September Job Estimates, Help Wanted Online and Manufacturing Activity

KEY DATA: ADP Jobs: 213,000; Conference Board Help Wanted: -137,200; ISM (Man.): -2.4 points

IN A NUTSHELL:  “The economy doesn’t seem to have picked up any steam in September.”

WHAT IT MEANS:  We had great growth in the spring but that high rate doesn’t look to have been sustained as the summer ended.  Today’s string of September numbers were simply disappointing.  The ADP estimate of private sector job gains was okay, but below what we need to have for the labor market to really be strong.  Essentially, it looks like it was more of the same.  What this means for Friday’s number is unclear.  ADP believes that the private sector created about 415,000 jobs in the last two months.  The Bureau of Labor Statistics’ first estimate of August private sector payrolls was a modest 134,000 rise.  Barring a major upward revision to the BLS August number, to get the two in synch would mean job gains of at least 250,000.  As for the ADP report, small and large businesses hired solidly.  The softness was in the mid-sized sector.  Why?  That is anybody’s guess.  As an added insult to those of us who think that the labor market is stronger than perceived, the Conference Board reported that online want ads fell sharply in September.  The trend is still up but the data are bouncing around an awful lot.

On the manufacturing front, the sector continues to expand solidly, but maybe not as robustly as it had been.  The Institute for Supply Management’s September activity index fell led by a sharp deceleration in order growth.  Let’s keep in mind that this is a diffusion index and if you reach a high level of orders and stay there, the index actually goes down.  The level of the index is still very high, indicating that demand is strong, which can be seen in robust and expanding production.  Hiring, though, did moderate.  Let’s see now: Orders are flowing in, production is ramping up but job growth is softening.  Got it.  Maybe the shrinking of backlogs can explain that.

MARKETS AND FED POLICY IMPLICATIONS: The first estimate of third quarter growth will be released at the end of October, so we have a month to wait.  It looks like the economy continued on a solid pace during the summer but well off the 4.6% rate posted in the spring quarter.  The recent data have provided few signs that the economy is picking up steam.  It would be nice to get a few quarters in a row of north of 4% growth but I doubt we will get that for a while.  Third quarter growth should be closer to 3% than 4%.  But at least the last six months have been pretty good.  Growth in the 3.75% range is something we have dreamed about yet people are discounting it.  I think that says a lot about how we are evaluating the economy.  Meanwhile, investors are waiting for Friday’s employment report and watching Hong Kong and the dollar, so who know if even today’s numbers will matter much.  As for the Fed, it still is all about the labor market and that means Friday is the big day.  I am sticking to my stronger than expected forecast but the consensus is for something in the 220,000.  An average number will keep the pressure off Fed Chair Yellen, but only as long as the other data remain moderate.

September Conference Board Consumer Confidence and July Case-Shiller Housing Prices

KEY DATA: Confidence: -7.4 points/Housing Prices (National): +0.5%; Year-over-Year: +5.6%

IN A NUTSHELL:   “Whether the sharp decline in consumer confidence is the result of rising international concerns or a slowing economy makes a big difference, so it is premature to start worrying.”

WHAT IT MEANS:  With the September jobs report on the horizon, we are looking for signs that the economy could be either stronger or weaker than expected.  Today’s reports were not particularly great, though they may not be as worrisome as the headlines imply.  First, there was a huge drop in the Conference Board’s Consumer Confidence Index.  That was a shocker as the August reading was the highest in nearly seven years.  The details were not particularly pretty either, as current conditions were down, though at only half the pace that future expectations dropped.  It is that difference that raises real questions about what is going on.  A cratering in confidence usually is caused by an event but there has been no major negative economic crisis.  Indeed, with gasoline costs falling, the logic would have been for consumers to feel better.  However, the emergence of ISIS/ISIL and the need to get militarily involved again in the Middle East was a very negative political event and that could be behind the drop.  If that was the driving force, the impact on spending should be limited as political issues usually don’t change consumption patterns significantly for any extended period.

