KEY DATA: PPI: +0.3%; Excluding Food and Energy: +0.3%/ NFIB: -0.6 point

IN A NUTSHELL: “The rise in price pressures continues and it is very likely the Fed will make a move tomorrow.”

WHAT IT MEANS: The Fed’s rate setting committee, the FOMC, is in day one of its two-day meeting and while you can never be certain what the members will do, it looks like a rate hike is coming when the statement is released tomorrow afternoon. Today’s data only reinforce that view. First, wholesale prices rose moderately in February, led by another jump in energy costs. Over the year, producer prices are have now risen by over 2% and are up by nearly that pace even excluding the volatile food and energy components, as the gains were spread across most areas. Food and services expenses posted solid increases, adding to the cost pressures. Looking down the road, sharp rises in intermediate goods costs are pointing to further increases in consumer finished goods prices and that doesn’t bode well for inflation.

Small business owners have been ecstatic about the election and their confidence has soared. But that could change. The National Federation of Independent Business’ small business index fell slightly in February. Though the index remains at a high level, the NFIB president issued this warning: “The sustainability of this surge and whether it will lead to actual economic growth depends on Washington’s ability to deliver on the agenda that small business voted for in November. If the health care and tax policy discussions continue without action, optimism will fade.” Given the chaos over the AHCA, which should be called Republicancare, and the lack of any proposal on tax reform, don’t be surprised if small business owners become a little more cautious about the future.

MARKETS AND FED POLICY IMPLICATIONS: With a rate hike potentially only 24 hours away, it is time to start recognizing that rates are really going up this year and probably faster and greater than thought. Fed Chair Yellen will have a press conference tomorrow after the meeting and might provide a small amount of guidance as to future actions. In addition, there will even be another round of the infamous and largely useless dot plots that provide “insights” into the members’ thinking. I suspect there will be a shift to as many as four increases. Coming into the year, I had forecasted three increases but a total of one percentage point. It looks like that 100 basis point forecast may occur, but through a quarter point increase every other meeting. Regardless, the markets didn’t have a full point hike factored in coming into the year and many still have the “when I see it, I will believe it” attitude when it comes to Fed actions. That is actually a rational approach given the hesitancy to raise rates we have seen from this Fed Chair. But my view is that once she gets going, and assuming the Republicans actually pass a tax and spending plan, Chair Yellen will push ahead steadily.

KEY DATA: ADP: +298,000; Construction: 66,000/ HWOL: -360,2000

IN A NUTSHELL: “If job gains are really heating up this much, the Fed might find itself behind the curve and having to catch up.”

WHAT IT MEANS: A strong employment number on Friday could cement a Fed rate hike next Wednesday and it looks like that could happen. ADP’s estimate of February private sector job gains was off the charts, or at least well above anyone’s expectations. The rise was led by a surge in construction jobs that was the second largest since the report was first released fifteen years ago. The only time there was a greater increase was at the peak of the home construction boom and we know that is not happening right now. The incredibly warm February weather across much of the nation may have played a major role in this outsized estimate. There was also a huge rise in manufacturing payrolls. That doesn’t seem to be weather driven, but the gain was the third highest in this measure’s history. Why the sudden surge in hiring, especially given the shortage of workers, is unclear.   It raises questions about whether this is the start of a greater hiring trend or just a seasonal adjustment anomaly. Regardless, it is really nice to see.

Another reason that I am cautious about the ADP report was the large decline in the number of online ads, as reported by the Conference Board. The level was the lowest in almost five years and every major state reported a drop. There are a number of divergent reasons for the nearly steady decline that has been going on for fifteen months. First, labor demand may simply be slowing, as the economy hasn’t grown particularly robustly. The second is that firms are recognizing that in this labor shortage environment, they cannot fill a lot of the openings so they are cutting back on their advertising. Actually, a combination of the two could be occurring. That would argue for slow job gains. Alternatively, firms may actually be finding workers all those workers they are saying they cannot find and filling the openings. That would argue for strong job increases. We may not know for a few months which explanation reflects reality.

