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July 25-26 2017 FOMC Meeting

In a Nutshell: “No funds rate hike but more hints that the balance sheet reductions are coming.”

Rate Decision: Fed funds rate range maintained at 1.00% and 1.25%

The FOMC members came to Washington with not much expected and they did pretty much what was expected: They kept the funds rate at 1.00% to 1.25% and signaled that it was the time to reduce the balance sheet was near. As for the details of the statement, the view of the economy was largely the same as it was in June. Everything is solid or expanding. Inflation is now ‘running below 2 percent” rather than “running somewhat below 2 percent”. In other words, not much of a change. There hasn’t been a lot of data since the June 14-15 meeting, so there was little reason to change the outlook.

What everyone was looking for was a signal on when the Fed might start shrinking its balance sheet. The Committee stated: “For the time being (emphasis added), the Committee is maintaining its existing policy of reinvesting principal payments from its holdings”. It then added: “The Committee expects to begin implementing its balance sheet normalization program relatively soon (emphasis added)”. In other words, the signal was sent to the markets that the there will be some reduction in the balance sheet sometime this year.

Okay, what should we make of this? First, expect the Fed to announce that the balance sheet adjustment will begin either at the September or November meeting. As for the funds rate, it is not likely to be increased at the September meeting unless the economy picks up steam and inflation, especially wage inflation, accelerates. If it is not hiked in September, expect the next move to come the meeting after the announcement of the balance sheet reduction. My guess: Nothing in September, November 2nd for the balance sheet move and December 13 for the next rate hike. That is also likely to be Fed Chair Yellen’s last meeting, so she will exit at the end of January with the interest rate and balance sheet normalization under way.

(The next FOMC meeting is September 19-20, 2017.)

June Consumer Confidence and April Home Prices

KEY DATA: Confidence: +1.3 points/ National Home Prices (Over-Year): 5.5%

IN A NUTSHELL: “Confidence is rising, but there is some uncertainty about the future setting in.”

WHAT IT MEANS: As the year grinds on and the economy continues to improve slowly, the euphoria about the future is beginning to wane. The Conference Board reported that consumer confidence rose in June, reversing a decline seen in May. The key to the increase was a jump in the impression about current conditions. Consumers felt that both business conditions and the labor market improved solidly over the month. Importantly, the percent of people saying jobs are plentiful kept rising while those feeling that jobs were harder to get declined. However, the outlook about the future, while still solid, is not as optimistic as it had been. Fewer respondents expected business conditions to improve and there was an increase in those who expect jobs to be harder to get in the future.

Home prices have been rising much faster than inflation and the question being raised is: How long can that continue? Well, one measure, the S&P CoreLogic Case Shiller national home price index did jump in April, but over-the-year, the gain was a little slower than in March. Indeed, the change from last year has been in a fairly tight range for the past five months, varying between about 5.4% and 5.6%. Other indices are still showing signs of accelerating housing price gains, so we need to wait before we conclude the situation is stabilizing.

MARKETS AND FED POLICY IMPLICATIONS: The second quarter is coming to an end and there are few indications that growth was robust. The consumer didn’t buy motor vehicles at any great rate in April and May. Yesterday, it was reported that durable goods orders declined in May and most of the manufacturing reports coming from the regional Federal Reserve Banks have pointed to slowing manufacturing activity. The trade deficit doesn’t look like it will be shrinking much, if at all, so don’t look to the foreign sector for much help. Maybe inventories built, but if that was due to slower sales than expected, it isn’t a positive sign for the economy. And why would business invest heavily? Demand is not growing rapidly and it only makes sense to wait until the tax changes, if any, are known before making a decision. To change things around, the consumer will have to spend more and while it is nice that people think current conditions are improving, it would better if they were becoming more, not less confident about the future. So, investors will have to find something else, if they actually need something, to drive markets up further. But with two hikes under their belt, the Fed members may want to see better growth before they make the next move this year.  

June Home Sales

KEY DATA: New Sales: +0.8%/ Existing Sales: -1.8%

IN A NUTSHELL: “Home sales need to pick up further if construction is to add much to economic growth.”

