All posts by joel

July Manufacturing Activity and June Construction Spending

KEY DATA:  ISM (Manufacturing): -1.1 points; Orders: -1.1 points; Employment: +3 points/ Construction: +0.1%; Private: +0.4%; Private Residential: +1.1%

IN A NUTSHELL: “With manufacturing strong and construction starting to rebound, any economic slowdown is likely to be fairly modest.”

WHAT IT MEANS: The economy boomed in the spring, even if many economists expected even stronger growth.  That said, most forecasts, including my own, see activity rising more moderately in the quarters to come.  The issue, is how much of a slowdown should we expect going forward?  Right now, it doesn’t look like it will significant.  The Institute for Supply Management reported that manufacturing activity grew at a “slower” pace in July than we have seen in six months.  Still, the overall index level was pretty strong.  Keep in mind, this is a diffusion index.  If businesses expand one month but only retain that pace the next, the index declines.  To highlight that point, the new orders index eased.  What happened was that a large number of companies reported that demand was stable, rather than rising.  In contrast, a smaller share reported that orders had declined.  Indeed, only 3.3% said they were lower, compared to 8.2% that said demand had declined in June.  In other words, demand solidified, at a high level, rather than accelerated in July, which is not that bad.  Similar results were seen in most of the other components, so don’t look at the decline in the headline number as saying anything.  On the clearly positive side, employment, which had eased minimally in June, picked back up in July.  Also, backlogs continue to expand at a rapid pace, indicating that production and hiring should improve going forward.

The housing numbers haven’t looked great lately.  Nevertheless, the construction sector remains solid.  Construction spending rose modestly in June, but there was a solid rise in private residential activity.  A sharp drop in road construction restrained activity.  State and local government spending patterns have been driven by federal government assistance, while revenues from taxes, such as gasoline taxes, are still falling.  That is affecting infrastructure spending.  That could change if the bipartisan bill that is making its way through Congress actually gets passed.IMPLICATIONS:It’s the first week of the month and that means Friday is the big day for the markets as the July jobs report will be released. Estimating the number is difficult as the reopening of firms and government offices raises issues about the accuracy of the seasonal adjustment factors.  It’s not the season that is leading to the surge in hiring we are seeing.  The consensus is for something in the 800,000 range, similar to the 850,000 June number, but it could be a couple of hundred thousand higher or lower.  I’ve seen estimates that range from 350,000 to 1.6 million, so don’t get too bulled up or disappointed if the number is viewed as a “surprise”.  Regardless, the economy is still moving forward solidly.  Today’s data point to that.  It is just that we have had unsustainable growth for the past year.  It is hard to think that the 12.2% growth from second quarter 2020 to second quarter 2021 will be repeated anytime soon.What investors have to start getting their minds around is what the pathway to normal growth will look like.  How many additional quarters of well above 2% trend growth can we have?  The forecasts are made uncertain by issues such as government policy, the Delta or other virus variants and consumer behavior.  Specifically, what will the infrastructure and budget bills look like?  How much of the spending will occur over the next year or into the future?  Will the cutbacks in federal assistance to workers and businesses lead to slower income growth, spending and hiring?  Will firms that stayed afloat because of government programs start going out of business and if so, how many?  Will the virus get worse, be brought under control again or just become part of life?  How quickly will consumers, who have shopped ‘til they dropped in reaction to the economy reopening, resume more normal spending patterns?  It has never been easy to forecast the economy, but at least we have had trends to fall back on.  Right now, non-traditional economic factors may be the real drivers of growth over the next year, so take any forecast, including mine, with a grain of salt.

Second Quarter GDP, June Pending Home Sales and Weekly Jobless Claims

KEY DATA:  GDP: +6.5%; Consumption: +11.8%; Consumer Inflation: +6.4%; Ex-Food and energy: +6.1%/ Pending Sales: -1.9%; Over-Year: -1.9%/ Claims: -24,000

IN A NUTSHELL: “The economy boomed in the spring, but what matters is the next few quarters and there are reasons to believe growth will moderate sharply.”