As for housing, the S&P/Case-Shiller national index of home values rose but the pace of gains is slowing.  The year-over-year rise was the smallest in a couple of years.  Also, the 20-City Index of large metropolitan areas declined over the month.  Only three areas, Las Vegas, Miami and San Francisco, rose by double-digits since July 2013.  The deceleration is not bad as the last thing we want is for bubbles to start forming again. Prices need to continue rising moderately so homeowners’ equity can increase and the normal churn in the market can return.

Two other reports released today point to modest September growth.  The Paychex-IHL Small Business Jobs Index showed slowing small business hiring while the ISM-Chicago manufacturing index moderated.  So far, the September numbers have not been anything stellar.

MARKETS AND FED POLICY IMPLICATIONS: I will wait on the confidence issue as the Middle East worries may be dominating.  But any slowdown in spending would not be helpful as we need job growth to be strong and the unemployment rate to continue falling.  Of course, we will know more on Friday, but until then, we can only speculate, which is the most fun.  As for investors, the confidence drop has to hurt and given the unrest in Hong Kong, it is hard to see how any rational investor could feel great today.  Note, I said rational.  Remember, markets may be efficient by they don’t have to be rational.

August Income, Spending and Pending Home Sales

KEY DATA: Consumption: +0.5%; Real Disposable Income: +0.3%; Prices: flat; Excluding Food and Energy: +0.1%/Pending Sales: -1%

IN A NUTSHELL:   “With incomes starting to rise a little faster, the outlook for consumer spending on everything, including housing, is brightening.”

WHAT IT MEANS:  If wage pressure is the Fed’s focus of attention, then the most closely watched economic indicator should be labor compensation. Strong gains in worker income are the missing link to a robust economy and the key to the Fed raising rates.  We did see some better, though not great, increases in personal income in August.  Wage and salary gains, the biggie in this report, were the largest since March.  The increases need to almost double the August before gain it can be said that workers will have lots of money to spend.  Still, disposable income is rising and households are putting it to use.  Consumption surged as people bought lots of vehicles.  But the real gain came in services, which is the largest segment of the economy.  There was a decline in July, likely due to the relatively mild summer reducing utility spending.  A more normal August probably turned things around.  Health care is also in this category and that might have played a role, but we will not really know until the third quarter GDP figures come out at the end of October.  On the inflation front, the Fed still has little to fear.  Prices were flat and excluding food and energy, they were up modestly.  This allowed household spending power to rise strongly.  

On the housing front, the National Association of Realtors reported that pending home sales eased in August.  The level was the second highest in the last twelve months but was still down from August 2013.  As I have mentioned before, the housing sector is going through a rotation from investor driven activity to a more normal new home buyer/homeowner powered market.  This transition takes time as investors are pulling out, offsetting the increases in more traditional buyers.  That activity has increased fairly consistently since bottoming in the winter, is a sign that the sector should make it out of the other side in very good shape. 

MARKETS AND FED POLICY IMPLICATIONS: Friday we get the September employment report.  It should be really good, but I was wrong last time so I will wait to see the number before I start accepting my forecasting award.  Just kidding.  I do think job gains could challenge this year’s high water mark of 304,000 set in April.  I also expect the unemployment rate to come down to 6.0%.  But even if I am correct, what really matters is the translation of a tighter labor market into wage gains for workers.  Until that happens, there will be questions about when the Fed will move.  The August income numbers provide hope that the rise in compensation is starting to occur.  Adding to the belief that conditions are indeed changing, the Dallas Fed’s September Manufacturing survey found wages and salaries rising the fastest since February 2008.  But we need to see those rises spread across the nation before we can conclude that workers are getting a larger share of the pie and the Fed can start taking its foot off the gas.

August New Home Sales

KEY DATA: Sales: +18%; West: +50%; Inventories: -14.3%: Prices (Year-over-Year): +8%

IN A NUTSHELL:   “Home builders have become very optimistic and the explanation is simple, sales are rising!”

