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April Housing Starts, May Philadelphia Fed Manufacturing Survey and Weekly Jobless Claims

KEY DATA: Starts: +5.7%; 1-Family: +6.2% Permits: +0.6%; 1-Family: -4.2%/ Phil. Fed: +8.1 points; Orders: -4.7 points/ Claims: -16,000

IN A NUTSHELL:  “The housing market is coming back a little, another sign the economy continues to expand at a decent pace.”

WHAT IT MEANS:  If you believe the bond market, where rates have been plummeting, you would think that the economy is in deep trouble.  But that is just not the case.  Housing starts rebounded in April, which really should not have surprised anyone.  The levels we had been seeing over the previous two months were way below where they should have been.  Why do I say that?  Because permit requests, which also rose, had been and still are running above the level of actual construction.  That had to change and there still is more to come.  For the past three months, permits have averaged nine percent more than starts, which means there is a backlog of construction that will likely be filled in the next few months.  In April, construction activity showed what was likely the effects of weather.  Starts skyrocketed by 85% in the Northeast and by 42% in the Midwest, but fell by roughly 5.5% in both the South and the West.  Wet weather may play havoc with activity in May, so any result should be viewed accordingly.  One issue for the economy that comes out of this report is that the number of homes under construction declined for the third consecutive month.  Building activity is what really matters for economic growth and right now, that is softening.

On the manufacturing front, conditions there may be firming a little as well.  The Philadelphia Fed’s survey of regional manufacturing activity jumped in early May.  Keep in mind, this measure is wildly volatile, so the surge we saw was not really out of the ordinary.  Indeed, the details don’t consistently argue that conditions are improving significantly.  For example, while employment improved a touch, new orders expanded at a less rapid pace.  Looked forward, expectations were largely the same, though firms are thinking that hiring may pick up.  As for inflation, which was in the special question section, firms say their prices may rise a little less than had been thinking in February, but that overall consumer inflation would run a little hotter. 

Jobless claims declined back to more typical, at least for this tight labor market, last week.   MARKETS AND FED POLICY IMPLICATIONS:  In a normal world, where it is all about the economy, concerns should be minimal.  However, this is not a normal world.  Fighting a full-fledged trade war with China and a shooting war with Iran at the same time should be enough to unnerve investors.  But it appears as if many don’t believe that will be the situation.  How else can you explain the cratering and unwinding of that decline that has occurred over the past week?  Maybe investors are starting to understand they are mere puppets and the strings are being pulled by the tweeter in chief?  I make that statement not because I think those risks are not real; I believe they are.  But at some point, you have to start seeing it to believe it.  And then you have to determine the extent to which the economy will be harmed.  Right now, it is all fear and little analysis, so expect volatility to hold sway. As for the Fed, the uncertainty plays right into its hands.Why do anything until you know what direction policy will take us?  The difficulty, though, is that economic data tend to tell us what happened or is happening, not necessarily what will happen.  Being data dependent in an uncertain world where the data – and the markets – can be whipped around is an awfully risky approach to take.

April Consumer Prices and Real Earnings

KEY DATA: CPI: +0.3%; Ex-Food and Energy: +0.1%; Food: -0.1%; Energy: +2.9%/ Real Hourly Earnings: -0.1%; Over-Year: +1.2%

IN A NUTSHELL:  “Inflation is neither too hot nor too cold, but for the Fed, it is hardly just right.”

WHAT IT MEANS:  Normally, news about inflation would take center stage and it should.  So let’s keep it there, even though there are now higher tariffs on Chinese imports.  Consumer prices rose solidly in April, but much of the gain came from a surge in energy costs.  Meanwhile, food prices dipped.  Netting out those two volatile sectors, prices rose modestly for the third consecutive month.  Over the year, both headline and core prices were up about two percent, so the Fed’s target has been reached, at least for this measure.  The details of the report were a bit odd.  Clothing prices cratered again, but there was a change in the data collection process, so maybe we should also exclude clothing.  And there was a large drop in used vehicle costs, but it is unclear why that is happening given all the vehicles coming off of lease.  Maybe we should exclude that too.  And while I am at it…  Okay, just kidding around.   Not really.  There is a serious point in saying we should exclude most components.  The Fed claims there are transient factors restraining inflation and we have to determine which ones they are referring to and how much of an impact they are having.  Right now, core – i.e., non-food and energy – prices rose at a less than two percent pace over the past three months.  How long will the Fed wait to see if the impacts are indeed transient?  The one factor that we can agree is not transient is the continued surge in housing costs.  Those should remain high for an extended period.

