December 12-13 2017 FOMC Meeting

In a Nutshell: “The Committee decided to raise the target range for the federal funds rate to 1-1/4 to 1‑1/2 percent.”

 Decision: Fed funds rate maintained increased to 1.25% to 1.50%.

Not surprisingly, Federal Reserve Chair Janet Yellen went out with a bank, or a rather a rate hike. The FOMC announced that it was raising the target range for the federal funds to 1.25% to 1.50%. This constitutes the third rate hike this year, pretty much what most of us expected going into the year.

What was interesting in today’s releases was the sharp upward revision to the Fed’s expectations on economic growth next year. Instead of increasing at a 2.1% pace, which was the median forecast in September, the members now put it at 2.5%. That upward revision is in line with the projections of most economists when you factor in a tax bill. While the Committee didn’t specifically mention fiscal policy in its statement, Chair Yellen did say she thought a tax cut could be modestly positive next year. She didn’t think it would change the growth path afterward, which is also consistent with both the members’ forecasts and that of most private sector economists. There could be some greater growth, but echoing her view, it would be limited.

What was interesting is that the Fed believes that its rate policy will not only allow inflation to rise to its target of 2% in the medium term, nothing new there, but continue “supporting strong labor market conditions”. As one reporter pointed out, that could mean the Fed already thinks the labor market is strong enough and could become concerned if the unemployment rate goes lower. Strangely, despite the upping of growth and the lowering of their expected 2018 unemployment rate, the members have not altered their inflation forecast. One of the questions asked at her last press conference was whether Chair Yellen thought the unchanged inflation rate was inconsistent with lower unemployment rates and faster growth. Her answer was essentially that the Fed was unclear why the inflation rate had not accelerated lately, which to me means that a sudden spurt could create real concern. Finally, the so-called dot-plot called for about three rate hikes next year. That would be consistent with the forecast of decent (2.5%) growth but no major acceleration in inflation. Any deviation from either would likely mean more hikes.

Lastly, I think Janet Yellen did a wonderful job as Fed Chair. There were more than a few times I disagreed with her positions, but her leadership was outstanding and she leaves the Fed with an economy that is growing solidly and a financial system that is much more stable than when she started. It is hard to quarrel with her results, especially given that fiscal policy was in a state of gridlock during her term and economic policy was squarely on the back of the Fed. Well Done!

(The next FOMC meeting is January 30-31, 2018.)

November Consumer Prices and Real Income

KEY DATA: CPI: +0.4%; Over-Year: 2.2%; Less Food and Energy: +0.1% Over-Year: +1.7%/ Real Hourly Earnings: -0.2%; Over-Year: +0.2%

IN A NUTSHELL: “The continuing erosion of consumer spending power raises serious questions about future economic growth.”

WHAT IT MEANS: For the economy to continue to accelerate, consumers must step up to the plate and that is in question. Household spending power can only increase if the gains in income are not offset by the rise in prices. That means we have to look at both wages and inflation. On the inflation front, a jump in energy costs helped power another sharp rise in consumer prices in November. The surge in sales led to a jump in both new and used vehicle prices, while the cost of medical commodities also rose sharply. Food costs, thankfully, are going nowhere, though there continues to be pricing pressure for cakes and cupcakes. I am actually thinking of switching to fresh fruits and vegetables, whose costs are falling. (Not really.) In addition, apparel prices are plummeting, which is helping offset the rise in energy costs as you can put on warm clothes instead of raising the thermostat. Housing prices continue to rise at a moderate pace.

The greater than expected increase in consumer prices took a toll on household spending power. Hourly wages rose half as fast as inflation resulting in a decline in real, or inflation-adjusted income. Over the year, real wages rose minimally. Even if you adjust for the increase in hours worked, weekly earnings increased by less than one percent. In other words, people don’t have a lot more spending power today than they did a year ago. The solid gains in consumption were funded, at least in part, by a decline in the savings rate. That can continue only so long.