WHAT IT MEANS: The housing market has been wandering around for most of 2017 and it isn’t clear if that pattern will change anytime soon. Today, June new home sales were released and the results were good but not great. Yes, there was rise in total demand, but the level is nothing spectacular. Indeed, it is probably still at least twenty percent below what might be considered normal, let alone strong. At least the trend is up, especially when compared to 2016 levels. Looking across the nation, weakness in the South offset strength in the West and Midwest. Sales were flat in the Northeast. Median prices were actually off from June 2016 as there were a lot more lower-priced houses sold. While that is likely a one-month wonder, the trend in price gains has been down.

On Monday, the National Association of Realtors reported that existing home sales fell in June. It seems that there is one month were demand rises followed by one where sales falls. This saw tooth pattern has led to only a relatively small increase in sales since December 2016. Regionally, demand rose only in the Midwest. There just aren’t a lot of homes for sale and prices are rising, though at a decelerating pace.

MARKETS AND FED POLICY IMPLICATIONS: We need the housing market to be strong if the economy is to accelerate. The sector has been adding to growth, but not by much. That is happening despite low mortgage rates. We also saw that the National Association of Home Builders confidence index slipped in July, pointing to only modest gains in construction. Housing starts should increase, as permit requests are outstripping starts, but if demand doesn’t pick up, that rise in construction is not likely to be significant. When you add the housing data to the consumer information, they point to only a minimal increase in growth. The Fed will be ending their meeting soon and we will know what the members think about the economy. It is clear that the FOMC members feel further increases in interest rates are needed and the Fed must start shrinking its balance sheet. To do that, though, inflation has to stay close to the target. It hasn’t done that lately. A better housing market would help and that is happening only slowly. That said, investors are focusing on earnings and that will be the case since they cannot use expectations of major tax cuts and spending increases to power the economy. It just seems that when one reason to take the markets up dissipates, a new one is created. Around and ‘round the markets go, where they stop no one knows.

June Housing Starts and Permits

KEY DATA: Starts: +8.3%; 1-Family: +6.3%; Multi-Family: +13.3%/ Permits: +7.4%; 1-Family: +4.1%; Multi-Family: +13.9%

IN A NUTSHELL: “The home construction rebound was nice to see but that was not a major surprise given that activity had faltered the previous three months.”

WHAT IT MEANS: Housing has been a major concern as construction was on the downslide through the spring. That pattern was broken as builders picked up the pace quite sharply in June. The single-family sector improved solidly, but the really big increase came in the multi-family segment. This is a pretty volatile portion of the market and we do get double-digit increases or declines fairly often. For example, multi-family home starts more than tripled in the Northeast in June. So don’t read too much into the surge in the multi-family component and don’t be shocked if it slows in July. Still, this is where a lot of growth is expected to be seen, as Millennials pour into the housing market, so it is good that it is improving. Looking across the nation, The Northeast, not surprisingly given the rise in multi-family starts, led the way, followed by a large rise in the Midwest. However the number of starts was up modestly in the West and fell in the South.

Looking forward, permit requests rose solidly as well. The level of permits has been well above the construction rate and since builders are not doing a lot of spec construction, they should be using those permits soon. That implies potentially several more months of increases in construction. The only region where permit requests fell was in the Northeast. Developers in that part of the country probably used up all their permits in June putting up lots of apartment buildings.

MARKETS AND FED POLICY IMPLICATIONS: The rise in home construction in June, as well as some upward revisions to previous months numbers, hold out hope that the residential sector did not slow growth much in the second quarter. As with other sectors, a lack of workers is limiting the ability of builders to build. Land and input costs are also an issue. Thus, I don’t expect this part of the economy to add greatly to growth going forward. Still it would be nice if it does play a role in pushing up the growth rate. We get the second quarter GDP number on July 28th and it doesn’t look like it will be near 3% unless firms failed to control their inventories. Private domestic sales should be in the 2% to 2.25% range, which is nothing great. But the pace of growth is not terrible. Stronger growth would put even more pressure on the labor markets. If firms cannot find workers with the economy growing at 2%, where will those workers come from if growth hit 3% or more? As for investors, the Obamacare repeal movement crashed and burned and you would think that would cause investors to think that similar problems could arise when the budget, tax cut and infrastructure bills are debated. Exuberance played a major role in the rise in the stock markets since the election. The political uncertainties should lead to some caution. But now people are saying that even a small tax cut and infrastructure-spending bill would be just fine. That seems to me that they are looking for any reason to be optimistic. We may not know for six months if that confidence was warranted.

