August National Association of Home Builders Index

KEY DATA: Housing Market Index: 55 (up 2 points)

IN A NUTSHELL:  “Builders may not be irrationally exuberant but the rise in confidence is an indication that the housing market is getting better.”

WHAT IT MEANS: The housing market has been adding to growth but the recent data have not created any great feeling that the sector will lead the way toward much stronger economic activity.  That still seems to be the case but at least it now appears that residential construction should continue adding to growth.  The National Association of Home Builders/Wells Fargo Home Builders Index rose in August, making it three consecutive months that builders’ optimism increased solidly.  The level is not yet back to where it was last August, when it hit a nearly eight year high, but it is getting close.  The three components, current sales, future sales and traffic, were all up.  Only the traffic measure remains at a low level, which is clearly a concern.  Apparently, the limited traffic is turning into sales, though.  Regionally, optimism was mixed.  Gains were posted in the Northeast and especially the Midwest, but were down somewhat in the South and West.  The weakest link remains the Northeast, where builder confidence may be rising but it still is in the “not very good” range.

MARKETS AND FED POLICY IMPLICATIONS:  The housing sector has been sending mixed messages since the winter weather cratered activity.  Sales have been improving in fits and starts while construction has wandered aimlessly.  The trend may be up, but not with any vigor.  The Home Builders seem to be saying that activity could start picking up again.  Of course, that is only one voice.   Fannie Mae’s economists toned-down their view of the housing market for the second half of the year, indicating that “With respect to housing’s contribution to growth this year, we have downgraded our outlook following the disappointing housing activity seen during the first half of the year“.   I guess the simplest thing to say is that housing will add to growth but not be the driving force behind any major upturn in economic activity.  Anything that implies less than stellar growth helps those at the Fed who want to watch and wait, and that includes the Fed Chair.  As for the markets, the Home Builders and Fannie Mae reports will probably just add to the view that rates are not going up anytime soon.  Of course, there are geopolitical concerns that seem to ebb and flow, as well as Chair Yellen’s talk on Friday in Jackson Hole.  Past Fed Chairs have used this forum to send messages about the future direction of policy.  It is fervently hoped that we will get some idea about Yellen’s thinking on how a tightening in the labor market translates into inflation issues and the need to raise rates.  Wage pressures only matter to the extent they create inflation concerns and we have no idea about the speed of that transmission process and what that may mean for Fed policy.  In other words, the era of “better communication” continues with very little good communication.

July Industrial Production and Producer Prices

KEY DATA: IP: +0.4%; Manufacturing: +1%; PPI: +0.1%; Goods less Food and Energy: +0.2%

IN A NUTSHELL:  “With manufacturers ramping up production, it is clear the economy is accelerating, but it is doing so without any major inflation pressures.”

WHAT IT MEANS: Consumers may not be spending a whole lot of money but that doesn’t seem to matter to manufacturers.  Production surged in July and the increases were across the board.  Every durable goods and five of the eight nondurable goods sectors raised output levels.   On the consumer side, vehicle assemblies jumped 13% as sales remain strong.  But it wasn’t just what’s left of Detroit.  Output of electronics, appliances and furniture also increased solidly.  Even clothing production was up! There were some soft spots, such as food and energy, but that doesn’t change the picture.  Business goods production rose as a lot more business equipment and construction supplies were churned out.  The manufacturing capacity utilization rate hit its highest level since February 2008. 

While production may be jumping, costs are not.  The Producer Price Index rose modestly in July, helped along by a shape drop in energy costs.  Services costs rose a touch faster but than goods prices but they are still not rising sharply.  There appears to be only one area where wholesale costs are worrisome: Consumer foods.  Finished consumer food goods jumped one percent in July and are up nearly six percent over the year.  Those increases show up in the supermarket and with wages largely flat, households will have less left over after buying food to purchase other goods.