MARKETS AND FED POLICY IMPLICATIONS: The FOMC will release its statement soon and it will likely say that there was an increase in the funds rate. Given the direction and level of inflation, there is every reason for the Fed to hike rates. But the real threat to the economy is the continued, almost inexplicable lack of wage increases. As long as that continues, questions have to be raised about the capacity of the economy to grow. Yes, lower tax rates will incent some additional spending by businesses, but it is likely to be on labor-saving capital projects. Firms, if they can help it, are just not willing to pay their workers more. There are lots of anecdotal stories of firms bidding for key workers but the trend is not yet widespread enough to move the data. If we don’t get better wage gains, firms will have to be cautious in spending on capacity-increasing projects, regardless of their improved bottom lines. And companies who sell to the U.S. consumer have to question whether it makes sense to expand capacity in light of the lack of spending power growth. The tax cuts will help to some extent, but with most of the household tax cuts going to upper income households, the impact on overall spending may be disappointing. That, of course, will not derail investors as they know that the bigger companies who are listed on exchanges will, for the most part, make out like bandits.

November NonManufacturing Activity and October Trade Deficit and Home Prices

KEY DATA: ISM (NonManufacturing): -2.7 points; Orders: -4.1 points/ Trade Deficit: $3.8 billion wider/ Exports: down 0.1 bil.; Imports: up $3.8 bil./ Home Prices (Over-Year): +7.0%

IN A NUTSHELL: “All segments of the economy are doing just fine, though the surge in housing prices is a concern.”

WHAT IT MEANS: In the week where we get the employment data, most other numbers don’t usually create a stir. Still, there are some critical data being released this week. The Institute for Supply Management’s Non-Manufacturing Index is one of them. This follows the services sector, agriculture, mining and construction, so it is most of the economy. Activity did decelerate a touch in November but the October level was the highest ever. The November number can be characterized as really, really strong. Orders are still growing solidly, even if somewhat slowly, order books are filling and hiring is still pretty good. When you combine the nonmanufacturing report with the previously released manufacturing numbers, it is clear the economy is moving ahead quite strongly.      

A growing economy tends to suck in goods from around the world and that is the case with the U.S. economy. Imports rose solidly in October, led by a surge in demand for oil, consumer goods and vehicles. Softness in capital goods imports raises questions about the strength of business investment. Meanwhile, exports were essentially flat. The burgeoning energy export sector was the one bright spot as sales of food products, vehicles, capital and consumer goods were all down. Adjusting for prices, the fourth quarter started off with a pretty big deficit that could restrain growth.

If you are looking to buy a home you probably know that prices are rising and CoreLogic’s October Home Price Index report confirmed that reality.  Prices were up 7% over the year, the fourth consecutive month of above 6% growth. You have to go back to June 2014, during the tail end of the post-recession surge, to find the last time prices have risen so fast for so long. With mortgage rates still very low, homes on the market in short supply and the economy in good shape, the sharp rise in prices is not surprising. As long as people simply don’t want to sell their homes, the number of listings will be limited and these price increases will not only be sustained but we will probably see them accelerate. That raises questions about a bubble forming. It hasn’t yet, but it is something to watch.

MARKETS AND FED POLICY IMPLICATIONS: Businesses are doing quite well. Activity is strong, profits are solid and optimism is high. Clearly, if we do not cut taxes right away, we are going to fall right into a recession. Okay, I am a cynic. I don’t think you cut taxes just to hype the stock market. I believe you reform the tax structure to make the economy more efficient. I will continue to argue that point especially since the tax bills that have been passed do little for efficiency and lots of big company stock prices. As Jim Cramer, of CNBC fame noted, “…it may not be good for the workers, but boy is it good for the stock market“. Worse, as most economists are pointing out, it may generate faster growth in 2018, but coming when there are labor shortages, the likelihood is that inflation will accelerate as will market rates and Fed rate hikes. So I will keep raising the warning. As for investors, it is all about the tax bills. That may change with Friday’s employment report. The consensus is for another strong number in the 200,000-range. I don’t think we will get anything near that. I have it more in the 160,000-range. We have a few days to debate that number.

November Supply Managers’ Manufacturing Index and October Construction

KEY DATA: ISM (Manufacturing): -0.5 percentage point; Orders: +0.6 percentage point/ Construction: +1.4%; Public: +3.9%

IN A NUTSHELL: “Manufacturing continues to surge and with government construction picking up, it looks like fourth quarter growth will be quite solid.”