June Producer Price Index and Weekly Jobless Claims

KEY DATA: PPI: +0.1%; Goods Excluding Food and Energy: +0.1%/ Claims: -3,000

IN A NUTSHELL: “The tame inflation is causing the Fed to reconsider its normalization path.”

WHAT IT MEANS: Inflation, where art thou? With the unemployment rate near, at or even below full employment, the assumption has been that accelerating wage pressures would appear. That hasn’t happened so far. And it doesn’t look like consumer costs will jump anytime soon either. Wholesale prices increased minimally in June as rising food costs were offset by declines in energy prices. The details, though, were not quite as clear as to the extent of inflation in the economy. Stepping back and reviewing the many subcategories and special indices, few are showing any decline in prices. That indicates a floor is being set on wholesale prices. Finished consumer food prices are rising fairly sharply and that gets passed through quickly. Finished consumer goods excluding food and energy are also increasing at a moderate pace. And while all finished consumer goods prices were up modestly in June, they are 2.7% higher than they were last June. Meanwhile, producer services costs are increasing at a pace that, while not high, can hardly be considered as minimal. Services are nearly two-thirds the index, which is important since intermediate services prices are increasing significantly. That implies that we should see the pressures on services continue in the months. Goods costs are rising sharply at the crude level, but it is a long and winding road from crude to finished goods, so it would be premature to say producer costs are going to rise sharply in the future.

Jobless claims decreased a little last week. The level is low and given the lack of available workers should remain near or at historically depressed levels for quite a while.

MARKETS AND FED POLICY IMPLICATIONS: Fed Chair Yellen, in her semi-annual testimony to Congress on monetary policy this week, hinted that a continuation of low inflation might allow the Fed to limit the increase in interest rates. If inflation remains restrained, what economists call the neutral funds rate, which is when the Fed is neither stepping on the brake nor accelerator, would also be low. That adds even greater import to the inflation data. Right now, there isn’t a lot of pressure on prices. Firms may have large numbers of job openings and great difficulty finding qualified workers, but they have yet to find it necessary to raise wages faster to attract workers. The recently declining energy costs have helped corporate bottom lines, providing further flexibility on the labor side. And what was the strong dollar had helped restrain import prices. Inflation is still low enough that the Fed has some flexibility in its rate and balance sheet normalization process. Looking forward, though, the declining dollar needs to be watched and the path of both energy and food costs is critical. But most importantly, if firms can maintain their limited pay increase policy in the face of the huge number of job openings, there will be minimal pressure to raise prices. Thus, the Fed may be able to go more slowly than had been expected, at least before this week’s testimony. That should buoy investors’ confidence.

June Employment Report

KEY DATA: Payrolls: +222,000; Private: 187,000; Revisions: +47,000; Unemployment Rate: 4.4% (up 0.1 percentage point); Wages: +0.2%

IN A NUTSHELL: “Strong job gains, rising labor force and moderating increasing wages: What more could we want?”

WHAT IT MEANS: Well, wrong again. I didn’t think the economy had it in it, but apparently there are still enough “qualified” people looking for jobs to hire an awful lot of new employees. The June payroll increase was well above expectations, though much of that overshoot was due to a huge increase in local government employment. Consensus was for almost 180,000 private sector jobs, so the 187,000 June gain was not that different from expectations. That said, it was a really good report. Looking at the details, just about every major industry added workers, with both the goods producing and service sectors up. Strong hiring was seen in construction, wholesale trade, finance and real estate, health care and restaurants. In addition, job gains in the previous two months were revised up, adding to the belief that we should watch what employers do, not what they say.

