June 16-17 ‘15 FOMC Meeting

In a Nutshell: “Conditions for the first rate hike have not yet been met.”

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

The FOMC concluded its two-day meeting this afternoon and the statement basically told us nothing we didn’t already know. The economy picked up from the winter downdraft but there is still a way to go before we get back to strong growth. Yes, 2015 growth was downgraded from the March forecasts, but few expected a negative first quarter at that time. It was just math. Otherwise, there was little change in the comments as the Committee kept the funds rate range the same and there was no change in its investment policy.

So, does that mean there was nothing to be gleaned from today’s news? Absolutely not. First, and maybe most importantly, most members expect there to be at least two rate hikes this year. According to the “dot chart” of forecasts, the “central tendency” is for the funds rate to be at 0.625% at year’s end. The only way to get there is if the rate hikes start in either September or October. Since there is no press conference in October (it’s that dumb press conference calendar issue again), the target month looks like September.

Chair Yellen’s press conference also provided some good information. First, she made it clear, time after time, that the conditions for a rate hike had not yet been met – but they could be soon. While the labor market has gotten a lot better, there is still some slack that needs to be taken up. A reduction in the number of people working part-time but wanting full time jobs needs to fall while wage gains and the participation rate need to rise. She seemed to think the participation concern is less of an issue now that it has stabilized.   Stronger growth, which most members expect, would resolve the labor slack issue.

Chair Yellen noted often that almost all members expect rates to rise this year. However, she tried to persuade everyone that there was no set pathway once the first rate hike occurred. She pointed out that most members expect something on the order of 100 basis points rise each year. Even with my challenged mathematical abilities, I can figure that to be a 25 basis point rate hike every other meeting. She is trying to dissuade people from assuming there had to be 25 basis point moves every meeting. I don’t believe it because at that pace, a neutral fed funds rate of 3.75% will not be reached until sometime in 2018. If it takes that long, I fear for the economy.

Okay, what is the takeaway here? Barring some negative international event, such as Greece hurting European growth, the Fed remains on track for a September rate hike. I suspect that most market participants don’t believe that. People still want to see it before they believe it. So, don’t be surprised if there is some real volatility if the Fed does what it says it will likely do.

(The next FOMC meeting is July 28-29, 2015.)

May Housing Starts and Permits

KEY DATA: Starts: -11.1%; 1-Family: -5.4%; Multi-Family: -20.2%/ Permits: +11.8%; 1-Family: +2.6%; Multi-Family: +24.1%

IN A NUTSHELL: “Surging permit requests indicate that builders will be really busy this summer.”

WHAT IT MEANS: Housing starts fell sharply in May. Boo hoo. Enough of the crocodile tears. The housing market is coming back and it looks like it will be with a vengeance. Yes, construction activity slipped and while the declines were largely in the volatile multi-family component, single-family activity was off solidly as well. All regions saw less construction than in May with the biggest drop being in the Northeast. A pick up in single-family activity in that part of the nation was more than offset by a nearly 40% decline in multi-family activity. While the drop in housing starts would seem to be worrisome, it really isn’t. That is because permit requests soared to its highest pace in nearly eight years. For the past three months, permits are running nearly ten percent above starts and one thing we know, builders don’t waste money on permits unless they expect to use them. The gap between permits and starts will be narrowed and that points to an awful lot of construction across the entire nation during the summer.

MARKETS AND FED POLICY IMPLICATIONS: The Fed is starting its two-day meeting and all eyes will be focused on tomorrow’s statement, forecasts and press conference. Thus, any reaction to this report should be muted. But have not doubt, despite the sharply negative headline housing starts number, the details of this report indicate the housing market is in very good shape. Second quarter housing starts are up about 12.5% from the first quarter monthly average and that rise is likely to be above 15% once we get the June data. Residential construction is likely to add significantly to second quarter growth. With the trade deficit no longer widening, business investment improving and households buying vehicles like crazy, the GDP number could come in a lot better than most expect. Investors need to recognize that while a rate hike tomorrow looks to be off the table, the economy is already strong enough to support one at any meeting in the future. The message that I suspect will be sent tomorrow is that if the data continue to show improving economic conditions, a move up in rates would be warranted. Since the consensus is for a hike in September and there is a press conference that month, barring some really bad data or a major international crisis, that is when the first rate increase in a decade should occur.

