All posts by joel

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July Consumer Price Index and Real Earnings

KEY DATA: CPI: +0.1%; Excluding Food and Energy: +0.1%/ Real Hourly Earnings (Monthly): 0.1%; Real Weekly Earnings (Monthly): +0.4%

IN A NUTSHELL: “The Fed has to decide if modest inflation is good enough.”

WHAT IT MEANS: The slow water torture the Fed is putting us through continues unabated and it would be nice if the economic data helped stop the pain. No chance. The Fed has a dual mandate and while the economy is good enough to raise rates, inflation remains well below target levels. Today’s July Consumer Price Index report does nothing to change that picture. Prices rose minimally and that included energy and food. That is, you can exclude energy or food and energy, and there was just a modest rise in consumer costs. Interestingly, the Bureau of Labor Statistic has gasoline prices rising solidly in July but the Energy Information Agency has gasoline costs down a touch. What the government’s left hand is posting has little to do what the right hand is presenting. Regardless, there remains a clear demarcation between goods inflation and services inflation. Since July 2014, commodity prices, which are about 38% of the index, were down 3%. Energy commodity costs dropped over 22% over the year. Meanwhile, the services component, the larger portion of the index, was up 2.2%. Shelter, especially rent, is rising sharply. As for the specific categories, medical care costs, both services and commodities, is rising faster than most other areas. Food price pressures are increasing and it is not just eggs. New vehicle prices are up but used are down. The high demand for new vehicles is putting a lot of used vehicles on the market. Clothing prices rose in July, but that was probably an aberration as they are down over the year. Basically, consumer price pressures exist, but they are not great and are concentrated in services, where there is less volatility than in the commodities segment.

With prices up modestly but hourly and weekly earnings up more solidly, real earnings rose. Workers are seeing gains in pay, but more of it is coming from longer hours worked rather than higher hourly wages.

MARKETS AND FED POLICY IMPLICATIONS: The battle between the Fed’s growth mandate and the inflation mandate continues unabated. Under normal circumstances, the Fed would simply wait until inflation starts approaching its target rate before raising rates. But this is not a normal situation. Rates are well below “normal” levels and it is no longer clear that the low level of rates is doing more good than harm. The argument du jour against a rate hike, which is likely to be just ¼ percentage point, is that it would cause the dollar to skyrocket, killing tourism and wrecking the junk bond market. Huh? I guess since people have thrown just about everything else against the wall, those worried that a Fed mini-move would cause the world as we know it to collapse, have to come up with even more bizarre rationalizations to argue against a rate hike. All these excuses are the best arguments to raise rates. Perceptions of what are high rates have been so totally warped that the Fed is playing catch up. It’s time to act, if only to bring some semblance of normalcy back into the fixed income markets.

Economic Indicators

July Housing Starts and Permits

KEY DATA: Starts: +0.2%; 1-Family: +12.8%; Multi-Family: -17%; Permits: -16.3%; 1-Family: -1.9%; Multi-Family: -31.8%

IN A NUTSHELL: “Housing continues to steadily improve, reinforcing the view that the economy is in good shape.”

WHAT IT MEANS: The housing market is a leading light of the economy and it looks like that will be the case for a while. Home construction edged up in July to a level not seen since the fall of 2007. Single-family activity also returned to late 2007 levels. While those may not be quite where we would like them to be, the steady progress in a sign that this housing recovery is not being hyped by artificial factors. There was a major fall-off in multi-family construction but this is a very volatile segment of the market. Looking forward, the rise in starts should be sustained, though don’t look for a huge increase. Permit requests tanked in July but that came after a spike in June. Over the past three months, permit requests have been running over 6% faster than starts, so even with the July decline in permit purchases, builders have to get going if they are to use up all the permits they have stashed away.

Adding to the expectation that housing will add to growth in the future was yesterday’s report by the National Association of Homebuilders that their index of builder optimism hit its highest level since November 2005. Builders are confident about the future and they are backing that up by actually doing what they are supposed to do: Build!