With prices up solidly but hourly and weekly earnings rising more slowly, real, or inflation-adjusted earnings fell in April.  Consumer spending power has grown about one percent over the year and that is hardly enough to support strong consumption growth. 

MARKETS AND FED POLICY IMPLICATIONS:  Today’s news on inflation may disappear in the uproar about the raising of tariffs on Chinese imports and the threats to broaden them to all Chinese products.  But consumer prices are something that need to be watched.  It’s not that inflation is likely to soar; there is little reason to believe that.  It is that the tariffs are passed through to consumers.  The tariffs affect only a small percentage of the economy, so the pass though of the costs should not raise consumer prices significantly.  But the impacts don’t fall evenly across income groups.  In addition, inflation-adjusted earnings are growing modestly and the combination of higher tariffs and slow spending power does not bode well for consumption going forward.  First quarter household spending was weak and April’s vehicle sales were really soft, so second quarter consumer demand may not be that much better.  Meanwhile, the tariffs only make the Fed’s job more difficult.  They slow growth but may raise inflation enough to keep it near the Fed’s target.  Yet any agreement would unwind those impacts, whipsawing the data.  With no clear idea where the economy and inflation are going, the Fed will likely stay on hold for a long time.   

April Producer Prices, March Trade Deficit and Weekly Jobless Claims

KEY DATA: PPI: +0.2%; Goods: +0.3%; Services: +0.1%/ Deficit: up $0.7 billion; Exports: +1%; Imports: +1.1%/ Claims: -2,000

IN A NUTSHELL:  “It looks like the big bump the economy received from a narrowing trade deficit in the first quarter will disappear in the spring.”

WHAT IT MEANS:  The events swirling around the economy continue to create chaos but economists still have to make sense of the economic data.  Wish me luck.  Let’s start with inflation, since that is the key to Fed behavior.  As long as inflation remains near the target, there is not likely to be any change in rates.  Well, that is likely to be the case.  Wholesale prices rose moderately in April, led by another sharp increase in energy prices.  Offsetting that, though, was a decline in food costs.  As a result, producer goods prices, excluding food and energy, were largely flat.  Since April 2018, business costs are up between 2% and 2.5%, depending upon which special index you look at.  As for the pipeline, there appears to be some pressure building in the cost of food.  Those higher prices tend to be passed through.  Still, given that the path from wholesale to retail prices is not straight and is often a dead end, it is hard to make the case that inflation will accelerate significantly due to rising costs of production.   That is especially true given that the trend in services inflation, which had been leading the way, is down.   

Meanwhile, all is not quiet on the trade front, even before the president made his threat to impose higher tariffs on Chinese imports.  The trade deficit widened somewhat modestly in March, in line with what would have been expected given the data in the GDP report. But while I don’t expect a major revision to the trade numbers for the first quarter, it looks like the narrowing we saw has largely disappeared.  At least in March, the numbers were actually heartening, despite the widening.  Both exports and imports rose, which is what should happen when the economy is strong and the rest of the world is growing.  On the export side, the soybean farmers were back in the market, as sales surged.  But that could change quickly if the tariffs are imposed.  Energy exports were also up.  On the other hand, aircraft exports cratered. As for imports, higher prices and growing demand led to a rise in demand petroleum-related productsIndeed, imports of just about everything else rose, the major exceptions being cell phones and televisions. 

