KEY DATA:  Starts: +4.3%; Permits: +14.4%

IN A NUTSHELL:  “The housing market is setting up to be the leading force in the recovery.”

WHAT IT MEANS:  One of the first sectors that was allowed to reopen was construction and we are seeing the positives of the decision to do that.  If you just looked at the construction numbers, you might not come to that conclusion.  Housing starts rose moderately in May, led by a major recovery in the West and a solid gain in the Northeast.  However, weakness persisted in the South and Midwest.  It was expected that starts would rise more, so this was a bit of a disappointment.  Indeed, if you compare the level of starts in May to February, you see a nearly 38% decline.  So why am I so upbeat?  Simple, housing permit requests are soaring.  They were up sharply in May and have are now about 15% below the February level.  That seems large, but it can be made up reasonably quickly.  More importantly, for the last three months, permits were running over fourteen percent above starts.  Builders are not wasting money on permits and the big gap points to a strong increase in construction over the next couple of months. 

Adding to the belief that the home construction and housing in general will be solid going forward was a report by the Mortgage Bankers Association.   As noted, “Purchase applications increased to the highest level in over 11 years and for the ninth consecutive week. The housing market continues to experience the release of unrealized pent-up demand from earlier this spring, as well as a gradual improvement in consumer confidence”.  That is very good news for builders, who seem prepared to meet the growing demand.    

IMPLICATIONS: The home construction segment still has a long way to go to get back to the pre-virus pace of activity.  But while other sectors, such as restaurants or manufacturing, may take a very long time to get there, the indicators are mounting that housing will be one of the first segments to recover.  Unfortunately, the depressed April and May starts numbers point to home construction restraining second quarter growth significantly.  On the other hand, if the permits/starts gap gets narrowed during the summer as expected, the sector could add greatly to third quarter growth.  The markets have rallied on what I call false positive reports.  Those are numbers that look great, but only because they started from such a low level.  With housing, while the levels remain lower than hoped for, supporting data argue for a major comeback that could get us within range of the February standard of comparison in a reasonable time period.  But it is really not clear that the economic data are the major drivers of the markets.  The Fed is buying just about anything that is being sold and that includes individual corporate bonds.  Mr. Powell has made it clear he doesn’t want to give up the gains – even as he claims he doesn’t target the equity indices.  Really?  It is best to watch what the Fed does, not what the Fed Chair says, as he doesn’t want to appear to be supporting the equity markets, which of course he is doing.  About the only thing he admits he cannot do is to get money into the hands of specific household groups.  So, he has strongly suggested that Congress get busy doing that.  Let’s see: The Fed is supporting the equity and bond markets and the government is supporting businesses and households.  Isn’t capitalism great?     

KEY DATA:  Sentiment: +9.1%; Current Conditions: +6.7%: Expectations: +10.9%/ Import Prices: +1%; Fuel: +20.5%; Food: +2.2%; Exports: +0.5%; Farm:-0.5%

IN A NUTSHELL:  “Households are feeling a little better about the economy, but they are hardly exuberant.”

WHAT IT MEANS:  To get the economy really going, we need households to start spending a lot more.  How they feel about things will be the key factor in consumption and confidence is rising.  The University of Michigan’s Consumer Sentiment Index rose solidly in the first part of June.  Households have seen the unemployment rate go down and they feel a little better about the labor market.  That said, this is hardly a “happy days are here again” report.  As the statement noted: “… few consumers anticipate the reestablishment of favorable economic conditions anytime soon. Bad times financially in the economy as a whole during the year ahead were still expected by two-thirds of all consumers, and a renewed downturn was anticipated by nearly half over the longer term.”  While uncertainty about the future is beginning to ease, it is still higher than it was at anytime during the Great Recession.  That raises questions about the willingness to purchase big-ticket items.  If we don’t see that happen, the recovery will be slower than hoped for.

As for inflation, import prices rose in May, but you can chalk that up to the rebound in petroleum costs and the continued increase in food prices.  Crude petroleum led the way, rising by over thirty percent.  Food costs were driven by jumps in meat and vegetable prices.  Excluding those two categories, the cost of foreign products entering the country fell slightly.  On the export side, the long-suffering farm sector took another hit as prices sold around the world declined again.  They are now off by 3.5% since May 2019.    

