KEY DATA: Phila. Fed Index: +16.8 points: Orders: -2 points; Expectations: -11.6 points/ LEI: +0.3%/ Claims: -4,000

IN A NUTSHELL: “The manufacturing sector continues to lead the way, creating expectations that second quarter growth could be quite decent.”

WHAT IT MEANS: Have the animal instincts taken over the manufacturing sector? I think it is too early to make that judgment, but it does look as if activity is springing back. Earlier this week we saw that industrial production soared in April. The Philadelphia Fed’s May reading of manufacturer activity in the MidAtlantic district points to continued gains. The overall activity measure soared to one of its highest levels ever. Over the past thirteen years, it was higher only twice, with one of those times coming just this past February. Now the Philadelphia region is not a major player in manufacturing, but the strong performance does hint at good numbers around the nation. The details of the report were not nearly as robust as the overall number. Orders and payrolls expanded solidly, but not quite as rapidly as in April. On the other hand, order books are filling more quickly and shipments soared. Looking forward, though, there was a lot more caution. Expectations dropped sharply and are now pretty much at the average over the past eight years. Managers are hopeful about the future, but are no longer irrationally exuberant.

Another indication that first quarter growth was an aberration was the solid rise in the Conference Board’s Leading Economic Indicator in April. This follows good gains in the previous two months, so growth should be much better through the summer.

The labor market continues to tighten and jobless claims fell again last week. In addition, the percent of the workforce on unemployment insurance continues to set new record lows. Yes, it is nice to say that the economy will grow by 3% or more, but unless firms find the labor to help drive the greater output, it will be difficult to sustain that level of expansion for very long.

MARKETS AND FED POLICY IMPLICATIONS: The appointment of the Special Council makes it is clear the issues facing the Trump Administration will be with us for a long time. These investigations rarely are concluded quickly. So investors need to focus on the actual economy and right now, it can be said that growth looks like it is back on track – for another year of 2% or so growth. The Republican leadership still wants to get a tax cut/reform bill done by the end of the year, but that could be more hopes than realistic expectations. Thus, it is reasonable not to expect any major economic impact from tax changes for another year. And that is why I don’t expect growth to accelerate much this year. But 2% growth, given the sluggish increase in the labor force, will be enough to keep the unemployment rate slowly falling. That means the Fed is likely to raise rates slowly but steadily. As we move closer to the June 13-14 FOMC meeting, look for the members to stake out their positions – i.e., send messages to the markets about what is likely to happen. If there is no hike in June, as most expect, it almost certainly will come at the July25-26 meeting, assuming second quarter growth isn’t totally disappointing.

KEY DATA: Starts: -2.6%; 1-Family: +0.4%; Permits: -2.5%; 1-Family: -4.5%/ IP: +1.0%; Manufacturing: +1.0%

IN A NUTSHELL: “The pick up in manufacturing activity comes at the right time as home construction seems to have hit a lull.”

WHAT IT MEANS: Watch what people do, not what they say. Yesterday, surveys indicated that housing was moving forward strongly but manufacturing may be slowing. At least that is what the respondents said. Well, today’s data indicate the exact opposite happened in April. First, home construction slowed. Housing starts fell, though the decline was driven by a slowdown in the always-volatile multi-family segment. Sharp reductions in building activity in the Northeast and South overwhelmed solid increases in the Midwest and West. Looking forward, permit requests were off as well. Since permit requests outpaced starts over the past three months – and were well above the April level – look for a pop in starts in May. That, however, will just bring us back to an average pace.

Industrial production jumped in April and the rise was broad based. Not only did we have a nice increase in utility production, but the energy sector rebounded significantly and manufacturing output surged. Eight of the eleven durable goods manufacturing segments and seven of the eight nondurable sectors posted gains. The biggest increases were in vehicles and petroleum. It is nice that the energy sector is growing rather than contracting sharply as it did last year. As for the pop in assembly rates, unless sales pick up, we are could see some shaving in output. There was also a large rise in the production of computers and business equipment, indicating firms may be investing again. That would be good news for growth this quarter.