The improvement in the labor market is pulling people back into the job search process. The labor force expanded, as did the labor force participation rate. The participation rate has been largely stable for the past 3.5 years. However, even with a lot of people finding positions, the unemployment rate ticked up. Not to be too technical, but the rate now stands at 4.36%, which was rounded up to 4.4%, so let’s not get too worried about the rise in the rate.

As for the numbers I was most interesting, wages and hours worked, there was some good news and bad news in the data. Weekly hours worked were up sharply as firms are working their employees longer. Wages rose less than expected. Over the year, hourly wages are up only 2.5% before adjusting for inflation. Worker spending power is growing by less than 1%, which makes it hard for people to spend a lot more money.

MARKETS AND FED POLICY IMPLICATIONS: This was a good report. Lots of people found work, wages were up and hours worked increased. We can nit pick about the details, which weren’t nearly as great as the headline number, but there is no escaping the fact that employer complaints notwithstanding, firms are hiring. And that is the key for the Fed. This report tells the FOMC members that rate hikes are not slowing things down. Second quarter growth should be between 2.5% and 3%, barring a large, unintended increase in inventories. That would put first quarter growth at about a 2.25% annualized pace, right on target. Thus, there is no reason to slow the normalization process. Keep in mind, normalization means both rate hikes and balance sheet reductions. If the data keep showing that the economy is moving forward, the Fed is likely to raise rates at least one more time this year and also start cutting its holdings by the end of the year. But growth would have to be solid to have both to happen.   One quarter of 3% or more GDP growth doesn’t mean much unless it is backed up by additional strong increases. For investors, the data are a conundrum. While the labor market data imply the Fed will tighten further, more jobs imply the economy is in good shape.   Balancing the two will determine the direction of the markets.

June Private Sector Jobs, Layoffs, Non-Manufacturing Activity, May Trade Deficit and Weekly Jobless Claims

KEY DATA: ADP: +158,000/ Layoffs: 31,105/ ISM (Non-Manufacturing): +0.5 point/ Deficit: $1.1 billion narrower/ Claims: +4,000

IN A NUTSHELL: “The tight labor market is the limiting factor when it comes to job gains despite an improving economy.”

WHAT IT MEANS: Tomorrow is Employment Friday, but it could be one of those shoulder shrug reports. ADP’s estimate of June private sector job gains came in at what I call trend job growth. Given the shortage of available, qualified labor, it is hard to see how firms can hire lots of people. And more than likely they didn’t. But if the ADP forecast is anywhere near what we get, then you can categorize the number as decent. The one concern in the data was that small business hiring was weak. If the hiring slowdown was due to sluggish demand rather than a lack of qualified workers, it could be a warning that growth is moderating.

Yesterday I wrote that I expected the June payroll increase to be somewhere in the 160,000-range, which is enough to keep the unemployment rate slowly declining. It is also enough to keep the pressure on firms to find ways to retain their current workers. Challenger, Gray and Christmas reported that layoffs were pretty modest in June. They were down from May’s total and the May 2016 number. Of course, last year the energy companies were shrinking like crazy, so the year-over-year numbers must be looked at carefully. For the first half of the year, compared to 2016, layoff announcements fell nearly 28%. Excluding the energy sector, they were down about 8%. While unemployment claims rose a little last week, they are still quite low, which reinforces the view that firms are holding onto their workers very tightly.

The trade deficit narrowed in May as imports declined a touch while exports grew. Our imports of vehicles and consumer goods were off sharply, but that was largely offset by increases capital goods and industrial supplies purchases. On the export side, sales of vehicles and consumer goods were strong enough to overcome lowered demand for U.S. food, industrial supplies and capital goods. Oil played a limited role in the change in the deficit. It looks like the trade deficit, which narrowed and added to growth in the first quarter, may have subtracted a little from growth in the second quarter.

Yesterday, I incorrectly reported on the Institute for Supply Management’s Non-Manufacturing June report. Today’s release shows that this sector expanded faster in June on the strength of surging new orders. However, payrolls increased less quickly. With both the ISM manufacturing and non-manufacturing activity and orders indices rising, it looks like the economy picked up some steam in June.    

