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July Industrial Production and Leading Indicators and Weekly Jobless Claims

KEY DATA: IP: +0.2%; Manufacturing: -0.1%/ LEI: +0.3%/ Claims: -12,000

IN A NUTSHELL: “Softening vehicle sales are weighing down the manufacturing sector.”

WHAT IT MEANS: The Federal Reserve released the “minutes” of the last FOMC meeting yesterday and it seems there is a lot of uncertainty about what to do next and when to do it. In particular, there was great debate about the slowdown in inflation, why it is happening and what that means for the pace of rate hikes and balance sheet reduction. It is no longer clear that in September, the Committee will announce when it will be starting the process of balance sheet normalization. It had been the consensus that we would get something next month.

If the Fed is to start the reducing its bond holdings and continue raising rates, the economy and inflation may have to pick up steam. If or when that will happen remains uncertain after today’s data. While industrial output rose moderately in July, it was largely due to improving utility and energy production. Weak vehicle sales, which led to a sharp reduction in assemblies, are holding back not only transportation but also those sectors, such as metals, that feed into vehicle production. Large increases in apparel output (likely an anomaly) and chemicals kept total output from tanking. Basically, the manufacturing sector may be expanding but it is hardly booming.

While the industrial production data didn’t point to any major improvement in growth, the Conference Board’s Leading Economic Index did indicate that activity should pick up. After posting a large rise in June, the index rose solidly in July, led by rising financial indicators. As the press release noted, “the U.S. economy may experience further improvements in economic activity in the second half of the year”.

As for the labor market, unemployment claims fell sharply last week, reaching record low levels when adjusted for the size of the labor force. The labor market is tight but wage gains are not rising, which is confusing to an economist – or at least me.  

MARKETS AND FED POLICY IMPLICATIONS: So, we have uncertainty in manufacturing, but strength in financial indicators pointing to stronger growth. However, yesterday’s report on July housing starts and permits was a real downer. Both fell, which was a surprise. This segment of the economy had been showing signs of strength. Well, maybe not. When you put it all together, it is hardly clear whether we can get to the administration’s goal of 3% growth for more than even one quarter. We might see something close to that in the current quarter, but unless incomes growth faster, that pace would not be sustainable. And if we continue on the 2.25% growth path, businesses may be able to hold the fortress against faster wage gains. The potential for greater labor cost pressures, in conjunction with the unwinding of some temporary factors that the Fed believes is currently restraining inflation, is what has driven the belief that the normalization process can continue unabated. But for some at the Fed, patience is running thin and they are saying that maybe the process should be slowed. The next meeting is September 19-20 and that one may take on even greater importance, as we need further guidance on what the Fed’s normalization schedule might look like. This might also be Janet Yellen’s last meeting before a new Fed Chair is nominated. If, as expected, it is not Yellen, that could introduce another dynamic into the discussions.


July Consumer Prices and Real Earnings

KEY DATA: CPI: +0.1%; Less Food and Energy: +0.1%/ Real Earnings: +0.2%; Over Year: +0.7%

IN A NUTSHELL: “The only thing saving consumers is low inflation as spending power is going largely nowhere.”

WHAT IT MEANS: Inflation remains well under control. Yesterday we saw that wholesale costs were soft and today’s consumer price report also pointed to minimal inflation pressures. The Consumer Price Index rose modestly in July. While energy prices edged down, food costs increased moderately. (The all-important bakery component surged, so my diet is safe.) Excluding food and energy, prices were up minimally. Looking at the details, several components stood out. Prices of medical commodities and services continue to surge. The deceleration in medical costs had been going on for quite some time but that is no longer the case. On the other hand, costs of both new and used vehicles keep falling. The slowdown in demand and the large number of vehicles coming off leases are pressuring the sector. Households are also being buffeted by large increases in vehicle insurance. Clothing prices were up in July but for the year, they are still down.