MARKETS AND FED POLICY IMPLICATIONS: Rising output and modest inflation pressures: Who could ask for anything more?  The increase in production is the result of improving economic conditions and that implies hiring should continue to improve and the unemployment rate decline.  Those are necessary conditions to shift the excess of supply in the labor market to an excess of demand and ultimately higher wages.  With producer costs tame, inflation should also continue to be fairly modest, allowing purchasing power to rise once compensation gains pick up.  The Fed members who want to keep holding the economy’s hand will look at the tame inflation numbers and say that policy can remain untouched.  The inflation hawks will say the industrial production gains argue that conditions are changing and the Fed needs to get out in front of any potential inflation pressures.  In other words, nothing will change at the Fed.  These reports, coupled with geopolitical pressures subsiding, at least a little, should put some smiles back on investors’ faces.

July Retail Sales

KEY DATA: Total Sales: 0.0%; Excluding Vehicles: +0.1%

IN A NUTSHELL:  “The consumer has taken a holiday from shopping.”

WHAT IT MEANS: Remember the phrase “shop ‘till you drop”?  Well, forget about it.  Consumers are not shopping very much at all.  I often argue that we shouldn’t expect a major return to the malls (or Internet) until incomes started growing.  Since incomes are not growing, it is not a major surprise that retail sales would be sluggish.  But this is getting ridiculous.  For the second consecutive month, households skipped the trip to the store.  July retail sales were flat after rising modestly in June.  We knew that vehicle purchases eased from the robust June sales pace but that is hardly a concern as they are still at a very strong level.  The real worry is weakness in electronics and appliances, which has been faltering since they surged in the first quarter.  A similar trend was also seen in furniture sales.  It looks like a new vehicle is the only big-ticket item people are buying.  Sales at department stores were down sharply, indicating a trip to the mall was not something a whole lot of households did.  Not every retailer hit the skids in July.  Supermarkets, restaurants, sporting goods, health care, building materials and clothing stores all posted gains, though they were nothing special.   

MARKETS AND FED POLICY IMPLICATIONS:  People just don’t seem to be into shopping right now.  Undoubtedly, income is an issue.  But six years of economic uncertainty may be changing spending patterns, at least for a while.  Consumers are finding they can live without a lot of the stuff they used to buy automatically.  Our consumption society bought an awful lot of things that we probably didn’t need but thought it might be nice to own.  Just as the Great Depression scarred a generation of consumers, the Great Recession may be modifying the need for things.  How long that “I don’t need that” attitude may last is unclear.  We will not really know until incomes start rising strongly for an extended period.  But there is a good possibility that the savings rate during this expansion will be higher than during the housing bubble-driven spending boom in the 2000s.  Savings as a percent of disposable income was on a clear downward trend from 1975 to the beginning of the recession in early 2008.  Fear and financial necessity drove the rate up.  It is down somewhat this year but it is still above the average posted from 2000 to 2007.  Regardless, right now people are just not parting with their hard-earned funds and that is a concern.  For the Fed, though, softer retail sales mean more moderate economic growth so there is less need to raise rates.  That should make investors happy, even as it raises questions about earnings.

June Job Openings and Labor Turnover Survey

KEY DATA: Openings: +94,000; Hires: +92,000; Quits: +48,000; Layoffs: -32,000

IN A NUTSHELL:  “Businesses are hiring and people are quitting, two clear signs that the labor market is firming.”

WHAT IT MEANS: There no longer is a question that the labor market is getting better.  The focus of attention has shifted to how quickly, since that will determine the speed at which worker compensation increases.  One report that has taken on more intense focus is the Bureau of Labor Statistics’ Job Openings and Labor Turnover survey.  This report is starting to flash red.  Job openings are surging and were the highest since early 2001 – over thirteen years ago!  Meanwhile, hiring is also improving and that is back to spring 2008 levels, about six months before the banking meltdown.  But maybe the most important number in this report, at least as far as I am concerned, is the quits component.  People are actually leaving their jobs, something that has been unheard of over the past five or six years.  True, the number of people telling their employers to take the job and, well you know what, is still not very high.  But that is changing, maybe the clearest indication that the labor market is getting back to normal.

