All posts by joel

December Housing Starts and Permits, Industrial Production and November Job Openings

KEY DATA:  Starts: +16.9%; 1-Family: +11.2%; Permits: -3.9%; 1-Family: -0.5%/ IP: -0.3%; Manufacturing: +0.2%/ Openings: -561,000; Hires: +39,000

IN A NUTSHELL:  “The surge in home construction was an eye-opener, but outsized gains are usually aberrations so don’t get too excited.”

WHAT IT MEANS:  Wow, what a housing number.  At least that was the initial reaction to the huge rise in housing starts.  Indeed, the level of activity reached a thirteen-year high.  Gains were not just in the volatile multi-family segment, which posted a nearly thirty percent rise, but they were in single-family as well.  The increases were spread across the entire nation and the only negative was a decline in single-family construction in the West.  On other hand, permit requests dropped.  They were down in the Northeast and the South but improved somewhat modestly in the Midwest and West.  When you see this type of outsized rise, the initial reaction is to think that conditions may be changing.  But the reality is that huge, unexpected increases are typically created by temporary factors.  December’s weather was warmer than usual with close to average precipitation.  Last December, the opposite was the case as temperatures were well below average and precipitation was above average.  There was likely a solid increase in construction, but much of the rise may have been due to seasonal factors.  We will know better when the January numbers come out, which I expect to be awful, so don’t rush to judgment about the housing recovery just yet.

While industrial production declined in December, largely due to the warm weather cutting utility output, manufacturing activity increased.  Despite the end of the GM strike, which aided the November numbers, the vehicle segment was still quite soft.  Assemblies were down sharply in December.  The good news was that computer, electronic and electrical equipment production is picking up steam.  Still, the outlook is uncertain.  Vehicle sales are slowly declining and Boeing is shutting it 737Max line and together, those negative as likely to lead to some pretty bleak manufacturing numbers in the first part of this year.

Job openings continue to fade, even as hiring remains solid.  Compared to November 2018, available positions were off by over eight hundred thousand.  The level was the lowest in nearly two years.  That said, there are still an awful lot of unfilled jobs waiting to be filled.  As for hiring, it has become more volatile and the trend is flattening out.  MARKETS AND FED POLICY IMPLICATIONS:The data for the final month of the year are flowing in and they are about as mixed as you can get. Yesterday’s December retail sales numbers were okay, but nothing special.  They indicated that fourth quarter consumption is not likely to be significantly below what we saw in the third quarter, which is good given that vehicle demand faded at the end of last year.  Today’s data muddy the waters a bit.  The shockingly large rise in home construction is likely to provide an unexpected boost to growth.As for the manufacturing sector, production was off compared to the third quarter.  But offsetting that could be a narrowing in the trade deficit.So, when you put things together, it looks like fourth quarter growth is coming in around 2%.  However, the first quarter of 2020 it might be a lot softer.  Decelerating wage gains and Boeing’s cut backs could restrain growth sharply.  While the phase one trade agreement might provide some temporary help to the agricultural sector, it is not clear when the additional sales will occur.  Which means that growth is likely to be at a pace that the Fed will be holding rates low for quite a while.  As for investors, sub-2% growth should be a red flag, but I have yet to see much that sways the markets from its seemingly never-ending upward drive.Economic fundamentals should matter, but I will believe that when I see it.

December Consumer Prices, Real Earnings and Small Business Confidence

KEY DATA:  CPI: +0.2%; Over-Year: +2.3%; Ex-Food and Energy: +0.1%; Over-Year: +2.3%/ Real Hourly Earnings: -0.1%; Over-Year: +0.6%/ NFIB: -2 points

IN A NUTSHELL:  “Despite reasonably tame inflation, household spending power continues to fade.”

WHAT IT MEANS:  With the Fed happy with its position on interest rates, we have to ask what could knock it off its stand.  They could hike rates if inflation or growth accelerates sharply or even reduce rates further if the opposite occurs.  Today’s data contain some insights into both growth and inflation.  On the household cost side, the Consumer Price Index rose moderately in December.  Energy prices jumped, as expected and food costs were up moderately.  Taking out those two volatile components, the so-called core index rose minimally.  There are always outliers and in this report there were two.  First, medical costs, including both commodity and services, are rising faster and faster.  Medical costs had been surprising tame for much of the past decade but that is changing.  It may be too early to conclude this but it is beginning to look like the current laissez-faire approach to health care is allowing providers to ramp up prices.  On the other hand, used vehicle prices cratered in December.  The record sales we saw are now creating huge inventories of vehicles coming off lease and that is an issue for dealers.  Overall, though, it looks like inflation is now running at a pace near the Fed’s target.   

