KEY DATA: GDP: 3.5%; Consumption: 4.0%; Fixed Investment: -0.3%; Prices: 1.6%/ Sentiment: -1.5 points

IN A NUTSHELL: “The headline says strong growth but there are warnings in the details.”

WHAT IT MEANS: The economy grew really solidly in the summer. The headline number pretty much matched economists’ expectations. But if you look at the individual components, there are some concerns. First, almost sixty percent of the increase came from inventory building. Firms have been adding to stocks to support their strong sales, but the inventory build added over two percentage points to growth, which is greater than expected and clearly not sustainable. This is just the first estimate of GDP and I would not be surprised if the inventory number was revised. The consumer also spent money like crazy, buying everything that moved or didn’t. But the gain was also above expectations and it too is not likely sustainable. Over the past two quarters, disposable income increased at a 2.5% pace while spending soared at a roughly 3.75% rate. Again, something has to give. As for the business sector, except for filling up warehouses, firms did little investing in structures or equipment. They did buy lots of software (intellectual property), but business fixed investment overall was a drag. If we were going to see massive capital spending, we should have started to see it already. We haven’t. As for the trade deficit, it widened sharply as exports declined while imports surged. So much for tariffs turning things around. One bright spot was government spending. Government purchases added over one-half percentage point to growth. It is good to see that our politicians at all levels are now embracing Keynesian economics and have opened the spigot wide. Despite the strong growth, consumer prices rose at the slowest pace in a year. The rate was well below expectations as the costs of both durable and nondurable goods fell, at least that is what the government claims. Services inflation remained fairly high.

The University of Michigan’s Consumer Sentiment Index eased a touch in October. However, the level remains extremely high, indicating that households have not been affected significantly by either rising rates, rising inflation or rising political rhetoric.

MARKETS AND FED POLICY IMPLICATIONS: When we got the second quarter number, I suggested that it could be the high water mark for this expansion. It is looking more and more like it will be. Household incomes are just not expanding fast enough to sustain the rapid spending paces posted in the second and third quarters. Businesses are showing few signs of spending heavily on plants or equipment. Indeed, in yesterday’s durable goods report, the proxy for business investment declined for the second consecutive month. Firms are doing what they are supposed to do, regardless of tax cuts: They are looking into the future and deciding if spending large amounts of funds on major projects will pay off. It appears most business leaders have become somewhat cautious about the future and are holding off committing to major investment plans. That is what many economists feared and a point I have made for this entire year. As for the trade situation, how many times economists have warned that anything with war in it cannot be good, I don’t know, but the trade battles have not made things better. So, all we have to fall back on is expansionary fiscal policy. I will not point out the obvious irony of a government run by Republicans depending on heavily on government spending for growth. Oh, yes, I just pointed that out. So, don’t expect fourth quarter growth to be anywhere near what we have seen over the past two quarters. The economy is not faltering, it’s just that we are moving back toward more sustainable growth.

KEY DATA: Sales: -5.5%/ FHFA Prices (Monthly): +0.3%; Over-Year: +6.1%

IN A NUTSHELL: “And the downbeat goes on, and the downbeat goes on.”

WHAT IT MEANS: Another set of housing numbers, another set of soft housing numbers. New home sales fell sharply in September and it wasn’t simply a matter of weather. Yes, demand tailed off in the South, but there were much bigger drops in the Northeast and the West. Home prices have been soaring in parts of the West and the elevated costs, coupled with higher mortgage rates, may be taking their toll on the ability to move new houses. Conditions would have been worse if it hadn’t been for strong sales in the Midwest. It looks like higher priced units are suffering the greatest decline. Sales of new homes above $500,000 fell, while the share of purchases in the middle range, between $200,000 and $500,000 increased. Indeed, the share hit its highest level since the data were first released in 2002. That is good news as it looks like middle-income households are still buying new properties.

Housing prices rose moderately in August. Still, the increase over the year in the Federal Housing Finance Agency’s index, which uses prices on mortgages sold to Freddie Mac and Fanny Mae, continues to decelerate. The gain remained above 6%, which is nothing to sneeze at. Prices are still soaring in the West, but with demand moderating, those increases should fade and the national slowdown in housing price inflation should continue.