MARKETS AND FED POLICY IMPLICATIONS: Firms are looking for new employees but they are also having trouble filling the positions: Over the year, openings rose nearly twice as rapidly as hiring.  That point was also seen in the National Federation of Independent Business July survey which found that 24% of the respondents had trouble filling openings.  Firms are also starting to face the problem that a growing number of workers are simply leaving.  I have been warning about this likelihood for over six months now and the data are starting to support the view that six years of treating workers as if “they are just overhead” is going to be paid for by much faster increases in wages and/or benefits than most business leaders have been expecting or planning for.  And my argument that the decline in the participation rate is due to longer-term demographic and social issues, i.e., it is structural not cyclical, also implies that labor supply will not keep up with demand and wages will have to rise.  The Fed can continue on its current course without creating massive problems for a while.  But those who think that rates don’t have to rise until the second half of next year are underestimating the rate of tightening in the labor market.  I have the Fed beginning to raise rates in the first quarter of 2015 – my forecast since last December – but for that to happen, the FOMC has to start outlining when it will start reducing its reinvestment of assets and then actually raising rates.  Quantitative easing is history.  Now is the time for Janet Yellen to tell us where we go from here and how she is going to get us there.

Second Quarter Productivity and Costs

KEY DATA: Productivity: +2.5%; Output: +5.2%; Real Hourly Compensation: +0.1%; Unit Labor Costs: 0.6%

IN A NUTSHELL: “Productivity rebounded, keeping business costs low as wage gains remain largely under control.”

WHAT IT MEANS: Rising wages don’t have to be a major problem for firms as long as workers offset those increases with improved output.  Unit labor costs, which reflect the balance between wages and production, edged upward in the spring.  Strong spring economic growth, a reflection of the rebound from the winter weather-restrained production in the first quarter, offset an increase in wages.  Indeed, there was a huge rise in labor costs in the first quarter, which points out that the quarter-to-quarter numbers really don’t mean a whole lot.  Smoothing out the data by looking at the year-over-year numbers gives a better indication of what is happening with productivity and costs.  If you want to know about the potential for consumer spending to rise faster, just look at compensation adjusted for inflation.  Real hourly compensation was at the same level in 2013 as it was in 2007.  But that may finally be changing, at least a little.  While workers inflation-adjusted income fell by 0.3% in 2013, it is rising at about a 1.5% during the first half of the year.  If wage gains accelerate, as I expect, we might actually hit 2%.  Will that cause business labor costs to rise?  Probably, but not necessarily a whole lot.  Productivity will likely rise about 1.5% to 2% this year so labor costs should be mostly offset by additional worker output.  But we may see unit labor costs look a lot less positive for businesses than they have been the case for a decade.

MARKETS AND FED POLICY IMPLICATIONS: Labor costs are and will be the focus of attention for a very long time.  Yesterday’s unemployment claims report points to strong job gains and a decline in the unemployment rate.  Full employment is on the horizon, whether the business community wants to accept that or not.  Today’s report doesn’t say that labor costs are a problem yet, but it hints at some improvement in pay.  That is good.  Real worker compensation has essentially gone nowhere for six years, so how can anyone think that people will be able to shop ‘till they’re tired let alone ‘till they drop unless wages rise solidly?  The Fed members, at least the inflation hawks, will likely look at the report as supporting their view that it is time to change direction.  But investors will probably take solace from the headline number, which implies that labor costs are again well contained.  These numbers are hugely volatile and believing the quarterly numbers mean anything is a short-cut to muddled thinking.  Regardless, with geopolitical issues heating up, who knows what will drive the markets these days.

June Trade Deficit

KEY DATA: Deficit: $41.5 billion ($3.1 billion narrower); Exports: up $0.3 billion; Imports: down $2.9 billion

IN A NUTSHELL:  “The narrowing of the trade deficits indicates growth was stronger than expected though the softening in our demand for imported products raises some questions.”

