KEY DATA: Deficit: $59.8 bil. ($9.5 bil. wider); Imports: +2.1%; Exports: -1.9%/ ADP: +183,000/ HWOL: +0.3 points

IN A NUTSHELL:  “The soaring trade deficit is troublesome, especially if job gains begin to fade.”

WHAT IT MEANS:  The markets are fixated on the trade discussions with China and for good reason: The trade deficit is soaring.  In December, it reached its widest level since October 2008, when the financial system was collapsing.  Of course, conditions are a lot different now, since we are growing decently while we were in a recession then.  But the hoped for narrowing has not happened.  Since the fourth quarter of 2016, the quarterly trade deficit has widened by nearly 18%.  In December, imports rebounded from a sharp decline in November while exports continued to decline.  As for the situation with China, the numbers for the year were ugly.  The deficit widened by nearly 12%.  Yes, exports were up, by nearly 6%, but imports rose faster.  Keep in mind, our imports from China in 2018 totaled nearly $540 billion but our exports were a paltry $120 billion.  But our trade deficit didn’t just widen with China.  It was larger against the EU, Canada, Mexico, Germany and OPEC nations.  In other words, we are funding a large part of the growth, whatever pace it may be, of an awful lot of nations.    

Friday is Employment Friday, so today is ADP Wednesday.  Okay, those are my nicknames, but when the job report is due out, we get an indication of what the level might be when ADP releases its reading on private sector payroll gains.  Not surprisingly, the increase in February payrolls is likely to come in well below the initial January government reading of 304,000.  Two things stand out in the ADP report: Construction and manufacturing continue to boom but small businesses are having a tough time getting and/or holding workers.  Larger firms, which can pay the higher costs, are leading the way.

Confirming that the labor market remains strong was the rise in the Conference Board’s Help Wanted OnLine index in February.  However, the details contain some warning signs.  Five of the nine regions posted declines in both January and February.  This may indicate that the surge in payroll gains is coming to an end and more sustainable numbers, in the 150,000 to 175,000 range, could be what we see for much of the remainder of the year. MARKETS AND FED POLICY IMPLICATIONS:The widening trade deficit, when combined with a softening of consumer spending (February vehicle sales were quite soft), points to a pretty ragged first quarter GDP growth number.  I haven’t seen any negative numbers yet, but estimates of around 1% growth are popping up all over the place.  I have dropped my estimate to 2%, but the vehicle numbers are compelling enough to take that forecast down further.  As I have noted, even if there is a trade agreement of some sort, it will not cause a sudden burst in U.S. exports to China.  That will take time and if the Chinese growth is as soft as most economists believe (forget the official numbers), it is hard to see how they can ramp up demand for U.S. products very much this year.  At least we have the massive government spending bills to fall back on, but those effects will fade as we go through the year.  So, expect growth this year to be a lot less than many had thought, though in the range of what most economists expected.

KEY DATA: GDP: 2.6%; Consumption: 2.8%; Business Investment: +6.2%; 2018 (Annual): +2.9%/ Claims: +8,000

IN A NUTSHELL:  “Growth is settling down to more normal, sustainable levels as the tax cut impacts fade.”

WHAT IT MEANS:  As expected, economic growth came in at a very solid level at the end of last year.  Of course, it is slower than the previous two quarters, which every economist outside the White House forecast. The growth rate represents a moderation not a major slowdown, a critical distinction.  For all of 2018, GDP expanded at the strongest pace since 2015.  Consumers spend solidly on just about everything, with most categories rising solidly.  Business investment was decent, though not great.  Firms purchased software and equipment and added to inventories, but didn’t build any new structures.  The level of inventory building was extremely high and likely the result of tariff fears. That could turn around sharply this or the second quarter, especially if any trade agreement is concluded.  Housing, not surprisingly, declined, a trend we could see continue for a while.  Meanwhile, the trade deficit continued to widen.  Our exports fell, largely because of lower farm sales, but imports rose. Tariff issues likely distorted the numbers.  Finally, a surge in defense purchases offset a drop in federal nondefense and state and local government spending.  Inflation remained tame, running below 2%.