Jobless claims remained slightly elevated, but there are few signs the labor market is weakening.    MARKETS AND FED POLICY IMPLICATIONS:The latest research makes it clear that consumers are paying the cost of the tariffs.  But the volume of goods being taxed is small given the size of the economy, so there is little pressure on prices.  That is likely to be the case if the tariffs in Chinese products are raised.  But the threats, their imposition, their relaxation, new threats and on and on just makes it impossible to determine where the trade deficit is going.  Clearly, given sufficient lead-time, firms will expand imports in the months before the tariffs are imposed and lower them afterward.  Just the threats change patterns.  With companies now making decisions on what to order for the holiday shopping season, the uncertainty over when and how much to order is heightened. If new tariffs do come on, as is likely to be the case, then firms could hesitate importing goods, hoping that the tariffs will be rescinded.  On the export side, the Chinese will be true to their word and respond in kind. I suspect the farmers are not a very happy bunch.  Since trade flows have been modified by politics, it is necessary to look at growth excluding this crucial sector.Trade added one full percentage point to growth and could add nothing or even subtract from growth this quarter.   That could help create an artificially low growth rate in the second quarter, just as it created an artificially high number in the second quarter.  As for inflation, there is no reason to think it will accelerate or decelerate, which is good news for the Fed.  Finally, while today’s data are important, the trade threats matter and until some of the fog of trade war lifts, uncertainty will likely drive investment decisions.  And that is rarely good for the markets.

March Retail Sales, Leading Indicators and Weekly Jobless Claims

KEY DATA: Sales: +1.6%; Vehicles: +3.1%; Gasoline: +3.5%/ LEI: +0.4%/ Claims: -5,000

IN A NUTSHELL:  “The economy appears to have thrown off some of the winter lethargy and is growing again at a decent pace.”

WHAT IT MEANS:  When in doubt, panic.  At least that seems to be the motto of those who worry about each and every data point released, such as most investors.  Even the Fed, in particular Chair Powell, seemed to have subscribed to that approach.  But as more level-headed economists argued at the end of last year, the market crash made no sense when the fundamentals of the economy were analyzed and now we are seeing that a “wait and see” approach was the right way to go.  Consumer spending rebounded sharply in March led by a jump in vehicle demand.  We need some time to see if the March vehicle sales were just a one-month wonder, but at least purchases didn’t fall off the cliff.  There was also a major increase in gasoline sales, but those were largely price driven.  Still, there was only major component, sporting goods/hobbies/musical instruments, etc. that declined and that was modestly.  Over the year, non-inflation adjusted sales were up 3.6%, a decent gain, though nothing special given the roughly 2% inflation rate.  With consumption rebounding, first quarter growth is likely to come in a little better than expected and it sets up a solid second quarter number.

The Conference Board’s Leading Economic Indicators index jumped in March, led by improving labor markets, expectations and financial markets. The Coincident and Lagging Indices rose modestly.  Still, as the report noted, “the trend in the US LEI continues to moderate, suggesting that growth in the US economy is likely to decelerate toward its long term potential of about 2 percent by year end.”  So, don’t look for robust growth coming anytime soon.

Jobless claims, incredibly, continue to drop.  The level is almost incomprehensible, given the size of the labor force and the dynamism of the economy.  There seems to be almost no turnover.  What makes this so weird is that wage gains have stabilized despite what appears to be a drum-tight labor market.MARKETS AND FED POLICY IMPLICATIONS:The Fed has tried to give itself an out by reiterating that a rebound in growth could make them rethink their stance.  I am not saying growth is so strong that the Fed will actually do that, but it is clearly not so soft as it believed it to be when it suddenly decided it would do nothing this year.  First quarter GDP growth should be in the 2% range but could be higher if inventories increase rapidly.  That would help the first quarter. But if, as believed, those additions to stock were unintended, it would pull down second quarter growth when firms push back orders so they can whittle down their excessive inventories.  That points the need to look at the trend in growth, not just the data on one quarter.  Of course, I raise the point of not giving too much credence to any one number constantly and that warning goes unheeded, but I will keep on trying.  As for investors, they should like today’s reports though a certain report may dominate the discussion.  