WHAT IT MEANS:  There has been a disconnect between the attitude of residential developers and the new home sales and housing starts data.  I have argued frequently that builders don’t smile unless they are selling something and right now, at least according to the National Association of Home Builders, they are giddy.  So housing sales had to have been rising and the August data finally point in that direction.  Sales surged, but the level of demand is a bit suspect.  There was a 50% jump in the West to a sales level not seen since January 2008.  Meanwhile, in the rest of the country, demand is solid, if not strong, but nowhere near as exuberant as we saw in the West.  Basically what I am saying is that there may be a bit of a seasonal factor issue involved in the West’s increase, which may come out in the September numbers.  That said, it is likely that sales are rising and probably sharply.  Indeed, we still need the sales pace to increase about fifty percent before we can say the new home market is really strong.  Prices seem to be holding in, as the 8% year-over-year increase is similar to what we have seen much of the past couple of years.  The number of homes for sale rose but the number of months of supply came down sharply because of the jump in the sales pace.

MARKETS AND FED POLICY IMPLICATIONS:  Even if the extent of the increase in new home sales is somewhat overstated, it is likely that demand is rising pretty solidly.  We haven’t seen this increase in sales show up in the starts numbers but that too is coming.  And when it does, it will be clear that the housing sector is doing just fine and can likely withstand the coming increases in mortgage rates.  The idea that a 5.5% or even a 6% 30-year fixed rate mortgage or a 4.5% to 5% 15-year rate would kill the market is, at least to me, bizarre.  Over the last twenty years, the 30-year rate has averaged 6.2%.  During the housing boom of 2003 through 2006, the rate averaged 6.0%.  We suffer from a false frame of reference.  Saying 6% is high may be true given the historically low levels that were created during the Great Recession and Disappointing Recovery, but they are clearly not normal rates.  Once it is accepted that the economy is in good shape and even the Fed figures that out, mortgage rates will rise, possibly quickly.  But that doesn’t mean the housing market will tank. Fed Chair Yellen doesn’t want to see another 100 basis point rise that occurred when tapering was announced, so she is going slowly on removing “considerable time” from its statement.  But that is just image.  The economic reality will drive Fed decisions and rate hikes are coming sometime during the first half of next.  Investors need to get their heads around the reality that higher rates are actually good because they represent a strong economy and solid growth supports improving demand in even interest sensitive sectors such as housing.

August Existing Home Sales

KEY DATA: Sales: down 1.8%; Prices (Year-over-Year): up 4.5%

IN A NUTSHELL:   “The rotation from investor to homeowner continues and that is keeping a lid on housing sales and prices.”

WHAT IT MEANS:  When no one else would buy a house, investors saw an opportunity and they came in by waves.  That started the housing rebound and led to solid increases in prices.  Now that costs are rising back toward levels that might have existed if we didn’t have the surge and bust, investor opportunities are shrinking and so is their share of the market.  The result: Existing home sales seem to have hit a plateau.  They fell in August and are down fairly sharply from the August 2013 pace.  But the weakness was hardly spread across the nation.  The West and South saw declines but there were almost equal increases in the Northeast and Midwest.  Over the year, sales in the West are down almost 10%, an indication that investors are pulling back sharply as this area was a prime spot for activity in the past.  As for prices, they are still up over the year and it looks like the deceleration has stopped. The number of homes for sale, while down in August, has been on a modest upward trend.  Still, it is not that much higher than existed during the early 2000s, before the irrational exuberance really hit.  Indeed, price increases and inventories seem to be reasonably well in line with historical patterns.