MARKETS AND FED POLICY IMPLICATIONS: For the most part, the recent data have been pointing to solid growth this quarter. Yes, yesterday’s Empire State Manufacturing Index did tank, but it is hard to understand how confidence could rise but activity collapse. We have had some bizarre moves in the confidence reports lately and I am not sure why. Consumer optimism tanked in July, if you believe the Conference Board, but why people suddenly started feeling sullen is anyone’s guess. Some regional manufacturing indices fell, yet industrial production surged. So you tell me what is going on with that data and we will both know. My take is the economy is moving forward solidly. We may not get two growth rates above 4% as we did last year, but second half growth should exceed 3%. That would mean solid job gains and decline in the unemployment to 5% or less by the end of the year. In other words, the economic numbers should support a Fed rate hike. The FOMC is not likely to change its timing because of the strong dollar. Yes, every company that reports weak earnings is blaming the dollar, but that is a foreign earnings issue, not a domestic economic problem. There is no reason to change policy because of a currency translation issue. Once we get the August jobs report, the Fed members will have to get serious with their signals about a September rate hike. As for the markets, oil prices and the dollar, rather than fundamental economic data, seem to be driving daily action. But over the remainder of the year, investors should not fear the Fed. A rate hike would signal that even this group of worrywarts thinks the economy is in good shape and that would send a strong, positive message. But as I like to say, markets are efficient but not necessarily rational.

Economic Indicators

July Industrial Production and Producer Prices

KEY DATA: IP: +0.6%; Manufacturing: +0.8%/ PPI: +0.2%; Goods: -0.1%; Services: +0.4%; Excluding Energy: +0.3%

IN A NUTSHELL: “With the vehicle makers leading the way, the manufacturing sector is ramping up even as costs are moderating.”

WHAT IT MEANS: Despite some decent consumer spending, the manufacturing sector had been lagging. Not anymore. Industrial production soared in July as the vehicle sector decided to start ramping up output to meet the high sales pace. Assembly rates jumped by nearly 16%, to its highest level in over 35 years. But it wasn’t just automakers who saw the need to increase output: Eight of the eleven durable goods sectors and six of the eight nondurables posted gains. Whether it was business equipment, consumer goods, construction supplies or high tech products, the need to run the factory longer and faster was seen. The really weak area, not surprisingly, was petroleum. Clothing production also took a big hit and with the dollar rising, that could continue to be a problem area. Capacity utilization rose sharply, but it is not high by any means.

On the wholesale cost side, prices rose, but less than they did in May and June. The restraining factor was energy and the decline in costs is likely to accelerate given the recent drop in crude prices. Excluding energy, prices rose moderately and taking out food, costs also ticked up, though modestly. Still, even on the goods side, finished consumer goods less food and energy were up a solid 2.9% over the year. That is important to note because the major portion of the cost pressures, to what extent they exist, is coming from services. We forget about this component but it is nearly two-thirds of producer costs. Services expenses rose solidly and no major sector posted a decline. Trade, transportation, warehousing and government services all posted gains. This portion of the economy should provide a base for inflation.

MARKETS AND FED POLICY IMPLICATIONS: It would be nice if the two components of the Fed’s dual mandate were behaving consistently, but that is not happening. If you just look at the domestic economy, everything is hunky-dory (that’s a technical economic term). But on the inflation front, the falling price of petroleum and the rising value of the dollar are putting downward pressure on prices. What will the FOMC consider most important? If we look at their words, the Fed members view low inflation as a medium term issue, not an immediate problem. Thus, they are saying they can be patient, as long as expectations remain stable, which they are. Consequently, we should continue to focus on the real economy and the data imply it is strong enough to absorb a rate hike. Meanwhile, back in the markets, the wild ride is likely to continue until some semblance of order returns to the oil and currency markets. With traders worried about the issue of the day and the earnings number of moment, a longer-term viewpoint of stocks based on economic trends is not likely to dominate behavior.

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July Retail Sales, Import and Export Prices and Weekly Jobless Claims

KEY DATA: Sales: +0.6%; Excluding Vehicles: +0.4%/ Imports: -0.9%; Nonfuel: -0.3%; Exports: -0.2%; Farm: +0.8%/ Claims: +5,000

IN A NUTSHELL: “With consumers spending and the labor market really tight, the only thing that could keep the Fed from raising rates is the weakness in prices.”