WHAT IT MEANS: Can we get another quarter of 3% growth? The recent data point to that possibility. The Institute for Supply Management’s Manufacturing Index edged down in November, but that is hardly a concern. The index level remains high so a modest decline is not anything of consequence. Production soared and with new orders continuing to expand strongly and order books fattening, the output gains should continue. As a result, firms are hiring solidly.   Basically, there was little in this report that would point to a manufacturing slowdown.

Construction activity jumped in October, which really should not have surprised anyone. There is a lot of both public and private rebuilding that has to be done to repair the mess made by the hurricanes that hit Houston and Florida. Just about every component of the report was up strongly but the eye-opener was the surge in public sector activity. That points to a rise in government spending, if as expected, these gains will be sustained. On the private side, a pop in office construction points to growing confidence that the expansion will continue and that firms are willing to build for future employment needs.    

MARKETS AND FED POLICY IMPLICATIONS: Most of the data we have been getting indicate the economy is in really good shape. It looks like November vehicle sales may have been somewhat sluggish, but some issues with some data may delay the final reading. The vehicle numbers are important because they were artificially high in September and October due to hurricane replacements. A slowdown was expected, but given the robust October sales pace, we could still see vehicles add to growth this quarter. But for traders, it is all about the tax bill. Regardless of what is passed and its impact or lack thereof on long-term growth, it will create a 2018 sugar high. And since investors worry about the next quarter, the passage of a tax cut bill should be greeted joyously, even if the likelihood of that happening is already being priced in. The Fed is meeting on December 12,13 and at this point, it would be a shock if there weren’t a rate hike. That would occur even if the November jobs number, which is released next Friday, were weak. I expect that to be the case. If tax cuts hype the economy and inflation starts accelerating, more will be coming next year. Assuming a tax bill is passed, my belief is that new Fed Chair Powell will steer four more hikes through the FOMC if there is any rise in inflation. Without accelerating inflation, we should still expect three more increases next year.

October Income and Spending and Weekly Jobless Claims

KEY DATA: Real Consumption: +0.1%; Real Disposable Income: +0.3%; Inflation: +0.1%; Prices less Food and Energy: +0.2%/ Claims: -2,000

IN A NUTSHELL: “Consumers may have slowed their drive to empty their wallets in October, but if the Black Weekend is any indicator, they were just saving up for the real deals.”

WHAT IT MEANS: Having just gotten through what looks like a massive Black Friday, Small Business Saturday and Cyber Monday, news that consumers didn’t go out and shop ‘till they dropped in October was not necessarily something to worry about. Yes, households didn’t keep up the pace, but after the huge increase in spending in September, that was not a great surprise. After splurging on vehicles in September, sales ebbed, though not significantly. In contrast, consumption of services was up strongly and demand for nondurable goods rose at a decent pace. Without any additional increase, real, or inflation-adjusted consumption is already rising at a 1.7% pace so far this quarter. It looks like households will add to growth at a moderate, though not spectacular rate this quarter.

Going forward, there remain questions about the ability of households to lead the way. Disposable income was up solidly in October, but it didn’t come from wage gains, which rose only moderately, at best. Most of that increase was largely due to hiring, as hourly wage increases continue to be minimal. Still, after-tax income did increase faster than spending so the savings rate edged upward. At 3.2%, it is still too low.

As for the labor market, firms are not giving out lots of pink slips. Jobless claims declined a touch last week and the level, as usual, is quite low.

MARKETS AND FED POLICY IMPLICATIONS: Solid consumer confidence, massive job openings and little fear of layoffs is likely to translate into a very merry holiday season for retailers of all types. The early data point to a very big weekend of sales and that is good news for the economy. But with Cyber Monday lasting about six weeks and Black Friday starting in September, it is hard to know what the last few weeks of the shopping season will bring. We need the consumer to step up. Some of the good growth we have seen was driven by hurricane replacement and that is just not sustainable. With the savings rate at a level not seen except just before the start of the last two recessions, and with wage gains disappointing, there is only so much the consumer can do to drive growth forward. And if the Accounting Principals survey is any indicator, workers shouldn’t expect end of year bonuses, which firms seem to be doing away with. About the only thing saving consumers is that inflation is still low and it is not accelerating. As for the businesses taking up the slack, that too is open to debate. The tax bills making their way through Congress do little to incentivize productivity enhancing investment, so don’t expect capital spending to surge, no matter what the politicians tell us. So, let’s enjoy all the bargains we got this past week, but keep in mind that growth requires us to spend more and more and more and without the funds to do that, consumers are not likely do that.

