KEY DATA: CPI: -0.1%; Excluding Energy: +0.2%; Gasoline: -7.4%/ Inflation-Adjusted Hourly Earnings: +0.5%; Over Year: 1.1%

IN A NUTSHELL:  â€œInflation continues at a pace that should make the Fed happy, but accelerating wage gains remain a threat.”

WHAT IT MEANS:  While parts of the government’s data mill are shut down, the Bureau of Labor Statistics keeps churning some key numbers.  Consumer Prices declined in December, led, not surprisingly by a sharp drop in energy costs.  Excluding energy, consumer costs rose at a moderate pace.  Over the year, the core index, which excludes food and energy, increased at a 2.2% rate, slightly above the Fed’s 2% target.  Looking at the non-energy components, inflation pressures are building in a number of areas.  Food costs, which had jumped in 2017 but stabilized last year, look like they could be back on the rise.  The drive to eat healthier is becoming much more expensive as fish and seafood costs are jumping.  My biggest concern is that my bellowed cake and cupcake prices are skyrocketing.  Time to diet again.  Eating out is also becoming much more expensive, as is the cost of shelter.  And the flattening in medical costs may be coming to an end.  So, while consumer inflation is not accelerating significantly, there seem to be underlying trends that indicate we could see the rate rise as we go forward.

The tight labor market continues to push up wages, which rose sharply in December.  They jumped by over 3% from the December 2017 level.  With overall consumer costs declining, inflation-adjusted (real) earnings improved quite solidly.  Over the year, they broke back over the 1% level for the first time in over two years.  Since energy prices are rebounding, that may not hold.  Still, when spending power is rising by only 1% and with the savings rate trending downward, it is hard to see how spending can hold up. 

MARKETS AND FED POLICY IMPLICATIONS:  Chairman Powell baffles me.  He talks about the economy as if it is in good shape, but then indicates that continuing the rate normalization process may or may not continue.  Growth is still good and inflation is at or above the Fed’s target.  So, what is his problem?  You can say that the sharp drop in the equity markets is a sign of impending doom, or you can argue as I have that the decline simply corrects for some irrational exuberance.  If the markets are signaling a recession ahead, then slowing or ending the normalization process makes sense.  If the volatility was more emotional as well as a normal correction from excessively optimistic expectations, then it doesn’t make sense to slow the rate hikes.  Since the Fed’s own estimates are for at about 2.3% growth this year, which is above the members’ estimate of trend growth, what is the problem?  As I said, I just don’t get it.  The next FOMC meeting where a hike might occur is not until March 19-20.   Unless the government shut down and the trade war seriously harm growth, I don’t see why an increase shouldn’t happen at that meeting, if the Fed really is basing its decisions on economic data.     

KEY DATA:ISM (NonManufacturing): -3.1 points, Activity: -5.3 points; Orders: +0.2 points/ Employment Trends: +1.38 points

IN A NUTSHELL: “Growth may be moderating but it is hardly slow.”

WHAT IT MEANS: The government’s data mills may not be churning out all the numbers they usually do, shutdowns have a tendency to do that, but the private sector is still providing some important data.  The Institute for Supply Management’s NonManufacturing index dropped in December, but there really is nothing to be alarmed about.  The level of the index is still fairly high. While overall activity in the services and construction sectors has eased, it is not falling apart, as can be seen by the continued strong rise in new orders.  It is hard to make the argument that the economy is about to fall off the cliff if demand is accelerating.  Firms are still hiring solidly, but not robustly, which is also nothing to complain about.  There was just one warning sign in the report: Backlogs have pretty much stopped building.  But they are not falling, so the warning is more yellow than red. 

Was the huge December jobs number an aberration or a sign of things to come?  Well, it is doubtful we will be seeing payroll increases above 300,000 many times, if at all, this year, but we could get some above 200,000.  The Conference Board’s Employment Trends Index popped back up in December after declining in November.  It is pointing to continued solid job gains.