While they wait for wage gains to accelerate, workers can be thankful for the modest inflation. Hourly wages rose moderately and only part of that gain was lost to the low inflation. Still, the increase over the year of real, or inflation-adjusted earnings is pathetic. For all of 2017, real hourly earnings have expanded by less than 1%. Households are earning more, but some of the gains are coming from working longer. Even when you add the rising hours worked to the gain in wages, family spending-power has increased by just over one percent. That is why so many people are unhappy.

MARKETS AND FED POLICY IMPLICATIONS: The Fed may want inflation to pick up, but that would not be good news to households. Wages are growing modestly and the only way spending power has increased at all is that inflation has remained below the Fed’s target rate. As I have noted on countless occasions, it is hard for the economy to grow much more than 2% if earnings are largely flat and that is still the case. Real wages had accelerated during 2015, but the gains have slowed over the past eighteen months. Consumers have had to reduce their savings rate to maintain their lifestyles. That is not good news. So we are stuck in the same trap that we have been in for several years now: Wages are rising modestly so consumption is mediocre. That is keeping growth down, limiting business pricing power and causing inflation to decelerate. The slow growth is also enabling businesses to restrain wages and allow job openings to go unfilled. The Fed members really want inflation to rise above 2%. But if that happens without a concomitant increase in wages, consumer purchasing power will decline, slowing growth. Essentially, the driver of stronger growth appears to be, at least to me, better wage increases. That would expand demand and growth, induce workers to work harder not just longer, improve productivity, pricing power and profits and induce greater investment. That’s my theory and I am sticking to it.

July Private Sector Jobs and Help Wanted OnLine

KEY DATA: ADP: +178,000; Manufacturing: -4,000/ HWOL: -157,700

IN A NUTSHELL: “Job growth is really solid, even as firms give up advertising for workers they cannot find.”

WHAT IT MEANS: It’s Employment Friday week, which means we get the estimate of private sector job gains by ADP. The employment services firm is predicting that payroll increases were pretty solid in July. Strong hiring by mid-sized firms, those with 50 to 500 employees, led the way. But both the smallest and largest companies added workers at a decent pace. Looking at the sectors, it is nice that energy is adding to not subtracting from job growth. There were strong increases in professional and business services, education and health care. On the other hand, manufacturers cut workers while the construction boom may be slowing as builders added only a modest number of new employees.

While ADP is telling us that firms are hiring, the Conference Board is indicating they are cutting back sharply on their advertising. The number of help wanted ads posted online fell sharply in July. The level peaked at the end of 2015 and has been on a fairly steady downward trend since. Just in the past year, there was a nearly 10% drop. And the fall off was widespread. Declines were seen in nineteen of the twenty largest states and only five states showed increases. Similarly, nineteen of the twenty largest metro areas showed reductions in advertising activity and only four of the top fifty-two areas were up. Finally, every one of the ten occupational categories posted declines. In other words, this is a nation-wide, economy-wide slowdown.

MARKETS AND FED POLICY IMPLICATIONS: If the ADP numbers are anywhere close, something that doesn’t happen all the time, we should get a pretty good employment report on Friday. That raises the following questions: First, if firms are hiring so strongly, why are they complaining they cannot find qualified workers? Are they only hiring unqualified workers? Second, if they are having so much trouble finding qualified workers, why are they cutting back on the search process? The labor market is a real conundrum. Job gains are solid and no matter which measure of unemployment/underemployment you use, conditions are tight. Meanwhile, wage increases are tepid. Something has to give. I don’t think we will get the strong increase that is forecasted (consensus is 180,000). I think it will be less than 150,000. But even my number is more than the labor force growth and should lead to a decline in the unemployment rate. And it should put even more pressure on wages. Until that actually happens, though, I will join the Fed members in being confused about the true state of the labor market. As for investors, they want to see that wages are rising faster for an extended period, so even if we get a pop in labor costs on Friday, I don’t expect panic to set in.