May Industrial Production and June Home Builders Index

KEY DATA: IP: -0.2%; Manufacturing: -0.2%/ NAHB: 59 (up 5 points)

IN A NUTSHELL: “Housing is up, manufacturing is down and the data remain all over the town.”

WHAT IT MEANS: The FOMC starts its two-day meeting tomorrow and the latest numbers on the economy remain mixed. The Fed’s own industrial production index showed that activity contracted in May. While the energy sector is having issues that we all are aware of, what was unexpected was the decline in manufacturing output. It was assumed that the rampaging vehicle sector would pull up with it other sectors. While assembly rates did jump, not a whole lot of other areas posted gains. There was a solid increase in technology, but oil and gas drilling cratered once again. Food production also fell sharply. Whether that was due to the bird flu was not made clear. Basically, vehicles and technology-related products, such as computers and communications equipment, were up, but much of the remainder of the manufacturing sector was down.

Reinforcing the view that manufacturing has hit a soft spot was a decline in the New York Fed’s June Empire State Manufacturing index. While just about every component of the index was off, hiring and the workweek increased. You tell me what that says and we both will know.

While manufacturing seems to be wandering around, housing is off and running. The National Association of Home Builders/Wells Fargo Housing Market Index gapped upward in June. Current sales, sales expectations and traffic all rose significantly.  It was noted that the indices of current and future activity were at “their highest levels since the last quarter of 2005”. We are talking about the peak in the housing bubble here. While there is no way that we will see anything close to the level of activity we had a decade ago, the measures point to strong dales and construction in the months ahead.

MARKETS AND FED POLICY IMPLICATIONS: So, what shape is the economy in? That is bond market’s $64 trillion question. It was great to see that the vehicle sector, technology and housing are all in very good shape. Normally, that would create real optimism about the future. But the drag from energy continues to keep a lid on growth. Consumers seem content to bank the savings from the lower energy costs, but they may also be feeling a lot better about their financial situations. That seems to be reflected in the improved housing and vehicle sector and strong credit demand. If households are borrowing, either long-term or through revolving credit, that should mean solid gains in consumption. We don’t get May consumption data until a week from Thursday, but they should be really strong. So, what will the Fed say on Wednesday? I am guessing there will be some positive views about the economy and an indication that a tightening is coming, but also a need for continued good data to support the first rate hike. In other words, Janet Yellen, whether in the statement or at her press conference, will likely only hint, not confirm, that a move to increase interest rates is likely to happen “soon”.

May Retail Sales, Import and Export Prices and Weekly Jobless Claims

KEY DATA: Sales: +1.2%; Excluding Vehicles: +1%/ Import Prices: +1.3%; Nonfuel: 0%; Export Prices: +0.6%; Farm: -1%/ Claims: 279,000 (up 2,000)

IN A NUTSHELL: “Consumers stepped up their spending sharply in May, adding to the belief that the economy has moved back into a solid growth trend.”

WHAT IT MEANS: Households have been stashing away a lot of the savings from the gasoline price drop, limiting the positive impact on spending expected from lower energy costs. But that may be changing. Retail sales soared in May and it wasn’t just the huge rise in vehicle sales. Demand was up solidly for just about everything except health care products and restaurants. I guess the headaches caused by the winter are cured. Eating out had been the favorite way to spend money and for the first five months of the year, total restaurant spending is up almost 9% from 2014 levels. A one-month modest rise was not a major surprise. The sharp rise in gasoline sales was due to the jump in gasoline prices. The sub-category that best mimics the consumption number in GDP, core sales, rose solidly after a modest increase in April. That provides some hope that consumption will strong in the second quarter.

After ten months of declines, import prices finally rose in May. However, all of the gain was in energy. Still, after eight months of falling prices, we did get some stability in the nonfuel portion. Imported foods started to increase again but capital and consumer goods costs were flat. On the export side, if you weren’t a farmer, you could raise prices. But the long-suffering farm sector saw another sharp decline in the prices they are getting on the world market.