November Consumer Confidence, September Home Prices

KEY DATA: Confidence: +3.3 points/ Case-Shiller Home Prices (Over-Year): +6.2%/ FHFA Home Prices (Over-Year): +6.5%

IN A NUTSHELL: “The sharp increases in home prices and high level of consumer confidence may be something to start worrying about.”

WHAT IT MEANS: The economy is moving ahead solidly in so many ways, but there could be problems forming. According to the Conference Board, Consumer confidence rose again in November. This was the fifth consecutive increase and the last time the index was higher was in November 2000. Both current conditions and expectations were up solidly. But the surge in confidence may not be backed by economic factors. Yes, the labor market is tight, but household spending-power is going nowhere. Maybe people are actually hoping to get the $4,000 to $9,000 income increase the administration has promised, but if so, they are going to be sorely disappointed. They can hope for major tax cuts, but for most, that is just not the case. So, one cloud on the horizon is consumer confidence. Household exuberance may be somewhat irrational.

A second concern comes from the housing market. Housing prices may be rising too rapidly. Both the September S&P/Case Shiller and the third quarter Federal Housing Finance Agency indices were up solidly. Price gains may not be quite as rapid as they were last decade, but they are strong and have persisted for quite some time. Worse, near double-digit increases are being posted in a number of metropolitan area.   We may not be in a new housing bubble just yet, but the jump in prices needs to be watched carefully.

MARKETS AND FED POLICY IMPLICATIONS: When I see economic data this strong, I ask once again, “Why the mad rush to cut taxes?” I keep hearing that we need more jobs, but the problem is workers not job openings. The only time over the past forty-give years the unemployment rate was below the current level was during 2000. I keep hearing that the middle class needs a break, but about 90% of the proposed tax cuts go to businesses and upper income households. Then I hear the economy is not growing fast enough. Fast enough for whom?   The growth rate has matched trend growth for the six years. And now we see that home prices are rising sharply and consumer confidence is at seventeen-year highs. Do we really need the massive tax cuts being debated in Congress? Shouldn’t we be concentrating on productivity-enhancing reform, something the bills don’t do much of? If growth does accelerate, even if for a limited period, don’t we run the risk of bubbles forming, especially in the labor market? When you do something is often as important as what you do and the tax bills contain the wrong things at the wrong time. But tax cuts do make for great political ads.

October Durable Goods Orders, November Consumer Sentiment and Weekly Jobless Claims

KEY DATA: Durables: -1.2%; Excluding Transportation: +0.4%; Capital Spending: -0.5%; Sentiment: -2.2 points; Claims: -13,000

IN A NUTSHELL: “Businesses may have paused in their capital spending in October, but they are still investing heavily.”

WHAT IT MEANS: With the passage of a corporate tax cut becoming more possible, the likelihood is that future business capital spending should be strong. While there was a drop in investment in October, the trend this year is still up solidly. A sharp drop in Boeing’s aircraft orders created the decline. In contrast, vehicle orders surged. This sector has been up and down, but with demand really strong the past couple of months, it should continue to help push the economy forward. There were also increases in demand for machinery, electrical equipment, computers and communications equipment. Given the breadth of the gains, I guess you can say that this is another number where the headline was misleading.

Consumer sentiment eased a little in November. The University of Michigan’s index fell as both the current conditions and expectations were down roughly the same amount. Still, consumer confidence is up 5% over the year, a pretty solid gain.

Jobless gains fell back to more normal levels last week after having increased the previous two weeks. That said, it is clear from the level that the labor market remains quite tight.