MARKETS AND FED POLICY IMPLICATIONS: The housing market is in transition from investor-driven to owner-occupied.  As is usually the case with transitions, you get some dislocations and that is happening.  But the sales pace has flattened over the past few months, not fallen, and that is good news.  First time buyers are still in the game and rates remain at very low levels, so the outlook is good for the market.  Just don’t expect any surge in sales, which also is something positive.  We hardly want another bubble.  Housing should be a positive for the economy this quarter but maybe not a huge one.  Of course, with Janet Yellen hung up over “extended period”, this type of report can only add to her obsession.  Why do anything to cause rates to rise when housing is not surging, especially since it is the key interest sensitive sector in the economy?   And with Charles Plosser retiring this spring, a major hawk will be leaving the group of bank presidents.  It will be interesting to see who replaces him.

August Housing Starts and Permits and Jobless Claims

KEY DATA: Starts: -14.4%; 1-Family: -2.4%; Permits: -5.4%; 1-Family: -0.8%/Claims: 280,000 (down 36,000)

IN A NUTSHELL:   “Home construction keeps bouncing around but with builder confidence soaring, it is likely the August slump will be followed by a September surge.”

WHAT IT MEANS:  Housing starts cratered in August but the Alfred E. Neuman in me holds strong: I am not worried.  July’s level was revised up to the highest rate in nearly seven years.  A 31.5% decline in buildings of five units or more was the major reason for the August drop and this component is extremely volatile.  For the first eight months of the year, starts are up by nearly nine percent, keeping up hopes that we could see another double-digit rise in construction activity.  I think that is likely for two reasons.  First, permits are still running above starts.  That points to an acceleration in construction.  Second, the National Association of Home Builders/Wells Fargo Housing Market Index surged in August to its highest level since November 2005.  Builders can get irrationally exuberant at times, but that is usually when construction activity is surging.  So look for a rebound when the September numbers come out.

With the Fed still focusing on labor, the sharp drop in the weekly jobless claims number was eye opening.  We are about as low as can be expected.  Don’t be surprised if this number soars soon.  The closing of three casinos in Atlantic City will likely mess up the data for a short time.   Also, the Philadelphia Fed’s Business Outlook Survey showed that activity grew at a somewhat slower pace in September.   Nevertheless, orders were strong, backlogs grew and hiring jumped.  Those details point to continued strength in the manufacturing sector.

MARKETS AND FED POLICY IMPLICATIONS: Housing continues to improve even if the gains are inconsistent.  Builders are a pretty confident bunch and that can only be because they are seeing activity pick up.  Thus, the fall off in construction activity should not be viewed as any sign of weakness.  With the labor market tightening, Janet Yellen may be repeating her point that if the data are stronger than expected, the Fed is prepared to act sooner than whatever the term “extended period” means.  Indeed, if housing starts do bounce back and manufacturing continues to grow strongly, that is precisely what the Fed will have to do.  Regardless, investors may be a bit confused by the inconsistencies of these numbers but that has never stopped them before.

A further thought on the Fed’s leaving in “extended period” in the statement.  Given her weird comments about the meaning of the phrase, that it was not calendar based but data based, I can only conclude that the Fed members would like to remove the words but only when they think the markets will not overreact.  They don’t want another 100 basis point gap up in rates.  I suspect that as soon as there are consistently robust job gains and the unemployment rate drops below 6%, which could happen by the end of the year, the phrase will be removed.  December is my guess.

Sept 16-17 ‘04 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 $15 billion.  Quantitative easing is expected to end at the next meeting.

One again, the FOMC and Janet Yellen tried to provide some clarity about how the monetary authorities will proceed with rate hikes when they eventually come.  And again, we did not get much that was new.

On the economic front, the economy continues to improve but there remains a significant amount of slack in the labor market.  That was Chair Yellen’s reason why wages are showing little change.  It is all about a tight labor market and the Fed doesn’t see that situation occurring soon.  As it does four times a year, the FOMC released the members’ forecasts for growth, inflation and unemployment rates. The central tendency of the forecasts puts full employment in the 5.2% to 5.5% range, which is not expected to be reached until sometime in late 2015 or early 2016.  However, the members are a bit more optimistic about pace of decline in the unemployment rate.