MARKETS AND FED POLICY IMPLICATIONS: The sharp increase in industrial activity is a clear sign that the first quarter sluggishness is behind us. But we have to be cautious in reading these numbers. March was a strange month and the April data have averaged out the ups and downs. What we need to see is consistently good numbers, not one bad and one good. A 3% or more second quarter will not indicate the economy is in off to the races. It will, however, make it possible we don’t have another sub-2% growth rate. My point is that the data are volatile and if the March and April numbers were switched, we probably would have two quarters both in the 2.25% range. Big deal. Given that investors seem to be turning a blind eye to any negative information but are celebrating anything that looks good, I suspect they will cheer the production report and skip the housing numbers. But they shouldn’t. The April starts number was almost 6% below the average for the first quarter and it will be hard to get above 3% growth if housing isn’t expanding. That is especially true given the less than stellar vehicle sales. I point all this out to make the point that I just don’t know where the earnings will come from to support the constant increase in equity prices. It is doubtful is will come from domestic activity. As for the Fed, it produces the industrial production report and the large increase adds to the belief that the next rate hike is coming very soon.

KEY DATA: NAHB: 70 (up 2 points)/ NY Fed: -6.2 points; Orders: -11.4 points; Expectations: -0.6 point

IN A NUTSHELL: “The housing market is beginning to look a little like it did a decade ago.”

WHAT IT MEANS: The housing market continues to recover and in many metropolitan areas, prices are pretty much where they were at the peak of the housing bubble. Meanwhile, developers are feeling like things are really strong once again. The National Association of Home Builders’ Index rose in May to a level seen only in boom times. I am not saying construction is booming; only that builders feel that way. For the first five months of the year, the index averaged 68, a level that was exceeded only in 2005 and 1999, two economic bubble years. The present conditions and expectations indices are near record highs. Interestingly, though, traffic is good but hardly great. That reflects the reality that sales levels are no where near the peaks we had seen and will not likely be there anytime soon – if at all. I guess what you have to conclude is that builders feel real good about the industry, even if it is running at a lower pace than in the past.

Manufacturing has helped keep the economy moving forward, but the strength of this sector may be waning a touch. The New York Federal Reserve Bank’s Empire State Manufacturing Survey took a tumble in May. Overall activity slowed as orders and backlogs declined. Still, hiring remained solid and respondents were still pretty optimistic.

MARKETS AND FED POLICY IMPLICATIONS: Most economists expect that second quarter growth will rebound from the weak gain recorded in the first part of the year. But it is not clear how strong it will be and what it will say about the state of the economy. Tomorrow we get housing starts and industrial production and if the NAHB and NY Fed surveys tell us anything about what is actually happening, starts should be good but production not so much. That would further muddle the economic picture. Even if second quarter GDP growth is in the 3% range, as I expect, the economy would have expanded during the first half of the year at a roughly 2% pace. In other words, the more things may change in other places, the more the economy remains the same. Yet investors seem to be assuming growth will stay at 3% for as long as the eye can see and that all the other things happening in the world just don’t matter. Aren’t rose-colored glasses wonderful? There is nothing at work that should cause growth this year to be much more than about 2.25%. I don’t know what that means for equity prices, but I do think it raises questions about earnings expectations for the rest of the year. Oh, well, I guess that’s why I am an economist and I don’t run money.

KEY DATA: Imports: +0.5%; Fuel: +1.6%; Nonfuel: +0.3%; Exports: +0.2%; Farm: +0.3%

IN A NUTSHELL: “The steady acceleration in nonfuel imported goods costs is another reason for the Fed to raise rates.”