WHAT IT MEANS: If all the Fed worried about was the domestic economy, there would be no worries at all. Retail sales were strong in July, led by robust vehicle demand. There were also decent gains for firms that sold furniture, building supplies, health care products, sporting goods, clothing and gasoline. The gasoline sales rise occurred despite a modest price decline, indicating people are driving more. People also ate out more and shopped online heavily. However, electronic and appliance purchases were off and people didn’t do much buying at department stores. So-called “core” sales, which better mirror the GDP consumption number, were up a solid 0.3%. There was also a sharp upward revision to June retail activity. Second quarter consumption looks like it was better than initially believed.

As for the labor market, the rise in unemployment claims was really modest. More importantly, the level remains extremely low, implying that firms are simply not laying off workers.

While the economy and labor markets are strong, the Fed’s other mandate, inflation, looks like it is not going in the right direction. It may seem strange that the Fed wants higher inflation, but that is because it is well below its target. The July import price report indicates inflation pressures are limited. Declining energy costs played a role in the fall in import costs but there was also a drop in consumer and capital goods prices. Vehicle costs were stable. Export prices fell, but the reeling farm sector was able to push through some price increases.

MARKETS AND FED POLICY IMPLICATIONS: The economy is strong enough to absorb a rate hike, especially since the increase is expected to be modest. Why anyone thinks a quarter point rise in short-term interest rates would hurt the economy is beyond my understanding. But there is inflation, which the Fed continues to argue will get back to normal rates over the next year or two. The Chinese currency devaluation should put downward pressure on prices. Let’s face it, the Chinese want to dump cheap goods onto the U.S. market to keep their economy from failing. The U.S. consumer is the target in this trade war. It is uncertain, though, who is hurt by the Chinese actions. U.S. consumers get lower cost goods but that might displace goods made in either the U.S. or other countries. To the extent that the Chinese action hurts other countries that export to the U.S., those countries will depreciate their currencies so they can remain competitive. But domestic firms cannot change their currency so there is a possibility of slower U.S. growth. Will the Fed put off raising rates because the Chinese action may lower inflation? I said this before and I will say it again: If the Fed doesn’t hike rates because the dollar may rise in value because of currency manipulation, the message sent is that the Fed can also be manipulated.

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June Job Openings and Labor Turnover

KEY DATA: Openings: -108,000; Hires: +117,000; Quits: +18,000

IN A NUTSHELL: “Hiring is improving and that is cutting into job openings.

WHAT IT MEANS: The JOLTS report is one of the most closely watched releases that we get each month as it provides insights into the availability of positions and the willingness of firms to fill those openings. In June, firms picked up the pace of hiring, which is good news. Indeed, there was a 7.4% rise over the year, which is robust. That pace was rarely seen in the last expansion and is a clear indication the labor market is solid. With payroll gains improving, the number of job openings eased. Smoothing the monthly ups and downs out, though, the second quarter level of job openings remained at record highs. Firms may be eating into their open job requisitions a little, but they have a long way to go. The one negative in the report was the modest rise in the number of people quitting. The level remains well below what we saw in the 2000s and we will not be able to say that the labor market is in good shape until people feel comfortable to simply tell their employers to take their jobs and you know what. We are not there yet.

MARKETS AND FED POLICY IMPLICATIONS: The labor market is in very good shape. Yes, the monthly job gains have been less than they were last year but they are still strong enough to keep the unemployment rate coming down. The JOLTS data raise some questions about the monthly job gain slowdown. Is it due to a moderation in demand or supply? Think about the housing market. Few debate the idea that a dearth of inventory is keeping home sales depressed. If you cannot find the right home, you don’t buy. But when you do find it, you have to pay the price or risk losing the home. Well, why don’t people think the same thing should be going on in the labor market? The low unemployment rate is making it difficult to dip into the shrinking “reserve army of the unemployed and underemployed”. But just like homebuyers who refuse to pay more for the home they like – and thus lose the homes – employers who refuse to pay up for workers are not getting the workers they need. Very simply, firms are behaving as if there isn’t a labor supply curve, just a labor demand curve. If you keep wages below the market-clearing wage by refusing to increase compensation, in a growing economy, demand will exceed supply. That is precisely what is going on in the labor market right now. Firms say they cannot find qualified workers but they will not pay up to attract qualified workers. The result: Slower job gains and modest wage increases. Interestingly – and in contrast to traditional economic thinking – higher wages could induce workers who are skilled and willing to move, to actually move! That would allow for a more dynamic labor market where people move up the ladder, creating openings for people at all skill levels. In other words, if wages increase faster, job gains could accelerate! Extending this logic to the housing market, higher home prices could induce more homeowners to list their homes, especially those with minimal equity, expanding inventory and increasing sales. When it comes to markets, if you don’t think about both supply and demand, you don’t get the analysis right.