On the growth side, my concern has been and will likely continue to be the diminishing gains in consumer purchasing power.  This is defined as the increase in earnings adjusted for inflation.  Real hourly earnings fell in December and the gain was well under 1% over the year.  When hours worked were factored in, inflation-adjusted weekly earnings were absolutely flat since December 2018.  It is hard for the average household to keep up the spending we have seen if their spending power is going nowhere. 

Meanwhile, small businesses remain pretty upbeat.  Yes, the National Federation of Independent Business’ Optimism Index eased in December.  But the level remains high and the components are still fairly strong.  But there is a warning sign in the report.  Earnings growth continues to fade, led by a growing softness in sales.  If the small business sector is the canary in the coal mine, the bird is still chirping but not quite as loudly as it had been.     MARKETS AND FED POLICY IMPLICATIONS:We get the first reading on fourth quarter growth in two weeks.  It should be in the 2% range, meaning the gain for the year should be about 2.3%. Basically, growth started off strong but faded as we went through the year.  Will that softening in growth continue?  One major factor restraining activity, especially capital spending, was the trade war.  As long as that doesn’t get out of control again, business spending may improve.  However, the deceleration in household earnings is likely to force consumption growth to slow.That likely means this year should be slower than 2019.  The January Blue Chip consensus is for 1.9% growth this year. I am a member of that survey panel and that is my forecast as well.  That may be enough to keep the unemployment rate relatively stable (I expect it to start rising slowly in the second half of the year), but it raises serious questions about corporate earnings.  Profits were soft last year and fading growth doesn’t point to better gains this year.  It could take additional financial manipulation, such as further stock buybacks, to keep equity prices up.  So, the Fed may be satisfied with inflation and growth right now, but that doesn’t mean everything is as beautiful as the members seem to believe it to be.

December Employment Report

KEY DATA:  Payrolls: +145,000; Private: +139,000; Revisions: -14,000; Retail: +41,000; Manufacturing: -12,000; Unemployment Rate: 3.5% (Unchanged); Wages: +0.1%

IN A NUTSHELL:  “Despite the ebbs and flows of the job data, the message remains that the labor market is strong.”

WHAT IT MEANS:  After the robust increase in new jobs in November, it was expected that the December report would be disappointing and that it was.  Hiring faded sharply, though the average for the last three months of 188,000 is still quite solid.  Actually, given the lack of workers, that was about as good as could be expected.  Still, there were questions raised by the data.  The over-the-year percentage increase in jobs continues to fade and was the second lowest in over eight year.  Just to get to the total payroll increase it took a huge rise in retail hiring. Three-quarters of that increase was in clothing stores.  Really?  Gains in professional and business services were a lot softer than they had been.  And as expected, manufacturers cut workers.  With Boeing shutting the 737 Max assembly lines, that weakness is likely to continue as suppliers react.  Wage gains continue to decelerate and that is not good news for workers.  Over the year, the average hourly wage was up only 2.9%, the lowest increase since July 2018.

The good news was that the unemployment rate remained at fifty-year lows.  But that was largely the only good news.  The labor force rose moderately and the gain over the year was decent but nothing spectacular.  The participation rate was flat over the month and up only modestly from December 2018.