March NonManufacturing Activity, Private Sector Jobs and Help Wanted OnLine

KEY DATA: ISM (NonMan.): -3.6 points; Orders: -6.2 points; Employment: +0.7 point/ ADP: +129.000; Manufacturing:  -2,000/ HWOL: -1.6%

IN A NUTSHELL:  “There are more signs the economy is slowing.”

WHAT IT MEANS:  If there is one consistency in the data, it is that they are inconsistent.  We have gotten some good numbers this week, some iffy numbers and some disturbing ones.  Today’s data were somewhat weaker than expected.  Let’s start with the Institute for Supply Management’s NonManufacturing Index.  It came in lower than forecast.  That said, the level is still pretty solid, or at least points to continued moderate growth.  The details were a bit odd.  The overall index fell solidly, business activity and orders crashed, but backlogs and hiring improved.  Those results tend not to say the same thing.  What they seem to be implying is that there is a easing in activity but it is not spread across all segments of the economy.  Indeed, the manufacturing supply managers indicted that conditions were improving.  Conclusion:  Conditions are a lot more mixed than they had been.

With Friday being the day of the March employment report, today’s ADP estimate of private sector job gains was looked toward to provide some insight into the extent of the bounce from the February modest 20,000 payroll rise.  Well, it could be somewhat less than hoped for.  There were some concerns that popped up in this report.  First, the small business segment, which had been hiring quite solidly, appears to be shutting things down.  It is unclear whether that is due to softer demand or a lack of qualified applicants, but regardless, that is a critical component of job growth and right now it is lacking.  The second is the sharp slowing in manufacturing payroll gains.  I don’t know what to make of that as the ISM manufacturing survey pointed to a rebound in manufacturing employment.  I guess we will have to wait a couple of days to find out.

On the jobs front, the Conference Board’s Help Wanted OnLine index fell in March.  This index has become somewhat more volatile than usual and it may be due to temporary factors such as the government shutdown and the weather.  Of course, it could be due to uncertainty over the direction of growth, which would not be a good thing.  But just as the ISM nonmanufacturing index still points to solid growth despite its decline, the HWOL index decline only means that job growth should be good not great.MARKETS AND FED POLICY IMPLICATIONS:So, where is the economy going?  Good question.  The yin and yang of the numbers makes it clear that the year of tax-induced solid growth is over.  But growth is still decent.  Indeed, yesterday’s surprising report that vehicle sales popped in March provides some hope that the slowdown is bottoming.  My first quarter GDP number has been 1.8% for a few months now and I am sticking with that.  But I also expect the second quarter to bounce back up to around 2.5%.  Taken together, that means first half growth will likely come in at about 2.25%, which is where I have growth for the year.  Is that bad?  Not at all – it is trend growth or maybe even a touch higher.It’s just the expectations we will get 3% growth for the next decade were overblown as we will probably see that level (or close to it), for only one year.  That is not even good for government work, but the administration’s economists at the Office of Management and Budget tend to be politically directed.  Instead, we are seeing something closer to the nonpartisan Congressional Budget Office economists’ forecasts, which mirrored the private sector forecasts.  As for Friday, I think we will be in the 160,000 to 175,000-range.  That would put the three month average also in that range, which is where it should be.  That is not so strong or weak that the ad-libbers at the Fed will have to change course again, but it is solid enough to push back at those who want to see rates cut.

March 19-20, 2019 FOMC Meeting

In a Nutshell:  “… the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.”

Decision: Fed funds rate target range remains at 2.25% to 2.50%.

After the January FOMC meeting, I noted that the Fed has decided that it no longer has to do anything, but I also thought it hadn’t declared victory.  Well, they got pretty close to it today.  The Committee made it clear there is not likely to be any rate hikes this year and maybe just one next year.  And, the dreaded balance sheet runoff, which investors believed was sapping the liquidity that bolstered the markets, will start to slow in May and end in September. 