Job claims jumped last week, but they remain low.   MARKETS AND FED POLICY IMPLICATIONS:The slow but steady deceleration in the economy continued in the last quarter of 2018 and we could see an even weaker number for the first quarter.  Vehicle demand has softened and coupled with the government shutdown, we are likely to see lower consumer spending in first quarter.  There was a huge surge in business software purchases and it is hard to see the excessively large gain repeated.   The inventory build looks to be unsustainable and it is not clear what will happen to the trade deficit.  I have no idea when or if a trade agreement of any kind will be consummated.  So, the best guess right now is that first quarter GDP growth will come in around 2%, give or take a quarter percent.  Basically, we are moving back to a sustainable growth pace that we experienced during most of the Obama years.  Of course, most people didn’t think that was a good growth rate, but the reality is that is what trend growth looks like.With the tax cut impacts largely done with and Europe and China slowing, it is hard to see how growth can accelerate sharply.  That is actually good news.  It means inflation is not likely to jump so the Fed can keep on its current path.  Of course, given Mr. Powell has more moves than Gayle Sayers had, who knows when the Fed will start rethinking the rethinking it rethought – or whatever.  Regardless, rates are going nowhere for a while.  As for the equity markets, the one major hope is that a trade agreement will remove the uncertainty overhanging investor thinking.  That could provide a short-term boost, but why China and Europe would suddenly buy lots more U.S. product after the initial push occurs is beyond me.

KEY DATA: Starts: -11.2%; Permits: +0.3%/ Confidence: +9.7 points/ Phil. Fed (NonMan.): +9.0 points

IN A NUTSHELL:  “The wild swings in the data continue so we shouldn’t rush to judgment on the state of the economy.”

WHAT IT MEANS:  I’ve been doing this for a very long time and while I haven’t seen it all, the current data seem awfully volatile.  Today’s numbers continue that trend.  Housing starts cratered in December, which was a surprise.  Yes, we knew that construction peaked in the spring, but the collapse at the end of the year made no sense, especially given that housing permit requests remained solid.  Indeed, during the fourth quarter of last year, permits ran nearly twelve percent above starts.  Since builders stopped spec building many years ago, that differential is likely to be narrowed in the months to come.  Of course, January is problematic as the weather was brutal.  Basically, housing is likely to be stronger going forward than the data indicate, but not strong.

Not surprisingly, consumer confidence rebounded sharply in February.  The Conference Board’s current conditions component rose modestly but the expectations component surged.  Basically, the government shutdown ended and so did the total disgust with Washington.  Now we can go back to being only disgusted with Washington.   

As far as business activity is concerned, the Philadelphia Fed’s NonManufacturing survey rebounded sharply in February.  Again, special conditions were at work.  The frigid weather, coupled with the government chaos, led to a huge drop in the index in January. With conditions improving in February, it was hardly a shock to see the current and future conditions measures jump.  The Richmond Fed’s Manufacturing Index posted a similar pattern, as activity rebounded in February after a January lull.

MARKETS AND FED POLICY IMPLICATIONS:  On Thursday we get the first (and in this case second as well) reading on fourth quarter GDP growth.  Don’t expect anything great.  Indeed, only a possible large increase in inventories may have kept the number from coming in below 2%.  Housing should be one of those components that will depress the growth rate.  But neither consumer nor business spending look like they were stellar.  I still think the estimate should come in somewhere between 2.00% and 2.50%, but given the wild swings in the data, I am not sure.  Regardless, the economy is moderating and we are headed back to more normal growth, which is roughly about 2.25%.  That is neither too cold nor too hot, which means the Fed should be able to maintain its cautious approach to monetary policy.  Indeed, Fed Chair Powell, in his semi-annual testimony to Congress, reiterated that today.  The Fed could reconsider raising rates, but it will take stronger growth for it to start hiking again.  As I have noted before, I think that is a mistake.  The current level of the funds rate is not high enough to provide much ammunition if the economy falters.  The idea was to get back to normal.  Since the Fed keeps arguing that rate policy is its primary tool, by failing to raise rates to higher levels when the economy is in good shape, and it is, the members are betting they don’t face a major recession in the relative near term.  I hope they are correct. 

KEY DATA: Durables: +1.2; Ex-Transportation: +0.1%; Capital Spending: -0.7%/ Existing Home Sales: -1.2%; Prices (Over-Year): +2.8%/ Philadelphia Fed (Manufacturing): -21.1 points/ Claims: -23,000

IN A NUTSHELL:  “With housing and manufacturing slowing further, it appears the bloom is off the economic expansion rose.”