WHAT IT MEANS:  There was little doubt that economy surged in the spring and the first reading of second quarter GDP activity showed just that.  Many economists expected a lot faster increase, but gain is still great.  Consumers shopped ‘till they dropped.  Consumption exploded and the increases were almost evenly spread between durable and nondurable goods as well as services.  Business spending on equipment and intellectual property was also strong.  However, construction of business structures and housing fell, constraining growth.  As expected, the trade deficit widened, slowing growth. Also, inventories were drawn down sharply, taking over one percentage point out of growth.  Finally, the federal government cut its spending on goods and services.  It was busy supporting income through transfer payments.  As for inflation, it soared, no matter how you measure it.  Consumer goods and services prices skyrocketed, even when you excluded food and energy.  Housing prices soared, as did imports and exports.  Only the cost of business equipment declined.    

Once again, the National Association of Realtors reported that in June, pending home sales edged down.  Over the last five months, the index has gone up then down, but the average is near the level posted for 2020 – which was a pretty good year.  It is just that there was bubble for about six months that is, surprisingly, deflating not bursting.  Indeed, demand is solid, but with inventories extremely low, it is hard to sell lots of homes.

New unemployment claims gapped down last week, though the previous week’s number was revised upward.  The 400,000 level is a bit disappointing.  A few weeks ago, we were hoping it would start approaching 300,000, but it has gone in the opposite direction.  Also, there was sharp rise in the number of workers receiving benefits.  These data are extremely volatile and there is every reason to think the number of new claims and recipients will fall more consistently going forward.  It’s just that it may take longer than expected to get back to full employment.

IMPLICATIONS: We have had four consecutive quarters of strong to spectacular economic growth.  But that was driven by the reopening of the economy and massive government transfer payments.  We should see another really good gain this quarter, though it will likely be less than we have seen for three major reasons: The reopenings have largely occurred; states are already reducing their payments and in September, the federal government will follow suit; and job gains, though strong, are not likely to come close to the last twelve months given the problems firms are having finding workers.  Yes, businesses could get some help when the supplemental unemployment funding disappears, but it isn’t clear how big a factor that will be or how long it will take to significantly reduce the number of people on traditional unemployment rolls.  Income growth in the last quarter of the year will be mostly dependent on wage and job gains, not government largesse, and that doesn’t bode well for consumption.  There is little reason to expect a surge in business spending on structures.  Why the trade deficit would narrow is beyond me, as the rest of the world is not showing signs of growing a lot faster.  The only significant positive could be federal government spending.  States and local governments are losing their sugar daddy, the federal government, so don’t look for them to start buying all sorts of goods and services anytime soon.  While we might get an infrastructure bill, it will take a long time for those funds to make their way into the economy.  The Biden administration wants to spend like crazy and if it gets its way, the rise expenditures could offset somewhat the slowdown caused by the factors listed above.  That would imply a moderation in growth going forward, not a rapid deceleration.FOMC Decision: The FOMC met Tuesday and Wednesday and it kept rates constant.  No surprise there.  What was hoped for was a signal about when the asset purchases would start to slow.  The comment that “the Committee will continue to assess progress in coming meetings”, toward meeting their inflation and employment goals, with meetings being plural, implies that it will not signal when the tapering will occur until near the end of the year.  The Fed has indicated it will start tapering before it raises rates, so we need to see that happen first.  With the Fed pledging that short-term rates will remain near zero, the Fed is showing it will keep supporting the markets.  It is when tapering begins that the real challenge for investors will begin.

June Durable Goods Orders, July Consumer Confidence and May Housing Prices

KEY DATA:  Durables: +0.8%; Ex-Aircraft: -0.2%/ Confidence: +0.2 points/ Case-Shiller National Prices: +1.7%; Over-Year: +16.6%/ FHFA National Prices: +1.7%; Over-Year: +18%

IN A NUTSHELL: “Growth is slowing, and households seem to be taking stock of what may happen going forward.”

WHAT IT MEANS:  The recent economic data point to continued economic growth, but at a more moderate pace, and today’s numbers do nothing but support that view.  Durable goods orders rose solidly in June, but as usual, the headline number doesn’t tell the full story.  Excluding the strong rise in aircraft orders, my preferred data point since airplane orders don’t lead to increased production for quite a while, demand for big-ticket items fell modestly.   The details were also mixed as orders for vehicles, computers and fabricated metals dropped, offsetting increases in demand for electrical equipment, metals, machinery and communications equipment. There was a positive number in this report: Backlogs continue to build at a solid pace and that points to increases in production and hopefully hiring in the future.   