WHAT IT MEANS: The second quarter is past but we are still getting a picture of what happened.  The latest number is the June trade deficit, which was a lot less than expected.  On the one hand, that is good news.  It looks like the negative impact that trade had in the initial GDP estimates will be revised downward, meaning that growth was likely higher than thought.  However, the details are a bit strange, especially on the import side.  The decline in purchases from the rest of the world was largely across the board.  Demand for foreign capital and consumer goods, vehicles and industrial supplies were all off.  Moderating petroleum demand, which is a trend that should continue as we replace foreign products with shale energy, played a role but is only a partial explanation.  With the economy growing, consumer and business spending rising and vehicle sales robust, there is every reason to believe that imports will rebound going forward.  On the export side, we sold a lot more aircraft, chemicals and medical products but not much else.  Looking across the world, the Chinese economic issues have them ramping up their export machine while their purchases of U.S. products remains limited.  Our trade deficits with most of the rest of the world either narrowed or turned to a surplus.

MARKETS AND FED POLICY IMPLICATIONS: The sharp narrowing in the trade deficit is something I will take every month, but I would prefer it happening by exports growing a lot faster than imports.  That would be reflecting strong economic growth around the world.  It is doubtful that buying less from foreigners is a trend as the U.S. economy seems to be picking up steam.  So look for the deficit to widen going forward and that could mean the foreign sector will restrain growth.  I still expect third quarter to show a growth rate of at least 3% as consumers and businesses keep buying and investing.  With the supply managers telling us the service sector is getting on a roll, that missing link may no longer be absent without leave.  If services spending, which is 45% of the entire economy, is indeed expanding more rapidly, then we should get growth between 3.5% and 4% during the second half of this year and in 2015.  But the Fed seems to be in “show me” mode so a forecast of stronger growth is just that, a forecast.  Until it occurs and the labor market tightens to the point where wage inflation actually shows up, this Fed seems willing to keep rates low.  As for investors, we have Russia, earnings and mergers and acquisitions roiling the markets so who knows what they are thinking.

Supply Managers’ Non-Manufacturing Index

KEY DATA: ISM: +2.7 points; Orders: up 3.7 points: Employment: +1.6 points

IN A NUTSHELL:  “The services sector is bouncing back rapidly and since that is the largest part of the economy, it looks as if strong growth is just about here.”

WHAT IT MEANS: To get to rapid growth, you need just about every component of the economy hitting on all cylinders.  True, you can have one or two smaller sectors soft and still get a quarter or two or robust gains.  But for strong activity to be sustained, you cannot have the big dog sitting on the porch.  That has been the case with the U.S. economy as minimal income gains have limited services growth.  That is changing.  The Institute for Supply Management’s Non-Manufacturing index jumped in July, rising to the highest level since December 2005.  Yes, 2005!  Supporting that gain was the Markit Purchasing Managers’ services sector index, which did ease a touch but was still near the record level that had been reached in June.  In other words, non-manufacturing firms seem to have turned the corner.  The rise in business activity was driven by surging new orders as thirteen of the sixteen industries reported gains.  Exports didn’t accelerate but import orders did.  With factory orders up by a robust 1.1% in June, it is clear that someone is buying lots of goods and now we see services as well.  The strengthening demand is translating into new hiring.  Inventories are growing, but minimally and that may lead to even more activity going forward, especially since backlogs continue to expand.

MARKETS AND FED POLICY IMPLICATIONS:  The economy has seemed poised to break out before and we have been disappointed so I will believe it when I see it, but the data are really pointing to strong growth.  The employment report was not as great as hoped for but the data don’t go in a straight line.  Don’t be surprised if the August gain is above consensus.  But even with the less than hoped for rise in payrolls and the modest increase in the unemployment rate, the labor market situation remains positive as unemployment claims are at levels not seen in forty years.  Since both manufacturing and non-manufacturing accelerating, it is likely that the labor market will tighten further.  But wages will likely remain restrained as businesses still don’t think they actually have to raise compensation.  It may take a jump in employee turnover before the reality strikes home and we may not see that until much later this year.  Regardless of the timing, it is coming and the Fed is going to have to deal with it.  Chair Yellen seems to believe that she can wait until she sees the whites of wage inflation’s eyes until pulling the trigger so don’t expect a whole lot of talk about rate hikes for a while.  But that discussion, as well as information about how and when the Fed intends to shrink its balance sheet, needs happen in the public view soon.  The Fed has done great work in getting the economy to this point and now we have to know how it intends to unwind the crisis-based policy it has been operating under for the past seven years.  As for the markets, who knows what investors are worried about right now?  While this report should be positive, that doesn’t mean the markets will look at it that way or even consider it an important aspect of today’s trading