June Spending, Income and Construction and July Manufacturing Activity

KEY DATA: Consumption: 0%; Disposable Income: -0.1%/ Construction: -1.3%; Private: -0.1%/ ISM (Man.): -1.5 points; Orders: -3.1 points; Employment: -2.0 points

IN A NUTSHELL: “The consumer may be slowing down but that has yet to have a major impact on manufacturing.”

WHAT IT MEANS: The economy rebounded nicely in the spring, but the first half of the year was the same as it has been for the last seven years. Now that we are in the second half, the question is: Will the second quarter rise in activity be sustained or will we fall back into the usual pattern? If the consumer has any say, don’t expect any major improvement in growth. Consumption, when adjusted for inflation, was flat in June. A modest rise in services demand was offset by declines in durable and nondurable spending. The broad based moderation in consumption is a concern, especially when you consider that incomes are just not improving. Real disposable income, which is the best measure of spending power since it adjusts for taxes and prices, fell slightly. That is not as much of a concern as it might appear since the drop was due to a major cut back in interest and dividend income. This is a wildly volatile component. Wage and salary gains were good but still nothing spectacular. Households are trying to maintain their lifestyles and they are doing that by cutting their savings rate.

Despite tepid consumer demand, the manufacturing sector is in good shape. Yes, the Institute for Supply Management reported that the activity index fell in July. Actually, just about every component was off. So why do I say conditions remain strong? The levels of the overall and component indices are still pretty high. New orders are increasing strongly, just not robustly. Firms are adding to payrolls at a solid pace, even if it is slightly less rapidly than in June. And order books continue to fill, providing hope that production will continue to increase. Indeed, the overall index seems to be pointing to GDP growth closer to 4% than the 2% we have seen so far this year.

The June construction report was released and it showed that building activity fell sharply. A major reduction in public sector activity made the numbers look really bad, though the lack of increase in the private sector was a real disappointment.

MARKETS AND FED POLICY IMPLICATIONS: Until I see differently, I am going with my headline from last week’s GDP report: Same as it ever was. The consumer is spending but is hardly exuberant. Income growth is just not strong enough to pull us out of this 2% economy. Yes, manufacturers are saying things are good, but with vehicles sales trending downward compared to last year, it is likely there is little room for further improvement. And construction is going nowhere. All this points to another quarter of maybe 2.50% growth, give or take a quarter percentage point. So, why are investors so buoyant? Earnings are holding up and as long as that continues, the party could keep going and going and going.

June Durable Goods Orders and Weekly Jobless Claims

KEY DATA: Orders: +6.5%; Excluding Aircraft: +0.2%; Capital Spending: -0.1%/ Claims: +10,000

IN A NUTSHELL: “It still doesn’t appear as if the private sector is investing heavily, and that is troubling.”

WHAT IT MEANS: Another day, another indication that the economy continues on its less than stellar growth path. Durable goods orders soared in June, but don’t get too carried away by the headline number. Nondefense aircraft demand surged by 131%, making up just about all of the increase. Still, the details weren’t terrible. Orders for metals, both raw and fabricated rose and the demand for machinery and communications equipment was up. But the computer and electrical equipment and appliances sectors posted declines. The real concern in the report was the measure of private sector capital spending. This indicator was off slightly after having posted a sharp rise in May. Businesses just cannot seem to make up their minds if they want to go all in on the future economy or move ahead cautiously. With all the chaos in Washington, it should not be a surprise if firms take a wait and see attitude.

New claims for unemployment insurance jumped last week. The four-week moving average, which smooth’s out the volatile data, was flat and remains at a pretty low level. The labor market is tight and a week from tomorrow the July employment report is released. It should give us a better indication of how tight things really are. With the Fed hoping for inflation, the wage and hours worked numbers continue to be the real focus of attention.