MARKETS AND FED POLICY IMPLICATIONS:Just as the November report was misleading on the upside, the December report was misleading on the downside.  Put the two together, though, and you have a better picture of the state of the labor market: It is solid but the lack of supply is constraining hiring.  And that raises an interesting point.  Normally, strong growth drives strong hiring.  But with the labor shortage, it the softer growth we have seen may be the consequence of lowered payroll gains.  For businesses to continue expanding they will need more workers and they are just not being pulled into the economy at a pace to offset the loss of baby-boomers from the market.  About the only good thing for businesses in this report was the further slowing in wage increases.  That seems counterintuitive in that the labor shortages should be forcing firms to pay up for employees.  Instead, businesses are attracting workers with non-pecuniary compensation.  How long that can continue is unclear in that once you provide those benefits, it becomes harder to add to them.  The risk the economy faces is that firms are faced with the inability to meet growing demand because of the lack of workers.  They have only so many options, then.  They can reject contracts and grow more slowly or start a bidding war for workers so they can fulfill those contracts.  Neither would be very good for the economy.  So let’s hope for slow growth and be glad the wackos who told us we would get 3% growth for as far as the eye could see were dead wrong.

December NonManufacturing Activity and November Trade Deficit

KEY DATA:  ISM (NonMan.): +1.1 points; Orders: -2.2 points; Backlogs: -1 point/ Trade Deficit: -$3.9 billion; Exports: +0.7%; Imports: -1%

IN A NUTSHELL:  “Growth might have been modestly better than expected at the end of last year, but only because the tariffs created dislocations in trade flows.”

WHAT IT MEANS:  It’s a new year but we are still trying to get a handle on how the economy ended last year.  It looks like growth in the 2% is the new normal.  Actually, it is more like the old normal given that is what we averaged during most of the 2010s.  Looking at the service segment of the economy, that is the level of growth we are still seeing.  The Institute for Supply Management’s NonManufacturing rose in December.  The fourth quarter average points to a GDP growth rate of somewhere around (drum roll please) 2%.  That said, the details were not that great.  In particular, orders grew more slowly and backlogs shrank for the third consecutive month.  Those results don’t point to any improvement in the service portion of the economy in the early part of 2020. 

On the other hand, it looks like the fourth quarter may have been helped along by distorted trade flows. Indeed, despite what appears to have been decent consumer spending, imports fell in November.  That shouldn’t happen in this type of economy.  While we should not expect demand for foreign products to be booming, they should be growing.  Purchases of consumer and capital goods were down solidly.  Contrasting that was a moderate increase in exports.  The rest of the world is growing slowly and is still buying our products, an indication that our import situation is not due to fundamental economic factors.  With exports rising and imports falling, the trade deficit narrowed to the smallest level in three years.  Much of that came from the roughly fifteen percent drop in imports from China.  The trade deficit with China has also narrowed by the same percentage.   MARKETS AND FED POLICY IMPLICATIONS:We will not get the first reading of fourth quarter growth for three more weeks, but it is likely to be about 2% to 2.25%.  At least that is what I have had for months now and there is no reason to believe that will not be the case.  The wild cards are the usual ones.  We don’t know what happened to trade in December since the decision to put off the additional tariffs on Chinese products was made too late to cause any major change in the import pattern.  Also, Boeing’s decision to suspend production, which had led to planes being inventoried, also may have come too late to change the inventory number, though that is unclear.  But consumer and business spending looks to have been moderate and if we focus on those fundamental components, it is clear that growth is okay but not great. So, where do we go from here?  More than likely, more of the same.  And given the way investors loved that level of growth last year, they will likely continue to eat up stocks this year.  The one big difference is that there isn’t an extra trillion dollars to buy back stock, so the artificial hyping of stock prices may slow.  At least it should.  As for the Fed, it is likely on hold for quite some time.  There may still be some who think rates should be lowered, but not a lot of them are voting members of the FOMC.

December Manufacturing Activity and November Construction Spending

KEY DATA:  ISM (Manufacturing): -0.9%; Orders: -0.4%; Production: -5.9%; Hiring: -1.5%/ Construction: +0.6%; Private: +0.4%; Public: +0.9%

IN A NUTSHELL:  “Manufacturers did not end the year on a high note as the sector continues to contract.”

WHAT IT MEANS: Last year may have been the best of times for the equity markets but that was hardly the case for the manufacturing sector.  In December, the Institute for Supply Management’s index was in the red for the fifth consecutive month.  Continued declines in demand led to a sharp drop in production.  Indeed, the production measure was the lowest since April 2009 and lest we forget, that was during the peak of the Great Recession cut backs.  The slowdown in output has triggered a decline in payrolls.  Four of the six major industry sectors posted shrinking employment.  Only one was up.  We could see a negative number in the manufacturing segment of the employment report that will be released next Friday.  With demand, production and backlogs fading, firms are slimming down and inventories are shrinking.  Basically, this report was ugly.