Jobless claims edged upward but they are still at levels consistent with further tightening of the labor market.

MARKETS AND FED POLICY IMPLICATIONS: Consumer spending on nondurable goods was the chief reason that first quarter consumption was modest. That is no longer the case. In addition, we are likely to see even better durable goods demand. So it looks like consumers will be adding more to growth in the second quarter than they did in the first quarter. Add to that a turnaround in the trade deficit, which cost the economy nearly two percentage points, and we are setting up for a very solid quarter. In addition, the long decline in import prices should start stabilizing the inflation data. Indeed, the Consumer Price Index’s non-food and energy component has been rising at about a 2.5% pace for the past four months and there is no reason to think that will change going forward. I expect the Fed’s preferred Personal Consumption Expenditure deflator to follow the CPI upward. And if you add in the continued tightening in the labor market, it looks like most of the conditions for a rate hike are nearly in place. By the July meeting, there should be little reason, other than the lack of a press conference, not to start raising rates. Assuming Chair Yellen wants to personally “meet the press”, a September rate hike is highly probable – and it could be a foregone conclusion by then.  

May Employment Report

KEY DATA: Payrolls: +280,000; Private Sector: +262,000; Revisions: +32,000; Unemployment Rate: 5.5% (up 0.1 percentage point); Hourly Wages: 0.3%

IN A NUTSHELL: “It’s time the Fed faces the reality that businesses aren’t hiring lots of workers because the economy is weak.”

WHAT IT MEANS: The soft economy was then; a much better economy is now. It really looks like temporary factors slowed first quarter growth. Nothing says “good economy” more that strong job growth and that is precisely what we got in May. Indeed, the details of the report were almost universally good. On the payroll side, job increases were pretty much across the board. About the only real weakness was due to the problems in the oil patch. Between direct cut backs in mining and indirectly through reductions in manufacturing industries such as fabricated metals and machinery, the energy sector caused payrolls to fall by over 20,000 workers. With oil prices having rebounded somewhat, those cuts should fade. Meanwhile, the services sector is hiring like there is no tomorrow. Temporary help companies are seeing more business and that may be due to the inability of firms to find suitable workers. Even the government is back in the job creation business and not all of the gains were in education.

On the unemployment side of the report, the modest uptick in the unemployment rate can be discounted. In April, the rate was 5.44%. In May, it was 5.50%. An increase that small is not significant. More importantly, the labor force rose solidly and the labor force participation rate increased. Over the year, the participation rate has actually gone up, so it is hard to argue the 0.8 percentage point drop in the unemployment rate over the year is anything but real.

On the wage side, a portion of the report that the Fed members have been paying close attention to, average hourly wages rose solidly and are now up 2.3% over the year. That is nothing spectacular, but it is accelerating, which is what the Fed wants to see. With aggregate hours increasing sharply, it looks like May personal income will be up big-time.

MARKETS AND FED POLICY IMPLICATIONS: One month of strong job gains doesn’t make the Fed hike in June, but it sure does raise the ante of a move sometime soon. The Fed members believe that they need some cover to raise rates even though most of them feel that they have overstayed their welcome at 0%. With job growth coming back and wages and total compensation on the rise, the conditions are nearly in place for the long-anticipated start of the process of rate normalization. I suspect the FOMC will note in the June 16-17 statement that it would like to see some confirmation of the improving growth. We get another jobs report before the July 28-29 meeting and given that the three-month average of 207,000 jobs created is probably below trend, don’t be surprised if the June report is strong as well. That would put pressure on the members to begin tightening right away. Chair Yellen said she would not be limited by the press conference schedule (there is none set for July), but it is likely she would want to face the press.   A September hike looks to be in the cards.

May Challenger Layoff Estimates and Weekly jobless Claims

KEY DATA: Layoffs: down 20,548/ Claims: down 8,000

IN A NUTSHELL: “The turnaround in oil prices is also turning around the labor market data as layoffs are declining.”