The Labor Department released revised productivity data for the final quarter of 2016 and it was depressing. Productivity increased in 2016 by the slowest pace since 2011. It is hard to grow rapidly, especially with businesses having so much trouble finding “qualified” workers, if firms cannot get a lot more out of current workers. Indeed, if we do get a surge in payrolls this quarter, as the other data imply, productivity will likely start of the year on a down note.

MARKETS AND FED POLICY IMPLICATIONS: Friday we will get the February payroll and unemployment government data and they should be good. Every once in a while, ADP and the Labor Department differ significantly in their estimates of private job gains, so it is unclear how big a number we will get. But if the employment increase exceeds 200,000 and wages rise solidly, as expected, a Fed rate hike should be assumed. I never say “done deal” when it comes to the Fed, but a strong report would get us pretty close to one. And it would reinforce the warning that I have been making that rates could rise faster and go higher than the markets currently anticipate.

I am headed out on my annual father/son Phillies spring training trip, so I will not be around for what may be a fun morning on Friday. Buckle up, everyone. The only roller coaster I will be riding will be in Islands of Adventure.

KEY DATA: ISM (Non-Manufacturing): +1.1 points; Activity: +3.3 points; Orders: +2.6 points

IN A NUTSHELL: “With all components of the economy on the rise, the question for the Fed is this: What are you waiting for?”

WHAT IT MEANS: We’re hitting on just about all cylinders. Wednesday, the Institute for Supply Management reported that manufacturing activity accelerated in February and today it was announced that the rest of the economy picked up steam as well. Business activity improved, led by rising demand for not only for domestic firms but for those involved in both importing and exporting. The improving world economic situation is helping drive additional sales to other countries. It’s funny how economics works that way. Employment growth was a little faster and is likely to increase more as backlogs are building. About the only negative in the report was a large increase in the percentage that think inventories are too high. Stocks are building and demand will have to remain strong or firms will look to ease up on additional production.

Yesterday, a report was released that should have really opened eyes at the Fed. The weekly unemployment claims number came in at 223,000, the lowest since April 1973. Let me put that in perspective. The labor force back then was 89 million compared to about 160 million today. Adjusting for the size of the labor force, the number of claims would have to currently be 400,000 in order for the two to be comparable. Simply put, this labor market is really tight.

MARKETS AND FED POLICY IMPLICATIONS: Due to calendar oddities and when the labor market data are collected, the employment report was delayed a week. That is actually too bad. There will only be four days between when we get the numbers and when the FOMC starts its two-day meeting. The Fed will not be able to react to the report. It is clear the economy is moving forward and may be picking up steam. Consumer confidence is very high, spending is decent, just about all sectors, including energy, are growing and the Fed’s dual mandate has essentially being met. There is every reason for the FOMC to announce its first rate hike of the year on March 15^th. But what happens if the jobs report is weak? The January job gains were outsized and these data can be pretty volatile, especially in winter months. The Fed should look past one report and probably will, but this has been a group of decision makers who panicked at any sign of economic trouble in the past. That said, the messages being sent by Fed members have all been similar: A rate hike is coming and a half-decent employment report, which is the consensus right now, should be enough. Going into this year, few were predicting a March increase. I had the following meeting, in May. But the general belief was that it wouldn’t happen until June. A March increase creates the possibility that we could have more than the Fed’s implied three rate hikes, especially if the Republicans stop acting like disorganized Democrats and start actually passing something that has to do with the economy – or at least proposing something. As I keep saying, highly stimulative fiscal policy, especially in a labor shortage economy, is likely to cause the Fed to be more aggressive than most people think. Investors seem totally clueless or unconcerned by that possibility.  

KEY DATA: Consumption: +0.2%; Income: +0.3%; Prices: +0.4%/ ISM (Manufacturing): +1.7 points; Orders: +4.7 points

IN A NUTSHELL: “It’s nice that manufacturing is accelerating, but it is worrisome that rising prices are wiping out household income gains.”