MARKETS AND FED POLICY IMPLICATIONS: Politics aside, if that is possible, the labor market is strong and is constrained not by a lack of demand for new workers but the ability to find workers, at the going wage, who have the qualifications firms need. Realistically, any job increase that is 150,000, plus or minus 25,000, should be considered as “good as can be expected”. But when labor demand exceeds supply, firms face a dilemma: Do they raise wages to attract workers from other firms and retain their own employees, do they try to meet the growing demand for their goods or services through productivity increases, or do they simply turn down orders or push out deliveries? Right now, companies are not raising wages much but are also not doing much of a job increasing productivity. That combination may be a reason economic growth is so slow. In any event, watch two numbers tomorrow, wages and hours worked. They should provide insight into the extent that the tight labor market is forcing firms to pay up for workers and/or extend out workdays, including moving people from part-time to full-time status.

June Supply Managers Indices, Help Wanted OnLine and Paychex Jobs Index

KEY DATA: ISM (Manufacturing): +2.9 points/ ISM (NonManufacturing): -0.6 point/ HWOL: -45,800/ Paychex: -0.24%

IN A NUTSHELL: “The economy continues to wander along at a steady, but not so great pace.”

WHAT IT MEANS: While there may have been fireworks across the nation last night, there is not much happening when it comes to the economy. The Institute for Supply Management (ISM) released its June manufacturing index results on Monday and its survey of non-manufacturers today. There was good news and not so good news. The manufacturing sector, which had been softening for quite some time, is continuing to show signs that the slowdown is behind it. The ISM activity index rose sharply, helped along by solid gains in new orders, production and as a consequence, hiring. Even so, order books continued to fatten at an accelerating pace. In other words, this segment of the economy is improving. On the other hand, activity in the non-manufacturing portion is moderating a touch. Demand is still solid, but is expanding a little less robustly. Still, hiring remains strong, as firms do what they can to meet their expanding backlogs.

On the labor market front, the indications are mixed. While both the ISM surveys point to strong job gains, the Conference Board’s Help Wanted OnLine measure showed that there were fewer ads for positions in June. The trend in this survey has been down for a couple of years and that may reflect the inability to find qualified workers. There was a sharp decline in listings early this year, but they have rebounded over the past few months to what look like a more reasonable level. A similar message, that the labor market may be softening, was seen in the Paychex IHS Markit June index, which dropped for the fourth consecutive month. Nevertheless, wage gains are accelerating. That may be a further indication that even if job growth has slowed, the lack of suitable labor is finally forcing firms to pay a little more for workers.

MARKETS AND FED POLICY IMPLICATIONS: The best news in the recent reports comes from the apparent improvement in the manufacturing sector. I say apparent because there is some concern for the vehicle sector. Sales were not particularly good in June and the trend is down. Some manufacturers have inventory well above desired levels. While that may lead to a little better than expected second quarter GDP, the pop from the inventory will be short-lived. Companies will likely start working off the excess stock of vehicles in the summer by slowing assembly rates. That would reverberate through their entire supply chains. But when all is said and done, we need wage increases to accelerate if growth is to improve. Friday’s employment report may provide some additional evidence that the tight labor market is forcing firms to actually raise wages. I don’t expect job gains to be great, somewhere in the 160,000-range, and the unemployment rate might tick up a touch. But if hourly wages accelerate, the rest of the report could be downplayed. Alternatively, given current below target inflation and mediocre job and economic growth, lackluster wage gains could lead the Fed to slow its rate normalization process.

May Consumer Spending and Income and June Confidence

KEY DATA: Consumption: +0.1%; Disposable Income: +0.5%: Prices: -0.1%/ Confidence: -2 points

IN A NUTSHELL: “Despite better income growth, worries about the future may be restraining household spending decisions.”

WHAT IT MEANS: The consumer needs to get going if the economy is ever to reach the promised 3% growth rate and right now, that doesn’t seem to be the case. Consumption was up minimally in May as households bought few goods. Both durable and nondurable goods purchases were off. On the positive side, spending on services, which is the largest component of consumption, was up solidly. Hopefully, that will continue. So far this quarter, consumer demand is rising at a roughly 2.6%, so it will take stronger growth in June to get to the magic 3% number. Can that happen? I am not so certain. Income gains were strong in May, but the rise was mostly due to a surge in dividends, which don’t get translated into demand very quickly. Meanwhile, wage and salary increases were modest. And what people make, they seem to be stashing away as the saving rate is rebounding. On the inflation front, prices were largely flat, especially when food and energy were excluded. Over the year, both the headline number and the core, which excludes the volatile components, posted declines. That is something that the Fed will likely watch closely.

