August Consumer Confidence, July Durable Goods Orders and June Home Prices

KEY DATA: Confidence: +2.1 points: Current Conditions: +6.7 points; Expectations: -1 point/ Orders: +22.6%; Excluding Aircraft: +1.6%/ Home Prices (Monthly): 1%; Year-over-Year: 8.1%

IN A NUTSHELL:  “Consumers are getting some real smiles on their faces and that should help propel spending, but only if wage increases improve.”

WHAT IT MEANS: There were a number of key reports released today and maybe the most interesting one was the Conference Board’s Consumer Confidence numbers.  Overall confidence rose solidly again in August, the fourth consecutive increase.  The level hasn’t been this high since October 2007.  The eye-opening component was the Present Situation index, which surged.  There was a sharp rise in the percentage of respondents who thought that jobs were plentiful and a modest decline in those who felt it was difficult to find a position.  Strangely, fewer believe job openings will rise in the near future.  Rationality may not be at work here.  The other key finding is that people are not overly optimistic about their incomes increasing going forward.  That, even more than their general view of the world, could keep households from spending briskly.

Orders for big-ticket items skyrocketed in July, but when civilian aircraft orders rise 318%, you know that the headline is largely meaningless.  Excluding private and defense aircraft, orders did jump and that was due to strength in the vehicle sector, which was up over 10%.  Otherwise, the numbers were largely off, with only communications posting a nice gain.  Business capital spending eased, but quite modestly compared to the jump posted in June.  Backlogs are building nicely and that should mean expanding production going forward.

Home prices continue to rise, but the rate of increase is decelerating.  The S&P/Case Shiller 20-city index was up decently in June and has moved back to fall, but the gain over the year was down in all twenty cities.  The price index is back to where it was in fall 2004.

MARKETS AND FED POLICY IMPLICATIONS: Consumers are feeling a lot better about economic conditions, but they are not exuberant about their income possibilities.  That is holding back spending and until the labor market tightens further, wage increases will remain limited.  That is why the debate over the slack in the workforce is so important.  In addition, home price gains are slowing.  While that may help affordability, it hurts the churn in the market as fewer homeowners will see their equity levels rise to where they can once again sell their homes.  That said, the jump in orders does point to continued decent overall economic growth but until we get the consumer going, strong growth will remain a wish not a reality.  Investors should understand that, even as they bid up prices.  But these reports only add to the divisions that exist at the Fed.  It’s still the labor market and we don’t get the August employment report until the Friday after Labor Day.

Fed Chair Yellen Talk at Jackson Hole Conference

In a Nutshell: “… if progress in the labor market continues to be more rapid than anticipated by the Committee, then increases in the federal funds rate target could come sooner than the Committee currently expects … Of course, if economic performance turns out to be disappointing … then the future path of interest rates likely would be more accommodative than we currently anticipate.”

If you don’t like two armed economists, you will truly dislike the talk that Fed Chair Janet Yellen gave today at the Federal Reserve Bank of Kansas City’s Economic Symposium in Jackson Hole, Wyoming.

The greatly anticipated speech delved into the details of the labor markets, the impact of wages on inflation and the way that monetary policy should react.  Of course, being a good economist and academic, Chair Yellen discussed all sides of the issues.  For example, is the decline in the participation a result of changing structural factors such as the aging workforce or is a cyclical decline due to frustration that will unwind once the labor market firms more?  The answer is, of course, yes.  That is, it could be one, or the other or even both, which it likely is.

Similarly, there were discussions about wage pressures, how long it could take for wages to rise faster and when rising labor costs would actually translate into rising inflation.  As any economist will tell, the answer is hardly clear since there are multiple competing factors.  Thus, wage pressures could ignite quickly or be delayed.  Rising wages could signal future increases in inflation, or maybe not.  The Fed should react quickly to rising wages or maybe wait if the wage increases are temporary.  In other words, the answer is any or all of the above.

So, given the talk, is there anything to take away from the speech?  Yes.  First, the Fed members recognize that we are a lot closer to their desired goals than they had projected.  Second, the lack of wage inflation is not necessarily a good sign for future inflation.  The apparent current slack in the labor market could disappear more quickly than expected.  In the past, the Fed Chair had generally been on the side that current labor market conditions argue for keeping rates low for an extended period.  Now, those same conditions need to be watched more carefully.

If Janet Yellen was viewed believing the labor market had plenty of slack and wage pressures would not build anytime soon, that perception has to change.  She recognizes that the risks are more balanced.  That means she will be more willing to move rapidly if the economy continues to improve surprisingly quickly.  Thus, investors should not assume any time frame for Fed rate hikes.  It is easy for economists and market analysts outside the Fed to pick a date.  But today’s talk makes it clear that if the Fed has to move sooner or deems it necessary to wait longer, the Fed Chair is totally prepared to go in that direction, whatever it may be.

July Existing Home Sales and Leading Indicators, Weekly Jobless Claims

KEY DATA: Home Sales: +2.4%/ Leading Indicators: up 0.9%; Claims: 298,000 (down 14,000)

IN A NUTSHELL:  “It looks like the economy is approaching escape velocity.”

WHAT IT MEANS: There were a lot of numbers released today and they all were really good.  First, there was existing home sales, which rose solidly in July.  The pace of demand is back to October after having posted four consecutive increases.  While the level is not spectacular, it is probably within ten percent of a solid market.  The huge levels posted during the mid-2000s should be viewed as aberrations not targets.  Increases were in all regions except the Northeast, which was flat.  As for prices, they continue to moderate.  After peaking last August at a 13.4% rise over the year, the gain is now under 5%.

 

Looking forward, the Conference Board’s Index of Leading Indicators popped in July.  This measure is accelerating as there were 0.6% increases in both May and June.  Gains in both the coincident (current conditions) and lagging indicators support the view that the economy is in really good shape.  And then there were the weekly jobless claims number, which got back to “normal”, that is, below 300,000.  Last week’s pop was a surprise and assumed to be due to a non-seasonally adjustable pattern of vehicle production shutdowns.  That we moved back to such a low rate is an indication that the labor market is really in good shape.

There were two other reports released that also point to a strengthening economy.  The Philadelphia Fed’s Business index surged in August, as did expectations.  Supporting the view that manufacturing is really cooking was the Markit flash August number which jumped to its highest level in 4.5 years.  The report noted that “robust manufacturing growth momentum has been sustained through the third quarter”.

MARKETS AND FED POLICY IMPLICATIONS:  Janet Yellen speaks tomorrow morning and that is the focus of attention.  Her talk takes on even more importance given the growing indications that the economy is beginning to break out of its sluggish growth mode.  While waiting for wage gains is not exactly the equivalent of sitting on a bench waiting for Godot, it is not really the best way to run monetary policy.  Wages is a lagging, lagging indicator and monetary policy needs to look forward.  The economic data are pointing to stronger growth than the Fed has been forecasting, which is hardly a surprise.  I always use the Fed’s numbers as a lower bound for growth.  Of course, I have been aggressively optimistic this year and seeing the possibility that my forecast could actually turn out to be correct makes me a bit giddy, so I will limit my criticism of the Fed.  That said, I have argued that wage gains are coming sooner than later and that the Fed will be compelled to raise rates earlier than many have expected.  Today’s data reinforces that view.  These data should make investors happy, but only when they realize that it’s the economy not the Fed that should be driving prices.

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

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