WHAT IT MEANS: If the consumer is going to lead the way, and household spending kept the economy afloat last year, then incomes better start growing faster because inflation is on the rise. Consumer spending was solid in January as households bought lots of soft-goods but not a lot of durables or services. Indeed, the only category reporting an increase was nondurables and that was due to increasing prices. Actually, the big story in this report was not the jump in spending but the sharp rise in consumer costs. The acceleration in inflation totally wiped out the rise in consumption and that raises questions about the ability of households to keep holding up the economy. Yes, incomes did increase nicely but spending power declined. We need wages and salaries, which rose moderately, to show bigger gains going forward. For the Fed, its preferred measure of inflation is now just a small tick away from its target. The Personal Consumption Expenditure deflator was up 1.9% over the year.

Manufacturers are going to watch the situation with the consumer carefully. The sector has been recovery very nicely and the Institute for Supply Management’s reported that activity accelerated again in February. This was the sixth consecutive month the headline index rose. Demand was strong, production increased and orders swelled. Hiring is still solid but not quite as strong as it had been.

Separately, the U.S. Census Department reported that construction activity fell in January as a large drop in public sector overcame a moderate rise in the private sector.

MARKETS AND FED POLICY IMPLICATIONS: The Fed is meeting in two weeks and we now have everything in position for a rate hike. The Beige Book summary of economic activity indicated that the labor shortages are getting worse and causing wages in some areas to rise faster. The members will be discussing that when they start the meeting on March 14^th. Adding to the Fed’s concerns is that inflation is now at its target on likely to go through it in the next month or two. So, its two mandates, full employment and stable (i.e., target) inflation are being met. While last night’s presidential address didn’t provide any usable details about policy, it is clear the President is intent on pushing his agenda of tax cuts and spending increases. To whatever extent that happens, growth should accelerate by year’s end. So, the Fed has no reason to stand pat. Yes, rising prices are curtailing consumer spending power, but the labor market tightness offset some of that. More importantly, the Fed knows it has a long way to go before it hits a neutral or long-term rate and it needs to get going on that process before inflation becomes an issue. Will we get a rate hike in two weeks? The members are trying to get the word out that it is now a real possibility. I had been expecting the move at the following meeting in May, but now I think it is a toss up. Regardless, rates are going up and if the expansionary fiscal policy does get passed, look for them to rise faster than the market currently expects. I a sticking with my 100 basis points – one percentage point – increase this year.

KEY DATA: Sales: +3.7%; Over-Year: +5.5%; Prices: +7.5% / Confidence: -2.2 points

IN A NUTSHELL: “Consumers are confident and are buying homes, but builders are not getting their share of that demand.”

WHAT IT MEANS: The economy is solid, consumer confidence is high and growth in the United States and around the world is improving. That is a mess every new president should hope for. Today’s data only add to the belief that while conditions are not booming along, they are accelerating. New home sales rose moderately in January. Still, the level of demand remains less than most builders would like to see. Whereas existing home sales were the highest in a decade, newly built units are still selling at depressed rates. Indeed, sales need to increase between 15% and 20% for the market to be called solid. Looking across the nation, solid gains were seen in all areas except the West. As for prices, they are rose rapidly, though the gains have had their ups and downs. Inventory is also improving, though it is hardly what one would call excessive. There is not a whole lot of speculative building going on.

Consumer confidence has skyrocketed since the election so it was not a great surprise that the University of Michigan’s Consumer Sentiment index eased in February. Household views on current conditions improved but they were more cautious about the future. That also should shock no one. Not surprisingly, Republicans are borderline irrationally euphoric about the future while Democrats are borderline irrationally depressed. That makes clear how the political divide is affecting people’s views on the future economy and possibly spending patterns.