WHAT IT MEANS: Tomorrow is Employment Friday, so any labor market data will be swamped once the numbers are released, but you can get some insight into the pressures that are developing by looking at things other than the unemployment rate. The latest employment numbers point to further tightening in the labor market. Layoff announcements had been soaring as the oil patch started drying up. To put things in perspective, Challenger, Gray and Christmas reported that for the first four months of this year, layoff notices rose by a little over 28,000 from the same period last year. Meanwhile, the energy sector’s announcements rose by nearly 57,000. About 30% of all layoffs were in Texas. In other words, except for the energy firms have been holding tightly to their workers. With the rise in oil prices, energy sector layoffs have largely stopped – and so have overall layoff announcements.

Despite the weaknesses in energy and related industries, jobless claims have been low and they stayed down. Keep in mind, layoff announcements don’t necessarily become layoffs. The rise in energy prices may reduce actual payroll cut backs. Jobless claims declined last week and the level remains so low that payroll gains are highly likely to accelerate as we go forward.

MARKETS AND FED POLICY IMPLICATIONS: Payroll cuts in mining and machinery (support industry for the energy sector) totaled 20,000 in April and there still was a 223,000 rise in total employment. Don’t be surprised if in tomorrow’s employment report, we see a lot smaller job loss in those two industries. That should help drive the total gain to well above what we saw last month. The Fed will be watching the employment report closely, not just when it comes to employment but also what is happening with wages. But the hourly wage number doesn’t account for lots of other, more imaginative ways businesses are compensating employees. When you consider total compensation, it is clear that the upward trend is accelerating. In today’s revised first quarter productivity report, inflation-adjusted compensation per hour soared at a 6.5% rate over the quarter and was up a decent 2.2% over they year. Labor costs are reflecting the tight labor market and if hourly wages in the employment report doesn’t reflect that yet, we should be asking if we should even follow that number. For businesses, it’s all about total compensation and that is what we need to watch. If investors are focusing on the right numbers, they will have to start thinking that Fed has all the ammunition needed to start doing what the members really want to do: Raise rates.

May ADP Jobs Estimate and April Trade Deficit

KEY DATA: ADP: 201,000; Services: 192,000/ Trade Deficit: $40.9 billion ($9.7 billion narrower)/ May Vehicle Sales: 17.8 million units annualized (up 1.4 million units annualized)

IN A NUTSHELL: “Moderate job growth continues and with the trade deficit narrowing sharply and vehicle sales soaring, it looks like we could have a really good second quarter growth number.”

WHAT IT MEANS: Maybe the economy really is as strong as I think. Yesterday, we got the May vehicle sales numbers and they were the strongest in nearly a decade. We are talking housing bubble peak time here. And with gasoline prices down, people are buying bigger, gas-guzzlers again, so the May retail sales report should be really good. Today, ADP released its estimate of private sector job growth in May and it was solid, though nothing spectacular. However, the slide in job growth looks to be over. A positive sign was that payroll gains in the services component of the economy were pretty good. This is the largest portion of the economy and if the hiring reflects improving sales, then that too points to better consumption numbers. There were some concerns raised by the report. Large firms just don’t seem to be hiring. Strong additions to payrolls had helped create the robust jobs numbers we had been getting, so the moderation in hiring in this sector is a warning that we shouldn’t expect Friday’s government payroll increase to be huge. In addition, manufacturing remains soft, but the recent Supply Managers’ numbers seem to indicate that may be changing.

One of the major reasons the economy contracted in the first quarter was a widening in the trade deficit. That too seems to be in the past. The trade deficit, which everyone thought had soared because of the West Coast port strike, narrowed sharply in April. Exports expanded while imports fell. That is good news. Where we go from here is unclear, but the March deficit was so out of whack that it is likely that trade could be largely a nonevent in the second quarter GDP report. When you consider that trade reduced growth in the first quarter by nearly two percentage points, it is clear that the expected economic rebound should be pretty sharp.