WHAT IT MEANS:  We are still one week from getting the first reading on fourth quarter 2018 GDP, but things are not looking up for the number.  In a report delayed by the government shutdown, durable goods orders rose solidly in December.  However, much of that gain was derived from a 28.4% surge in nondefense aircraft orders.  The rest of the economy, excluding Boeing, didn’t do nearly as well.  Motor vehicle orders rebounded and demand for fabricated metals was up, but there were negative signs on the computers, communications equipment, machinery, electrical equipment and primary metals components.  But most troubling, the indicator of private sector investment spending, capital goods orders excluding aircraft and defense, fell sharply again.  Whatever business spending boom we got from the tax cuts looks like it has dissipated.  Also, backlogs are declining and inventories are growing faster than order books, which isn’t a great sign for future capital spending. 

A second indicator of growing economic weakness was the report by the National Association of Realtors that showed existing home sales continued to fade in January.  Yes, it was bitterly cold, but the slowdown has been going on for a year now and there is no indication that the latest data are anything but a continuation of that trend.  Housing prices are rising slowly, further reinforcing the belief that the sector is soft.  Finally, despite the weakening demand, inventories remain well below healthy levels.  It is hard for buyers to find a house they want given the low level of supply.

If the slowdown in housing and manufacturing were not enough, the Philadelphia Fed’s February report on regional manufacturing activity turned negative for the first time in nearly three years.  However, we shouldn’t read too much into this report as the weather was brutal, hiring remained strong and the outlook for the future held up quite well. 

Finally, unemployment claims declined back to what are more normal levels last week.  I had warned that the data were volatile due to the government shutdown and cold weather, and that looks to have been the case. 

MARKETS AND FED POLICY IMPLICATIONS:  The economy is coming off its tax-induced sugar high.  No surprise there, except it might be a little quicker than expected.  The biggest concern is that the tax cuts didn’t bring forth nearly the gains in capital spending that many had hoped for.  Economists had warned that would likely happen, but we still held out hope that the past, limited reactions to tax cuts by businesses would not be repeated this time.  Well, this time was just not different.  The Fed, in the minutes of the January 29-30 meeting released yesterday, made it clear that it would be cautious going forward.  The members did remind everyone that increases in rates could not be ruled out if there were a rebound in growth and inflation.  Hardly anything new there.  What was new was a clarification of the balance sheet normalization process.  The run down is likely to end later this year at a level above what was expected.  The members want to build in some flexibility, which makes sense, especially since this is new ground for the Fed.  For investors, the data don’t paint a picture of strong growth going forward.  Again, economists warned that the likelihood of an extended period of 3% growth was small and that too appears to be coming true.  I guess we can be right every once in a while.        

KEY DATA: ISM (Nonman.): -1.3 points; Orders: -5 points; Jobs: +1.2 points/ Markit (Services): -0.2 point

IN A NUTSHELL:  â€œThe nonmanufacturing portion of the economy is still solid, but growth, as expected, is fading slowly.”

WHAT IT MEANS:  While the government data mills try to dig out from the partial shutdown, the private sector keeps churning out its numbers.  Today we got two readings on the nonmanufacturing portion of the economy and both showed continued solid growth but at a decelerating pace.  The Institute for Supply Management’s NonManufacturing Index dropped moderately in January.  The level tied the lowest over the past year.  Of significance was a sharp slowing in new orders growth.  On the other hand, job growth accelerated and backlogs expanded faster, so conditions are not that bad. 

Confirming the modest slowdown in the services was a small decline in the IHS Markit Services Index.  Yes, there was a drop, but the level remains high and that indicates growth in this sector is still quite solid.  Indeed, the commentary indicated that demand remained strong, though not quite as good as it had been.   

MARKETS AND FED POLICY IMPLICATIONS:  The economy is in very good shape, despite all attempts by Washington to make sure that would not be the case.  The manufacturing sector continues to boom while the moderation in services activity is not particularly great.  But as almost every economist has noted, the impacts from the tax cuts can last only so long and we are beginning to see them fade.  It is impossible to determine how quickly the economy will come down from its sugar high, but I doubt it will suddenly collapse and take a nap.  There is still hope that businesses may actually invest more this year.  Of course, with over one trillion dollars in corporate buybacks vacuuming up much of the tax breaks, I am not counting on that happening.  But, we can always hope.  Since we will not get the first reading of fourth quarter GDP growth until February 28^th, we will be flying somewhat blind on exactly how well we were doing going into the shutdown.  The consensus is for something in the 2.5% range, which seems reasonable and representative of the expected movement back toward trend growth.  As for investors, there is the State of the Union speech tonight, the steak dinner meeting of the president and Chair of the Federal Reserve and tepid comments about a trade agreement with China to contend with.  Today’s numbers will likely go largely unnoticed.   

