All posts by joel

August Factory Orders and Trade Deficit and Weekly Jobless Claims

KEY DATA: Orders: +1.2%; Durables: +2%/ Deficit: $1.2 billion narrower/ Claims: -12,000

IN A NUTSHELL: “The hurricanes may have caused havoc, but the economy seems to be bouncing back.”

WHAT IT MEANS: This is one resilient economy. Neither rain, nor wind nor the gloom in Washington seems to stay businesses and consumers from their appointed rounds of producing and buying. Factory orders were strong in August, led by solid increases in durable goods demand. But orders for nondurable products were also up decently, indicating that the manufacturing sector is experiencing broadly based increases in sales. Indeed, the only major sector that posted a decline in demand was furniture products.

There was also good news on the trade front. Rising exports, especially consumer and capital goods, led to a narrowing of the trade deficit. However, the decline in imports is a warning. We bought less of most products, except vehicles and consumer goods. A strong economy should mean that our demand for all products, including foreign goods, should rise. It didn’t. Still the narrowing trade deficit implies that trade will likely be a nonevent in the third quarter GDP report. It shouldn’t help or hurt growth.

Consumer spending looks like it was pretty strong in September, though not for the reasons we would want to see. The destruction of so many vehicles led to a surge in sales as households began to replace their flooded out autos and SUVs. We also saw this week that job cuts in September were modest. Challenger, Gray and Christmas noted that the third quarter layoff announcements were the lowest third quarter total in 21 years. Jobless claims came down last week, but they remain well above what they had been before the hurricanes blew up the data. And finally, the Conference Board reported that there was a modest increase in online help wanted ads. In other words, most of the data reported this week were positive.

MARKETS AND FED POLICY IMPLICATIONS: Tomorrow is employment Friday and it is hard to really know what the report will look like because of the hurricanes. It is likely that the unemployment rate will rise, if the elevated number of jobless claims is any indicator. We could also see an unusually small number of jobs created. Houston was largely back online by mid-September, but some firms may never reopen. In Florida, Irma’s timing may have led to a lot of workers not being employed during the survey week. Thus, don’t be too surprised if the number of jobs added is well below the even modest consensus of 75,000 – 100,000. I am on the lower side, but I have been surprised at how well the economy has held up despite the hits it has taken. My point is that if we get a truly ugly report, don’t assume that is anything more than temporary. Just as vehicle sales rebounded well above what they would have been without the storm damage, expect job gains to bounce back as households and business start repairing and rebuilding.

August Spending and Income and September Consumer Confidence

KEY DATA: Consumption: +0.1%; Disposable Income: +0.1%; Prices: +0.2%/ Confidence: -1.7 points

IN A NUTSHELL: “Sluggish consumer spending points to a weak third quarter growth number.”

WHAT IT MEANS: This week we received the final (for now) revision to third quarter GDP growth and the slight rise came from improved household consumption. It looks like the economy slowed sharply this quarter, in no small part because of a softening in consumer demand. Consumption ticked up in August, but when it was adjusted for inflation, it was actually down. Weakness in durable goods sales, basically motor vehicles, offset some increases in nondurables and services demand. The hurricanes were no helpful. But the uncertainty about consumers is not limited to the wrath of Mother Nature. Disposable personal income, while rising modestly, was also off when inflation was taken into account. It is hard to spend more when your purchasing power declines. Wage and salary growth pretty much disappeared and that does not bode well for future retail sales. Another warning sign is the savings rate, which edged downward again. Savings have declined five out of the last six months. On the inflation front, prices rose moderately overall but minimally when food and energy were excluded. The year-over-year increases in both the headline and core numbers are below 1.5%. Given the Fed’s target is 2%, there is a lot of room for prices to rise before the Fed has to worry about inflation.

Despite the chaos in Washington, the failure to reform the ACA and horrible hurricanes, consumer confidence remained pretty high in September. The University of Michigan’s Consumer Sentiment index did decline, but the level is strong. For most people, the hurricanes hit somewhere else and while there was concern for those who were hit by the storms, the impacts were not felt directly by most Americans. Thus, confidence did not tank.