MARKETS AND FED POLICY IMPLICATIONS: As we go into the Thanksgiving Day weekend, it is clear that the economy is in good shape. Household confidence is up this year as is the stock market. Basically, if you are working and invested, you have a lot to be thankful for, no matter what your political preferences. And with the tax bill cutting taxes so significantly for many large companies, it is likely that after-tax earnings will be better next year and firms will probably be passing that on through increased dividends. However, it is doubtful they will want to lock themselves into higher labor costs by raising wages, as the administration seems to think. That said, there should be decent hiring as well. On that note, to everyone:

 

Have a happy and healthy Thanksgiving weekend!

October Housing Starts and Permits

KEY DATA: Starts: +13.7%; 1-Familly: 5.3%; Multi-Family: 36.8%; Permits: +5.9%; 1-Family: +1.9%; Multi-Family: +13.9%

IN A NUTSHELL: “With home construction back on track, one of the softer segments of the economy is picking up steam.”

WHAT IT MEANS: Home construction had been in a funk for a number of months, but that seems to be changing. Indeed, residential investment, as it is called in the GDP report, restrained growth in the second and third quarters. However, builders have suddenly found reasons to put shovels in the ground. Housing starts soared to the second highest pace in over a decade in October. Much of the increase came from the ever-volatile multi-family segment, which surged by 37%. While the single-family component didn’t rise nearly as much, the gain was still quite good. Geographically, there were some discrepancies and oddities.   In the Midwest and South, all segments were up solid. But in the Northeast, single-family starts tanked but multi-family construction more than tripled. And in the Midwest, total activity decline as single-family starts fell sharply.

Looking outward, the rise in permit requests indicate that home construction should remain firm, though it is doubtful that future gains will look anything close to what we saw in October. Even with the surge in construction, the number of permits requested by not yet used still rose. Indeed, permit requests were slightly higher in October than starts. It is likely that housing will add to growth in the fourth quarter.

MARKETS AND FED POLICY IMPLICATIONS: I keep hearing from our learned members of Congress that we desperately need a tax cut because growth is terrible and we people are desperate for jobs. Either I am living in a parallel universe or they are just blowing smoke, but that is just not the case. This isn’t 2009. The economy is moving ahead solidly and as I constantly point out, the issue isn’t available jobs it’s qualified workers. But, of course, in Washington, letting facts get in the way of a good political speech would be tantamount to treason, so we will have to keep listening to the babble. Interestingly, since the tax cuts go largely to upper income households, who will not spend nearly as much of the after-tax income gains as lower and middle-income families, that could wind up being a benefit. The increase in consumer demand will be muted. And from reports coming out of meetings that administration officials have had with business leaders, not a whole lot of the tax cuts cuts will go to new investment. Paying down debt seems to be the usage of choice. I suspect that a lot of the increased profits will, as usual, be used to raise dividends, buy back stock and expand merger and acquisition efforts. So maybe my concerns about the economy picking up too much steam given the lack of workers is overblown. But think about this: The deficit will rise even more than expected if the retained taxes don’t go to new economic activity while at the same time, the Fed is shrinking its balance sheet. That seems to argue for rising supply, falling prices and increasing interest rates. That cannot be great for the economy or equities. Just a thought.

October Industrial Production and Import/Export Prices, November Philadelphia Fed Survey and Home Builders Index and Weekly Jobless Claims

KEY DATA: IP: +0.9%; Manufacturing” +1.3%/ Import Prices: +0.2%; Export Prices: 0%/ Philadelphia Fed (Manufacturing): -5.2 points/ NAHB: +2 points/ Claims: +10,000

IN A NUTSHELL: “With manufacturing surging, housing solid and inflation near target levels, it is clear the economy can withstand additional rate hikes.”

WHAT IT MEANS: While everyone seems to be focusing on the tax bill as it relates to business spending, I am more concerned that a major tax cut could create enough of a sugar high to cause inflation to accelerate. That could cause the Fed to move next year more often than expected. My worry is based on the already tight labor market and what looks like continued solid economic growth. Industrial production jumped in October led by surges in the vehicle, petroleum, chemicals, computers, apparel and furniture sectors. Put simply, most of manufacturing, whether it was durables or nondurables, was up sharply. This was a broad based increase that really does grab your attention.