IMPLICATIONS:  There is no reason that inflation should surge, which is important as the Fed is embarking on flooding the economy with massive amounts of liquidity.  The energy price increases we have recently seen represent the ending of the price war between Russia and Saudi Arabia.  Prices should settle down now.  As for food, eventually the supply chain will start catching up and while we may see a few more months of elevated food cost increases, those should also move back toward more normal levels.  So the Fed has a green light to do whatever it wants to do – and from Chair Powell’s comments this week, it intends to do that.  Still, the Fed can provide only liquidity; it cannot get income into workers hands or convince people to spend.  That would require a combination of fiscal policy and improving consumer confidence.  From the Michigan survey discussion, it is clear that the threat of a resurgence in the virus continues to hang heavy on household thinking.  With so many states seeing an uptick in cases, the impact on confidence could offset, at least to some extent, the improvement created by the reopening of the economy.  Also, as we go through the summer, the income supplements are slated to disappear.  That raises questions about the ability of many households to keep spending even at their reduced pace.  Thus, there remain many uncertainties facing the economy. 

The markets have bought into the V-shaped recovery with no impact from a virus resurgence. But the extent of the right side of the V is in doubt.  Yesterday’s meltdown is an example of what could happen once the surge in job gains fades after the economy largely reopens and if the current uptick in cases accelerates and becomes more widespread.  The exuberance has taken us almost all the way back and it can have long legs.  Alan Greenspan gave his famous irrational exuberance talk in early December 1996.  The market (NASDAQ) kept going up for another 3.5 years. When the music will stop, if it ever will, is anyone’s guess, especially given all the liquidity the Fed is pumping into the system.  But as we saw on a number of occasions over the past twenty years, if it does, the impacts can be massive.    

KEY DATA:  Claims: 1.54 million (-355,000); Continuing Claims: 20.93 million (-339,000)/ PPI: +0.4%; Foods: +6.0%; Energy: +4.5%

IN A NUTSHELL:  “Layoffs are slowing, but the level of people still applying for unemployment payments remains incredibly high.”

WHAT IT MEANS:  Given the surprising May jobs report and the widespread reopening of the economy, the unemployment claims and continuing claims numbers have taken on new importance. New unemployment claims declined for the tenth consecutive week, which is the good news.  However, the number of people being laid off remains extraordinarily high.  There is really nothing good about having one and a half million more people becoming unemployed.   The number of workers who are receiving unemployment checks also fell, but the level remained above twenty million, a sign that the labor market is coming back but is still hurting.  The Bureau of Labor Statistics admitted that there was a misclassification in the data and the unemployment rate should have been a lot higher ion both April and May.  Once the reopenings are largely complete, or as complete as they will get, the claims numbers have to drop below 350,000 before we can have confidence that the decline in the unemployment rate will continue unabated.  Since that is not likely to happen for quite some time, the unemployment rate could remain in double digits for much of the remainder of the year. 

Wholesale prices jumped in May, which was a surprise.  What was not that great a surprise was the jumps in food and energy.  Meat shortages led to the wholesale price of beef and veal to surge by 69% and as every shopper knows, those costs have been passed through to the consumer.  Crude oil prices (West Texas Intermediate) jumped by almost 73% in May, so the wholesale surge in energy costs also made sense.  Excluding those two sectors, though, the prices of wholesale goods were flat.  On the services side, there really was minimal inflation pressure except from airlines starting to increase their prices from the rock bottom levels they had been. 

IMPLICATIONS: In May, for the first time since the unemployment numbers were created in 1967, the number of people receiving unemployment checks (continuing claims) exceeded the number of people unemployed.  That, of course, makes no sense since you have to be unemployment to remain on the unemployment rolls.  That is the clearest indication that BLS, which produces both of those numbers, got the May unemployment report wrong.  They admitted that the misclassification of data started in March and the unemployment rate was understated by one roughly percentage point in March, five in April and three in May.  Assuming that BLS will finally correct the classification process in June, you have to use an unemployment rate of approximately 16.4%, not 13.3%, when comparing the May to June numbers.  That would be the apples to apples comparison.  Given the size of the labor force, three percentage points means about 4.75 million workers have to come off the rolls before we can cut into the reported 13.3% rate.  That could happen in June, but it also means that the decline in the rate might be minimal. 