There is some uncertainty setting in when it comes to consumer confidence.  The Conference Board’s July index was up just a touch.  There was a small gain in the view of present conditions while expectations eased back a touch.  On Friday, we get the University of Michigan’s Consumer Sentiment Index, which had dropped sharply during the first half of the month.  With Covid cases picking up and inflation pressuring households, it would not be surprising to see this measure post a solid decline for the entire month.    

Speaking of inflation, as expected, home prices spiked further in May.  Both the Case-Shiller and Federal Housing Finance Agency indices posted major increases, over the month and the year.  Three of the nine regions in the FHFA index had home price gains over-the-year in excess of twenty percent, with the smallest rise being 15.4%.  Similar increases were posted for the twenty cities in the Case-Shiller measure.  These are clearly unsustainable rises that reflect the panic buying we saw over the past year.  The surging home costs are reducing affordability, which helps explain yesterday’s sharp drop in June new home demand. IMPLICATIONS:Thursday we get the first reading on second quarter GDP and there is every reason to believe it will come in faster than 6.4% surge posted in the first quarter.  But there is also every reason to think that going forward, we could see a constant moderation in growth that could get us back closer to trend 2% in over the next year or so.  Part of the problem is the supply chain, which is not showing signs of being fixed in the near future.  Housing costs are pricing households out of the market and inflation is eating into many workers purchasing power.  With the supplemental unemployment insurance payments being cut by states and ending in September, much of the government-supported personal income growth is also coming to an end.  But as is the case with most economic issues, there is the other hand.  Slower growth should bring inflation down, easing pressure on the Fed to reduce asset purchases and/or raise rates sooner than expected.  Indeed, the Fed members are making that argument, which is music to investors’ ears.  Moderate growth is something that most economists like to see. Most economists have built into their 2022 forecasts an end of the pandemic (or a limitation of its effects).  Let’s hope that is the case.  But the pandemic is not over, yet many citizens and politicians are acting as if it is.  The greater risk is on the side of slower economic growth next year, as the Delta and/or future variants could keep the pandemic going longer than expected.

June Existing Home Sales, Leading Indicators and Weekly Jobless Claims

KEY DATA:  Sales: +1.4%; Prices (Over-Year): +23.4%/ LEI: +0.7%/ Claims: +51,000

IN A NUTSHELL: “The surge in unemployment claims was a surprise, but not necessarily a signal that the economy is slowing.”

WHAT IT MEANS: The data this week are limited but that doesn’t mean they are not important.  The housing market is the center of attention and while demand is hardly surging, it is still quite strong.  The National Association of Realtors reported that demand rose modestly in June, which is actually good news.  Sales had fallen on a fairly consistent basis since they peaked last October, so maybe this is an indication that the downslide is coming to an end.  Three of the four regions posted similar gains and the fourth was flat, indicating that demand is stabilizing across the nation.  The problem in the housing market is inventory.  While there was a rise in the number of homes for sale, the number of months of inventory remained ridiculously low.  As a consequence, the median price of a home sold was up over-the-year by the second largest rate on record and the median price itself hit a new record high.  Affordability is fading and that, in conjunction with the lack of homes on the market, may be the reason demand is not rising.

week we get second quarter GDP, and it should be really strong.  But where do we go from here?  If you believe the Conference Board’s Leading Economic Index, growth should remain solid.  The index increased solidly and the gain was broad based.  Yes, it is signaling a moderation in growth, but, as the report noted, it is pointing to not only a 6.6% rise this year, but a “healthy” 3.8% gain next. 