Economic Indicators

Second Quarter Employment Cost Index

KEY DATA: Compensation: +0.2%; Private Sector: 0%; Private Sector Wages and Salaries: +0.2%; Private Sector Benefits: -0.2%

IN A NUTSHELL: “The labor market may be tightening but that has yet to help generate greater gains in compensation.”

WHAT IT MEANS: As the unemployment rate approaches the bottom range of the Fed’s estimate for full employment, you would expect to see wages start increasing faster. When a number of large companies announce that in the beginning of April they will raise their minimum wage, you would expect to see wage and salary growth accelerate. When job openings hit record highs and jobless claims reach record lows, you would expect to see businesses doing whatever they could to retain workers. Well, if you expected any or all of those things, you would have been wrong. Apparently, the labor market crashed in the spring as employment costs rose at the slowest pace since the Bureau of Labor Statistics started producing these numbers thirty-three years ago. Yes, even in the depths of the Great Recession, compensation didn’t increase more slowly. If you are guessing that I think the report may have been a little off, you would be correct.

Enough for the sarcasm, or maybe the attempt to put the data into perspective. So, what were the numbers? Basically, private sector firms not only held the line on compensation, but also managed to roll back benefits. The private sector wage increase was the smallest on record while the decline in benefits was only the second time that has happened. The public sector increases were generally in line with what we had been seeing for a while, so the slowdown in worker income gains came entirely from businesses using their market power to keep workers in line. Okay, there’s the sarcasm again. My apologies.

MARKETS AND FED POLICY IMPLICATIONS: I really like the Employment Cost Index report as it takes into account a much wider range of data than the hourly wage number we get in the employment report. That is why I am so surprised that with all indications that firms are doing what they can to hang onto workers and attract new ones, we would see the weakest compensation gains in over thirty years. Part of that may have been some outsized bonuses in the first quarter, but that also is not clear from the personal income numbers. So, I am at a loss to explain what happened. Will the Fed members worry about this? I am not sure. Sometimes data are just strange and this is one of those cases. But a stronger increase in compensation would have made it a lot easier to defend a rate hike in September. The weak rise gives ammunition to those who argue that the FOMC can wait a little longer before taking action.

Economic Indicators

Second Quarter GDP and Weekly Jobless Claims

KEY DATA: GDP: +2.3%; Consumption: +2.9%; Investment: -0.6%; Private Domestic Demand: +2.5%; Consumer Inflation: +2.2%; Excluding Food and Energy: +1.8%/ Jobless Claims: +12,000

IN A NUTSHELL: “Moderate growth and a slight firming in inflation don’t provide either side of the rate-hike debate with much ammunition.”

WHAT IT MEANS: Yesterday, the Fed hinted, slightly, at a bias toward raising rates in September, but they didn’t send a particularly strong message. One of the reasons is that the economy continues to grow at a moderate pace. Second quarter GDP came in a little less than expectations. Keep in mind, the Bureau of Economic Analysis, which crunches the numbers, completed the first round of a massive revision of growth and the way the data are seasonally adjusted. The first quarter of this year, which looked like it contracted by 0.2%, is now seen as having grown by 0.6%. So we started the year out above where we thought, which makes the gain a little better – though nothing spectacular. Second quarter growth was powered by strong vehicle demand. But households bought nondurable goods and spent a fair amount on services. In contrast, business investment declined. Much of that came from a drop in equipment spending, which is probably the oil-patch retrenchment. Housing added nicely to growth, the trade deficit helped as it narrowed a little and inventories played a modest role in slowing activity. The federal government continues to do whatever it can to kill the economy but at least state and local governments are spending again. There was a new measure created that reflects private domestic demand as it excludes trade, inventories and government spending. It rose solidly. This will be watched closely as it relates to what is happening in the domestic economy. On the inflation front, the Personal Consumption Expenditures price index rose at an annualized pace that should make the Fed members happy. Even excluding food and energy, it was near the Fed’s target.   Now it just has to keep that up.