MARKETS AND FED POLICY IMPLICATIONS: It looks like the economy fell back to its normal growth rate, or even lower, in the third quarter. We don’t have the September numbers, but given the hurricanes, it is likely that consumer spending will come in at half the 3.3% pace posted in the spring. But eyes are now turning to tax reform/tax cuts and the administration’s proposal has already come under intense fire since there are lots of winners and losers. That is always the case with any changes in policy. But the major issue is the impact on the deficit. Working backwards, the supporters have come up with a growth rate that implies the plan will pay for itself. If you believe that, I have both a Broadway show that I am producing and a bridge I am selling and you can have as much of each as you like. But it is not just bogus growth estimates that create risks to the plan. It provides significant tax breaks for upper income households, something the administration pledged not to do. By eliminating the state and local tax break, it creates the likelihood that upper-middle-income households will see their taxes rise not fall. And if the past is any example of how the money will be spent, don’t expect the repatriation of foreign earnings to lead to a lot of new capital spending. You can argue for or against all of the changes in the plan but they will create major disagreements. The one good thing is that the battle for tax reform/tax cuts has begun, though I suspect we will wind up with some cuts and not a lot of reform.

August New Home Sales, July Home Prices and September Non-Manufacturing Activity

 

KEY DATA: Home Sales: -3.4%/ Case-Shiller (Over-Year): +5.9%/ Philadelphia Fed Index (Non-Manufacturing): +1.4 points; Orders: +7.3 points

 

IN A NUTSHELL: “Housing sales may not be strong, but a lack of inventory is causing prices to continue to jump.”

 

WHAT IT MEANS: The housing market is likely to be a puzzle over the next few months as the two hurricanes created havoc in the market in Texas and Florida. And since Harvey hit during August, that month’s data are likely to be a bit skewed. So it wasn’t surprising to see that new home sales fell in August. But the decline could not be blamed on the weather as no region posted a gain. There was a little bit of good news in the report. Though still low on an historical basis, the number of homes on the market was the highest since June 2009. As for prices, the median declined while the average rose. What we are seeing is an increase in moderate priced homes and solid demand for the extremely high cost homes.

 

The reality is that home prices are likely to continue increasing and may even gap up a little if mortgage rates start to increase. There just isn’t a lot of supply out there and that goes for not just new homes but existing homes as well. The S&P Case Shiller National Home Price Index posted a faster gain in July. Only one of the twenty metro areas, Chicago, was down over the month. Except for Seattle on the high-side and Chicago and New York on the slow-side, most of the other cities saw their prices increase by between 5% and 7.5%, a pretty tight shot pattern.

 

As for the services component of the economy, if the Philadelphia region is any indicator, and it tends to be just that, the industrial sector is doing just fine. The Philadelphia Fed’s Non-Manufacturing Index rose in September, led by a jump in new orders. Even with sales rising faster, backlogs are building. Looking toward the future, while respondents were less certain about the general economy, they were more optimistic about their own companies.

 

MARKETS AND FED POLICY IMPLICATIONS: Next week, when we start getting September data, we will begin to see how the two hurricanes affected the economy. Until then, we can only assume that they slowed third quarter growth. I have marked my forecast down to under 2%, which puts me toward the bottom of most panels. I suspect other economists will be coming down if the data keep coming in as soft as they have. But fourth quarter is likely to be quite solid, assuming some rebuilding starts up and the government actually spends part of the money it has allocated to the recovery process. Meanwhile, the Fed will also be entering the equation as it will be reducing its balance sheet a touch. It is never easy to forecast any given quarter’s growth and when Mother Nature and the government combine to create chaos, it is almost impossible. So, the third and fourth quarter growth numbers should be viewed as aberrations. Whether investors get that is a different story as there is still hope that taxes will be cut (hope for reform is fading) and that alone is viewed as positive for stocks. But the rubber still has to meet the road and the politicians remain unwilling to actually work on a plan that both sides of the aisle can structure and support. That means the risk of another health care debacle is real if the Republicans overreach again and fail to get Democrats to buy in to their tax proposal.

September 19-20 2017 FOMC Meeting

In a Nutshell: “In October, the Committee will initiate the balance sheet normalization program.”

Decision: Fed funds rate maintained at 1.00% to 1.25%: Balance sheet normalization begun.