Second Quarter Employment Cost Index and Weekly Jobless Claims

KEY DATA: ECI (Private, Year-over-Year)): +2.0%; Wages: +1.8%; Benefits: +2.5%/Claims: 302,000 (up 23,000)

IN A NUTSHELL: “Wage and benefits pressures are barely starting to accelerate even as the labor market continues to strengthen.”

WHAT IT MEANS: If the labor market matters to Fed members and the concern centers around employment costs, then the quarterly Employment Cost Index should be an important number.  Whether it is or not for others, for me it is another critical part of the picture and right now businesses are still controlling workers costs but maybe not as well as they had been.   Private sector compensation costs rose at a solid pace in the second quarter though that came after an aberrant nonexistent increase in the first quarter.   Both wages and benefits jumpedLooking over the year, though, the increases in total compensation, wages and benefits were all at the top of the range we have seen for the last couple of years but not above it.  Public sector costs are rising at the same pace even though wages and salaries are barely budging.  Looking across occupations, service workers are doing the worst, which is not surprise.   Whatever gains in compensation we have seen have been centered in the professional and construction worker ranks.

Jobless claims jumped, but that was expected.  Last week’s report was assumed to be a bit too low due to the random nature of vehicle sector summer shutdowns.  The four-week moving average, though, was the lowest in over eight years and that is without adjusting for labor force size.  If the claims numbers relate in any way to job gains, and I believe they do, then the July employment report which comes out tomorrow should be good.  Given the robust June gain, I expect July’s to be lower but we could easily average between 260,000 and 275,000 for the two months.  That would be impressive.  The unemployment rate could also decline.  I would not be shocked if it breaks 6%, though that is not in the forecast for this month.

MARKETS AND FED POLICY IMPLICATIONS: So far, so good, at least when it comes to controlling employment costs.  Yes, the second quarter number was hotter than expected but the first quarter rise was strangely minimal.  Average them out and there was not any major change in the rate of worker cost increases.  Benefit expenses have accelerated a touch and wages seem to be moving upward, but the pressures do not look great.  But the Fed has to look at least six to twelve months down the road and if the unemployment rate keeps declining, unless the law of supply and demand has been repealed for the labor market, compensation pressures simply have to increase.  The issues are when and how fast.  Most members of the Fed appear to believe it will be a lot later and not very rapidly but I am not that sure.  Tomorrow’s jobs report will give us another piece of the puzzle and hourly wages should be watched carefully.  Workers need more income to spend more and power growth to a higher level.  That does not seem to be happening just yet but I think we will be seeing signs very soon.

July 29, 30 ’14 FOMC Meeting

In a Nutshell: “…a range of labor market indicators suggests that there remains significant underutilization of labor resources.”

Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%

Quantitative Easing Decision: Bond purchases reduced by $10 billion to $25 billion

The latest FOMC two-day meeting was not expected to create any major change in the messages that the Fed members have been trying to send, and it didn’t.  But there were still some interesting takeaways from the statement.

If it is all about the labor market and wage pressures, then the Committee did elevate its thinking about the potential for rising compensation to the top of the discussion.  That said, the members then decided to downgrade the threat by indicating there was “significant underutilization of labor resources”.  There is still belief that the labor market will improve, but right now they seem to be saying potential wage pressures are not a threat.  The statement seemed to be a little more cautious about inflation, which has accelerated recently.  The comment was that “Inflation has moved somewhat closer to the Committee’s longer-run objective” rather than just being below target. I am not exactly sure how much worry that shows given the lack of concern about wages, but at least there was recognition that the rate is moving upward.