KEY DATA: Confidence: -6.4 points; Expectations: -10.4 points/ Jobs Index (Over-Year): -0.96%/ Home Prices (Monthly): +0.4%; (Over-Year): +5.2%

IN A NUTSHELL:  â€œThe shutdown not only hurt the economy but it battered household feelings about the future.”

WHAT IT MEANS: It’s time to get back to real economic issues and put the partial federal government shutdown behind us, which may take some time.  One place where the insane decision to close government offices had a major effect was, not surprisingly, on consumer confidence.  The Conference Board’s January reading of household sentiment dropped sharply.  While current conditions were largely flat, an indication the economy continues to expand decently, the expectations measure cratered.  It’s hard to be confident about the future when the government is so dysfunctional.  Still, the economic impacts of declining confidence that results from political events are usually modest, so don’t expect households to suddenly start cutting back spending sharply. 

Friday, the employment report is expected to be released.  It may be a little better than expected as the Paychex/Markit IHS small business jobs index rose slightly in January.  Still, it is likely to be a lot weaker than the huge 312,000 gains reported for December.  I think it could be closer to 125,000. Looking forward, the downward trend in the small business jobs index points to softer job gains in the future.

The S&P CoreLogic Case-Shiller national index rose moderately in November, but the year-over-over gain continues to decelerate.  Costs in the largest metro areas seem to be easing back faster than in other areas.  Growing economic uncertainty is likely to restrain housing demand, but at least mortgage rates have backed down, which should keep sales from faltering.

MARKETS AND FED POLICY IMPLICATIONS:  Well, the government shutdown is over and hopefully this will be the last one for a while.  Every once in a while, the wackos who run Washington think that refusing to fund government operations is a good idea and they proceed to do that.  And as usual, they learn that government shutdowns are not very good ideas.  Of course, most politicians have very short memories, so I cannot rule out another one, though I doubt that will happen at the end of the current deadline.  That said, the Congressional Budget Office made it clear that there will be lasting effects and the total is likely a lower bound.  The impacts on businesses not able to operate effectively, whether it was due to regulatory or lending issues, is hard to estimate.  And don’t think going forward that the government workers will spend at the pace they had been before the shutdown.  Their rainy day funds will look more like hurricane funds.  The Fed is meeting today and tomorrow and with little indications the chaos in Washington will subside anytime soon, the better part of valor is to punt.  Look for the statement and the comments of the Chair to mention that the uncertainty will be watched carefully.  That, in real world language, means the members will take their time deciding when to raise rates again.  With the trade situation with China in flux, that wait could last a while.  I originally put on my forecast an April/May meeting move and that is still possible, but I am not so sure.  The Chinese economy is not likely growing anywhere near the 6.5% pace the government claims and until we see demand pick up, a significant slowdown in the world’s second largest economy has to be taken into consideration when setting monetary policy.  My point is that the rate hikes were not the major problem facing the economy and the markets; the trade war was and is.  Until this issue is settled, the Fed is likely to move very slowly as a full out trade war could send the world economy into recession.

KEY DATA: Sales (Month): -5.5%; Over-Year: -10.1%; Prices (Over-Year): +2.9%/ Phila Fed (Nonman.): -6.7 points; New Orders: -20.6 points; Expectations: -15.6 points

IN A NUTSHELL:  â€œThe manufacturing sector may be holding up but the rest of the economy, especially housing, isn’t.”

WHAT IT MEANS:  While the shutdown continues, the economy is being battered.  The latest ugly numbers show issues in housing and the non-manufacturing portion of the economy.  The National Association of Realtors reported that sales plummeted in December.  The drop in demand was seen in three of the four major regions, with only the West posted a gain.  For all of 2018, sales fell by 3.1% compared to 2017.   Every region declined, led by a sharp drop n the West.  The rate of price increases continues to decelerate, though when you look at the year as a total, prices were still up solidly (6.1%).  