The great experiment of quantitative easing is over. The Fed calls the act of reducing its ownership of assets “balance sheet normalization” and it is to begin in October. This is important and we need to view the normalization of both the funds rate and the balance sheet as a dual process. The Fed considers quantitative easing to be a tool that ranks only just behind interest rate (fed funds rate) management.

The process of raising the funds rate to its normal level, which today’s report indicates to be roughly 2.75%, started in December 2015. Eleven of the sixteen members expect another hike in December and at least three more next year. The funds rate normalization process is proceeding at a reasonable rate and should continue to do so, barring a major economic problem.

The second tool, quantitative easing/tightening, had yet to begin before this meeting. Before the financial crisis, the Fed’s balance sheet was below $1 trillion. Now, it is about $4.5 trillion. When interest rates approached zero, the Fed turned to asset purchases to increase liquidity in the system and keep the whole range of interest rates low. This was supposed to add to growth.

The consensus is that the Fed needs to shed somewhere in the range of $2 trillion to get to a “normal” balance sheet. The process, as outlined in June, is for this reduction to begin slowly so the Fed will start rolling off only $10 billion per month starting in October. That will slowly ratchet up to at maximum of $50 billion per month by the end of next year. But the process has a long way to go and it needed to get under way. Balance sheet reduction is expected to continue unabated, barring an economic crisis.

So, why is the Fed normalizing the levels of its tools? Inflation is still below its target and while the economy is near full employment, there may be room to for the rate to decline further. The answer is simple. The Fed’s quiver is largely empty. If the economy falters, does anyone believe The Fed can really add another few trillion dollars to its balance sheet? As for the funds rate, would a reduction of only one percentage point provide much policy impact?

The Fed needs to positions itself so it can provide all the stimulus needed if the economy falters. That is their thinking now and it is why they have begun to reduce their balance sheet and raise rates. The members will move as quickly as reasonable, though the process could take over two years for the funds rate and as much as five or six years for the balance sheet.

(The next FOMC meeting is October 31-November 1, 2017.)

August Import and Export Prices and Housing Starts and Permits

 

KEY DATA: Imports: +0.6%; Nonfuel: +0.3%; Exports: +0.6%; Less Fuel and Food: +0.1%/ Starts: -0.8%; 1-Family: +1.6%; Permits: +5.7%; 1-Family: -1.5%

 

IN A NUTSHELL: “With the housing sector entering a period of hurricane-induced uncertainty and inflation pressures building only slowly, the Fed’s decision tomorrow will not be made easily.”

 

WHAT IT MEANS: The Fed has started its two-day meeting and the data they are looking at couldn’t be less clear. Take today’s numbers. Import prices jumped in August, led by a surge in petroleum and petroleum-related goods costs. It also looks like food expenses are picking up. But excluding those two volatile components, there really were not a lot of cost issues coming from the import side. Consumer goods, vehicles and capital goods prices increased a touch, but over the year every one of those three categories were up less than 0.5%. That is hardly anything for the Fed to fear.   In contrast, U.S. firms are beginning to push through somewhat higher price increases for the goods they sell overseas. A wide variety of non-food or fuel prices were up decently in August.

 

Meanwhile, the housing market continues to post strange numbers. In August, housing starts fell, but only for multi-family dwellings. Single-family construction improved. Did Harvey have a hand in the overall decline? Hard to say since single-family starts rose in the South, even as multi-family activity dropped sharply. The Northeast was the weakest link and I don’t remember us getting hit by any major storm. And then there were the permit requests. While they were up, it is the levels that are odd. Over the past three months, permit requests have run about 6% above starts, implying that that construction should surge in the months ahead. That is especially true for single-family units. But starts have outpaced permits by 33% for multi-family structures and that points to a major slowdown in that sector. And when you add in the uncertainty from the hurricanes, who knows what the housing data will look like in the months ahead?  

 

MARKETS AND FED POLICY IMPLICATIONS: The summary of the data going into the FOMC meeting was that growth in the third quarter looked like it was moving back toward trend before the storms hit. Now, it is likely to come in below 2%. But all those vehicles, homes, businesses and infrastructure have to be rebuilt, demolished, repaired or whatever, and that means an awful lot of spending will have to occur over the next six to twelve months – at a minimum. With labor shortages already an issue in the construction sector, much of the rebuilding will have to wait, possibly for years. If you can do anything in construction, there will be a job waiting, and at a very good salary. But that means inflation could pick up, especially for building supplies and used vehicles. I believe that Fed will indicate, in both the statement and during Chair Yellen’s press conference, that they will monitor the data, but will be moving forward with the interest rate and balance sheet normalization process. The only issue is timing. I expect a specific start-data for balance sheet reduction will be communicated, if not at tomorrow’s meeting, then after the October 31/November 1 meeting and a rate hike to occur before year’s end.