MARKETS AND FED POLICY IMPLICATIONS: Are we headed for another housing market collapse? I don’t see that happening. First, and most critically, the market never did reach the bubble stage, at least as far as sales are concerned. In the new home market, sales peaked at about half of the high posted in 2005. Existing home demand peaked at about 20% below the highs set during the bubble. The problem is that demand has not been evenly distributed across the nation and prices have soared in some areas. Are there price bubbles in some of the major cities in the West? Undoubtedly, but we have gone through regional price bubbles in the past and come out the other side reasonably rapidly. It was when demand got totally out of hand and people were buying home with little equity and less financial capacity that the problems arose. Still, housing did add to growth for the last six years. It is likely that will not be the case this year. That is a reason I, and most other economists, think that the expansion should moderate going forward. As for the Fed, clearly, the members just don’t get it. We need zero interest rates. If it was good enough for the Obama economy, it should be good enough for the Trump economy. Of course, Obama had to deal with a housing market collapse, a meltdown in the world financial system, massive layoffs, deteriorating world growth and the steepest recession since the great depression, but hey, who’s counting? The president’s comment about zero interest rates probably gave even those at the Fed who might have been concerned about political pressure a reason to discount the president’s attacks. When faced with a choice between an economy that is collapsing but has zero rates and one that is growing strongly with rates rising, I think the Fed members will take the rising rate/strong growth economy every time. So don’t expect anything but another rate hike in December.

KEY DATA: LEI: +0.5%/ Phil. Fed (Manufacturing): -0.7 point; Orders: -2.1 points; Payrolls: +1.9 points/ Claims: -5,000

IN A NUTSHELL: “The economic momentum should be carried into next year.”

WHAT IT MEANS: The first reading on third quarter growth is released next week and it should be good. And if the Conference Board’s Leading Economic Index is any indicator of future growth (it is, even if it is a rough one), then the expansion should remain solid in the months ahead. The Index posted a strong gain in September after rising sharply in the previous two months. Taken together, they point to a solid gains in the next six months.

One sector that has been leading the way is manufacturing and it looks like it is continuing to do so. The Philadelphia Fed’s index of manufacturing activity eased modestly in early October, but the level remains quite solid. New orders are still strong, even if they are expanding a little less rapidly. To meet the high level of demand, firms are hiring a lot more workers and expanding hours worked, probably to make up for an inability to find even more employees. But there was one warning sign in the data for the Fed. Expectations on future price increases are rising and are at levels that indicate firms think they have significant pricing power. The last time we saw numbers in this range for any period of time was the 1980s. If Chair Powell thinks that inflation expectations are well anchored, he might want to think that over.

 Jobless claims fell last week. The level is quite low. Enough said.

MARKETS AND FED POLICY IMPLICATIONS: Investors are trying to figure out the impact of rising rates on earnings and the confusion is great. The minutes for the last FOMC meeting make it clear the members are steadfast in their belief that rates will rise through next year and that the Fed might have to not only take its foot off the accelerator but could be forced to put it on the brakes. I think that is likely and the Philadelphia Fed’s future prices received index supports the view that inflation will accelerate. It is difficult to look past the strong earnings numbers that so many companies are putting up, but given the huge tax breaks, they should be robust. Hopefully, firms will invest those funds and the rising capital stock will allow for more and more efficient production. But as of now, little of that is happening, though it is still early. The Fed has a conundrum. Growth may moderate, but it is still likely to be above trend for the next year. That means firms pricing power is likely to grow and inflation is likely to accelerate. But unless housing and capital spending improve, the expansion is likely to fade. If inflation accelerates before growth slows, the Fed will have no choice but to start stepping on the brakes. That is why I believe we will have at least three if not four increases next year. As long as the Fed doesn’t jam on the brakes, and four increases only means at worst a mild tapping, then we should be fine. The Fed is sending the right signals and following the correct policy, regardless of what the equity market focused commentators may think.

KEY DATA: IP: +0.3%; Manufacturing: +0.2%/ Openings: +59,000; Hires: +71,000

IN A NUTSHELL: “The manufacturing sector is holding its own. ”

WHAT IT MEANS: Let’s skip past the stock markets for a while and actually start focusing on the real economy and nothing is more real than industrial production. Output rose moderately in September, led by the sharply rebounding mining/energy sector and an oddly booming vehicle industry. I say oddly because while sales did jump in September, the expectations are for demand to resume moderating going forward. The rising assembly rates helped lift production in the metals industry. Another oddity was a surge in wood product output. Given the softening in the housing market, that was not really expected. A strong rise in business equipment production may signal improving capital spending. Overall, the manufacturing sector is expanding nicely and third quarter output increased at a solid 2.8% pace, which was up from the second quarter 2.3% gain.

The labor market remains tight and firms continue to have major problems finding suitable workers. In August, job openings rose to their highest level on record (the data began in December 2000). The increase in unfilled positions occurred despite a record level of hiring. Interestingly, the number of workers quitting their jobs eased a bit. While these data do bounce around, the rate of employees quitting positions has not surged, which would have been expected. Mobility should be improving, given the level of openings and the difficulty employers claim to be having finding qualified people. Workers don’t seem to be taking as much advantage of it as was projected.