While manufacturing may be fading, construction seems to be picking up.  Given how soft it had been, that is not a major surprise, though it is welcome news.  Both public and private spending was up solidly in November.  However, it is still the government that is the driving force as activity was up twice as quickly as the private sector.  Year-over-year, November total public construction rose by 12.4% compared to only 1.6% for the private sector.  The private sector weakness was largely in nonresidential building, which fell in both November and over the year.  Residential activity has picked up, but not by a whole lot.  MARKETS AND FED POLICY IMPLICATIONS:The economic data did not provide us with a very merry welcome to 2020.   The manufacturing sector is not in great shape and even the comments reported in the Supply Managers’ report were cautiously optimistic at best.  We don’t know a whole lot about the so-called phase one trade agreement with China, but it looks to be mostly centered on trying to keep the farm sector from going bankrupt. But I will hold my judgment until we see the text.  As for the markets, the shift from trade war to potential shooting war with Iran was hardly something investors wanted to see.  The ball is now in Iran’s court and it is likely something bad will be attempted.  We just don’t know how big or how long before it occurs.  That could keep investors on edge. Concerns about the trade war hardly slowed investors down in 2019, so it is not clear that a shooting war will do much this year.  Keep in mind, the economy grew at a roughly 2.25% pace last year while the major equity indices soared by well over 20% and even over 30%.That seems to imply that the economy and the markets are not closely linked.  That is something the Fed doesn’t seem to be overly concerned about as the members continue to pat themselves on their backs for doing such a great job.  Well, there goes one of my resolutions.  I promised myself I would lay off criticizing the Fed for a while and here I am in my first commentary of the year doing just that.  Oh, well, I just calls ‘em as I sees ‘em. 

November Consumer Confidence, October New Home Sales and September Case-Shiller Housing Prices

KEY DATA:  Confidence: -0.6 points/ New Home Sales: -0.7%/ C-S Home Prices (Month): +0.4%/ Over-Year: +3.2%

IN A NUTSHELL:  “The housing market is showing some life and that is good news for builders and the economy in general.”

WHAT IT MEANS:  The fourth quarter is not looking good, but maybe we shouldn’t give up hope just yet.  We are entering the key shopping season and households may not be irrational exuberant, but they are not depressed either.  The Conference Board’s Consumer Confidence Index fell in November, the fourth consecutive decline.  You would think that would set off warning bells, but the reality is that the level of the index is still quite solid.  In addition, expectations rose, an indication that while current conditions are fading, households still hold out hope that things will turn around.  And hope tends to drive demand at this time of year, especially since people are looking for any reason to spend. 

Another positive sign is coming from the new housing market.  Sales eased back a touch in October but demand is on a clear, upward trend.  And purchases are beginning to close in on what might be considered to be a solid sales level.  So far this year, total sales are up over 9% compared to the same period in 2018.  Unfortunately, the gains are not being shared evenly across the nation.  In October, demand rose in the Midwest and West but dropped in the Northeast and South.  For the first ten months, sales surged in the South and West but were down almost as sharply in the Northeast and Midwest.  As for prices, they were off over the year but much of that had to do with the significant decline in the percentage of high cost homes purchased.  That seems to be turning around, though.

The S&P CoreLogic Case-Shiller National home price index rose in September and it looks like the decline over the year is stabilizing.  There is an interesting pattern that has occurred since the end of the Great Recession.  While the housing price recovery was early and sharp in some of the larger metro areas used in the 20-City index, those gains have faded significantly.  Meanwhile, the National index, which includes metro areas of all sizes, is holding up quite well.   

There were two Federal Reserve regional bank indices released today and they went in opposite directions.  The Philadelphia Fed’s NonManufacturing Index rose sharply but the Richmond Fed’s manufacturing measure softened.  That shows how some sectors and parts of the county are doing well while others are faltering, which is right in line with the belief that the economy is growing, but at a modest to moderate pace.MARKETS AND FED POLICY IMPLICATIONS:The economy is neither a turkey nor a sweet potato pie (I love sweet potato pie!).  It is growing, but it would take a politician to say it is in good, let alone great shape.  GDP growth is likely to have remained below 2% again in the final quarter of the year and for all of 2019, it looks like it will come in at about 2.25%.  So, when I call it the “back to the future economy”, I am simply saying that we are matching the growth that we saw during much of the 2010s. Most people considered that pace to be disappointing, but as I noted then, it is still trend growth.  So, saying things are bad would be too harsh. 