August Retail Sales and Industrial Production

KEY DATA: Sales: -0.2%; Less Vehicles: +0.2%/ IP: -0.9%; Manufacturing: -0.3%

IN A NUTSHELL: “The early returns from Harvey are trickling in and the news is not good.”

WHAT IT MEANS: It looks like Harvey was not invisible, not a buddy and clearly not a cuddly bunny (anybody remember the movie?). It was, however, an economy wrecker – at least initially. Retail sales fell in August, largely due to a sharp drop in vehicle sales. Large parts of Texas and segments of Louisiana shut down and demand dropped, which should surprise no one. Vehicle sales this month will probably be bad as well, since Florida is shut down and much of the insurance payments, when they do arrive, will likely go to used vehicles. But there should be a rebound in October. Excluding vehicles, sales weren’t anything special, especially when you consider that the biggest winners were gasoline dealers, which were charging a lot more. Households spent money on food, both in restaurants and at supermarkets, while furniture stores saw things pick up. Despite the hurricane, sales at home improvement stores fell. I have no idea why that happened.

Not only did consumer spending slow in August, but industrial production cratered as well. Of course, utilities going offline does have a tendency to depress output. But even manufacturing activity hit the skids. Yes, the expected suspects, chemical and energy firms, were down, but there were a variety of other sectors that posted production cut backs. Still, the hurricane impacted industries are already turning around, though the lack of utilities in Florida will make it anyone’s guess what the September industrial production report will look like. As a counterpoint, the Empire State Manufacturing Index, produced by the New York Fed, was up sharply in August and held onto most of the gain in September. That gives some insight into how much the hurricanes changed the direction of the data, at least in the short run.

MARKETS AND FED POLICY IMPLICATIONS: The economic data are being distorted by the hurricanes and the first signs of how much the monthly numbers may be affected were seen in the August data. It looks like it is a lot. All I can do is report the data and suggest how they will likely change in the months ahead. Judgments on whether the longer-term trend in growth has been altered cannot be made until we see how quickly the recovery takes hold, how much money is poured into the affected states and the timing of the spending.   What can be said is that most economists are likely marking down third quarter growth and marking up the fourth quarter. I would not be surprised if the third quarter comes in below 2%. As for investors, they seem to be looking past the economy. They want nothing to rain on their parade.

August Consumer Prices, Real Earnings and Weekly Jobless Claims

KEY DATA: CPI: +0.4%; Less Energy: +0.2%; Gasoline: +6.3%/ Real Earnings: -0.3%/ Claims: -14,000

IN A NUTSHELL: “The hurricane blew up the cost of energy, but otherwise, inflation is still reasonably well contained.”

WHAT IT MEANS: We knew that Harvey’s hitting Texas would affect the inflation indices and it did. Consumer prices jumped in August, led by a surge in gasoline costs. A loss of production, even for a short time, tends to do that. Are we are likely to see some spillover into September? Gasoline costs spiked during the early portion of the month, though they have started coming down. We still have half the month to go so it is not clear what will be the impact this month. Otherwise, prices rose moderately. Food and clothing costs increased minimally while clothing, medical goods and vehicle prices were either flat or even down. Restaurants continue to push through price increases even as supermarket prices fall. Whole Wallet is now only Half a Wallet. Inflation is picking up in the services side of the ledger. Housing, transportation and medical services costs were up sharply.

The large rise in overall consumer costs in August cut deeply in household spending power. While hourly wages rose, the increase was more than offset by the jump in prices. Thus, real earnings declined. Over the year, inflation-adjusted hourly earnings were up only 0.6%. As I keep saying, it is hard to grow quickly if purchasing power is rising modestly.

Weekly jobless claims fell sharply last week but the level is extremely high due to the Hurricanes. These numbers will be likely remain elevated as Irma’s impact is still to be seen in the labor data. It is impossible to know how high they will go and when they will come down, so just use the data to understand the impact on jobs, not the trend in the labor market.

