY IMPLICATIONS:  As the data for this quarter mount, it appears that growth will be somewhere in the 2% range.  I have it a little lower, but given the wild revisions in the retail sales data, it is hard to know what consumers are thinking.  If the housing numbers are an indirect way of looking at household exuberance, it looks like they are shopping but not dropping.  And that may not be bad.  We have had three consecutive quarters of growth that was above sustainable levels, so if we have a fourth one that is pretty much at trend, it would be hard to say the economy is weakening.  There is a big difference between a soft economy and one that is easing back to more realistic growth rates.  That seems to be happening.   Whether Jay Powell and his band of scaredy-cats see it that way is another story.  There is no reason to change anything right now.  Indeed, now, more than ever, the term patience makes the most sense.  The fundamentals of the economy remain good.  It is the overarching political issues that are so threatening.  But as long as those threats don’t turn into reality, the economy does not need any additional help.  Since we will not know where things are going for a while, the best thing for the Fed to do is punt, that is, remain patient.  The markets are expecting the Fed to lose that term when the FOMC meeting ends tomorrow and the statement is released.  If the members don’t keep it in, it would be a mistake as they would be taking a big risk that actual second quarter growth comes out at or below expectations, not above it.  How do you square a message saying a rate cut is coming when the economy remains solid?  I don’t know.  I would argue that if the Fed signals that a cut could happen soon, it will have basically moved to a single mandate which contains neither full employment nor stable inflation, which we have.  It would be essentially saying that its purpose is to maximize markets.  When it comes to turning points, and a move to lower rates would represent one, it is the Fed’s job to lead, not follow.  That is what previous Chairs did.  They then followed the markets up or down until they decided to signal that enough was enough.  It would be a terrible change in strategy to not only allow the markets to lead during an easing or a tightening, but also to determine when the easing or tightening should stop and when it should be reversed.  That would be an abdication of the Fed’s responsibility.

KEY DATA: Sales: +0.5%; Ex-Vehicles: +0.5%/ IP: +0.4%; Manufacturing +0.2%

IN A NUTSHELL:  “Consumers are consuming, even if manufacturers are not manufacturing.”

WHAT IT MEANS:  Consumer spending meet Samuel Clemens: The reports of their demise were both greatly exaggerated.  But don’t blame economists, please.  The April retail sales numbers, which initially came in as down, were revised to show a decent rise instead.  The government got the magnitude right but the sign wrong.  Duh.  And in any event, economists expected and got a sharp improvement in May.  We thought households were spending decently and that is exactly what is going on.  In May, demand rose in almost every major category, including vehicles, sporting goods, restaurants, electronics and appliances, general merchandise, health care and on the Internet.  Food and beverage stores were down modestly, while the shrinking department store component, not surprisingly, posted a large decline.  Those sales are being picked up elsewhere, which is why all those stores are closing.   Finally, there is a so-called “core” retail sales number that best approximates the consumption number in the GDP report.  It excludes vehicles, gasoline, building supplies and food services and was up strongly in May and (after revision) moderately in April.  In other words, households are still shopping.

As for the weakest link, industrial production rose in May as manufacturing posted its first gain of the year.  But let’s face it, a modest rise after large declines in January, February and April (March was flat) doesn’t tell me that the industrial heartland is doing fine.  Manufacturing production is up less 1% over the year, which really says it all.  Indeed, what saved the sector were rebounds in the output of vehicles, plastics and electrical equipment, which had been faltering much of this year.  I am not sure that those increases represent a reversal of fortune or just a temporary uptick.  Overall industrial production was helped by a jump in utility output, but it is not clear if that was due to improved industry demand or weather conditions.   MARKETS AND FED POLICY IMPLICATIONS:When the markets find a sucker they move mercilessly and it appears that Jay Powell is that target right now.  Amazingly, there are a fair number of analysts that think we could get a rate cut at next week’s FOMC meeting.  Really?  Meanwhile, the July meeting is considered a lay up.  I just don’t believe it.Granted, the economy is not booming, but it is also not faltering and today’s data make that clear. Yes, the Fed Chair has shown that if the markets huff and puff enough they can blow down the will of the Fed.  They did that in December and that has given investors the confidence that they can pressure the Fed to provide the drug of choice, liquidity, whenever the going gets tough.  If we do get a rate cut, the markets will likely rally, despite the reality that a 25 basis point reduction will do absolutely nothing to the economy. But hey, there is so much out there these days that bears no resemblance to reality that adding the Fed to the list would not surprise me.  I grew up watching Rod Serling’s “The Twilight Zone” and now we seem to be living it. 

KEY DATA: CPI: 0.1%; Over-Year: 1.8%; Ex-Food and Energy: 0.1%; Over-Year: 2%/ Real Earnings: 0.2%; Over-Year: 1.3%

IN A NUTSHELL:  “Tame inflation is allowing consumer spending power to hold up as earnings growth is slowing.”