As for when the Fed might tighten, those who thought that the FOMC might signal that rates could rise sooner rather than later were disappointed.  The Fed Chair made it clear that she was in no hurry to raise rates.  But she also noted that the decision is not “calendar driven” but is “data driven”.  The hawks are not making very much inroads into Fed policy.

Finally, the Committee went over procedures for normalizing policy.  One new thing was that the FOMC would be targeting rate ranges rather than a given rate.  That may be reflection of the concern that transitioning to a normal Fed policy and a normal Fed balance sheet will likely have some bumps in the process.  It would be amazing if the Fed pulls off the normalization process without any hiccups.

So what should we make of all this?  Janet Yellen is firmly in command at the Fed and we should stop doubting it.  She is a dove and until the data make her think differently, she will run monetary policy accordingly.

But I have some issues with the Fed’s forecast.  The unemployment rate has declined by about 0.7 percentage point for the past three years yet the members think the decline will slow sharply starting in 2015 and only edge down in 2016 and 2017.  Yet growth is expected to be a lot stronger over the next two years than it had been.  This doesn’t seem to be consistent.  But it is necessary for the members to argue that the funds rate will not be increased soon and will not be raised quickly, which they seem to be indicating.

August Industrial Production

KEY DATA: IP: -0.1%; Manufacturing: -0.4%; Vehicles: -7.6%

IN A NUTSHELL:   “If you believe that vehicle production is crashing, I have a bridge for sale and you can buy as much of it as you like.”

WHAT IT MEANS:  One of my more common warnings is that the headline number hides what is truly going on and the devil is in the details.  Well, welcome to the August industrial production report.  Output fell in August for the first time since January, and we know what the weather did to everything that month.  Worse, manufacturing production was down sharply.  So, has the industrial sector finally come to a grinding halt?  Yeah, right.  The biggest decline was in vehicles, where assembly rates dropped by nearly 12%.  Of course, the pace of new vehicle construction had surged by almost 13% in July, highlighting the problem with seasonal adjustments when trends change.  The important point is that vehicle sales in August hit their highest level in 8½ years, so output is likely to expand further.  It is clearly not shrinking.  Indeed, the 3-month assembly rate average was the highest since early 2006, when the housing bubble was funding everything that moved and didn’t move.  Meanwhile, the rest of the economy was doing just fine.  Production of high tech products, consumer products, business equipment and business and construction supplies were all up. 

Adding to the belief that the manufacturing sector is in great shape was the September Empire State Manufacturing Survey, a product of the New York Federal Reserve Bank.   The index hit its highest level in almost five years as new orders surged, hiring jumped and backlogs built.  Enough said.

MARKETS AND FED POLICY IMPLICATIONS:  It is sometimes good to get a headline that is so obviously misleading as today’s industrial production number.  It is not that the data are wrong; it is just that sometimes the marquee number is not reflective of what is actually going on.  The data are often volatile and the seasonal adjustments sometimes don’t work right if conditions change.  That was true with today’s industrial production decline and was likely the case with the weak August employment report.  Basically, the manufacturing sector is strong and should continue to lead the way.  The FOMC starts its 2-day meeting tomorrow and on Wednesday Janet Yellen will hold a press conference.  I expect the statement and the discussion to focus on changing the thinking from rates staying low an extended period to the strategy that the data will drive decisions.  If the numbers are stronger than projected, the Fed will be prepared to move sooner than expected.  This report changes nothing and investors will have to start getting used to the reality that the Fed is going to raise rates, most likely during the first half of next year.

August Retail Sales and Import Prices

WHAT IT MEANS:  The missing link in this economy is strong household consumption.  It’s hard to buy more when your pay is barely keeping up with inflation.  But wage gains are slowly improving and with so many more people working, income is growing.  The added funds are being spent on just about everything.  Retail sales jumped in August, led by a surge in vehicle sales.  With the vehicle sales pace of 17.4 million units being the highest in over eight years, that was hardly a surprise.  But even when you exclude vehicles, consumers were pretty frisky.  Demand for furniture, appliances and electronics, sporting goods, home building supplies, medical products and clothing were all up.  We even went out to eat again.  The only weak links were department stores and gasoline stations.  The decline in gasoline purchases was probably due to the sharp drop in prices, not a fall off in purchases, as these data is not inflation-adjusted.  All this came on top of an upward revision to July sales.