Otherwise, everything was expected.  The Committee knew that growth had rebounded in the spring and said so.  With growth back on track, it was easy to continue the reduction in asset purchases by another $10 billion.  It is likely that quantitative easing will be a thing of the past as of the October meeting.  But other than indicating that all funds would be reinvested, there was no indication of what will happen to the Fed’s balance sheet after asset purchases end.  As for the funds rate, it was repeated that “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends”.  Since considerable time is about six months – per Janet Yellen – and the program should end in October, that gets us to April.  I think the March meeting is still a good possibility.

Okay, what does this all mean?  There seems to be a growing discontinuity between the firming labor market data, excluding wages, the upward trend in consumer costs and the Fed’s lack of concern about future inflation.  Indeed, it is unclear why the Fed believes that wages will not start rising faster by year’s end.  Keep in mind, the Fed has been so easy for so long that it will take at least two years or longer to unwind everything.  If they are using wages, which is a lagging indicator of a lagging indicator, to signal inflation pressures, then they are taking a fascinating gamble.  While I am not an inflation hawk by any means, it is time for the Fed to explain how it will know when labor market conditions are becoming tight.  My view is simple: If you wait until you see that wage pressures are building, it will be very late in the process to begin dealing with the rising cost pressures.  That is true for both businesses and the Fed.

Second Quarter GDP and July ADP Jobs Forecast

KEY DATA: GDP: +4.0%; Consumption: +2.5%; Consumer Prices: +2.3%/ADP: 218,000

IN A NUTSHELL:  “The strong second quarter growth supports continued solid payroll gains and a further tightening of the labor market.”

WHAT IT MEANS: The Fed is meeting and the members now know that the winter of our discontented economy is past.  Economic growth had declined sharply in the first quarter, though the latest estimate of 2.1% was not as ugly as the previous 2.9% guess.  Still, that size fall in activity raised questions about the true strength of the economy, an issue that is no longer a concern.   Growth rebounded sharply in the spring, led by strong vehicle sales, solid export activity, strong business investment and inventory building and renewed government spending at the state and local government sectors.  In other words, only the federal government remains a weight around the economy’s neck.  On the inflation front, consumer costs accelerated, rising at the fastest pace in three years.  The pace was not great but at 2.3%, it is above the Fed’s target of 2%.  Excluding food and energy it was right at the number.

Friday we get the July jobs report and ADP expects it to come in a little lower than the June gain.  The economy probably still averaged at least 250,000 new jobs over the past two months and that is strong.  The moderation in hiring, if you can call it that, was largely in the small business component.  Payrolls rose by about 40,000 less in this component than in June.  That doesn’t worry me since Paychex/HIS reported yesterday that small businesses were adding jobs faster, so that slowing may unwind in August.  Still, the increases appear to be across all industry segments.  Consensus is for about 230,000 new positions which should support a drop in the unemployment rate to 6.0%.  I think job gains could be a touch better, closer to 250,000.

 

MARKETS AND FED POLICY IMPLICATIONS:  This report was much higher than most expected (I was at 4.1%).  It should also put to rest the questions about the rebound from the winter.  The economy came back and even though there may have been a little extra inventory building that could moderate third quarter growth, solid activity was so widespread that you cannot call this number an aberration.  We are likely to see growth in the 3.5% to 4% range during the second half of the year.  With job gains strong and the labor marketing tightening, income should begin rising faster, powering better consumer spending.  Chair Yellen is focusing on wages, but that is a lagging indicator which may lag even more because of business intransigence on raising compensation.  That is, when broad wage increases start showing up, it will be late in the process to begin dealing with the rising cost pressures.  That is a warning to both the Fed and business executives.  Either have plans in place soon to deal with the inevitable workings of supply and demand in the labor market or play catch up.  That is why I think the first rate hike comes in the first quarter of next year.  It is also time the bond markets begin focusing on the increasing likelihood that growth will be closer to my forecast, which is well above consensus, and as a consequence prices will accelerate faster than expected.  We are not talking high inflation, but inflation that exceeds Fed targets.

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