MARKETS AND FED POLICY IMPLICATIONS: The gasoline situation will not mislead the Fed into thinking inflation is on the rise. It is accelerating, but only slowly. Excluding energy or even when both food and energy are removed from the index, the rate is still below the Fed’s 2% target. The Fed will look past the short-term impacts as Fed policy works with a lag anyway. The members are worried about next year not next month. They might want to temporize at next week’s FOMC meeting, as there is a lot of uncertainty about the impacts of the storms. Even if they do, expect announcements about balance sheet reductions and a rate hike to come in the November and/or December meetings. As for the markets, when it rallies on the belief that the insurance costs will by huge but not incredibly huge, then you have to wonder about the rationality of investors. It is hard to see that the storm didn’t cause massive damage. The real problem will come if insurance companies don’t pay or are slow to pay for repairs. Without those funds, much of the needed renovations will either not be made or it will take a really long time for homeowners and businesses to make them. Lower and slower insurance payments mean less growth. Regardless, the cost of the Hurricanes will likely be enormous and a lot of the infrastructure will have to be repaired. Government spending will rise sharply at the federal, state and local levels. The huge cost to utilities will likely lead to price increases down the road. We are looking at a change in a lot of the economic indicators and investors will need to understand what is trend and what is temporary. The answer, my friend, is not blowing in the wind. The problem was the wind.

August Producer Prices

KEY DATA: PPI: +0.2%; Less Food and Energy: +0.2%; Energy: +13.4%

IN A NUTSHELL: “The winds of change hit the energy sector in August, driving up prices sharply.”

WHAT IT MEANS: The Fed meets next week and good luck to the members as they try to figure out where we go from here. The best they can do is determine where things were BH (before hurricanes) and as we have seen, economic growth was running pretty much at a normal pace. As for their inflation concerns, wholesale costs rose in August, but most of that had to do with energy dislocations that drove up the prices of most products. Excluding energy, producer prices increased modestly. Food costs were down fairly sharply with a variety of products posting declines. The other sectors where prices jumped were transportation, warehousing and construction. Services costs, which had been leading the way toward higher inflation, rose again but not by much. Over the year, finished goods costs have surged 2.9%.   Though there is a wide variation across the categories, the increases were widespread enough to point to some increased producer costs. Looking into the future, the major source of pressure is the energy sector. Once the problems created by the hurricanes dissipate, those will likely fade as well.

MARKETS AND FED POLICY IMPLICATIONS: Another day, another number that tells us where we were but not where we are going. Inflation is picking up and had this been the case without the weather, everyone would be saying that the Fed was going to hike rates soon. While energy prices are already starting to come down, other costs will likely rise and some of them sharply. Somewhere between one-half and a million vehicles may have to be replaced and that will put pressure on new and especially used vehicle prices. Home reconstruction in both Texas and Florida will put major price pressures on building supplies while labor is likely to be in short supply. Good luck trying to repair a roof. In other words, over the next six months we should see a whole slew of prices rise, at both the consumer and producer level. That will likely give the Fed some cover to raise rates and reduce its balance sheet. So we are only dickering over timing. I still believe there will be one more rate hike and the start of balance sheet normalization by year’s end. The members will likely look past any short-term negative numbers and that includes the surge in energy costs. They know the economy is moving forward and that ultimately, there will have to be an awful lot of private and public spending on goods and services that would not have happened without the massive losses created by Harvey and Irma. Let’s hope this is it for the hurricane season.

July Job Openings and August Small Business Index

KEY DATA: Openings: +54,000; Hiring: +69,000/ NFIB: +0.1 point

IN A NUTSHELL: “Small businesses remain optimistic and are hiring, even as the labor market tightens.”

WHAT IT MEANS: The August below-expectations jobs report was a disappointment to some but a reality check to others. The simple fact is that firms are hiring but are having massive problems finding workers in an ever-expanding economy. The Job Openings and Labor Turnover report, commonly called JOLTS, is one of the more closely watched releases that the government produces, especially by Fed Chair Yellen. The July report highlighted all the issues in the labor market. Hiring was solid, as we saw with the July jobs report. But more importantly, job openings reached their highest level on record. Firms cannot add workers fast enough to close the needs gap. The job openings rate, which is the number of openings as a percent of employment and openings, was up sharply over the year in a wide variety of industries. One of the problems facing firms is that workers are still pretty much locked into their current positions. The quit rate, which you would expect to rise in a tight labor market, ticked up but remained in the range it has been for the entire year. With companies unwilling to bid for workers from other firms, there is little reason to leave and that is limiting the availability of qualified workers.