While investors may cheer the interest rate and balance sheet messages, they should not overlook the economic forecast.  The Fed downgraded its outlook for growth this year to just 2.1% and believes it will be no more than 2% in the following two years. 

Of course, that is what most economists would call trend, which means the labor markets will remain tight and wage gains will likely continue accelerating.  Can equity values grow decently under those circumstances?  That is questionable, since productivity appears stuck at a low level, demand is hardly rising, while labor costs are on the rise.  That isn’t a recipe for strong earnings growth.

So, where do we go from here?  Mr. Powell continues to argue that the Fed will watch the data and be patient when it comes to interest rates changes.  But the forecast also indicates the Fed doesn’t think it is at “neutral” yet.  The possible increase next year, in the face of mediocre growth and limited inflation, says the members do want to raise rates at least a little.  How he pivots to that possibility in the face of 2% growth is anyone’s guess.

The takeaway is that short-term interest rates are going nowhere.  Inflation is not likely to accelerate sharply since demand is not expected to surge. Therefore, longer-term rates don’t look to rise significantly.  But watch out for wages.  Their rise may not cause inflation to jump, but could cause earnings growth to falter. 

(The next FOMC meeting is April 30-May 1, 2019.) 

January 29,30, 2019 FOMC Meeting


In a Nutshell:  â€œIn light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate…”

Decision: Fed funds rate target range remains at 2.25% to 2.50%.

The Fed has decided that it no longer has to do anything.  No, it hasn’t declared victory, but it has capitulated to the will of the markets and the reality of a slowing world economy.  The members, and especially Chair Powell, will sharply disagree with that characterization, but basically, the FOMC gave the markets everything it hoped for: No rate hike, a clear indication that conditions would have to change for the Fed to hike rates again and a willingness to slow the normalization of the balance sheet.  All this came after having indicated just four months ago that the Fed was a “long way” from getting to neutral.  Since then there has been exactly one rate hike, which is hardly a long way.

So, what has changed?  First, the tariff/trade war with China has harmed not just Chinese growth but the world economy as well.  Europe is suffering and U.S. economic growth is moderating.  When the three largest economies are in a slowdown, it is time to stop, look and listen.  Then there was the market meltdown.  First, the culprit was the Fed raising rates too much, but that made absolutely no sense.  Rates are still low, unless you think zero interest rates are normal.  Then the Fed’s reduction of the balance sheet was attacked, since it was reducing liquidity.  But the Fed’s balance sheet is still way too large, so that was a red herring.  Basically, investors wanted to blame everyone but themselves for the meltdown and they succeeded in pinning it on the Fed. 

So, where is the Fed now?  First, Mr. Powell, by saying the “case for raising interest rates has weakened somewhat”, basically changed the paradigm.  Now, the Fed has to see there is a reason to hike rates.  Mr. Powell indicated that inflation is likely to be the key.  So, as long as inflation remains well contained, the Fed is on hold.  That should anchor short-term rates at a lower level than expected.

As for the balance sheet, which is more technical but still important, the pace will continue, though it could be changed, and the end point will be a lot higher than expected.  The Fed will likely stop reducing the balance sheet, nicknamed quantitative tightening or QT, about a half trillion dollars above where previously expected.  That is about nine months sooner. 

The markets, not surprisingly, loved the FOMC statement and the Fed Chair’s press conference as they gave investors everything they wanted.  And there is good reason to show caution, as the outcome of the trade situation is still not clear.  But it sure looks like this Fed Chair may believe in a triple not dual mandate: Maximum employment, stable inflation and a solid equity market. 

 (The next FOMC meeting is March 19,20 2019.) 

INDICATOR: January Private Sector Payrolls and December Pending Home Sales


KEY DATA: ADP: 213,000; Construction: 35,000; Manufacturing: 33,000/ Pending Sales (Monthly): -2.2%; Over-Year: -9.8%

IN A NUTSHELL:  “Even in the face of the partial government shutdown, January job gains could be better than expected.”