MARKETS AND FED POLICY IMPLICATIONS: With Congress wrapped up in the theater of the absurd, businesses are now flying by the seat of their pants. How long will health care dominate the agenda? The quagmire that is health care, which sucked the life out of Democrats, seems to be trapping Republicans. The failure to actually come up with an alternative over the past seven years is causing chaos and there seems to be no simple way out of it. At least there is no simple political way out. When you claim you can quickly and easily replace the ACA with a plan that lowers costs, provides better health care and makes insurance more available, you have creating a challenge that is not likely to be met. The problem is, there is no second best when you start reducing the number of people insured, at least politically. How easily the Republicans can pivot to tax reform, and the impact of the health care debacle on their ability to actually reform the system rather than doing the usual, which is provide tax cuts, is just not clear. And that uncertainty has to weigh on corporate decision-making. As for investors, earnings look good so there appears to be little worry about the future.

July 25-26 2017 FOMC Meeting

In a Nutshell: “No funds rate hike but more hints that the balance sheet reductions are coming.”

Rate Decision: Fed funds rate range maintained at 1.00% and 1.25%

The FOMC members came to Washington with not much expected and they did pretty much what was expected: They kept the funds rate at 1.00% to 1.25% and signaled that it was the time to reduce the balance sheet was near. As for the details of the statement, the view of the economy was largely the same as it was in June. Everything is solid or expanding. Inflation is now ‘running below 2 percent” rather than “running somewhat below 2 percent”. In other words, not much of a change. There hasn’t been a lot of data since the June 14-15 meeting, so there was little reason to change the outlook.

What everyone was looking for was a signal on when the Fed might start shrinking its balance sheet. The Committee stated: “For the time being (emphasis added), the Committee is maintaining its existing policy of reinvesting principal payments from its holdings”. It then added: “The Committee expects to begin implementing its balance sheet normalization program relatively soon (emphasis added)”. In other words, the signal was sent to the markets that the there will be some reduction in the balance sheet sometime this year.

Okay, what should we make of this? First, expect the Fed to announce that the balance sheet adjustment will begin either at the September or November meeting. As for the funds rate, it is not likely to be increased at the September meeting unless the economy picks up steam and inflation, especially wage inflation, accelerates. If it is not hiked in September, expect the next move to come the meeting after the announcement of the balance sheet reduction. My guess: Nothing in September, November 2nd for the balance sheet move and December 13 for the next rate hike. That is also likely to be Fed Chair Yellen’s last meeting, so she will exit at the end of January with the interest rate and balance sheet normalization under way.

(The next FOMC meeting is September 19-20, 2017.)

June Consumer Confidence and April Home Prices

KEY DATA: Confidence: +1.3 points/ National Home Prices (Over-Year): 5.5%

IN A NUTSHELL: “Confidence is rising, but there is some uncertainty about the future setting in.”

WHAT IT MEANS: As the year grinds on and the economy continues to improve slowly, the euphoria about the future is beginning to wane. The Conference Board reported that consumer confidence rose in June, reversing a decline seen in May. The key to the increase was a jump in the impression about current conditions. Consumers felt that both business conditions and the labor market improved solidly over the month. Importantly, the percent of people saying jobs are plentiful kept rising while those feeling that jobs were harder to get declined. However, the outlook about the future, while still solid, is not as optimistic as it had been. Fewer respondents expected business conditions to improve and there was an increase in those who expect jobs to be harder to get in the future.

Home prices have been rising much faster than inflation and the question being raised is: How long can that continue? Well, one measure, the S&P CoreLogic Case Shiller national home price index did jump in April, but over-the-year, the gain was a little slower than in March. Indeed, the change from last year has been in a fairly tight range for the past five months, varying between about 5.4% and 5.6%. Other indices are still showing signs of accelerating housing price gains, so we need to wait before we conclude the situation is stabilizing.