Unemployment claims surge last week, which was quite a surprise.  Since these data are volatile, we should assume that it is pointing to a major economic slowdown.  An outsized gain one week is often met by a similar decline the next.  The number of workers receiving assistance fell sharply and that should continue.  IMPLICATIONS:Are investors irrationally exuberant?  It is hard to make that argument.Yes, bad news is met by shock and then an “aw-shucks” response.That is, the markets tank for a short period of time and then the rally takes off once again.  That has been the case for a very long time now, not just since the V-shaped sell and recovery of last spring.  When the Fed started tapering, the markets went into a tantrum, but the decline, though steep, was short-lived.  Basically, no matter how bad the news, investors don’t take it seriously for an extended period.  They have been rewarded as the initial sell off triggered actions by either the Fed and/or the government, that kept liquidity flowing to the markets and/or to businesses and households.  Whether this time is different is unclear.  While some government programs are slated to end, other may be expanded in President Biden’s first budget.  At the same time, the Fed is steadfast in favor of supporting the markets by keeping rates low for a very long time.  As long as the government and the Fed keep pumping things up, it is hard to see how the markets can stay down for an extended period.  Interestingly, that means earnings are not the true driving force for equities.  Government policy is supporting demand and liquidity and the outlook for the markets is no longer a function of what businesses do but what the government and the Fed do.  Earnings just determine the distribution of the economic gains, not the level of the gains.  So, watch public policy because when that changes, everything else could be up for grabs

June Housing Starts and Permits and July Philadelphia Fed NonManufacturing Index

KEY DATA:  Starts: +6.3%; 1-Family: +6.3%; Permits: -5.1%; 1-Family: -6.3%/ Phil. Fed (NonMan.): -6.5 points; Orders: +4.4 points

IN A NUTSHELL: “Home construction remains strong, mirroring the economy.”

WHAT IT MEANS:  This week, there are few economic reports and most center on housing.  It looks like the home building sector remains in good shape.  Yesterday we saw that the National Association of Home Builders’ index eased back slightly in July as traffic slowed.  But the outlook for sales over the next six months improved.  Today’s report on June housing starts and permits was solid, as new construction activity picked up sharply.  The gain was evenly distributed between single-family and multi-family projects.  However, permit requests declined.  That is not a great issue as permits were above starts for the previous fifteen months.  Builders have a backlog of permits to work off and they are starting to do that.  You can see that in the number of units under construction, which hit its highest level in fifteen years. 

The Philadelphia Fed’s July survey of nonmanufacturing firms fell, but as is often the case, the headline number doesn’t tell the story.  First, the level remains high.  But more importantly, demand and hiring picked up.  Also, compensation costs are accelerating, and firms are raising prices more rapidly.  The issue of labor costs was the focus of this month’s special questions.  Over forty-four percent of the respondents indicated that they were raising wages more than planned and the median wage increase is now expected to be between three and four percent.  Expected wage, health and nonhealthy benefit costs are projected to rise by four to five percent.  This must be putting pressure on earnings.IMPLICATIONS:  Today, the economic data are not the major focus of investors.  Yesterday’s sell off is, and from the look of things, it is being matched by a sharp rise.  The wild gyrations in equity prices are indications investors are skittish about where we are going – and there is good reason for that to be the case. The Delta variant has taken over and it is spreading rapidly.  At the same time, vaccinations are falling and there is now a growing and vocal anti-vaccination movement.  Last summer, there was a lull, only to be met by a massive rise in the winter.  It is unclear what will happen as we move out of the warm weather into the cold.  Shutdowns are not expected, but health concerns, especially for children, could become an issue.Adding to uncertainty is the looming reduction in stimulus funds.  Over the past year, investors have looked past most of the problems and they were rewarded.  The big difference between now and last summer is that the stimulus was adding massively to both household and business spending and the prospect was that it would continue.  That is not the case now.  That said, President Biden’s first budget is filled with new spending and that could offset the loss of the stimulus funds.  Consequently, investors have reason to be uncertain, but also hopeful.  That points to further volatility ahead, so fasten your seat belts.

June Consumer Prices, Real Earnings and Small Business Optimism

KEY DATA:  CPI: +0.9%; Over-Year: +5.4%; Ex-Food and Energy: +0.9%; Over-Year: +4.5%/ Real Hourly Earnings: -0.5%; Over-Year: -1.7%/ NFIB: +2.9 points

IN A NUTSHELL: “Inflation and optimism are sky high, but spending power is cratering.”