MARKETS AND FED POLICY IMPLICATIONS: While the markets crashed and burned, economists spent their time trying to explain that a recession was not likely to start for another year or more.  Of course, investors didn’t believe that, otherwise why were they selling their stocks? Well, the selling was due to, well, you tell me and we both will know.  There is a moderation in growth occurring,but only those who think unsustainable growth is actually sustainable didn’t understand that.  Solid but not robust growth is just fine. And the reaction to Fed Chair Powell’s comments that the Fed could change course was fascinating.  Keep in mind; he didn’t say to which direction the Fed would tack.  The markets took his words to mean the Fed might not raise rates this year or hike only one time.  But if the economy stays solid and inflation rises, does anyone think the Fed will not hike rates more than most investors now believe?  That would be changing direction, but in the opposite way that the markets now think.  You see, Fed Chairs rarely say anything specific.  They leave their options openand if you read Mr. Powell’s comments, they said nothing specific about raising, lowering or keeping rates constant.  As far as the balance sheet reductions go, the Fed has never done this before, so it has no idea about the impact the changes will have on the economy.  Saying they are flexible about changes is hardly news.  The members like schedules but have always been willing to deviate from them.  But hey, investors wanted to hear something and even if that something wasn’t actually said, they will believe they heard it.  So, if the Fed doesn’t do what the markets want it to do because they thought the Fed had said it would do that, investors have only themselves to blame – which of course they will not.  For me, the economy is growing above trend, which points to at least two and possibly three moves this year. 

KEY DATA: ADP Jobs: +271,000/ ISM (Manufacturing): -5.2 points; Orders: -11 points/ Construction: -0.1%

IN A NUTSHELL: “Job growth may be holding up but there are growing signs that the economy is indeed slowing.”

WHAT IT MEANS: Firms may still be hiring, but it is not clear how long that will last. Tomorrow is Employment Friday and a preview of the number is often, but not always, provided by the ADP estimate of private sector job gains. Well, if you believe the estimate, the number could be huge. Strong growth was reported in all sizes of businesses and across all sectors. There was a huge rise in construction hiring, though it is not clear why given the issues facing the housing sector. The only decline was in natural resources/mining, which was likely due to declining energy prices affecting jobs in that sector.

There were two other labor market-related numbers released. Jobless claims jumped last week, but they have been more volatile than normal lately. The level remains quite low. Challenger, Gray and Christmas reported that layoff notices rose sharply in December from the December 2017 levels and for the year, they were up nearly 29%. These data don’t tell us a lot given that job growth was solid in 2018 and the unemployment rate declined.

While the manufacturing sector joined in the hiring binge in December, activity decelerated sharply. Indeed, the Institute for Supply Management’s index hit its lowest level in two years. Critically, new orders cratered and are now barely expanding. Backlogs, which when rising generally point to expanding production, have stopped increasing. Still, the sector is not collapsing. Production is still growing solidly, those less rapidly as it had been, and hiring remains solid.

Construction spending eased back in November even as government activity jumped. The private sector cut back spending on both residential and nonresidential projects.

MARKETS AND FED POLICY IMPLICATIONS: The day started out well with a robust jobs report but then other numbers started showing up which were not as sanguine about future growth. The so-called “Trump Bump” that was seen in the markets and manufacturing, has been largely wiped out. But that doesn’t mean the economy is headed into recession. The “Trump Slump” seems to be taking us back to more normal growth levels, which we might not even hit until the spring or summer. We seem to be replacing the irrational exuberance of the election and tax cuts with an irrational despondence of a slowing economy. I, as well as most other economists who don’t work for politicians, warned that the tax cut sugar-high would wear off in about a year. Well, we are a year into the tax cuts and not surprisingly, growth is decelerating. Notice, I wrote decelerating not declining. Growth is still decent but the risks have risen. While most focus on the Fed, another fifty basis point increase would not kill the golden goose if it were indeed golden. But a trade war would and it already is causing real concerns. China’s economy is slowing more than even the U.S. economy and when you have the two biggest economies in the world decelerating, it is going to impact world growth. Will we wind up in a recession? Only if the tariff battles continue this year and almost definitely if the threat to impose a 25% tariff on Chinese imports comes true. More likely, we are headed toward moderate, sustainable, Obama-like growth if the trade war dissipates. We are not going to see 3% or greater growth for an extended period. Investors needed to be disabused of the bill of goods they were sold that the economy would expand at 3% for the next decade (per OMB) and it looks like they are in the process of coming to grips with that reality. Unfortunately, when everyone sees the same change at the same time, markets tend to overreact, which also seems to be happening. To me, we are just wiping out the exuberance. The question is, how far will that wipeout go? That is, how much of an overreaction will we get? Stay tuned.