MARKETS AND FED POLICY IMPLICATIONS: The second quarter is coming to an end and there are few indications that growth was robust. The consumer didn’t buy motor vehicles at any great rate in April and May. Yesterday, it was reported that durable goods orders declined in May and most of the manufacturing reports coming from the regional Federal Reserve Banks have pointed to slowing manufacturing activity. The trade deficit doesn’t look like it will be shrinking much, if at all, so don’t look to the foreign sector for much help. Maybe inventories built, but if that was due to slower sales than expected, it isn’t a positive sign for the economy. And why would business invest heavily? Demand is not growing rapidly and it only makes sense to wait until the tax changes, if any, are known before making a decision. To change things around, the consumer will have to spend more and while it is nice that people think current conditions are improving, it would better if they were becoming more, not less confident about the future. So, investors will have to find something else, if they actually need something, to drive markets up further. But with two hikes under their belt, the Fed members may want to see better growth before they make the next move this year.  

June Home Sales

KEY DATA: New Sales: +0.8%/ Existing Sales: -1.8%

IN A NUTSHELL: “Home sales need to pick up further if construction is to add much to economic growth.”

WHAT IT MEANS: The housing market has been wandering around for most of 2017 and it isn’t clear if that pattern will change anytime soon. Today, June new home sales were released and the results were good but not great. Yes, there was rise in total demand, but the level is nothing spectacular. Indeed, it is probably still at least twenty percent below what might be considered normal, let alone strong. At least the trend is up, especially when compared to 2016 levels. Looking across the nation, weakness in the South offset strength in the West and Midwest. Sales were flat in the Northeast. Median prices were actually off from June 2016 as there were a lot more lower-priced houses sold. While that is likely a one-month wonder, the trend in price gains has been down.

On Monday, the National Association of Realtors reported that existing home sales fell in June. It seems that there is one month were demand rises followed by one where sales falls. This saw tooth pattern has led to only a relatively small increase in sales since December 2016. Regionally, demand rose only in the Midwest. There just aren’t a lot of homes for sale and prices are rising, though at a decelerating pace.

MARKETS AND FED POLICY IMPLICATIONS: We need the housing market to be strong if the economy is to accelerate. The sector has been adding to growth, but not by much. That is happening despite low mortgage rates. We also saw that the National Association of Home Builders confidence index slipped in July, pointing to only modest gains in construction. Housing starts should increase, as permit requests are outstripping starts, but if demand doesn’t pick up, that rise in construction is not likely to be significant. When you add the housing data to the consumer information, they point to only a minimal increase in growth. The Fed will be ending their meeting soon and we will know what the members think about the economy. It is clear that the FOMC members feel further increases in interest rates are needed and the Fed must start shrinking its balance sheet. To do that, though, inflation has to stay close to the target. It hasn’t done that lately. A better housing market would help and that is happening only slowly. That said, investors are focusing on earnings and that will be the case since they cannot use expectations of major tax cuts and spending increases to power the economy. It just seems that when one reason to take the markets up dissipates, a new one is created. Around and ‘round the markets go, where they stop no one knows.

June Housing Starts and Permits

KEY DATA: Starts: +8.3%; 1-Family: +6.3%; Multi-Family: +13.3%/ Permits: +7.4%; 1-Family: +4.1%; Multi-Family: +13.9%

IN A NUTSHELL: “The home construction rebound was nice to see but that was not a major surprise given that activity had faltered the previous three months.”

WHAT IT MEANS: Housing has been a major concern as construction was on the downslide through the spring. That pattern was broken as builders picked up the pace quite sharply in June. The single-family sector improved solidly, but the really big increase came in the multi-family segment. This is a pretty volatile portion of the market and we do get double-digit increases or declines fairly often. For example, multi-family home starts more than tripled in the Northeast in June. So don’t read too much into the surge in the multi-family component and don’t be shocked if it slows in July. Still, this is where a lot of growth is expected to be seen, as Millennials pour into the housing market, so it is good that it is improving. Looking across the nation, The Northeast, not surprisingly given the rise in multi-family starts, led the way, followed by a large rise in the Midwest. However the number of starts was up modestly in the West and fell in the South.

Looking forward, permit requests rose solidly as well. The level of permits has been well above the construction rate and since builders are not doing a lot of spec construction, they should be using those permits soon. That implies potentially several more months of increases in construction. The only region where permit requests fell was in the Northeast. Developers in that part of the country probably used up all their permits in June putting up lots of apartment buildings.