WHAT IT MEANS: One of the greatest concerns, at least for consumers, is that inflation is soaring.  We saw again today, just how great a problem that is, at least right now.  The Consumer Price Index surged in June.  On a year-over-year basis, the rise was the second largest in nearly thirty years, beaten out by the gasoline price surge in 2008.  Excluding food and energy, you must go back to November 1991 to see any annual price increase greater.  Clearly, there are some special factors at work.  Used vehicle costs are up by 45% since last June, as the global supply chain is not working well.  Gasoline and fuel oil have also skyrocketed by a similar amount.  But while eating out is a lot more expensive, eating in costs have been tame, though that has been changing in the last few months.  Interestingly, health care costs, both goods and services, have been a restraining inflation.  Normally, it would be leading the way up.  Also, despite the surge in home prices, shelter expenses have been increasing at a moderate pace.  We need to be cautious in jumping to any conclusions about the yearly rise in consumer prices due to the price declines created by the shutting down of the economy.  That said, Since March 2020, before the pandemic impacts were felt, the headline index is up 5% while the core (ex-food and energy) has risen 4.2%.  In other words, inflation is soaring, and it is not just a statistical anomaly.

The problem for households is that their incomes are just not increasing nearly as rapidly as their expenses.  Adjusting for inflation, hourly wages fell sharply both over the month and over the year.  People are working more now but enjoying it less.

Despite the inflationary pressures on costs, small businesses are exuberant.  The June National Federation of Independent Business’s index rose solidly and the level is nearing the peaks seen after the 2016 election and the passage of the tax cuts.  But firms are having major problems filling open positions, raising costs and forcing firms to increase prices.  The percent raising prices hit its highest level since 1981 and no one who lived through that time period wants to go through that again.     IMPLICATIONS:The heat is on, it’s on the street” and the question is, will the Federal Reserve cops (yes, that is the song from Beverly Hills Cops) keep smiling and saying that transitory factors are driving the rise and they will dissipate and everything will be beautiful sometime in the future, whenever that sometime will be? But for workers, the surge in consumer costs is eating heavily into their spending power.  That is happening as states are trimming their unemployment compensation and the supplementary payments will terminate nationally in September.  Where households will get the money to keep spending as we move through the later portions of this year and into next is anyone’s guess.  While the strong job gains mean overall income will continue to increase, high or even moderate inflation, coupled with mediocre wage increases could limit consumption for those already working, and that is the bulk of the workforce.  But investors seem to think the Fed is totally correct that inflation will fade to trend and therefore don’t seem to be adding that issue to their decision making.  Given the markets tend to be cynical about Fed forecasting, to me this attitude looks like cherry picking those things that help keep the market going and discounting anything that doesn’t support that view.  That approach could persist for quite a while as we have no idea what the time frame the Fed has in mind when it says that inflation pressures are transitory.

June Service Sector Activity and Employment Trends

KEY DATA:  ISM (NonManufacturing): -3.9 points; Orders: -1.8 points; Employment: -6 points; Backlogs: +4.7 points/ ETI: +2.14 points

IN A NUTSHELL: “The easing of activity in the nonmanufacturing segment of the economy may be due more to labor issues than demand.”

WHAT IT MEANS: From all accounts, it looks like the summer party is on.  Mobs of people are out and about and seemingly spending money like crazy.  Yet the Institute for Supply Management’s NonManufacturing index fell solidly in June.  Are our eyes deceiving us?  Probably not.  So, what is going on?  Well, in today’s report, the details were mixed.  On the concerning side, business activity was off sharply.  There was a major rise in the share of firms reporting a decline in activity.  However, on an absolute basis, the level of the overall index and business activity are both quite strong. It is just that there were record highs set during the previous three months. Another negative component was employment.  But the problem here is that firms cannot find workers, not that they don’t need workers.  Finally, there was a huge rise in backlogs, as supplier deliveries are continuing to slow at a rapid pace.  That points to an inability to meet growing demand.