WHAT IT MEANS: We may be only a week past the last FOMC meeting, but it is already history. With job gains rebounding to decent levels, only some sudden deceleration in inflation might slow the Fed from its appointed round of rate hikes. (The members don’t care much about rain, heat or gloom of night.) Well, it doesn’t look like inflation is going to decelerate anytime soon. Import prices rose sharply in April, led by a jump in fuel costs. But it wasn’t just energy, which has backed off lately. Nonfuel prices rose solidly as well. Food, building supplies, metals, vehicles and even to a small extent consumer goods costs were up. The acceleration in the rise in imported goods prices, excluding energy, has been going on for sixteen months now. While the increase over the year of 1.4% for non-petroleum goods imports is not great, it is an awful lot more than the 3.7% decline that was posted as recently as December 2015.

On the export side, the farm sector is doing fine again. Prices rose for the fourth consecutive month and sixth out of the last seven. Since April 2016, prices are up 4.6%. In comparison, one year ago, farmers were looking at a 9% drop, over-the-year, in their export prices.

MARKETS AND FED POLICY IMPLICATIONS: Given yesterday’s events, it is likely this report and most others that come out this week, will be trees falling in the forest. Yes, we get additional inflation numbers and April’s retail sales report, but for investors, the political implications of FBI Director Comey’s firing are critical. Let’s face it, what matters to investors is whether the president’s agenda, specifically, tax cuts, regulatory reform and spending increases, is hurt by the action. The passage of the AHCA was viewed in that light, not whether it made health care better, worse or did nothing to it. If the firing backfires and harms the ability to pass legislation, then markets will react accordingly. If it goes away, then investors can continue dreaming of changes in those issues they hold dear. But we may not know for a while. There are lots of politicians hiding under rocks today but they may have to actually say something eventually. I just don’t know what stand they will take. Meanwhile, the Fed will be watching the week’s data carefully and if the consumer and producer price indices also show further acceleration in inflation, it would be prudent to expect that the FOMC will do something at its June 13-14 meeting.   

KEY DATA: Openings: +61,000; Hires: +11,000; Quits: +80,000/ NFIB Confidence: -0.2 point; Business Expectations: -8 points

IN A NUTSHELL: “The labor market is slowly tightening, yet even small businesses are managing to find workers to hire, though with great difficulty.”

WHAT IT MEANS: We hear lots of stories about how hard it is to find workers. Nevertheless, firms are still hiring. Job gains so far this year have been solid and all the measures of unemployment are at levels consistent with full employment. Today’s numbers support that view. The closely followed JOLTS report, produced by the Bureau of Labor Statistics, pointed to further hiring and some growing turnover in the labor market. The number of job openings was up in March, signaling that firms are still trying to add their workforces. That they are having problems finding the ones they want is clear in the somewhat limited increase in hiring. But the most interesting number in the report was the level of quits. The number of people willingly leaving their jobs continues to rise (though in a saw-tooth manner). Since September 2009, the level has nearly doubled. That shows that people have pretty much overcome their fear of making a move.

The problems that businesses are facing finding people was highlighted in the National Federation of Independent Business’ monthly survey. The optimism index eased a little in April, though it remains near record highs. But confidence about the future took a major hit. Political reality is colliding with hopes that regulations and taxes will be cut. That said, firms hired quite heavily and hiring plans remained strong.   Still, this segment of the economy is saying that qualified workers are extremely difficult to find. The report noted that “87 percent of those hiring or trying to hire reported few or no qualified applicants for their open positions”. When it comes to problems facing small businesses, quality of labor now ranks just below regulations and red tape and is rapidly closing in on taxes.