WHAT IT MEANS:  Is the Fed worried about inflation? Yes.  But it is probably because it is too low!  The Consumer Price Index barely budged in May and even the modest rise was misleading.  Hardly any components posted significant gains while there were quite a few that had negative numbers.  Energy costs dropped but food prices rebounded.  Essentially a wash there.  Used vehicle and medical goods prices declined but medical services were up.  The rest largely wandered around.  Basically, there is little pressure on consumer costs that you can find in this report.

And it is really good that inflation remains tame, as worker earnings are also going nowhere.  Yes, hourly earnings rose at a moderate pace, but the gain over the year has stopped rising.  But of real concern is that hours worked is dropping.  When you add hours worked to earnings and adjust for inflation, that measure of weekly earnings is running at only about 1%.  As I keep saying, it is hard to generate strong consumption spending if workers spending power is modest, at best.  And right now, it is extremely modest even given the lack of inflation.

MARKETS AND FED POLICY IMPLICATIONS:  The Fed is facing a lot of problems and a key one is that inflation is below target. It is the low inflation that is keeping consumer real income growth from totally falling apart.  So, if the Fed tries to get inflation up by cutting rates, it could wind up causing consumption to falter.  That could offset the gains from any stronger growth from interest sensitive sectors.  If Chair Powell really is signaling that he is going to cut rates, something I think is way too early to even consider, then he better hope that stronger growth does not cause inflation to accelerate.  Luckily, even with the unemployment rate below where most Fed members and economists think is full employment, wage gains are not increasing.  Firms seem to be willing to leave job openings high rather than pay up to get the workers.  Maybe that means a rate cut could encourage more growth without greater inflation.  However, to get that, you have to maintain the exceptionally strong productivity growth we have seen recently.  Otherwise, you don’t get more output, just lower rates.  On the other hand, the last thing the Fed wants to do is raise rates, which could slow growth, slow inflation, slow income gains further and cause investors to throw another tantrum. The Fed is stuck at the current rate and all this talk about a rate cut makes no sense unless the Fed actually sees the economic fundamentals clearly weakening.  That could take quite a while to become clear.  To paraphrase Laurel and Hardy, “Well, Jay, here’s another nice mess you have gotten us into”. 

KEY DATA: Payrolls: +75,000; Private: 90,000; Revisions: -75,000; Unemployment Rate: 3.6% (Unchanged); Wages: +0.2%

IN A NUTSHELL:  “The lean, mean job machine has sand in its gears.”

WHAT IT MEANS: Welcome to the real world.  All those firms saying they couldn’t find qualified workers may have been true statements not fake news as job gains faltered in May.  And, the huge increase we thought we had in April now looks less robust while the solid March hiring turns out to have been only mediocre.  The three-month average job increase now sits at 151,000, which is reasonable given the labor market conditions.  In May, the data were remarkable in that there were no major outliers.  Retailers cut workers, but not at any huge pace.  Manufacturers and construction added workers at the expected modest rate.  Health care and professional service companies hired moderately and restaurants continued to add workers at a typical pace.  Government employment did drop, but that came after an even larger rise in April, so nothing surprising there either.  In other words, there were no usual unusual numbers that I love to pick on. 

As for the unemployment rate, it was unchanged as both the labor force and the number of employed rose at a moderate pace.  All good there.  The labor force participation rate was stable and the so-called “real” unemployment rate declined. 

If there was one weakness in the report, it was the wage data.  Hourly wages were up moderately but the growth rate over the year year continues to decelerate.  After peaking in February, it has been a steady downward path and that is not good for workers or the economy.MARKETS AND FED POLICY IMPLICATIONS: Over time, the economic data wind up matching what is reasonable given the economic conditions, and that is finally happening with the employment numbers.  Going into the year, most economists expected job gains to be in the 150,000 to 175,000 range, given the low unemployment rate and demographics.  Guess what: That is where we are.  The idea that we could add over 200,000 employees a month was unrealistic and reality is hitting home.  With the labor market so tight, the pace of increase is still quite decent.  It’s just that it isn’t anywhere near where the politicians hoped it would be.  There are some signs that the market may be faltering more than perceived.  This was the second month out of the past four that job gains were below 100,000.  In addition, the data are being revised downward, which means that the models are expecting job gains from the smaller to mid-sized businesses to be stronger than what we are seeing.  That matches the ADP results, which showed that small business hiring ground to a halt and mid-sized firm added workers modestly.  They just cannot compete with the larger companies who can pay up for workers and either they do without or they face rapidly rising wage costs.  For small firms, that is usually a disaster. And maybe the most disconcerting numbers of all came from the wage data.  Despite tight labor markets, wage gains continue to decelerate.  The combination of more modest payroll and compensation increases does not bode well for income growth or consumption.Investors cannot be happy with this report.  It warns of moderating growth ahead as more modest job gains are starting to become a trend.  As for the Fed, this is actually a good report.The economy is not falling off a cliff: It is just easing back.  Thus, there is no reason to cut rates. Wage inflation remains muted and that means that price inflation is not likely to surge unless the tariffs are put on all Chinese and Mexican products.  There is no reason to raise rates.  Patience can and is likely to rule!  The next meeting is June 18-19 and that is what is likely to be the stance, though the Fed will likely reiterate that it stands ready to support growth if conditions tank.  Right now, that is not happening, despite this one weak employment report.