October Existing Home Sales, Leading Economic Indicators and November Philadelphia Fed NonManufacturing Index

KEY DATA:  Sales: +1.9%; Prices (Over-Year): +6.2%/ LEI: -0.1%/ Phyla. Fed (NonMan.): +4.8 points; Orders: -17.8 points; Hiring: -11.4 points

IN A NUTSHELL:  “Modest housing sales gains, coupled with weakening indications of future growth are a worrisome combination.”

WHAT IT MEANS: The drama that is playing out in Congress is not the only stage where concerns are growing.  On the economic front, the data are just not looking great.  Housing is okay, but just okay.  Existing home demand improved moderately in October.  The gains were concentrated mostly in the South, with a smaller increase in the Midwest. On the other hand, demand fell in the Northeast and the West.  As far as prices go, they are rising strongly again. A combination of firming demand and a paucity of homes for sale is driving up costs to buyers.

It doesn’t appear as if housing is improving enough to offset the weakness in other sectors.  The Conference Board’s Leading Economic Index posted its third consecutive decline in October.  For the first time in nearly three and a half years, the six-month growth rate was negative.  That is not good news and, as the report notes, “the LEI suggests that the economy will end the year on a weak note”. 

The Philadelphia Fed’s survey of nonmanufacturing companies posted a nice gain in early November.  But that was for general economic activity.  When it came to the firm itself, the details were not good.  New orders, backlogs, hiring and hours worked all expanded more slowly.  Optimism remains reasonably high, though.

Weekly jobless claims were flat, but they are still at a five-month high.  I don’t want to read too much into that, but it does need to be watched.         MARKETS AND FED POLICY IMPLICATIONS: And the beat goes on, and the beat goes on.  The current quarter is not setting up to be very good.  Thankfully, we have not only turkey coming up, but the biggest shopping period as well.  Consumers just might save the day, but it is not clear they can turn a mediocre quarter into something satisfying.That the Conference Board’s leading index points clearly to a slowdown (no recession yet) is not to be taken lightly since the other economic numbers support that conclusion.  But, as Mr. Powell has noted, Fed actions take up to a year to have full effect, so maybe the rate cuts will cause the economy to accelerate.  If you believe that, contact me and I will sell you my share of the Broadway play I am producing. So, there is only one thing to do.  Start your Black Friday shopping early and buy, buy, buy and then go out and eat like crazy next Thursday.  At least when it comes to the eating part, I will follow it as best as I can.  As for the shopping, nah, not so much.  Meanwhile, investors seem to be hiding under rocks and not taking any bold positions.  Given the growing uncertainty over the mini-trade deal, that makes sense.  Meanwhile the Fed keeps crowing (or is it gobbling?) about how great they are doing.  It was made clear in the minutes from the October FOMC meeting, which were released yesterday, that the Committee expects to be on hold for an extended period.

October Housing Starts and Permits

KEY DATA:  Starts: +3.8%; 1-Family: +2%; Year-to-Date: -0.6%; Permits: +5%; 1-Family: +3.2%; YTD: +2.4%

IN A NUTSHELL:  “Housing continues to wander around aimlessly, faltering one month, rising the next but essentially going nowhere.”

WHAT IT MEANS:  With the economy decelerating, we need to find some sector that will lead us back toward strong growth.  Well, it doesn’t look like that will be the housing market.  Yes, housing starts rose solidly in October.  There was a modest increase in single-family activity and a more robust gain in the always-volatile multifamily component.  But what caught my eye was the year-to-date numbers.  After ten months, home construction is slightly down compared to the same period in 2018.  The year started out quite slowly but it hasn’t accelerated sharply enough to overcome the early weakness.  Will housing construction pick up?  The data seem to argue that.  Permit requests rose again and hit their highest level since May 2007.  They have been running above starts for most of the year and are nearly seven percent above last year’s 10-month total.  Builders just don’t spend money on permits for the fun of it.  The number of homes permitted but not started is high, we should imply increasing starts going forward.