Doubts about the labor market should have been removed with the strong June employment report released last Friday.  Yes, there was an aberration in the government numbers, but the private sector did add a ton of new workers.  And today, the Conference Board reported that its Employment Trends Index rose solidly in June and level is back to where it was before the pandemic hit, when businesses were trying to cope with a lack of workers.  As the report noted, “A tight labor market is likely to be the new normal until the next recession.”IMPLICATIONS:The severe labor shortages are almost certainly muddling the economic data.Add to that supply chain problems and it is clear that while some data look as if they are pointing to a slowdown, what may be the case is that bottlenecks are creating output issues.  The problem is that when demand exceeds supply, there is a tendency for prices to rise.  At least that is what economists like to claim.  And in this case, we are indeed seeing that.  Unfortunately, we really don’t know how long the bottlenecks will continue to constrain activity.  On the microchip front, it is hoped that conditions will start easing over the second half of the year, but some sectors could see problems for another year or more, at least that is what some analysts are indicating.  That is important because the lack of chips has greatly affected U.S. manufacturing, especially vehicle production. Over the past year, the prices of used vehicles have risen faster than any other component of the Consumer Price Index except energy.  On the labor front, we could see an easing of the shortages when the supplemental unemployment compensation payments disappear, but it is unclear how much that will help given the need created by the reopening of the economy.  The Conference Board’s comment about being in a tight labor market until the economy crashes again is likely to prove prescient. Pressure on wages and signing bonuses will not likely disappear soon and that brings up the question I always ask:  If the current price and wage pressures continue for an extended period, to what extent will they become embedded in expectations?  It is hard to argue that there will be no impact, but that is what the Fed seems to be counting on.Let’s hope the Fed members are correct.  Otherwise, monetary policy will have to change a lot quicker than the markets currently expect.  That said, we are likely at least a year away from that possibly happening.

June Employment Report and May Trade Deficit

KEY DATA:  Jobs: +850,000; Private: +662,000; Leisure and Hospitality: +343,000; Unemployment Rate: 5.9% (Up 0.1 percentage point)/ Trade Deficit: +$2.2 bil.; Exports: +0.6%; Imports: +1.3%

IN A NUTSHELL: “Strong growth in payrolls reflect the reopening of the economy, but the failure of the labor force to grow strongly is a real concern for businesses.”

WHAT IT MEANS: Another jobs report, another sign that the economy is getting back to more normal conditions.  Payrolls surged in June, which should have surprised nobody.  The removal of restrictions is allowing firms to rush out and hire, if they can, new employees.  The increases were in the sectors that were expected: restaurants and hotels, and because firms cannot find workers, temporary employment services.  Retail hiring was also solid.  There was also a huge increase in government hiring, all in education.  Don’t expect that to be repeated.  But otherwise, the numbers were mediocre.  The manufacturing, health care and transportation sectors added a modest number of workers and construction was down.

On the unemployment front, the rate rose modestly.  But the labor force is not growing nearly as rapidly has expected: The participation rate was flat over the month and up modestly over the year.  As a result, wages rose solidly. 

The trade deficit widened sharply again in May.  While exports increased, the reopening of the economy is sucking in goods from the rest of the world at a massive pace.  The deficit should continue to widen as the U.S. economy is expanding faster than most of our trading partners.  However, adjusting for inflation, it doesn’t appear as if trade will restrain growth significantly in the second quarter.  IMPLICATIONS:The headline employment number was impressive, but as usual, when you look at the details, there was less there than meets the eye.  Much of the job gain came from the leisure and hospitality sector.  The total number of workers in this segment of the economy remains about 2.2 million below the peak set in February 2020.  But it has recovered about six million of the 8.2 million of the jobs lost due to the shutdowns and it is unclear how many more jobs will be recovered.  Undoubtedly, a large number of positions were lost due to firms disappearing and it will take years to regain those jobs.  So, look for the leisure and hospitality sector to add workers at a decelerating pace as we move through the summer and into the fall.  In addition, the pattern of hiring in the education sector was upset by the pandemic, so the seasonal adjustments may be off.  Don’t be surprised if that sector stops adding workers for a while.  On the other hand, construction looks to be strong, so we should see a rebound there.  Still, with education and leisure and hospitality accounting for about two-thirds of the June payroll gain, the outlook is for a lot slower job gains in the months to come.  There is also some concern over the limited rise in the labor force in the face of growing labor shortages.  Some of that may be due to altered seasonal factor that will wash out as the year proceeds.  But the real question is what extent the expanded unemployment compensation has kept people on the rolls for an extended period?We should start seeing over the next few months if that was the case as states are eliminating those extra payments and they end in September.  That could lead to a jump in those looking for jobs, though don’t be surprised if it also leads to a minimal decline in the unemployment rate.  It takes time to find a job and a surge in job seekers usually leads to a rise in the number of workers unemployed, at least for a period of time.  To summarize, the labor market is getting better, but don’t expect massive jobs gains to be repeated and don’t be surprised if for a while, the unemployment rate makes little progress in returning to full employment.  That is just the way things work.  What we should watch closely is the cost of labor.  If wages keep rising sharply, firms will have to continue passing those expenses on to consumers.  That would lead to an extended period of above trend inflation and if it runs through next year, which I think is possible, the Fed may be forced to move sooner rather than later.