MARKETS AND FED POLICY IMPLICATIONS: We are in the midst of earning season and not surprisingly, they are generally coming in quite good. If you cannot make lots of money right after taxes were slashed and growth was strong, I am not sure what you are doing in business. And investors are likely to love the number. But those numbers are for past performance and my concern is future earnings growth. It used to be that the markets were supposedly looking at least six months into the future. Well, most economists expect growth to moderate, albeit slowly, during 2019 and that hasn’t factored into thinking just yet. I guess the “I will believe it when I see it” approach continues to hold sway. It is hard to argue against it since it has worked quite well for nearly a decade. The data are still strong enough that the Fed will likely raise rates again in December and indicate that more will be coming in 2019. And don’t forget, for most of the past decade, the Fed was mainlining liquidity into the equity markets, almost single-handedly keeping things going. That is no longer happening as the reduction in the Fed’s balance is ongoing and if they continue to follow plans, it will be accelerating. The markets are facing headwinds of a likely moderation in economic growth, rising interest rates, reductions in liquidity, uncertain world growth and ultimately, comparisons with tax cut-hyped 2018 earnings numbers. So, if you are wondering why I keep issuing my warnings about next year, those are my concerns.

KEY DATA: Sales: 0.1%; Ex-Vehicles: -0.1%/ NY Fed: +2.1 points; Orders: +6.0 points

IN A NUTSHELL: “Consumer spending momentum is moderating and the hurricanes didn’t help.”

WHAT IT MEANS: Some of the final data for the third quarter are coming in and while they look good, growth is not likely to be close to the robust second quarter gain. Consumer spending on retail products sagged in September. A major reason was a sharp reduction in restaurant demand, some of which was probably due to Hurricane Florence. Other data sources, such as TDn2K’s, point to more solid gains in restaurant demand, so it doesn’t look like families have decided to boycott restaurants. Gasoline and health care purchases were also down. Offsetting those declines were strong increases in demand for vehicles, furniture, clothing, sporting goods, electronics and appliances. We also bought a lot of stuff online. So, taken together, this was a report that was probably skewed by events, not one that shows softening spending habits.

Meanwhile, manufacturing looks like it is still in great shape. The New York Fed’s October measure of New York area manufacturing was up, led by a sharp increase in new orders. Firms have been shipping like crazy and that led to a softening in backlogs. They are still hiring, but not as rapidly as before and are no longer extending out working hours. Looking forward, confidence is still good, but the trend has been down for most of the year. Firms have become more conservative in their expectations about hiring and investment. The capital spending high we saw earlier in the year has largely disappeared.

MARKETS AND FED POLICY IMPLICATIONS: The first guess (called the Advance Estimate) of third quarter growth will come out on October 26^th. It looks like it will be in the 3.25% to 3.75% range (I am toward the lower end of the range). That is really good in that it is well above trend. But we knew, given the massive tax cuts and government spending increases that we would see strong growth this year. What economists are debating is how long the sugar high will be sustained. I have been contending that consumers are pretty much tapped out and that we could start see slowing demand as early as the fourth quarter. What is needed, I argued, is stronger future capital spending. I keep looking for signs of that happening, but they just don’t seem to be there. The surveys are not that optimistic. In the New York Fed’s report, expectations on capital and technology spending are back to where they were before the tax cut was passed. The euphoria of early this year is gone and it looks like investment levels could be trending down toward more typical levels, not the elevated ones hoped for when the passed was being hyped and passed. So, while we should get a good third quarter growth number and the expansion should be solid well into next year, more typical 2% to 2.5% rates are likely to start appearing in the second half of 2019. That is when most economists expect the sugar high to have worn off. At that point, it may be only the government that is driving growth and that is not the kind of economy we can bank on. I am an economist not a psychologist so I don’t have any idea whether the recent hits to the stock markets have change outlooks. Investors have been following the “I will believe it when I see it” philosophy and until that slowdown actually appears, who knows where the markets will go. But it is hard to see how the economy can keep up the roughly 3% pace we should post this year and at some point, that likelihood has to be factored into earnings growth and equity prices.

KEY DATA: PPI (Final Demand): +0.2%; Less Food, Energy and Trade Services: +0.4%; Goods: -0.1%; Less Food and Energy: +0.2%; Services: +0.3%

IN A NUTSHELL: “Wholesale cost pressures are no longer accelerating sharply, but that should do little to change the direction of interest rates.”