In addition, The National Association of Home Builders’ Index came out yesterday and while it edged down in November, optimism remains near the level reached in 2005, the high point in the housing bubble.  Current and future sales are expected to be strong.  The combination of rising permit demand and high builder confidence argue for a rise in home construction.  However, I have been saying that for months and the upward trend, if there is one, has been fairly modest.  MARKETS AND FED POLICY IMPLICATIONS:The economy seems to be settling into a trend level growth pattern of something in the 2% range.  An improvement in home construction would help offset what is likely to be a slowdown in consumption to a more sustainable pace.The major unknown remains the trade tensions.  That is affecting business confidence and therefore capital spending as well as trade flows.  The trade “deal” that is being negotiated does not look like it will be much more than an attempt at placating both parties.  Each will get something but it is not being billed as a major agreement and it has to be viewed that way when considering the impact on the economy.  At best, conditions will move back toward where they were before the war started but it is doubtful that trade flows will reach levels we saw previously.  It is, as stated, only an initial, partial deal.  I am sure it will be billed as the greatest trade deal in the history of the nation, but my job is to analyze the real work impacts and from the little we know, that are not likely to be great.  We should see some additional capital spending as some companies decide the worst is behind us, but given the global economic slowdown, there is little reason to expect any extended surge.  In addition, that deal does nothing to the tariffs on European products.  So, a partial deal might lead to higher equity prices but not necessarily move the needle much when it comes to economic growth.  That said, it would bolster the Fed’s new stance that it has won the war on recession and doesn’t need to do anything unless conditions change significantly.

October Retail Sales, Industrial Production and Import and Export Prices.

KEY DATA:  Sales: +0.3%; Ex-Vehicles: +0.2%; Gasoline: 1.1%/ IP: -0.8%; Manufacturing: -0.6%/ Import Prices: -0.5%; Nonfuel: -0.2%; Exports: -0.1%; Farm: +1.9%

IN A NUTSHELL:  “With households not shopping that much, there isn’t a whole lot of need for the nation’s factories to keep producing as much.  ”

WHAT IT MEANS:  With the Fed indicating it is on hold for an extended period – unless economic conditions change significantly – we need to determine if those conditions are being met.  Let’s start with consumer spending.  Retail sales were tepid in October.  They were bolstered by a sharp rise in gasoline purchases, but that was driven by a sharp rise in prices.  Vehicle demand was solid, but September’s was so weak that the level of sales in October remained below the August total.  Other big-ticket purchases, such as furniture, electronics and appliances, were off, which is not a great sign.  Online sales, however, were strong, but restaurants saw activity falter.  Basically, there were ups and downs that support the view that consumer demand was mediocre.

Meanwhile, back at the factory, the assembly lines slowed once again.  Manufacturing output fell sharply for the second consecutive month, led by a third consecutive major drop in motor vehicle assemblies.  Seven of the eleven durable goods sectors and six of the eight nondurables sectors posted declines.  In other words, the cut back in production was wide spread.  Over the year, manufacturing output is off by 1.5%, a clear sign that this segment of the economy has hit a rough spot. 

As for inflation, if it is to keep accelerating, the pricing pressures will have to come form someplace other than imports.  Import costs fell sharply and have been up only once in the last five months.  Yes, fuel prices jumped, but nonfuel costs fell and have risen only once this year.  Food, capital goods and consumer goods prices were down while vehicle costs were flat.  As long as the dollar stays strong, import prices will not surge and inflation will likely remain in check.  On the export side, farm prices jumped again, but nonfood export prices were down.  MARKETS AND FED POLICY IMPLICATIONS: Okay, here’s the story: When if comes to the economy, listen to what Fed Chair Powell says and assume the opposite.  Well, maybe I am being too harsh, but this week, Mr. Powell was telling us that when it came to the U.S. economy, we are the stars!  Of course, with Europe barely keeping its head above water and Asia slowing, that may be the case.  But it still doesn’t say much.  Today we found out that maybe the U.S. economy is growing, but not at any great pace.  The consumer is still spending, but not robustly enough to support other sectors, especially business investment, which has been faltering.  And on top of that, manufacturing is contracting.   Even if a phase one mini deal is consummated, it doesn’t get us anywhere near back to where things were before the trade war began nearly twenty months ago.   So why anyone would think the economy would soar as a consequence is beyond me, but I am just looking at this as an economist.  As far as investors are concerned, any good news on the trade front is another excuse to push the market up.  Meanwhile, the Fed members will continue to pat themselves on their backs and claim to be doing a great job.  We shall see about that in 2020. 