Household spending power is not likely to be eroded very much by inflation.  Import prices dropped sharply in August as fuel costs cratered.  Excluded energy, prices rose just a little, with only vehicles showing a gain, though that was minimal.  The only real trouble spot is manufactured food import costs, which continue to surge.  As for exports, U.S. firms are also getting less for their products with the farm sector once again suffering sharp drops in its goods.

MARKETS AND FED POLICY IMPLICATIONS: The second quarter is setting up to be pretty good.  Consumers are spending again and not just on vehicles.  Right now they are being helped by the drop in gasoline costs, which is leaving a lot more money in their wallets.  Indeed, low inflation is has kept consumption from largely disappearing and with import prices essentially going nowhere, minimal inflation pressures are likely to continue.  Once we get better wage gains, spending could really surge.  The Fed generally treats energy costs as an indicator of consumer spending, not inflation and it looks like the downward trend in prices and the upward trend in household spending should continue.  Since it is all about a tightening labor market and the potential for rising wages, this report should buoy the spirits of the inflation hawks who worry that the Fed is waiting too long to start raising rates.  The FOMC meets next week and the pressure is building for the statement to drop the words “extended period” when describing how long rates will be kept low.  That would provide the flexibility to start tightening sooner than expected.  I suspect that will happen, since the public discussion about doing that has largely taken away any shock that would occur if the statement actually drops that language.  As for investors, it is the usual: Does good economic news trump rising rates?  Who know what side of that coin comes up on any given day?

August Conference Board Online Help Wanted

KEY DATA: Ads: up 164,600

IN A NUTSHELL:  “With job openings rising as unemployment is falling, is there really any doubt that the labor market is tightening?”

WHAT IT MEANS: Businesses are out there looking for workers all over the place.  The Conference Board’s Help Wanted Online Index jumped sharply in August.  The rise in labor demand was spread across the nation as only five states had lower levels of ads.  Seventeen of the top twenty metropolitan areas reported gains.  Philadelphia was not one of them, though.  Which jobs are seeing an increase in demand?  All of them!  Every occupation category posted a rise in want ads.  All of this is created some real labor shortages, not just a tightening in the labor market.  The ratio of the number unemployed to the number of job openings is a measure of labor availability.  Over the past three months, that ratio has averaged 1.93 workers per opening.  To put that in perspective, from May 2005, when the data were first released, to December 2007, when the expansion ended, the ratio averaged 1.95.  In other words, the current measure of availability is lower than what it generally was during a significant portion of the previous expansion.  Looking at occupations, computer and mathematical science, healthcare practitioners, management and business and financial operations all have ratios less than one.  In other words, they have already hit labor shortage status.

MARKETS AND FED POLICY IMPLICATIONS:  We still have to wait for Friday’s report to see how much, if any, the labor market tightened in August.  Regardless, most of the labor market tightness indicators are flashing red.  So, why are we not yet seeing any pressure on wages?  My argument, which I have made a number of times in the past, is simple:  Business leaders have not had to worry about compensation or attraction and retention issues for so long that they don’t believe they have to do anything but pick the perfect job candidate and pay the person what they want to pay them.  Well, Bob Dylan said it best: “The times, they are a-changin’”.  Maybe the best way to end this piece is to quote the lyrics, which when it comes to the labor market may be the clearest warning:

Come gather ’round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You’ll be drenched to the bone
If your time to you
Is worth savin’
Then you better start swimmin’
Or you’ll sink like a stone
For the times they are a-changin’.

(Copyright © 1963, 1964 by Warner Bros. Inc.; renewed 1991, 1992 by Special Rider Music)

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