MARKETS AND FED POLICY IMPLICATIONS: For an extended period, we had been getting disappointing economic numbers. That is changing, which is exactly what most economists had expected. If the winter, the dock strike and the collapse of petroleum prices were the causes of the slowdown, then the warmer weather, the end of the dock strike and the rise in oil prices should reverse the decline. They have. Friday we get the May employment numbers and it looks like an increase at least as great, if not higher than the 223,000 we saw in April is likely. I think it will be at least 250,000, but I have been too optimistic lately so that is a warning. The unemployment rate is likely to remain at 5.4% or even decline and the number of underemployed should come down as well. Those results would signal a further tightening in the labor market. Fed members have been somewhat dour about the condition of the economy. But the Fed has been behind the curve, when it comes to the economy, for decades and there is no reason to think that has changed. As for the markets, these data show a stronger than perceived economy but with employment Friday coming up, the reaction should be muted.

April Consumer Spending, Income and Construction and May Supply Managers’ Manufacturing Index

KEY DATA: Consumption: 0%; Income: +0.4%/ ISM (Manufacturing): +1.3 points; Orders: +2.3 points; Employment: +3.4 points/ Construction: +2.2%;

IN A NUTSHELL: “Despite continuing consumer cautiousness, the manufacturing sector is pulling out of its winter hibernation.”

WHAT IT MEANS: To spend or not to spend, that seems to be the question that is puzzling households right now. It is not as if they don’t have the money. Disposable (after tax) personal income rose solidly in April, even after adjusting for inflation. On a year-over-year basis, real income has grown by 2.4% or more for the past six months, the best stretch since 2006. In April, that increase was 3.5%, which is pretty decent. I am not saying that income growth is great, but it is no longer weak. The problem, though, is that wage gains have not been spectacular and workers have decided to save much of the gain. The savings rate rose to 5.6% and has averaged 5.4% this year. That is about one percentage point higher than during the expansion in the 2000s, which helps explain the sluggish nature of growth. In April, spending was essentially flat. A sharp drop in durable goods consumption and small decline in nondurable purchases offset a modest rise in services demand. We get May vehicle sales tomorrow so we will know if the sluggishness in that segment of the economy continued or, as expected, has turned around.

One sector that looks to have picked up some steam is manufacturing. The Institute for Supply Management’s May manufacturing index rose nicely and for all the right reasons: Orders rose strongly, hiring picked up solidly and order books started filling again. Production grew at a slower pace, but it is still expanding decently. The increasing demand and backlogs should lead to a rise in output soon. Fourteen of eighteen industries expanded and only one, petroleum and coal, said that orders fell. In other words, we are looking at a broad based improvement.

Another sign that the economic lethargy we saw in the first quarter is fading was a sharp rise in construction activity in April. Public and private, residential and nonresidential, all posted strong increases. It looks like the huge decline in energy sector spending may have ended.

MARKETS AND FED POLICY IMPLICATIONS: Incomes are growing, the manufacturing sector is coming back and construction is on the rise, so why am I not enthused about today’s data? Because we continue to see consumers holding back. Second quarter consumption growth is not off to a great start and we need a major pick up in shopping if growth is to beat expectations. The May vehicle sales numbers will be one sign, but until households get back online and start visiting the malls, economic growth will remain subdued. I still hold out hope we will get stronger growth but I am not sure many others share that belief. Investors have to start realizing that it is a robust economy, even if that means higher interest rates, which will support higher equity prices. I am not sure many share that view either.

Revised First Quarter GDP Growth and Corporate Profits

KEY DATA: GDP: -0.7% (down from +0.2%); Profits: -8.7%

IN A NUTSHELL: “The winter, a dock strike, lower energy prices and a strong dollar combined to hurt growth.”