But the real news came from Fed Chair Powell.  His press conference yesterday was a classic two-handed economist approach.  On the one hand, he made it clear the Fed would be providing massive amounts of liquidity to the system for an extended period.  The Fed’s Summary of Economic Projections (SEP) table showed the funds rate at the current level through 2022.  But then he produced the other hand.  He noted that millions of workers might never return to their old jobs, implying that getting back to February’s 3.5% unemployment rate was not likely to happen for who knows how long.  It is likely that the unemployment rate will not get below double-digits until the last quarter of the year.  The GDP growth forecast, which showed solid gains the rest of this year and next, still implied that we would not get back to the 2019 fourth quarter level until spring 2022, two years from now.  And all that is occurring without any assumption of a second wave of the virus, which the FOMC did not discount in its statement.  Basically, Mr. Powell let everyone know that the Fed will do all it can, but the best it can do is limit the damage.  That is a sobering message for investors, who were assuming that everything is beautiful and the virus was a nonevent.  We will see if politics takes over the future course of fiscal policy, as it seems to be doing.  My concern has always been what will happen when the economy has to stand on its own.  Stretching out that time frame will be up to our political leaders, which means putting politics aside.  Good luck with that.   

KEY DATA:  Claims: 1.88 million (down 249,000); Benefit Recipients: +649,000/ Deficit: $49.4 billion (Up $7.1 bil.); Exports: -20.5%; Imports: -13.7%/ Layoffs: 671,129

IN A NUTSHELL:  “The reopening of the economy is reducing the unemployment rolls in fits and starts as layoffs remain extraordinarily high.”

WHAT IT MEANS:  Tomorrow may be the big day when it comes to the jobs numbers, but today’s claims report provides some texture to the data.  Initial claims for unemployment insurance moderated once again, but anything over half-million is extremely high and over a million is unthinkable.  To put the nearly 1.9 million numbers in perspective, during the same week last year, claims were 220,000.  Last weeks numbers were simply ugly and imply that firms and governments continue to cut their workforces at a rapid pace.  In May, over nine million people filed for unemployment.  But the economy is reopening and the impact of people being called back to work should be seen in the continuing claims, or total recipients numbers.  They had been coming down, but rose in the latest report.  It should be kept in mind that the recipient numbers are a week lagged, so look for the total to drop sharply next week. 

The trade deficit surged in April as exports collapsed more than imports tanked.  The economy shut down in April and that included trade.  The level of exports was the lowest since November 2009.  On the import side, the level was the lowest since November 2010.  The only import category that posted a rise was industrial supplies and that was due to a massive influx of nonmonetary gold.  I guess everyone took the cash from the stocks they sold and bought jewelry from domestic fabricators (really, I have no idea).  Imports of vehicles were down 52%.  Of course, vehicle exports were off 66%.  That sector collapsed and we see it in the trade numbers. Trade with China has also collapsed, but that means the trade deficit is narrowing dramatically.  So far this year, it is off 28.5%.  The real or price-adjusted goods deficit began the second quarter over eight percent wider and with the economy reopening, it looks like trade will be a major drag on growth going forward. 

Challenger, Gray and Christmas reported that May layoff announcements hit the second highest level since the report began in January 1993.  The highest was, not surprisingly, in April.  The key point is that firms are still cutting workers like crazy and while the May unemployment rate could be the peak, the decline could be slower than many expect. That just may be the case through the summer as the slow reopening will likely lead to firms deciding to either downsize or upsize more slowly until the true growth potential of the economy becomes clearer. 