In a Nutshell: “The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity…”

Decision: Fed funds rate target range increased to 2.25% to 2.50%.  

Faced with political pressure from the president to stop raising rates and panic on the part of investors who were seeing their massive capital gains disappear, the Fed could have punted. Instead, it decided to continue trying to win the game.

The FOMC, as expected, raised the fed funds target rate by a quarter point. And they had every good reason to do that. Indeed, if you look at the Committee’s description of the economy, there was no change: The economy is strong and inflation is near target. Indeed, in his press conference, Fed Chair Powell indicated there was little reason for the Fed to remain accommodative given its forecast for solid growth next year.

You would think that continued good growth and inflation under control would be good news for the markets. Wrong again. Unfortunately, with the president and the equity-focused commentaries demanding the Fed give up the rate normalization process, investors expected the Fed to announce that there would be no more rate hikes.

However, the Committee indicated that it expects to raise rates two times in 2019, down from the three projected at the September meeting. Only two moves are quite gradual and about as low as the Fed was likely to go. But that doesn’t mean we will get two increases. Last December, the FOMC indicated it expected three moves in 2018. We got four.

So how many rate hikes will there be? This is one of those “it depends” moments. The Fed marked growth down for 2019 but forecast it would still be above, or at worst at trend for the next three years. If we get more moderate growth, yes, we there might be only two increases. But you cannot rule out three if growth is stronger than projected. The tax cut might actually start working. Of course, if a trade war breaks out and the economy tanks, we might not see any at all.

Still, investors were not happy with the two-move projection and markets tanked. As I always say, markets may be efficient but that doesn’t insure they are rational. In this case, the knee jerk reaction made little sense given that the Fed indicated it was optimistic about growth. And as the Chair made it clear in his press conference, pressure, be it political or not, did not and will be a factor in decisions or even in the discussions. It’s all about the economy and the data will decide.

(The next FOMC meeting is January 29,30 2019.)

KEY DATA: Starts (Over-Month): +3.2%; 1-Family: -4.6%; Year-to-Date: +5.1%; Permits (Over-Month): +5.0%; Year-to-Date: +4.2%

IN A NUTSHELL: “It’s hard to say that home construction is rebounding when the gain was mostly in the volatile multi-family segment.”

WHAT IT MEANS: The data on housing has been mostly negative for months now, so you would think a sharp rise in construction activity would be taken as good news. Well, not so fast. Yes, housing starts jumped in November, but all of the increase was in the wildly volatile multi-family portion. Single-family construction was down sharply and over the year, it was off by double-digits. For the first eleven months of the year, construction is up, but it looks like the pace peaked in the spring. Natural disasters are playing a role in the volatility. Activity surged in the South, which was likely due to make up from the hurricanes. Meanwhile, construction faltered in the West, possibly due to the fires. Look for rebuilding in California to create an artificial rebound in the months ahead. Multi-family construction is taking on a more important role. That likely mirrors the preferences of Millennials, who are renting, and boomers, who are downsizing. Since multi-family construction starts are random and can change dramatically over the month, the monthly changes will likely be even more unpredictable. As for the future, permits continue to run ahead of starts. That usually means construction activity should pick up going forward as builders don’t spend money on permits unless they are pretty certain they will be constructing the unit.

Another indicator, released yesterday, reinforces the belief that the housing market continues to decline. The National Association of Home Builders Housing Market Index tanked once again in December. The level was the lowest since May 2015. Traffic is slowing and while sales expectations are decent, they are way off their highs. Whatever confidence housing developers may have had is disappearing rapidly.