WHAT IT MEANS: Oh, my, the economy contracted in the first quarter. Get out the towels for all those crocodile tears that I am shedding. Yes, my sarcasm has reached new heights. As it was in 2014, first quarter growth was negative. It wasn’t a big deal last year and it isn’t a big deal now. The biggest reason for the negative number was a widening in the trade deficit that subtracted nearly two percentage points from growth. The ending of the dock strike led to a sharp increase in imports and the strong dollar hurt some sales. The dock strike’s impacts are fading and the dollar seems to have largely peaked. Don’t be surprised if the April trade deficit, which comes out next Wednesday, is much lower than the huge gap recorded in March. The second big problem was business investment in structures. Lower energy prices led to a collapse in oil patch spending on rigs. But the rising energy prices have largely halted that reduction. The recent durable goods orders report points to rising business investment. Finally, the cold restrained consumer spending. That segment of the economy remains somewhat uncertain as the latest retail sales numbers were unimpressive. Those numbers, though, don’t include services, which just happens to account for nearly 40% of the economy. Services demand was solid in the first quarter. Also, the “softness” in vehicle sales is hardly supported by the positive comments coming out of the vehicle makers. May sales come out early next week and I suspect they too will point to improving household demand. Interestingly, the income side of the ledger actually posted a 1.4% rise, so maybe things really weren’t that bad in the first part of this year. Inflation remains in check.

Corporate profits tanked, also not a major surprise. The strong dollar in the first part of the year affected sales and currency translations.

MARKETS AND FED POLICY IMPLICATIONS: There are all sorts of issues with the first quarter GDP numbers that have been highlighted recently. It seems the economy is always weaker to start the year, for whatever reason that may be. It could be seasonal adjustment issues or measurement issues or whatever, but this has been a pattern for quite some time and the Bureau of Economic Affairs is trying to figure out why. That said, the real issue for the Fed, interest rates and the equity markets is where do we go from here. Recent data point to the economy picking up steam and next week we get May vehicle sales and job growth and April consumer spending and trade deficit. Most of those could be pretty good and that would change the thinking about the state of the economy. Basically, if you don’t like the economic numbers, wait a week and they will change. The decline in first quarter activity happened last year and the economy was strong for the final three quarters and I would not be surprised if a similar pattern was repeated this year.

April Durable Goods Orders and May Consumer Confidence

KEY DATA: Orders: -0.5%; Excluding Aircraft: +0.1%; Capital Spending: +1%/ Confidence: +1.1 points: Present Conditions: +3 points: Expectations: -0.2 point

IN A NUTSHELL: “You know how business were supposedly no longer investing? Well forgeddaboutit!”

WHAT IT MEANS: If the Fed is data driven, then it must have been driven crazy by the weak data we got for several months. That is no longer the case. Now I am not saying that conditions have started to boom, but they are getting better. A clear sign that companies are once again moving forward comes from the April durable goods orders report. Yes, overall demand fell, but since aircraft orders are in this number, it is crucial to remove them. Basically, there is a long lag time between when Boeing or other civilian or defense aircraft companies get new orders and production ramps up – if it even does. Excluding aircraft, orders were up, though modestly. The details were somewhat mixed. Demand for metals, machinery and vehicles was up while orders for electrical equipment, computers and communications equipment fell. But the real story was in the capital goods category. Excluding defense and aircraft, the best measure of private sector investment activity, capital spending jumped for the second consecutive month. It appears that businesses are getting more confident about the future.

Problems remain in the oil patch and the Dallas Fed’s manufacturing index declined in May. However, there was a rebound in expectations, which may be following the price of oil. Cut backs in energy companies have been a key factor in the recent slowdown and any turnaround would be good news.

The winter weather and continued disappointing wage increases had put a lid on consumer sentiment, which is why the rise in the Conference Board’s Consumer Confidence Index was nice to see. It wasn’t a large increase, but maybe the decline is over. While views about current conditions improved, there was some slippage in the outlook for the future. With the attitude toward future labor market conditions brightening, that too could reverse itself soon.

MARKETS AND FED POLICY IMPLICATIONS: The foundation for the first Fed rate hike is being built one number at a time and today’s data, be it the capital goods orders, consumer confidence, new home sales or housing prices, all added to the structure. But the base is going up slowly and the Fed members will need a lot more solid reports before we can assume they will move. Next week we get April spending and income data, May supply managers’ numbers, job openings and help wanted reports. And most importantly, the next employment release is Friday, June 5th. A lot can happen in ten days so buckle up. Indeed, I suspect investors will get more and more worried as we approach the jobs numbers. Nothing would change views on when the Fed will hike rates first than a strong report. Right now, I am not sure the markets are prepared for one and given the frequency of large swings in the payroll growth data, that cannot be ruled out.

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