MARKETS AND FED POLICY IMPLICATIONS: There is a debate over which measure of unemployment is the best measure of unemployment. The reality is that it doesn’t matter. The two measures commonly used are both at levels consistent with full employment. Yes, one is higher than the other.   But level doesn’t matter, only what the level should be at full employment and we are there. In addition, people are quitting more often, while business people running firms of all sizes are saying they are having massive problems filling jobs with qualified workers. Those are indicators of a tight market. Yesterday, the Conference Board reported that its Employment Trends Index jumped in April, another sign that firms are hiring. But that doesn’t mean we are going to see job gains above or maybe even near 200,000 per month. Without the workers to hire, firms are doing the next best thing: They are moving part-timers into full time jobs. That solves the qualified worker problem without actually adding any workers. So going forward, it may be the hours worked number that really counts, as payroll gains should remain in the 150,000 to 175,000 range. Since that should be enough to keep the unemployment rate trending downward, look for the Fed to tighten again soon. If we get a tax cut bill by the end of the year and the economy accelerates even a modest amount, the Fed may be forced to move more quickly than anticipated. Timing is everything in life and while tax reform (not just tax cuts) is critical, when it occurs is important. The labor markets have limited slack now and will have even less at the end of the year. Hyping the economy with tax cuts and spending increases will come with a cost, which is likely to be higher wages, inflation and interest rates.

KEY DATA: Productivity: -0.6%; Labor Costs: +3%/ Trade Deficit: $0.1 billion narrower/ Layoffs (Over-Year): -27,539/ Claims: -19,000

IN A NUTSHELL: “The tightening labor market is raising costs but firms are failing to improve productivity to offset those increases.”

WHAT IT MEANS: You can get growth either through adding workers or working more efficiently (or, of course, both). Well, firms are adding workers, but they are showing few signs that they are able to use those workers more effectively. Productivity fell in the first quarter, which was not really a major surprise given the weak economic growth during the quarter. Since payroll gains were strong, it was clear that we would get an ugly labor cost number and we did. Unit labor costs, a key measure of the cost of producing a good, rose sharply. These data bounced around sharply, as does GDP, so it would normally not be major concern. But given that productivity has been growing at a pretty pathetic 0.6% pace for the past five years, today’s report provides little comfort that anything is changing. And if you don’t get a surge in productivity, the ability of the economy to accelerate will remain limited.

The trade deficit was largely flat in March, as exports and imports declined by the same amount. That is hardly good news since we would like to see both increasing. On the export side, we sold more food and capital goods, but that was just about it. Foreign demand for our motor vehicles, consumer products and industrial supplies dropped. Oil played a major role in that decline, but some of that may have been related to the decline in prices. Imports, though, also fell, hardly a sign that the U.S. economy is surging along. The only thing we bought more of was motor vehicles. Given the weakening sales numbers (the April pace was disappointing and that followed a truly soft March number), I am not sure that is a good thing. Adjusting for prices, it looks like the trade deficit estimate in the first GDP report was on target, so if the growth rate is changed, it is not likely to come from any major revision to the deficit.

Firms are holding on to workers quite tightly. The Challenger, Gray and Christmas April report on layoffs showed that workforce cutbacks continue to decline from 2016 levels. Just about the entire drop came from the new-found stability in the energy and computer sectors. On the other hand, retailers are closing stores like crazy and that is pumping up the layoff numbers.

Unemployment claims dropped back to labor shortage levels. That reinforces the view from the layoffs numbers that firms simply will not fire someone unless they have to, such as when they close stores.

MARKETS AND FED POLICY IMPLICATIONS: Today’s story is the productivity numbers. You cannot grow at a 3% pace if productivity is increasing at a 1% pace. That is because the labor force is just not there. There simply is no reserve army of the unemployed or underemployed to call on and hours worked are already fairly high. The increase in hours worked during the first quarter was less than what we saw in 2016. While jobs may be declining in traditional retailing, they are growing in Internet retailing, warehousing and distribution. Technology still requires people, either directly or indirectly. Robots may replace some workers, but a totally robotic economy is not in the near future. So, if you believe that all you need to do is loose the animal instincts of the business sector and growth will magically surge, you might want to reconsider that view. As for the health care bill, I am fascinated by the idea that the way to introduce more private sector competition into the health care system is to ramp up government payments to companies. Since when did Republicans start believing that the government should subsidize the private sector and that more government spending was a good thing? Please, someone explain this to me.