June Private Sector Jobs and May Pending Home Sales

KEY DATA:  ADP: +692,000; Hospitality: +332,000/ Pending Sales: +8%; Over-Year: +13.1%

IN A NUTSHELL: “The reopening of restaurants is driving the demand for labor and that should continue for a few more months.”

WHAT IT MEANS:  On Friday, we get the government’s June employment report, so Wednesday of the same week means ADP releases its estimate of private sector payroll gains.  It looks like we are in for another big increase.  The largest gain, not surprisingly, should be in the leisure and hospitality, as restaurants and hotels are moving rapidly toward full service again. But that was not the only strong sector.  Health care hiring soared as did construction.  That was expected, though the health care rise was somewhat outsized.  The job increases were also evenly split across firm size, which shows that the small business sector is coming back to life as well.  Finally, the ADP estimate and the consensus of economists for Friday’s jobs report are very much in line.  Either we are all wrong, a very real possibility, or for once we all got it right.  

Spring was not the greatest time for home sales as inventory restrained activity.  That may be changing.  The National Association of Realtors reported that pending home sales rebounded in May and every region posted a solid rise.  While demand remains strong, the improvement in sales may be coming from homeowners who cannot pass up the large rise in prices.  Inventories are beginning to increase, though they are still way too low given the level of demand.     

June Consumer Confidence and April Housing Prices

KEY DATA:  Confidence: +7.3 points; Present Situation: +9 points; Expectations: +6.1 points/ Case-Shiller (National): +2.1%; Over-Year: +14.6%; FHFA: +1.8%; Over-Year: +15.7%

IN A NUTSHELL: “The exuberance is spreading as both confidence and home prices continue to rise sharply.”

WHAT IT MEANS:  Happy days are here again.  The economy is largely reopened, job growth is strong, confidence is surging and if you are selling your home, it’s nirvana.  And today’s reports only add to the belief that the recovery is going full force.  The Conference Board reported that consumer confidence jumped in June, with the view of both expectations and present conditions increasing solidly.  The confidence measures had been improving at a pace that was disappointing, but it appears that could be changing. 

The housing market has gotten out of control, at least when it comes to prices.  Both the Case-Shiller and Federal Housing Finance Indices rose sharply in April and over the year, the gains are becoming scary.  When you are talking about increases that average in the 15% range with some regions posting gains over-the-year approaching or even exceeding 20%, you have to think bubble.  The Fed is intent on keeping longer-term rates down, so low interest costs are offsetting, to some extent, the higher prices.  How much longer that can continue is unclear, as affordability is deteriorating.   IMPLICATIONS: The economy is in getting back to normal, but inflation remains the great unknown.  Normally, facing the sharp acceleration in prices of just about everything and growth at levels that are two to three times trend, economists and the Fed would be putting out the warning signs that something should be done.  That something, of course, would be rate hikes.  But that is not likely happening for a year or more.  Yet the bond and equity markets are seemingly dismissing the possibility of an extended period of high inflation.  One major reason is that the strong growth is being driven largely by government stimulus funds.  As the income numbers show, wage and salary gains are mediocre.  Once the money runs out, growth is likely to moderate and once the economy is largely reopened, the income increases from payroll gains will also fade.  Also, the year-over-year numbers are suffering from the pandemic impacts on costs, and that too should start disappearing.  But the factors that should lead to lowered inflation mean more moderate growth, and that doesn’t seem to be a part of the thinking of investors.  Finally, there is the question I have been asking: Will the new-found pricing power be extended further into the future than most analysts expect?I think it will and we could have elevated inflation not just this year but next year as well.  While that may not sound terrible, two years of high inflation could change the long-term outlook for inflation, unmooring inflation-expectations.  Investors might consider asking what the markets would look like if trend inflation shifts from an average of 2% to maybe 2.5%?  It would certainly change the outlook for interest rates.