Job gains should remain decent going forward as small business optimism is still quite high. The National Federation of Independent Business’ index edged up in August, led by a jump in the percentage of those that felt now is a good time to expand. To do that, firms are looking to invest more, which for small businesses is a strong sign of confidence. Firms would like to hire but labor quality remains a huge problem. Interestingly, while businesses are raising wages, expectations of future increases are falling. Maybe they think they have done enough. I suspect they will be disappointed.

MARKETS AND FED POLICY IMPLICATIONS: Until we start getting September numbers, the data will basically be good only for knowing how the condition of the economy going into the hurricanes. But the numbers tell us nothing about what we will see in the next six months. Indeed, it really makes no sense to react to these data. Keep in mind, Texas and Florida have the second and fourth highest state GDPs. Together, they account for about 14% of total U.S. GDP and employment. In other words, when they have problems, it has an impact on national economic activity. And their economies have taken a lickin’, though they will start tickin’ again soon. All we know right now is that going into the hurricanes, the economy was growing at a moderate pace and the labor markets were tight. After the initial downdraft in growth, the rebuilding process will hype spending. Think of all the houses, appliances, furniture, household products, motor vehicles, commercial and industrial buildings and so on have to be replaced. But at the same time, many businesses will never come back and many jobs will be lost permanently. But that would also free up a lot of workers to take other jobs, possibly easing the labor shortage in some areas. So as you can see, how this all shakes out is unclear, but it is likely to add to growth by the end of this year and well into the first half of next.

August NonManufacturing Activity and July Trade Deficit

KEY DATA: ISM (NonMan.): +1.4 points; Orders: +2 points; Employment: +2.6 points/ Trade Deficit: up $0.1 billion

IN A NUTSHELL: “The economy was doing fine before Harvey hit and if Irma causes major damage, it could be many months before we know the actual trend growth rate.”

WHAT IT MEANS: Well, coming into the worst phase of the hurricane season, the economy was doing fine. How we will come out of it is anyone’s guess right now. In August, the Institute for Supply Management reported that non-manufacturing activity rebounded from the downdraft it hit in July. Orders increased, production rose and backlogs built, all pointing continued good growth in the months ahead. This report mirrored the manufacturing numbers that were released last Friday. About the only negative in the report was that the level of the index was below the average for the past twelve months. It is still solid, but we may not see any major acceleration in growth going forward.

The U.S. trade deficit widened a teensy bit in July as both imports and exports declined. That is not good news. We want to see both expand as it would indicate both the U.S. and world economies are growing faster. On the export side, we sold a lot more food and aircraft, but fewer cell phones and motor vehicles. We imported more food, cell phones and computer products, but our demand for foreign oil, steel, vehicles and pharmaceutical products dropped. The trade deficit with most countries and regions widened, which should not make the president happy. It hit an eleven-month high with China even though exports expanded.

MARKETS AND FED POLICY IMPLICATIONS: The climate may not be changing, but in the span of two weeks, a hurricane dropped the most amount of rain on the continental U.S. in recorded history and the strongest Atlantic storm on record is bearing down on Florida. These extreme climate events will have real impacts on the pattern and level of growth and will modify trends in the data. The great losses in Texas and potentially Florida would slow growth in the third quarter and into the fourth. But as rebuilding efforts kick into high gear, spending in a variety of sectors will expand at unusually high levels. Going forward, it will be important to dismiss the headline number and figure out what is real and what is fake news, I mean, temporary factors. That complicates the Fed’s decision-making process as it will be hard for the members to have a good handle on growth. And the uncertainty could last through the fall as some of the data are lagged a month. This will be especially true if Irma or any of the remaining storms hit the mainland and cause major damage. All we can say right now is going into September, the economy was moving ahead moderately. Investors should use data for the next few months only to understand where things are, not necessarily to forecast what will happen going forward.