MARKETS AND FED POLICY IMPLICATIONS: The more data we get, the more it is clear that the economy is moving forward solidly. No, we are not going to get 3% growth on an extended basis soon, but we should move back to the 2.25% to 2.50% range that we had seen until the collapse of energy prices shut down the energy sector. It is interesting, though, to see the divide between the new home and existing home sectors. In both places, inventory is low and prices are rising, but the sales pace of newly constructed properties is disappointing. Apparently, the real deals are in existing homes and people are moving in that direction. For construction to rise faster, we need demand to increase, but builders will not put the shovel into the ground unless they have a clear indication the product will move. That is not an easy cycle to break, but it will keep us from revisiting the housing bubble days. We could use a few more homes on the market to spur traffic and ultimately sales. On the consumer front, reality needs to set in. The future is neither a rosy as Republicans think or dark as Democrats believe. But the longer it takes for the replacement of the ACA and for tax cuts and spending increases to be passed, the more concerned households, especially Republicans, will become about the future. This shows how politics could affect economic activity in this highly divided nation. When or if the uncertainty over fiscal policy takes hold in the equity markets is a wholly different question, but for now, optimism reigns.

KEY DATA: Starts: -2.6%; Permits: +4.6%/ Phila. Fed (Manufacturing): +19.7 points; Orders: +12 points/ Claims: +5,000

IN A NUTSHELL: “There is not much to complain about the economy as housing and manufacturing are improving and the labor market remains tight.”

WHAT IT MEANS: We know that inflation is on the rise and while energy is a factor in the acceleration of price gains, it is not the only one. The economy is getting stronger and that has major implications for future inflationary pressures. In January, housing starts edged downward, but that came after an upward revision to the December numbers. Single-family construction rose but the volatile multi-family sector fell sharply. More importantly, the level of construction was 10.5% above the January 2016 pace and 6% above the 2016 average. In other words, builders started off the year in good shape. Permit requests jumped, moving back above starts. That points to greater home construction in the months ahead. Regional activity varied widely. Construction soared in the Northeast and South but cratered in the West and Midwest. Weather matters. The number of home under construction continues to rise, though it would be nice if it increased faster. Inventory remains too low.

The Philadelphia Federal Reserve Bank’s survey of manufacturers rose sharply in February. General business activity soared, helped along by a surge in demand. Only 6% of the respondents said new orders fell, indicating that the improving economy is lifting most boats. Hiring was a little slower than it had been. Firms seem to meeting the new demand by working their current employees longer. That makes sense given the labor shortage. This month’s special question had one result that should open Janet Yellen’s eyes. Manufacturers expect inflation to run at a 3% pace over the next ten years compared to a 2.7% average in the fourth quarter 2016 survey. The FOMC keeps noting that “most survey-based measures of longer-term inflation expectations are little changed”. If inflation expectations are rising, the Fed will have to act sooner rather than later.

Unemployment claims rose last week but remain near historic lows. There just aren’t a lot of people who have skills, are between 21 and 55 and can pass a drug and background check who are sitting at home watching The Price is Right. As a result, firms holding onto their employees tightly. I expect they will start moving part-timers into full-time positions, even if that raises costs. It is better than going without and could reduce turnover and improve productivity.

MARKETS AND FED POLICY IMPLICATIONS: While the economy is in good shape, the administration is not. The chaos is raising questions about the ability to push through significant tax cuts and spending increases. Unless revenue increases are found, the proposals will cause the deficit to soar. The political pressure a $1 trillion deficit forecast would put on the Republicans would be hard enough to deal with without political problems. With those issues, action could be either pushed into later this year or only showpieces would be passed. That would not be good news to all those investors who believe that happy days are here again. As for the Fed, the unmooring of inflation expectations that we saw in the Philadelphia Fed survey is a clear warning that the days of doing nothing are over. A large increase in both jobs and wages in the February employment report could put the March FOMC meeting into play. At the minimum, it would support my view that the next hike could come in May. Hey bond market people, are you looking at the inflation numbers?