MARKETS AND FED POLICY IMPLICATIONS: The FOMC is starting its two-day meeting today and I still expect a rate hike to be announced tomorrow afternoon. There are a number of reasons why I stick to that belief. The first is that while growth is moderating, it is not faltering. Fourth quarter GDP growth is expected to come in somewhere between 2.5% and 3%, which would be very good if we hadn’t had the artificially-sweetened spring and fall growth rates. Inflation remains at or above the Fed’s target and except for the trade war battered equity markets, there is every reason the FOMC should keep the normalization process going. What may be different is that the Committee may indicate it is willing to take a more wait and see attitude going forward. This buys the members time to see how the battles take shape. If a likely more puff than pastry agreement occurs, the Fed can continue on the path outlined this fall – three to four hikes in 2019. But if war breaks out, then the members know that all economic bets (and forecasts) are off and they can slow down. The earliest the next hike would occur is at the March 19-20 meeting. That should be far enough into the future that the shape of any trade agreement would be clearer. I have reduced my forecast to three hikes for next year, as I have no idea what the administration will do about a trade agreement with China. I don’t think there will be just two increases. If the situation is clarified and the economy continues to expand decently, we will get at least three increases. If there is a trade war, we might not get even one as economies and markets around the world would be in trouble.

KEY DATA: CPI: 0.0%; Over-Year: +2.2%; Ex-Food and Energy: +0.2; Over-Year: 2.2%/ Real Hourly Wages: +0.3%; Over-Year: +0.8%

IN A NUTSHELL: “Inflation remains in the Fed’s sweet spot.”

WHAT IT MEANS: If the Fed is worried about inflation, it shouldn’t be – either on the upside or the downside. That is, inflation is neither too hot nor too cold. Bring on the porridge. Consumer prices went nowhere in November, which hardly surprised anyone given that gasoline prices cratered. There was also a sharp drop in apparel expenses. Prices did rise a bit more than expected for a variety of goods and services, including utilities, medical costs, new vehicles and at restaurants. Since November 2017, consumer costs are up 2.2%, a pace that the Fed could live with for a long time. Even excluding the volatile food and energy categories, inflation rose at the exact same rate. In other words, inflation is right where it should be.

With hourly wages rising moderately and inflation flat, real, or inflation-adjusted wages rose solidly in November. However, over the year, the increase remains below one percent, which is hardly enough to generate much additional spending on the part of most workers. I suspect wage gains will accelerate, but so could inflation. Thus, household spending power is not likely to rise significantly in 2019.

MARKETS AND FED POLICY IMPLICATIONS: While some may blame the Fed for the wild ride in the markets, the real culprit is trade fears. I think we see that clearly as anytime concerns that the U.S./China trade battles will turn into a full-blown war, the markets crash, but when hopes reemerge that there will be some kind of agreement, the markets soar. Meanwhile, the Fed plods along and it should. Inflation is right where the members want it and the economy is still growing solidly. After ten years, doesn’t it make sense that interest rates should be back to normal levels? Yes, and that is why the Fed is raising rates and should continue raising rates. Maximizing equity returns is not a Fed mandate and in any event, the risk is trade not rates. Meanwhile, the important questions are not being asked of Chair Powell: What is a neutral funds rate and how do you determine what that rate should be? Without that knowledge, how can we determine if any given funds rate is well below, near or above normal? The Fed Chair must be a little bit more forthcoming about “neutral” if that term is to have real meaning. Right now, it doesn’t. Indeed, given the Chair’s recent inconsistent comments about the distance we are from neutral, it is not clear he knows what neutral is. So, if the Fed is creating any issues, it isn’t because they are raising rates to levels that are too high. It is that they have a failure to communicate effectively.

KEY DATA: Payrolls: +155,000; 3-Month Average: 170,000; Private: +161,000; Revisions: -12,000; Hourly Wages: +0.2% Over-Year: +3.1%

IN A NUTSHELL: “Sustainable is good and that may be the level toward which job growth is finally be trending.”

WHAT IT MEANS: Job gains in November were well below expectations – Yippee! The idea we could sustain hiring at or above 200,000 a month ranked up there with the idea that we could sustain 3% growth for a decade. You have to be living in a state where recreational use of drugs is legal to hold those views. Simply put, the November increase was a welcome sight. The three-month average is still a bit high but a lot closer to sustainable. Job increases were spread across much of the economy with only one major sector, information services, posting a decline. Why motion picture employment cratered is anyone’s guess, so let’s not make too much of that. Health care, food services, transportation and manufacturing all added workers at a solid pace. Even retail trade payrolls expanded.