While manufacturing in the Philadelphia Fed’s region picked up a touch in January, the rest of the economy continued to fade.  The nonmanufacturing index is now showing almost no growth after plummeting sharply in December and faltering further in January.  New orders, which had been surging as recently as November, are now flat.  Hiring, while still occurring, has softened significantly for both full time and part time workers.  And compounding the problems, costs are rising faster.  All of these issues are not playing well with owners and their optimism about the next six months has been shaken greatly. 

MARKETS AND FED POLICY IMPLICATIONS:  The economy is slowing, which most economists expected.  But the coming down off the sugar high is being compounded by the government shutdown and the trade disagreements and that is causing growth in other countries, not just China, to moderate as well.  Last year at this time, there was optimism not just because of the tax cuts but also because we were in the midst of a rare, in-phase worldwide expansion.  It seemed that growth was accelerating everywhere.  But to quote Inspector Clouseau: “Not anymore!”, and that does not bode well for growth going forward.  In economics, nothing is free and that includes government shutdowns and trade wars.  There are both real and emotional impacts.  In addition to the economic moderation, optimism, not just in the U.S. but around the world is fading.   Indeed, the International Monetary Fund revised down its 2019 world growth estimate for the second time in three months.  I am not saying we are headed into a recession.  We should get through this year unscathed.  But there are weaknesses that are emerging that could lead to a further slowdown as we go through the second half of this year and into 2020.  How the markets hold up will depend upon investors’ perceptions of the longer-term impact of the government shutdown and the trade war.  Currently, the shutdown is viewed as largely a nuisance.  That may not be off base, but only as long as it doesn’t go on much longer.  However, there is growing concern that the trade situation will create a more lasting worldwide slowdown. And that is something that could affect investment decisions not just in equities but capital spending as well.  We are in a period of uncertainty right now.  Growth is solid, but for how much longer is unclear.

KEY DATA: PPI: -0.2%; Goods: -0.4%; Services: -0.1%/ Empire State: -7.6 points; Orders: -9.9 points; Jobs: -10.1 points

IN A NUTSHELL:  â€œBusinesses are becoming more cautious about the future as the shutdown and trade battles start to bite.”

WHAT IT MEANS: While the economy slowly burns and Washington fiddles, the negative economic data are starting to mount.  One part of the government that is open is the Bureau of Labor Statistics and the data continue to be released, at least most of it.  December’s Producer Price Index pointed to a slowing in cost pressures at the wholesale level.  Clearly, the sharp drop in energy-related products (-5.4%) was the driving factor.  On the other hand, food prices soared, which they have been doing for a while. Still, excluding the volatile components, goods prices were largely flat.  As for services, where much of the inflation had been coming, costs declined.  Construction costs, which also had been on the rise, posted only a modest gain.  Most components of the report were either flat or down, indicating there is limited price pressure at the finished goods or services level.  As for the pipeline, except for foods, there appears to be no reason to think that there will be accelerating business costs in the next few months.

The manufacturing has been expanding and hiring like crazy, but that may be coming to an end.  The New York Federal Reserve Bank’s Empire State Manufacturing Survey tanked in early January.  Just about every component measuring current conditions posted large declines.  Not surprisingly, the outlook for the future fell sharply as well.  Expectations on new orders are now barely positive and hit the lowest level in nearly two years.  New York may not be the center of the world when it comes to manufacturing, but the level of decline is a warning.

MARKETS AND FED POLICY IMPLICATIONS:   

We now have the longest government shutdown on record.  Yes, it is a “partial” closure, but that doesn’t make much of a difference to the workers who are not being paid and businesses that cannot get things done because agencies are closed.  How much the shutdown will take out of growth is uncertain as it depends upon when the government reopens.  The sooner sanity returns to Washington, okay, forget that.  The sooner there is a bill that allows for the government to fully reopen and stay open and pays the workers and allows businesses who cannot get their subsidies, licenses, permits or whatever to get back to normal, the smaller the ultimate impact.  But if it lasts an entire quarter, look for a GDP number that is probably in the 1% to 1.5% range, or even lower.  Indeed, you cannot rule out a negative number.  Speaking of GDP, the first reading of fourth quarter growth is scheduled to be released on January 30^th.  The Bureau of Economic Analysis, which produces the report, is not open.  Given the stands taken by the major actors in this Shakespearean tragedy seem to be rock solid, there is a real likelihood the report will be delayed.  In addition, some of the numbers in the monthly employment report, most notably the unemployment rate, may not be available since they require data produced by the Census Bureau, which is closed.  Is everyone enjoying the chaos?