WHAT IT MEANS: Rising interest rates have become the biggest concern to maintaining the current strong growth. The 2- and 5-year Treasury notes are at their highest levels in a decade. The last thing the markets needed was an indication that inflation would surge, so it was nice that the Producer Price Index increased only moderately in September. Yes, the core index, which excludes food, energy and trade services, did jump, but there wasn’t any major acceleration in the yearly gains in the major components. Indeed, food, energy and overall final goods prices eased a touch over the month. Services costs, though, did rebound. Looking at the pipeline, there isn’t a lot of cost pressure at the intermediate goods level but services pressures are building. With energy prices are up again and the collapse in eggs costs probably behind us, wholesale prices will likely rise more sharply over the next couple of months.

MARKETS AND FED POLICY IMPLICATIONS: It’s time to repeat one of my favorite sayings: No good economy goes unpunished. The strong growth, coming on top of already tight labor markets, is helping drive up inflation and interest rates. That has provided the basis for current and future rate hikes and the sudden jump in longer-term interest rates. While wholesale costs may not be surging, they are still growing at a much higher pace than we saw for most of the post-recession period. There is also little basis to expect that business costs will moderate anytime soon, especially if we see an end to the rise in the dollar. So the rise in expenses should be sustained. While the path from producer to consumer prices is hardly straight, there is every reason to believe that consumer inflation will continue to accelerate slowly. That means the Fed will not be backing down anytime soon. Finally, investors are beginning to wake up and smell the concerns that economists have been talking about for months. I have been saying that the Alfred E. Neuman approach to investing will have to eventually end and the surge in rates may finally be causing that to happen. We will see over the next few months the extent to which the exuberance in the markets is brought under control. With political factors coming into play soon (the mid-term elections are less than four weeks away), everyone should fasten their seatbelts as it looks like we are in for a bumpy ride ahead.  

 KEY DATA: Payrolls: +134,000; Private: 121,000; Revisions: +87,000; Unemployment Rate: 3.7% (down from 3.9%); Wages: +0.3%/ Trade Deficit: up $3.2 billion; Exports: -0.8%; Imports: +0.6%

IN A NUTSHELL: “The labor market remains strong despite the weak payroll increase, as witnessed by the lowest unemployment rate since December 1969.”

WHAT IT MEANS: The big, bad U.S. jobs machine sputtered in September but before you start looking for the next recession, relax. First of all, the gains for July and August were revised upward sharply. Given the paucity of free agent workers, the three-month moving average of 190,000 is closer to a sustainable level than what we had been seeing. While BLS didn’t see any major impact in the survey sample from Hurricane Florence, the large decline in the hospitality sector could have been the result of weather-related closings. On the other hand, the surge in state government payrolls was a surprise that is not likely to be continued. More fundamentally, hiring was strong in construction, manufacturing, health care, real estate, warehousing, transportation, professional and business services, indicating the increases were broad based. The average hourly wage was up solidly, but this number is largely meaningless, despite the fact that it is widely followed. As for the unemployment rate, the decline to 3.7% was impressive. Keep in mind, the last time the rate was this low was in the middle of the Vietnam War when an awful lot of young adults were in the military, not in the workforce.

There was another number released today that will likely disappear in the noise over the employment report: The trade deficit, surprisingly, widened sharply. And the reasons were not good. Imports rose modestly but exports tanked. Foreign sales of soybeans tanked, as expected, as did petroleum-based products, computers and vehicles. We did export more drugs and civilian aircraft.   On the import side, we bought more petroleum products, vehicles, cells phones and industrial machines but purchases of food, crude oil and computer accessories dropped. Even adjusting for price changes, it looks like the trade deficit widened significantly in the third quarter, greatly slowing growth.

MARKETS AND FED POLICY IMPLICATIONS: The employment data are volatile, so don’t read much into the soft topline number. But also don’t think that wage gains below 3% over the year are an accurate measure of true compensation pressures. Firms are using benefits and nontraditional means to try to retain and attract workers and the average hourly wage, which I have written about many times, is simply incapable of measuring those changes. Businesses of all sizes are indicating they are doing whatever they can to keep their workers and while they are trying like crazy not to raise wages quickly, overall labor cost increases are accelerating. The standard measures just don’t reflect those increases well if at all. So don’t think the Fed will look at a faulty average hourly wage number and not be worried. They are and will continue raising interest rates. And the faulty number may not stop the rise in longer-term rates either. The last time we saw 10-year rates this high was in 2011. While I think the gap up in rates was too great, any pull back is likely to be followed by further increases, though more slowly. Whether investors worry about that is to be seen.