Reinforcing the industrial production report was the Philadelphia Fed’s survey of manufacturers. Yes, the index did recede, but it is still high. More importantly, the components were strong as orders rose faster and hiring remained solid, though not as strong as it had been. Looking forward, confidence about not just future activity, but hiring and just about everything else, was up.

On the housing front, the National Association of Home Builders’ index increased to its second highest level in over twelve years. Only this year’s March index was higher. Builders seem to have regained their confidence, though I hope it is not irrational. I don’t think that will be the case. CoreLogic reported that home equity wealth reached its highest level in history. Homeowners have the ability to move, if they want to.

As for inflation, pressures ebbed a bit in October. Import prices rose but not significantly. There is pressure on in the petroleum and related sectors as well as metals. On the export side, farmers got a big gain in prices but that was just about it.

 Jobless claims were up last week, but the level remains extraordinarily low.

MARKETS AND FED POLICY IMPLICATIONS: The economy is in good shape. The issue is neither growth nor jobs. Growth is solid and firms cannot find workers. So you need to ask what will happen if the economy surges as a result of tax cuts being implemented. Where will the added production come from if firms cannot get the workers already and productivity is in the tank? Maybe inflation doesn’t accelerate, but being an economist, I still think that markets actually work. So remember the old saying: “Be careful what you wish for, you just may get it”. The Fed needs to normalize its balance sheet and interest rates and faster growth and inflation are just the tickets they need to do so as rapidly as they want to.

October Retail Sales, Consumer Prices and Real Income

KEY DATA: Sales: +0.2%; Less Vehicles: +0.1%/ CPI: +0.1%; Less Food and energy: +0.2%/ Real Earnings: -0.1%

IN A NUTSHELL: “Prices may not be rising sharply, but they are increasing enough to restrain purchasing power and household spending.”

WHAT IT MEANS: We are starting to get the first set of fourth quarter numbers and right now they are not anything to write home about. Retail sales rose modestly in October and much of the gain came from sales of vehicles. Until we know about the extent of the flood replacement purchases, the vehicle component has to be viewed with caution. Once the replacement process is over, demand could tumble. The spending report was a bit misleading. For some strange reason, sales on the Internet were actually down. Also, falling gasoline prices reduced sales in that component. Meanwhile, in addition to the strong vehicle demand, people spent a lot of money on clothing, sporting goods, health care and furniture. And, they ate like crazy as spending at restaurants and supermarkets jumped.

On the inflation front, consumer costs didn’t increase a whole lot in October. Declines in gasoline prices, clothing and new vehicles offset increases in shelter, medical and used vehicles prices. Food costs were down in almost every category, including cupcakes. The breadth of the decline was odd and needs to be watched. It could mean they will be up next month. Excluding food and energy, the so-called core index, household prices increase a little faster. Since October 2016, the overall Consumer Price Index is up 2.0% while the core rose 1.8%, both pretty much at the Fed’s target.

Despite the modest rise in prices, household spending power declined in October. Real earnings, which adjusts for inflation, fell as wages were flat. Over-the-year, they are up only 0.4%. Need I say it again? Yes. It is hard to sustain strong economic growth if households don’t have the money to spend and right now, they don’t. They are maintaining their consumption levels by reducing their savings pace and that is not good news for future growth.

MARKETS AND FED POLICY IMPLICATIONS: There simply is not enough information to determine if we will once again se a growth rate near or even above 3% in the fourth quarter. The consumer is going to have to do a lot better if growth is going to be strong in the final quarter of the year and there is little reason to be confident that will be the case. Wage gains are moribund, energy pressures continue to build and labor shortages point to modest job increases. The one good thing we have going is that there is now a worldwide expansion. Almost all regions of the global economy are actually in phase and growing. That should help exports. Businesses are likely to wait and see what the tax bill actually contains, especially since some of the tax breaks may be put off for a year. Investors are becoming more cautious about the tax plans as they keep changing. As for the Fed, there is every reason to think that another rate hike will occur at the December 12-13 meeting. The economy has enough strength that there is no reason to slow the normalization process.

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