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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

MARKETS AND FED POLICY IMPLICATIONS:   

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

KEY DATA: CPI: -0.1%; Excluding Energy: +0.2%; Gasoline: -7.4%/ Inflation-Adjusted Hourly Earnings: +0.5%; Over Year: 1.1%

IN A NUTSHELL:  â€œInflation continues at a pace that should make the Fed happy, but accelerating wage gains remain a threat.”

WHAT IT MEANS:  While parts of the government’s data mill are shut down, the Bureau of Labor Statistics keeps churning some key numbers.  Consumer Prices declined in December, led, not surprisingly by a sharp drop in energy costs.  Excluding energy, consumer costs rose at a moderate pace.  Over the year, the core index, which excludes food and energy, increased at a 2.2% rate, slightly above the Fed’s 2% target.  Looking at the non-energy components, inflation pressures are building in a number of areas.  Food costs, which had jumped in 2017 but stabilized last year, look like they could be back on the rise.  The drive to eat healthier is becoming much more expensive as fish and seafood costs are jumping.  My biggest concern is that my bellowed cake and cupcake prices are skyrocketing.  Time to diet again.  Eating out is also becoming much more expensive, as is the cost of shelter.  And the flattening in medical costs may be coming to an end.  So, while consumer inflation is not accelerating significantly, there seem to be underlying trends that indicate we could see the rate rise as we go forward.

The tight labor market continues to push up wages, which rose sharply in December.  They jumped by over 3% from the December 2017 level.  With overall consumer costs declining, inflation-adjusted (real) earnings improved quite solidly.  Over the year, they broke back over the 1% level for the first time in over two years.  Since energy prices are rebounding, that may not hold.  Still, when spending power is rising by only 1% and with the savings rate trending downward, it is hard to see how spending can hold up. 

MARKETS AND FED POLICY IMPLICATIONS:  Chairman Powell baffles me.  He talks about the economy as if it is in good shape, but then indicates that continuing the rate normalization process may or may not continue.  Growth is still good and inflation is at or above the Fed’s target.  So, what is his problem?  You can say that the sharp drop in the equity markets is a sign of impending doom, or you can argue as I have that the decline simply corrects for some irrational exuberance.  If the markets are signaling a recession ahead, then slowing or ending the normalization process makes sense.  If the volatility was more emotional as well as a normal correction from excessively optimistic expectations, then it doesn’t make sense to slow the rate hikes.  Since the Fed’s own estimates are for at about 2.3% growth this year, which is above the members’ estimate of trend growth, what is the problem?  As I said, I just don’t get it.  The next FOMC meeting where a hike might occur is not until March 19-20.   Unless the government shut down and the trade war seriously harm growth, I don’t see why an increase shouldn’t happen at that meeting, if the Fed really is basing its decisions on economic data.     

KEY DATA:ISM (NonManufacturing): -3.1 points, Activity: -5.3 points; Orders: +0.2 points/ Employment Trends: +1.38 points

IN A NUTSHELL: “Growth may be moderating but it is hardly slow.”

WHAT IT MEANS: The government’s data mills may not be churning out all the numbers they usually do, shutdowns have a tendency to do that, but the private sector is still providing some important data.  The Institute for Supply Management’s NonManufacturing index dropped in December, but there really is nothing to be alarmed about.  The level of the index is still fairly high. While overall activity in the services and construction sectors has eased, it is not falling apart, as can be seen by the continued strong rise in new orders.  It is hard to make the argument that the economy is about to fall off the cliff if demand is accelerating.  Firms are still hiring solidly, but not robustly, which is also nothing to complain about.  There was just one warning sign in the report: Backlogs have pretty much stopped building.  But they are not falling, so the warning is more yellow than red. 

Was the huge December jobs number an aberration or a sign of things to come?  Well, it is doubtful we will be seeing payroll increases above 300,000 many times, if at all, this year, but we could get some above 200,000.  The Conference Board’s Employment Trends Index popped back up in December after declining in November.  It is pointing to continued solid job gains.