On the unemployment front, the rate remained the same. A solid gain in the labor force offset a jump in the number employed. Still, the rate is extremely low and that is causing wages to rise. The increase over the year was over three percent for the second consecutive month and that should continue. With some major companies starting to implement $15.00 per hour minimum wages, other firms will have to follow if they are to retain or attract workers. I would be surprised if the wage rise is less than 3.5% by mid-2019.

MARKETS AND FED POLICY IMPLICATIONS: Too much of a good thing is too often not a good thing. Everyone wants strong economic, job and wage growth. But the implications of an extended period of above trend growth in any, let alone all those factors, is an economy filled with bubbles. And we know what happens when bubbles burst. So, while those politicians, businesses leaders and business commentators who have been touting the likelihood of robust growth for as far as the eye can see may be unhappy with more moderate gains, economists are overjoyed. Steady, sustainable growth – you know, like we had until about a year ago – means we can stay out of a recession for a longer period of time. It may not lead to a surge in equity prices, but it would also restrain consumer prices. For the Fed, this report allows them to do what they want. A rate hike on December 19^th is highly likely, but if the Fed indicates it wants to see what happens to the economy, they can say that. Of course, even if the Fed were to move four times next year, the first move would not come until March, so the members have plenty of time to see if the markets calm down and the trade wars subside. In other words, the Fed really doesn’t have to make any changes other than say that the growth is moderating. Keep in mind, unless growth moves below trend, the unemployment rate will continue to slowly decline and wage gains will accelerate. Even moderate growth could create wage pressures at a level that the worries Fed. Rooting for a halt in Fed rate hikes is either rooting for a sluggish economy or saying that rising wage gains are nothing to be concerned about. I don’t think the Fed members believe either is a realistic way of looking at the economy.

KEY DATA: ISM (Manufacturing): +1.6 points; Orders: +4.7 points/ Construction: -0.1%; Private: -0.4%; Residential: -0.5%

IN A NUTSHELL: “The strong (manufacturing) keep getting stronger while the weak (construction) keep getting weaker.”

WHAT IT MEANS: The first readings on November activity are starting to come out, led by a solid rise in manufacturing activity. The Institute for Supply Management’s index rose more than forecast as orders surged. Hiring and production also accelerated. Still, more workers and more output didn’t keep order books from fattening at an increased pace, which is good news for future production. Maybe the best news was that the pressure on input prices, though still rising sharply, are not nearly as great as they had been.

Once again, the construction data came in soft. Overall construction spending fell slightly in October and the entire decline was in the private sector. The government continues to spend on all sorts of things but businesses have become quite conservative. Private residential activity was off moderately. That is hardly a surprise as the other housing numbers have been fading. There were some sectors in the private sector that did improve. Spending on offices, commercial buildings and educational facilities rose solidly.

MARKETS AND FED POLICY IMPLICATIONS: There was nothing surprising or even new in today’s reports. Manufacturing is strong while construction is weak. Investors know all that so there should be little reaction to these data. The focus of attention is back on trade. The 90-day “truce” between China and the U.S. was good news, but hardly a surprise. It was in the best interests of both nations to put off a full-fledged shooting war until it was clear nothing else could be done. And the Chinese are notorious for pushing into the future any decision they don’t want to make. The Chinese need time to restructure their supply chain. While there may be some short-term gains for the U.S. from any agreement, they come on top of short-term losses. Net-net, there may not be much improvement in the situation. It is the long run that is most concerning. If you run a business (or government) and your main supplier becomes undependable, you have not choice but to start looking at expanding your suppliers. To do anything else would be irresponsible. It may take a little while for the Chinese to get other countries to shift agricultural production to meet the Chinese needs, but they are starting that process. And buying more soy products at the bottom of the market is hardly a bad thing either. But once the alternative suppliers are in place, the U.S. farmer is likely to suffer as both sales and prices could decline. So, look past the deals headlines and think about the details and the implications for the future. I would be surprised if any U.S.-China trade deal has significant long-term benefits for either county. Let’s face it; the new U.S.-Mexico-Canada trade deal was hardly a major breakthrough. Indeed, when many analysts indicate the dairy industry will be the biggest winner, it looks like it is more puff than pastry. But we can always hope that is not the case with any new U.S.- China deal. Indeed, we have to hope there is at least some agreement as the alternative would be a disaster.