KEY DATA: ISM (Nonman.): +3.1 points, Orders: +1.2 points; Jobs: +5.7/ ADP Jobs: +230,000/ HWOL: +145,100

IN A NUTSHELL: “Whatever soft-spot the economy may have hit in August was wiped out in September.”

WHAT IT MEANS: As the August numbers came in, it was apparent that some sectors, including manufacturing and housing, were starting to slow. That is likely still the case, but you cannot say that about the services portion of the economy. The Institute for Supply Management’s nonmanufacturing index rose solidly in September to the highest level since its inception in 2008. There were no components of the index that were down. Orders grew faster and firms are hiring like crazy. That bodes well for Friday’s payroll numbers. Backlogs are expanding and coupled with the strong orders, should lead to continued robust activity. The only issue is growing input cost pressures. That includes both labor and goods.

Speaking of a potential strong September jobs report, ADP’s estimate of private sector payroll gains was off the charts. The projected gain was the largest since February and just about every sector posted solid increases. Small, mid-sized and large companies hired heavily. This report can miss greatly, at times, but it is so strong that the risk to Friday’s number is that it will be higher than the general consensus of about 180,000.

With firms hiring like crazy, it was not a surprise that the Conference Board’s Help Wanted OnLine measure increased strongly in September. However, the level of online want ads have been bouncing around in a range for the about two years now and the September number does not represent a break out.

MARKETS AND FED POLICY IMPLICATIONS: The big numbers in today’s economic data should be providing support to the bulls in the markets. But it is also creating the concerns that inflation could accelerate as well and interest rates are rising at the longer-end, not just the Fed-induced shorter-end movements. As for the Fed, the inflation doves may want to take cover as the hawks are likely out hunting. The next FOMC meeting is in a month and don’t be surprised if the Committee makes it clear another hike will occur at the December 18-19 meeting and many more afterwards. With Amazon raising its wage to $15 per hour, pressure will be on firms competing for the limited workers that are out there to match that number. It looks like the holiday hiring season will be strong, especially for online fulfillment (warehousing, call centers, transportation) and if the wage number in the employment report doesn’t start reflecting the growing pressures, maybe we should stop using it. I think the average hourly wage number is a joke, but it is all some people look at and it needs to be discussed. But for businesses, both wages and benefits are rising and that trend needs to be measured better. Regardless, the economy is in really good shape.

KEY DATA: ISM (Manufacturing): -1.5 points: Orders: -3.3 points; Employment: +0.3 points/ Construction: +0.1%; Private: -0.5%; Public: +2.0%

IN A NUTSHELL: “While manufacturing keeps humming along, the construction sector is being kept afloat by government spending.”

WHAT IT MEANS: It may not be the best of times for manufacturers, but it is pretty close to that. The Institute for Supply Management’s manufacturing index declined in September, but you have to keep in mind that the August number was the highest in fourteen years. That is, the level remains really high. A second survey, the HIS Markit manufacturing index, was also up, providing further support for the view that the industrial sector is in great shape. Looking at the details, orders did grow more slowly, but once again, the level indicates the pace moderated from an unsustainably high rate. Hiring remained strong while pricing pressures, though still high, eased.

On the construction front, conditions continue to deteriorate, especially for private sector residential activity. Nonresidential construction was somewhat mixed, with office and health care building up but commercial up. What kept the overall sector from going into the red was government construction. New offices are being built like crazy as the public sector has changed its philosophy on spending.

MARKETS AND FED POLICY IMPLICATIONS: Today’s decent manufacturing data but disturbing construction numbers expose the yin and the yang of the economy. Manufacturing is holding up but the housing market is offsetting those gains. Residential investment likely restrained growth fairly significantly in the third quarter while the strong addition to growth coming from investment in structures looks like it faded. That is a disappointment given the business tax cuts. We get the first reading on third quarter growth on October 26^th and it looks like it will be very good, but well below the second quarter’s 4.2% rate. As for investors, the easing of the trade tensions over the Nafta negotiations, which is now being called USMCA, for the United States-Mexico-Canada Agreement, undoubtedly will provide smiles. Whoever came up with that new name should be required to repeat the acronym one hundred times without pausing for air. There are some changes from current policy, with U.S. dairy farmers looking to benefit the most, which would make sense if the U.S. were moving back to an agrarian economy.   One of the biggest changes has to do with wages, which affects Mexico the most. It isn’t clear if the North American content increase for vehicles will greatly improve U.S. manufacturing activity. Regardless, the ratification process will likely fall to the next Congress and who knows what will it will look like. In this political and social environment, nothing will be done easily, so look for more fun and games when the process starts.