WHAT IT MEANS:  The broken record that I am keeps saying that the underlying economy remains solid and the issues with the equity markets are not the result Fed tightening or a realistic estimate on when the next recession could start.  So, it’s time to start focusing again on the economic fundamentals and Friday’s jobs report should give us some insight into how businesses reacted to the political absurdities versus the real economy.  If the ADP estimate of January private sector payroll growth, the shutdown may have been much ado about nothing.  The employment services firm’s reading of job gains came in above expectations.  The increases were widespread, with small, medium and large firms adding similar numbers of workers and just about every industrial sector hiring as well.  What is eye opening was the continued outsized jump in manufacturing and construction payrolls.  Together, they make up less than 16% of private payrolls, but the rise in those sectors accounted 32% of the January increase.  That surge is not sustainable.  In addition, firms that fall into the 500 to 999-worker range have also been adding workings at an elevated pace.  The implication is that job gains may remain good, but don’t expect continued large increases in private sector employment

As for the housing market, well things don’t look that good.  The National Association of Realtors reported that pending home sales eased again in December and were off by nearly ten percent from the December 2017 level.  For all of 2018, pending sales were of by 3.5%.  You have to sign contracts to have closings so the consistent drop in pending sales signals future weakness in existing home sales.

MARKETS AND FED POLICY IMPLICATIONS:  Today’s data reinforce the view that businesses are still seeing strong demand and as a result, are hiring more workers.  But there is also growing weakness in the housing market.  The FOMC is finishing off its meeting and we should know the members’ thinking in a little while.  Caution is likely the operative word, though the ADP jobs report, if born out by a solid government number on Friday, would not support that attitude.  The economy is in good shape, for the most part.  What is failing is government policy and that is creating chaos that is hurting the equity markets.  The Fed, in my view, is overreacting to the equity market issues.  But I want to hear what Mr. Powell has to say before making any further comments.   

November Private Sector Jobs, NonManufacturing Activity, Layoffs and October Trade Deficit

KEY DATA: ADP: +179,000/ ISM (NonMan.): +0.4 point; Orders: +1.0 point/ Layoffs: 53,073/ Deficit: $0.9 billion wider

IN A NUTSHELL: “The labor market remains tight and that could be the major reason we see a slowdown in job gains.”

WHAT IT MEANS: Today was a major data dump as a number of releases were held back yesterday due to the national day of mourning. Tomorrow is Employment Friday and the usual Wednesday ADP private sector job report was released today. It showed solid hiring occurred in November, but at a slower pace than had been the case. While middle and large-size firms added to payrolls strongly, small businesses have not been hiring lots of workers. This may be due to their inability to match the higher wages being paid by the larger companies. I suspect the government’s report will mirror this slowdown.

That a lack of workers may be behind any job gain slowdown could be inferred from the latest report on economic activity in the services and construction sectors. The Institute for Supply Management’s NonManufacturing Index rose in November, which was surprising. New orders continue to expand sharply, creating burgeoning order books. That should keep activity strong for an extended period. Despite the growing demand, hiring expanded at a somewhat slower pace. It is not as if firms don’t need the workers, they do. They may be finally hitting the wall that most economists expected to see months ago. It is hard to hire when there are not a lot of workers available.

Despite the strength in the labor market, layoffs have been increasing. Challenger, Gray and Christmas reported that worker cuts have rose sharply this year. The November number jumped by over 50% from the November 2017 total. For the first eleven months of the year, layoff announcements have soared by over 28%. While the economy is strong, not every industry has benefitted and the changing industrial structure has led to a restructuring of worker needs.

Maybe the biggest uncertainty about the economy is trade. Last week, I wrote that I thought the trade deals and announcements were more puff than pastry. It looks like the markets think that is possible. And the widening in the trade deficit in October didn’t help. Adjusting for prices, both exports and imports were down. The trade battles are not adding to growth, at least so far, and it is unclear how they will be beneficial in the long run. Undoubtedly, the Chinese are looking to diversify their supply chains to limit dependence on the U.S. and to open other markets for their goods. That can only lead to reduced exports to China in the future.