KEY DATA: Consumption: +0.6%; Disposable Income: +0.5%; Prices: +0.2%/ Pending Sales: -2.6%; Over-Year: -6.7%/Jobless Claims: +10,000

IN A NUTSHELL: “The strong spending and income numbers don’t hold up to careful scrutiny, so don’t assume the economy is surging again.”

WHAT IT MEANS: There is one warning I repeat consistently and that is: “the devil is in the details”. That saying is quite accurate when it comes to the October spending and income report. On the surface, it looks like consumers went wild. Spending surged and the increases were across the board and that is the good news. While this is a good report, there are lots of holes in it. The biggest consumption gain came from a massive jump in services demand. The major factor there was spending on utilities and gas – weather? Expect that to unwind in the next couple of reports. Durable goods purchases were up sharply, but there was a jump in vehicle sales that looks to have been driven by flood-related replacements. That too will wind down going forward. On the income side, you would think that workers are finally getting paid more money. Wrong again. Wage and salary gains were modest, which is another way of saying disappointing. Instead, farm income surged because the government bailout of farmers hurt by the trade war was in the data. Nonfarm proprietors’ income also soared, though it isn’t a clear why that happened. With spending exceeding income, the savings rate declined again. One unambiguous number was inflation, which is showing no signs of accelerating.

Another housing number, another indication that the residential real estate sector is fading. The National Association of Realtors reported that pending home sales fell for the tenth consecutive month.   The only region that reported a rise was the Northeast, which was up modestly. Over the year, the index has fallen sharply and given the sudden despondence in the homebuilders’ ranks, it is not clear that trend will change anytime soon.

New claims for unemployment insurance jumped last week. November is always a very choppy month; so don’t read too much into the rise.

MARKETS AND FED POLICY IMPLICATIONS: The income and spending report was a good one, but it was hardly great. With special factors at work, the best we can conclude is that the consumer is still spending but households are not flush. High levels of confidence, though, do imply a solid holiday shopping season. But unless wage gains accelerate, the early part of next year could be ugly as households cut back to pay for their holiday excesses.

Fed Commentary: Yesterday, Fed Chair Jerome Powell delivered a speech that has been interpreted to mean the Fed will be slowing its rate hike pattern. The conclusion came from a change in the description of how close the Fed is to “neutral”, the point where rates are neither adding to nor subtracting from growth. Yesterday, he noted that the Fed was “just below the broad range of estimates of the level that would be neutral for the economy”. Just below is the operative phrase here since in October, he noted that the Fed was “a long way from neutral”. This appears to be a huge change in emphasis and it brings up the question, what has changed over the past month to merit a significant recalibration of the stance of monetary policy. The answer is, very simply, little. The stock market has declined, but the Fed is not tasked with keeping up equity prices. Economic growth has moderated, but anyone who doesn’t work in the White House has been saying that would happen and in any event, growth remains above trend. Uncertainties about the world economy have increased, but no one is forecasting a worldwide recession. The president has stepped up his attack on Chair Powell, but it is hard to believe he caved because of political pressure. Unfortunately, it looks that way. That is very disturbing since protecting the Fed’s independence may be the Fed Chair’s most important job. Without it, policy could not be trusted.

In defense of Mr. Powell, it has been suggested he was referring to the “range of forecasts” for a neutral Fed funds rate. He did say range in in his comment. But if he changed his reference to the range rather than the level, he was terribly unclear in his presentation. If that is indeed the case, he set back the attempts at making the Fed more transparent more than any Alan Greenspan talk ever did – and Greenspan’s intentions were always to keep Fed intentions opaque.

Basically, Chair Powell has muddied a lot of waters. He needs another speech soon to clarify his thinking and where he believes monetary policy is going. Right now, the best we can say is that he whiffed badly. While that happens to everyone, it should not happen to a Fed Chair.