Jobless claims rose last week but the level and 4-week moving average remain at historic lows when adjusted for the size of the labor force. The July employment report, which comes out at the end of next week, should be pretty good.

MARKETS AND FED POLICY IMPLICATIONS: The economy is not booming along. But that doesn’t mean it is soft either. It is growing fast enough to keep job gains at a level so that the unemployment rate will continue declining. Going forward, while it is not likely that spending on vehicles will be as strong as it was in the spring, stability in the oil patch should lead to a pick up in business investment. My expectation is that we should see growth at or even in excess of 3% over the next two quarters – but we don’t have any proof of that yet. For the Fed, the key numbers may be private domestic demand, which is growing solidly, and consumer inflation, which is slowly accelerating. Everything considered, this report really doesn’t add much to the argument over whether the Fed should hike sooner or later. Data over the next two months retain their primary position in the decision process.

Economic Indicators

June Leading Indicators and Weekly Jobless Claims

KEY DATA: LEI: +0.6%/ Claims: -26,000

IN A NUTSHELL: “With jobless claims hitting the lowest level in over forty-one years and indicators of future growth soaring, we are seeing clear signs that the economy is in really good shape.”

WHAT IT MEANS: Next week we get the first reading of second quarter GDP growth and whatever the level may be, it is only the starting point for what looks like accelerating economic growth. The Conference Board’s Leading Economic Indicators Index jumped once again in June. This makes three consecutive months of large gains and the index is clearly pointing to an economy that is picking up steam. The moderate rise in current economic indicator shows that the expansion was decent but not spectacular in the spring. But if the economy is building off of those gains, then the summer could be really strong. Indeed, with the housing market starting to soar, we should expect growth this quarter to be really good, possibly above 4%.

Another reason I am forecasting robust economic activity for the rest of the year is that the labor market is really tightening. Weekly jobless claims hit their lowest level since November 1973. Keep in mind, the labor force was only about 58% of what it is now, so we are looking at historically low numbers. One week’s jobless claims numbers shouldn’t be over-valued, but the rise we had seen over the past few weeks looks like it was temporary or just a seasonal adjustment issue. It is awfully hard to seasonally adjust data on a weekly basis, which is why I always argue that we should watch the four-week moving average. That remains at a pretty low level and points to a pretty good July jobs report. Keep in mind, the number of jobs “created” is really a net number. It is the difference between new hires plus new companies creating new positions minus the total of job losses, which includes terminations, retirements and company shut downs. If terminations are low, the net is high, everything being equal. That is why we follow jobless claims and translate the level into job gains.

MARKETS AND FED POLICY IMPLICATIONS: The next two weeks should be telling for the Fed. Yes, they meet next Tuesday and Wednesday, but if the members really are data driven, then second quarter GDP and employment costs, as well as the July payroll and unemployment data should be critical to any decision to raise rates in September. Next week, the FOMC, which hates to take any firm stand, will likely send a strong signal that it is getting ready to move but temporize by wanting to see additional solid job, income and inflation data. They should have it by the end of August and the members will have enough time to give enough speeches to make it clear a hike is coming. Meanwhile, investors are probably more worried about earnings than the Fed, but if they are, then they have lost their way. Earnings look backward while some of the data are telling us about what will happen. If my forecast is anywhere close to being right, firms that are domestically focused should do well going forward and isn’t that what investors should be concerned about?