MARKETS AND FED POLICY IMPLICATIONS: The rise in home construction in June, as well as some upward revisions to previous months numbers, hold out hope that the residential sector did not slow growth much in the second quarter. As with other sectors, a lack of workers is limiting the ability of builders to build. Land and input costs are also an issue. Thus, I don’t expect this part of the economy to add greatly to growth going forward. Still it would be nice if it does play a role in pushing up the growth rate. We get the second quarter GDP number on July 28th and it doesn’t look like it will be near 3% unless firms failed to control their inventories. Private domestic sales should be in the 2% to 2.25% range, which is nothing great. But the pace of growth is not terrible. Stronger growth would put even more pressure on the labor markets. If firms cannot find workers with the economy growing at 2%, where will those workers come from if growth hit 3% or more? As for investors, the Obamacare repeal movement crashed and burned and you would think that would cause investors to think that similar problems could arise when the budget, tax cut and infrastructure bills are debated. Exuberance played a major role in the rise in the stock markets since the election. The political uncertainties should lead to some caution. But now people are saying that even a small tax cut and infrastructure-spending bill would be just fine. That seems to me that they are looking for any reason to be optimistic. We may not know for six months if that confidence was warranted.

June Producer Price Index and Weekly Jobless Claims

KEY DATA: PPI: +0.1%; Goods Excluding Food and Energy: +0.1%/ Claims: -3,000

IN A NUTSHELL: “The tame inflation is causing the Fed to reconsider its normalization path.”

WHAT IT MEANS: Inflation, where art thou? With the unemployment rate near, at or even below full employment, the assumption has been that accelerating wage pressures would appear. That hasn’t happened so far. And it doesn’t look like consumer costs will jump anytime soon either. Wholesale prices increased minimally in June as rising food costs were offset by declines in energy prices. The details, though, were not quite as clear as to the extent of inflation in the economy. Stepping back and reviewing the many subcategories and special indices, few are showing any decline in prices. That indicates a floor is being set on wholesale prices. Finished consumer food prices are rising fairly sharply and that gets passed through quickly. Finished consumer goods excluding food and energy are also increasing at a moderate pace. And while all finished consumer goods prices were up modestly in June, they are 2.7% higher than they were last June. Meanwhile, producer services costs are increasing at a pace that, while not high, can hardly be considered as minimal. Services are nearly two-thirds the index, which is important since intermediate services prices are increasing significantly. That implies that we should see the pressures on services continue in the months. Goods costs are rising sharply at the crude level, but it is a long and winding road from crude to finished goods, so it would be premature to say producer costs are going to rise sharply in the future.

Jobless claims decreased a little last week. The level is low and given the lack of available workers should remain near or at historically depressed levels for quite a while.

MARKETS AND FED POLICY IMPLICATIONS: Fed Chair Yellen, in her semi-annual testimony to Congress on monetary policy this week, hinted that a continuation of low inflation might allow the Fed to limit the increase in interest rates. If inflation remains restrained, what economists call the neutral funds rate, which is when the Fed is neither stepping on the brake nor accelerator, would also be low. That adds even greater import to the inflation data. Right now, there isn’t a lot of pressure on prices. Firms may have large numbers of job openings and great difficulty finding qualified workers, but they have yet to find it necessary to raise wages faster to attract workers. The recently declining energy costs have helped corporate bottom lines, providing further flexibility on the labor side. And what was the strong dollar had helped restrain import prices. Inflation is still low enough that the Fed has some flexibility in its rate and balance sheet normalization process. Looking forward, though, the declining dollar needs to be watched and the path of both energy and food costs is critical. But most importantly, if firms can maintain their limited pay increase policy in the face of the huge number of job openings, there will be minimal pressure to raise prices. Thus, the Fed may be able to go more slowly than had been expected, at least before this week’s testimony. That should buoy investors’ confidence.