October Consumer Prices and Real Earnings

KEY DATA:  CPI: +0.4%; Year-over-Year: 1.8%; Ex-Food and Energy: +0.2%; Year-over-Year: 2.3%/ Real Hourly Earnings (Y-o-Y): +1.9%; Real Weekly Earnings (Y-o-Y): +1.6%

IN A NUTSHELL:  “Inflation is firming and with hours worked down and wage increases flattening, household purchasing power gains are slipping. ”

WHAT IT MEANS:  You know all that room the Fed had to cut rates because inflation was going nowhere, well that is no longer the case.  Consumer prices jumped in October, led by large increases in energy, used vehicles and medical services.  There was even a solid rise in food costs, though this month it was food at home more than restaurants. The one component that is not showing signs of rising costs is apparel, which posted another sharp drop.  Imported apparel prices are up modestly over the year and it looks like the Chinese devaluation of their currency has had its intended effect of partially insulating the country from sharp rises in prices due to tariffs.  Excluding the volatile food and energy components, retail prices rose moderately.  But the real information is in the year-over-year numbers.  The overall index remains above the Fed’s 2% target and the core/ex-food and energy component is pushing 2%.  While the Fed prefers the Personal Consumption Expenditure price index to the CPI, this is still an indication that inflation is no longer something the Fed can use as an excuse to do the inexcusable, which is to cut rates again.

With inflation rising, consumer purchasing power is faltering.  Inflation adjusted (real) wages declined in October, as did real weekly earnings.  Once again, the key numbers are the year-over-year changes and the growth in hourly and weekly earnings remains tepid.  It is hard to sustain consumer spending at a 3% pace, which we have seen for most of this year, when purchasing power is increasing at less than 2%.  Something has to give and while savings may be the first casualty of the earnings slowdown, spending will likely be next.

Yesterday, the National Federation of Independent Businesses released its October survey and optimism posted a small increase.  Eight of the ten components were up.  The economy may be slowing, but the early-warning sector, small businesses, is not signaling any major faltering in economic activity.  I guess the Fed doesn’t read the report (just kidding, Dunk). MARKETS AND FED POLICY IMPLICATIONS:There is little reason for the Fed to cut rates again anytime soon.  Inflation is not trending downward, the trade war has moved back, at least for now, to trade skirmishes and longer-term interest rates have risen in response to the easing in tensions.  Indeed, in today’s testimony in front of the Joint Economic Committee of Congress, Chair Powell seemed to take a victory lap, though it probably had little to do with the Fed’s actions.  He noted: “Looking ahead, my colleagues and I see a sustained expansion of economic activity, a strong labor market, and inflation near our symmetric 2 percent objective as most likely. This favorable baseline partly reflects the policy adjustments that we have made to provide support for the economy.”  His puffery not withstanding, the economy is just where so many of us thought it always was and would be, if and only if the trade war fears were eased or even alleviated.  That is, modest to moderate growth and inflation near the Fed’s target.  Thus, there is little reason to make any additional moves – as long as the trade skirmishes don’t break out into full-fledged war.  Of course, as I have argued repeatedly, lower interest rates do almost nothing to counter the fears created by a political decisions to impose higher tariffs, but that is not likely to resonate in the halls of the Federal Reserve building.  Regardless, the best estimate is that we could see the Fed on hold for an extended period (assuming no trade war).  The Fed Chair made one other major comment in today’s testimony.  He made it clear he was concerned about the growing, seemingly out of control U.S. budget deficit.  And he should be worried.  It is likely that the current fiscal year’s deficit will be well in excess of one trillion dollars and if a recession hit, fiscal policy could be in a straitjacket.  Given the Fed also fitted itself with a straitjacket by lowering rates to a level that gives it minimal room to cut further, a recession could be extremely hard to counter.