IMPLICATIONS:Progress is being made on the labor front as the economy reopens. Though the pace has been disappointing, we should see things accelerate as we move through June.  That should limit the damage in the second quarter GDP report.  In the latest Blue Chip Financial report (of which I am a panel member), second quarter growth estimates range form -17.6% to -49.2%.  The consensus is -34%, while I am at -22%.  All of those are historic numbers, but the wide range shows how reopening is creating confusion in the forecasting ranks.  But the real issue is not so much the decline in the second quarter, but the recovery in the third and fourth quarters.  That will depend upon the pace in cutting the unemployment rate.  The Blue Chip Economic report will be released in a few days (we are just now filling that out now), and it will be interesting to see where the panel comes out on the fourth quarter unemployment rate.  I have it still around 10% and if that is the case, it will be tough to post two consecutive quarters of really strong growth even given the low level of activity from which we start.  Tomorrow, the May employment report should provide the depth of the hole we are in.  It is likely to be quite deep.

KEY DATA:  ISM (Manufacturing): +2.6 points; Orders: +4.7 points; Production: +5.7 points; Employment: +4.6 points/ Construction: -2.9%; Residential: -4.5%; Nonresidential: -1.8%

IN A NUTSHELL:  “The reopening is slowing the decline in activity.”

WHAT IT MEANS:  The economy is reopening and we are starting to see the economic numbers look less ugly.  Not, they are not good, but terrible can be an improvement from horrendous, so I will take it.  Consider the state of manufacturing.  The Institute for Supply Management’s May index rose.  On the surface, that looks good and in this case, up is always better than down.  But while just about every component increased, the levels still point to massive problems in the sector.  Consider new orders, which seemed to be a lot better.  Not really.  While the percent of respondents saying demand and production improved, the percent saying orders and output were down remained above fifty percent.  What is happening is that conditions are worsening at a slower pace.  That was also true with employment. The share saying payrolls were down fell to 41% from 46% in April, indicating that lots of firms are still downsizing. 

As for construction, it is actually holding in pretty well.  Yes, activity declined in April but less than expected.  Most of the drop was in residential.  Given the collapse of starts, the drop was much lower than forecast. States had started allowing construction to resume earlier than other activities, so I don’t expect construction to be the weakest link this quarter.

Commentary: Don’t take the data at face value.

We are entering a difficult time for the data mills, which includes the government, the Fed, industry groups and those private sector companies that produce numbers.  Government actions have created special circumstances that raise questions about the true meaning of the numbers.

The first and maybe biggest issue is that the seasonal adjustment factors may be largely meaningless.  Changes in activity are likely occurring more because of states allowing activities to occur rather than normal seasonal changes. Seasonal factors cannot adjust for that.  Thus, while all of the data creators are doing the best they can, the seasonally-adjusted data they produce are suspect. The employment numbers on Friday are likely to be really ugly, but they will suffer from an inability to decipher what was going on due to seasonal changes and what was happening as a result of government decisions or economic conditions.  

The second issue, which is something only we data wonks worry about, affects certain types of measures, such as diffusion indices.  For example, the ISM report referenced above is a typical diffusion index in that it asks if the measure under consideration (orders, production, employment etc.) was better (higher), the same or lower (worse).  The difference between better and worse is calculated, seasonally adjusted and turned into an index.  Consider the case of a firm that closed down its production line in April.  That month, it reported that output declined, which lowered the overall index.  But in May, if it was still shuttered, it reported that output remained the same i.e., zero.  With a diffusion index, going from down to unchanged actually increases the index level.  That would happen despite the fact that the firm still produced nothing.  In normal times, the ebb and flow of these changes even out.  In times like this, looking at the overall index level rather than the components can be very misleading.  Unfortunately, under the current circumstances, even the data nerds who dig into those details are having trouble understanding what is happening.

The final issue is the one I mentioned in my unemployment claims report.  To the extent that government policy was designed in a way that intentionally or unintentionally masks the true nature of the data, the numbers become suspect.  If the PPP causes firms to hire people that don’t actually produce anything, and that is likely given the spending requirements, the private sector employment numbers are corrupted.  A worker gets moved from unemployment, lowering that number, and is counted as employed, raising that number.  But that worker effectively remains on the government payroll (paid by a PPP grant) and still doesn’t produce anything.  The employment and unemployment numbers are artificially improved, but nothing changed.  We have no measure of those workers, so the best we can say over the next few months is that the payroll data overstate the true state of things while the unemployment rate understates what is happening.  Keep that in mind when you see the next few months of employment reports.