Consumer confidence is continuing to moderate. The University of Michigan’s Consumer Sentiment Index fell in June. The level remains solid, but there was a further deterioration in the outlook for the future. That stands in contrast to the view that the economy is getting better. Let’s see now. In Washington, the politicians are saying the economy is terrible but the future is bright. Consumers seem to be saying things are pretty good and getting better, but they are not so sure that trend will continue in the future. Does anyone in Washington have a clue to what is going on?

MARKETS AND FED POLICY IMPLICATIONS: Today’s reports don’t point to any major acceleration in growth in the second half of the year. Wage and salary gains are mediocre and without a better increase in worker salaries, consumption can grow only so quickly. We will get a better picture of household spending on Monday when June vehicle sales are released. Unless there is a bigger than expected pop in demand, it will be hard for GDP growth to have been robust this quarter. We could get a 3% number, but that might be due to a rebound in inventories. Sales, though, look like they were soft. We have a month before we know that number, which comes out after the next FOMC meeting. So the Fed looks to be on hold at least until September. As for investors, all eyes remain on Congress. Can the gang that cannot think straight get anything done this year when it comes to tax reform and infrastructure spending? I just don’t know.

For all those who are heading out today for a nice, long July 4th weekend, have a wonderful time.

May New and Existing Home Sales and April Housing Prices

KEY DATA: New Home Sales: +2.9%; Existing Home Sales: +1.1%; FHFA Prices (Over-Year): +6.8%:

IN A NUTSHELL: “The slowing in the housing market may be ending as demand is picking up and prices keep surging.”

WHAT IT MEANS: The housing market has been a puzzle recently, with sales and starts tumbling. That may no longer be the case. New home sales jumped up in May and the gain was on top of a sharp upward revision to the April sales pace. The rise in purchases over the year was nearly 9%, indicating that conditions are indeed getting better. That said, the increases were not well distributed across the country. The robust surge in sales in the West and strong gain in the South were almost entirely wiped out by double-digit declines in the Northeast and Midwest. As for prices, they hit record highs. The nearly 17% rise from the May 2016 median price level undoubtedly overstates the gain, so let’s don’t get too carried away. Nevertheless, supply remains limited and it is likely that the pressure that has been building for so long on prices will not go away anytime soon.

Earlier this week, two other reports on housing were released. The National Association of Realtors released their report on existing home demand and it too showed that demand is rebounding. Unlike the new home numbers, sales rose across the nation. And similar to the new home market, a lack of supply is keeping pressure on prices, which were up nearly 5% over the year.

There are many different reports on home prices, which is difficult to quantify given the changes in prices don’t necessarily measure the rise or fall in the cost of the same unit. Still, all the indices are showing the same thing: Prices are on the rise. The Federal Housing Finance Agency’s index posted another sharp increase in April and over the year. This index had decelerating during most of 2014 but has been on a slow but steady rise since.

MARKETS AND FED POLICY IMPLICATIONS: I don’t know how many times I have written that if it isn’t for sale, it is hard to buy and the housing market is clearly suffering from a lack of inventory. Just today I was cold-called by a realtor asking if I was interested in selling my house. That is how desperate things have gotten. Locational mobility has declined sharply and even those whose homes are now above water are hesitant to sell. Builders face cost and regulatory issues and those factors, plus more rational lending practices, is keeping new construction down. There is no simple solution to the problem, so don’t expect housing sales to surge. What should continue to rise are prices. For the Fed, that is good news as it will keep non-food and energy consumer costs from decelerating further and allow for additional rate hikes this year, assuming the economy keeps growing at a moderate pace. Investors, though, don’t seem to worry about economic fundamentals, so what, if anything, will slow the markets is unclear.