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June Existing Home Sales

KEY DATA: Sales: +3.2%; Prices: +6.5%

IN A NUTSHELL: “Dear Janet: The housing and labor markets are in great shape, so what are you waiting for? Your friend. –Joel”

WHAT IT MEANS: Well, so much for issues with the housing market. Yes, conditions weakened early this year but are there any doubts left that the problems were weather related? I don’t think so. Housing starts and permits jumped in June and existing home sales did the same. The National Association of Realtors reported that home sales hit its highest annualized rate since early 2007. All parts of the country took part in the party. Since June, demand is up by nearly 10%, with every region posting an increase of 7% or more over the year.   While sales are rising, inventories are barely budging and that mismatch is having the expected impact: Prices are soaring. Indeed, the median cost of an existing home hit its highest level on record. And with mortgage applications up solidly over the year, it looks like the housing market surge will be sustained.

MARKETS AND FED POLICY IMPLICATIONS: The FOMC meets next Tuesday and Wednesday and while there is almost no chance (I never say never when it comes to the Fed) that a rate hike will be announced, that doesn’t mean some serious signals that the Fed will finally pull the trigger will not be sent. We do get two more jobs reports and the second quarter GDP numbers before the September 16-17 meeting, so there is still some uncertainty about a move, but the odds of an increase continue to rise. If we see payroll increases in the 225,000 to 250,000 range in July and August, even just one downtick in the unemployment rate and any acceleration in wages, it will be hard for the Fed to say they need to see more good news. What would they be waiting for? Not a recovery in housing. That is here and indeed the issue is rising prices, not weak demand. Consumer spending? If wages keep rising, can retail spending be far behind? We may not have robust growth, but it is clearly solid enough to absorb a rise in short-term rates from 0% to 0.25%. I mean, seriously people, would that really crash the economy? A rate hike in September looks more and more likely.

Economic Indicators

June Consumer Prices, Housing Starts and Real Earnings

KEY DATA: CPI: +0.3%; Excluding Food and Energy: +0.2%/ Starts: +9.8%; Permits: +7.4%/ Earnings: -0.4%

IN A NUTSHELL: “With housing accelerating and inflation edging upward, the barriers to a Fed hike are starting to crumble.”

WHAT IT MEANS: With Greece on the back burner for now, we can focus on the U.S. economy again and the data seem to be trending upward. The residential sector looks like it really is on the move as housing starts jumped in June. Yes, there was a major decline in May, but the wild swings were due to outsized changes in the ever-volatile multi-family segment. Comparing second quarter starts to first quarter numbers, the monthly average rose 17% – not annualized. In other words, residential investment should be up big-time in the second quarter GDP report that comes out July 30th.   The increases were unevenly distributed across the nation. The lagging Northeast is finally coming around and the South is really strong. But the Midwest seems to be fading while in the West, construction is still solid but not moving forward. The best news was that permit requests were off the charts. Second quarter permits ran nearly 9% above starts and that points to even strong construction in the months to come.

The economy is one part of the Fed’s decision function; Inflation is a second segment. Consumer prices rose moderately in June, led by another jump in gasoline costs. But it wasn’t’ just fuel or eggs. Most other major components were up as only used vehicles and clothing posted declines. Excluding food and energy, prices rose by 1.8% over the year, not far from the Fed’s target. Over the last five months, overall consumer inflation has been running at a nearly 3% annualized pace. That should reduce concerns about too low inflation. When the energy price collapse comes out of the year-over-year comparisons in the fall, overall inflation should approach the Fed’s target. That is why Fed Chair Yellen keeps pointing to the medium term when it comes to inflation.

The modest acceleration in inflation may make the Fed’s decision easier, but it hurts workers. Real earnings fell in June. Flat wages and rising prices don’t make for a good combination when it comes to purchasing power.

MARKETS AND FED POLICY IMPLICATIONS: “Could it be? Yes it could. Something’s coming, something good (?). If (you) can wait.” The wait for the first rate hike may not be that much longer. As the data come in, it seems the only soft spot in the economy is the manufacturing sector. And with prices beginning to move toward the Fed’s target, the concerns about raising rates should be fading. Is the economy strong enough to absorb a rate hike? Let me ask it this way: Would a 25 basis point increase really make the cost of money prohibitive? Hardly. The July FOMC meeting is likely to contain a real battle over how much to hint at a rate hike. The Fed Chair seems to want to get it over with as reasonably soon as possible. But others are holding out as the data are not overwhelmingly strongly. Investors really should start building in a hike and jettison their “when I see it I will believe it” attitude.