 MARKETS AND FED POLICY IMPLICATIONS: The markets are in disarray while the economy remains in good shape. Are investors looking at the wrong thing? Yes and no. To the extent that the uncertain messages being sent about the status of trade negotiations with China are creating fear, there is every good reason to mark down values. That is especially true if you believe, as I do, that values were probably too high to begin with. Little risk was priced into them and the markets may have gotten ahead of themselves. I noted that a few months ago and it looks like that is starting to hit home. But I don’t agree that the Fed’s normalization policy or the potential inversion in the yield curve should be taken as signs the economy is about the crash and burn. If the economy were so strong as so many say, why would an extra 25 or 50 basis points make a major difference? That is the difference between three or four moves next year, which so many say are threatening, and one or two increases, which commentators and business leaders claim are non-threatening. Seriously, you cannot have a robust economy and a fear of an additional half percent increase in rates. The two are inconsistent. I know, consistency is the hobgoblin of little minds, but sometimes you need an argument to hold together. The Fed bashers just don’t have a consistent argument. As for the yield curve (10-year minus two-year) inverting, that is where consistency is foolish. You have to understand why the curve is inverting. In the past, the Fed was always jamming on the breaks. That is, the funds rate was way past neutral. Even if the Fed does raise rates one full percentage point next year, the rate will not be much, if anything, above neutral. The inflation-adjusted fed funds rate has to be significantly higher than it is currently. Indeed, it is still negative, and the curve normally doesn’t invert under these circumstances. If it did, it would not be because the Fed tightened excessively. So, the markets need to look for other scapegoats. I go with the over-valued market theory created by the belief that the tax cuts would produce an extended period of excessively high growth. When you get your economics from politicians, it appears you not only get the economy you deserve but the markets you deserve as well.

October Wholesale Prices and Mid-November Confidence

KEY DATA: PPI: +0.6%; Energy: +2.7%; Food: +1%/ Sentiment: -0.3 point

IN A NUTSHELL: “Despite the surge in producer prices, there are few indications that inflation will accelerate sharply.”

WHAT IT MEANS: Is inflation something the Fed should be concerned with? It doesn’t currently believe so and today’s Producer Price Index increase really doesn’t change things very much. First of all, the large rise was driven by jumps in energy and food. Petroleum costs have hit a downdraft and it isn’t clear that food prices will continue to rise sharply. Also, the change over the year in the index has decelerated over the past few months. That is not say the October report did not contain any potential issues. Transport costs are increasing and with growth strong, they are likely to continue putting pressure on distributors. Construction expenses are skyrocketing. And price pressures in the pipeline are picking up. Add to that rising labor expenses and firms will have to start determining if demand is strong enough to support faster increases in prices. I suspect that is what will happen, so look for consumer prices to begin accelerating slowly over the next few months.

Consumer confidence remains on the moon. That’s not quite Mars, but pretty close. The University of Michigan’s mid-month reading of consumer sentiment fell only modestly in November. Still, the index is on track to record the highest level since 2000. The dot.com bubble hadn’t burst yet and confidence did crater afterward. A similar result occurred when the housing bubble burst. If the economy tails off over the next year, as expected, look for confidence to start deteriorating.

MARKETS AND FED POLICY IMPLICATIONS: The Fed, as expected, made no change in rates yesterday, in part because the members were fairly sanguine about inflation. They noted that “On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.” In other words, the strong growth they see is not threatening. But that doesn’t mean there is no reason to raise rates in December and going forward. Remember, the Fed is simply trying to get back to neutral, which Chair Powell has stated is far from the current level. To the members, as long as there are no deflationary pressures at work, the need to move to neutral will dominate. And also remember that the Fed has a dual, not a triple mandate that would include the stock markets. So if increasing rates has a negative impact on equity prices, so be it, unless it sets off a major stock market correction. Why that would happen with an economy that is as strong as the current one and which is being propelled by massive fiscal stimulus is something I cannot figure out – and something that doesn’t seem to worry the Fed right now. So, look for further rate hikes in 2019, even if growth moderates, which it likely will.