MARKETS AND FED POLICY IMPLICATIONS: While the markets crashed and burned, economists spent their time trying to explain that a recession was not likely to start for another year or more.  Of course, investors didn’t believe that, otherwise why were they selling their stocks? Well, the selling was due to, well, you tell me and we both will know.  There is a moderation in growth occurring,but only those who think unsustainable growth is actually sustainable didn’t understand that.  Solid but not robust growth is just fine. And the reaction to Fed Chair Powell’s comments that the Fed could change course was fascinating.  Keep in mind; he didn’t say to which direction the Fed would tack.  The markets took his words to mean the Fed might not raise rates this year or hike only one time.  But if the economy stays solid and inflation rises, does anyone think the Fed will not hike rates more than most investors now believe?  That would be changing direction, but in the opposite way that the markets now think.  You see, Fed Chairs rarely say anything specific.  They leave their options openand if you read Mr. Powell’s comments, they said nothing specific about raising, lowering or keeping rates constant.  As far as the balance sheet reductions go, the Fed has never done this before, so it has no idea about the impact the changes will have on the economy.  Saying they are flexible about changes is hardly news.  The members like schedules but have always been willing to deviate from them.  But hey, investors wanted to hear something and even if that something wasn’t actually said, they will believe they heard it.  So, if the Fed doesn’t do what the markets want it to do because they thought the Fed had said it would do that, investors have only themselves to blame – which of course they will not.  For me, the economy is growing above trend, which points to at least two and possibly three moves this year. 

KEY DATA: ADP Jobs: +271,000/ ISM (Manufacturing): -5.2 points; Orders: -11 points/ Construction: -0.1%

IN A NUTSHELL: “Job growth may be holding up but there are growing signs that the economy is indeed slowing.”

WHAT IT MEANS: Firms may still be hiring, but it is not clear how long that will last. Tomorrow is Employment Friday and a preview of the number is often, but not always, provided by the ADP estimate of private sector job gains. Well, if you believe the estimate, the number could be huge. Strong growth was reported in all sizes of businesses and across all sectors. There was a huge rise in construction hiring, though it is not clear why given the issues facing the housing sector. The only decline was in natural resources/mining, which was likely due to declining energy prices affecting jobs in that sector.

There were two other labor market-related numbers released. Jobless claims jumped last week, but they have been more volatile than normal lately. The level remains quite low. Challenger, Gray and Christmas reported that layoff notices rose sharply in December from the December 2017 levels and for the year, they were up nearly 29%. These data don’t tell us a lot given that job growth was solid in 2018 and the unemployment rate declined.

While the manufacturing sector joined in the hiring binge in December, activity decelerated sharply. Indeed, the Institute for Supply Management’s index hit its lowest level in two years. Critically, new orders cratered and are now barely expanding. Backlogs, which when rising generally point to expanding production, have stopped increasing. Still, the sector is not collapsing. Production is still growing solidly, those less rapidly as it had been, and hiring remains solid.

Construction spending eased back in November even as government activity jumped. The private sector cut back spending on both residential and nonresidential projects.

MARKETS AND FED POLICY IMPLICATIONS: The day started out well with a robust jobs report but then other numbers started showing up which were not as sanguine about future growth. The so-called “Trump Bump” that was seen in the markets and manufacturing, has been largely wiped out. But that doesn’t mean the economy is headed into recession. The “Trump Slump” seems to be taking us back to more normal growth levels, which we might not even hit until the spring or summer. We seem to be replacing the irrational exuberance of the election and tax cuts with an irrational despondence of a slowing economy. I, as well as most other economists who don’t work for politicians, warned that the tax cut sugar-high would wear off in about a year. Well, we are a year into the tax cuts and not surprisingly, growth is decelerating. Notice, I wrote decelerating not declining. Growth is still decent but the risks have risen. While most focus on the Fed, another fifty basis point increase would not kill the golden goose if it were indeed golden. But a trade war would and it already is causing real concerns. China’s economy is slowing more than even the U.S. economy and when you have the two biggest economies in the world decelerating, it is going to impact world growth. Will we wind up in a recession? Only if the tariff battles continue this year and almost definitely if the threat to impose a 25% tariff on Chinese imports comes true. More likely, we are headed toward moderate, sustainable, Obama-like growth if the trade war dissipates. We are not going to see 3% or greater growth for an extended period. Investors needed to be disabused of the bill of goods they were sold that the economy would expand at 3% for the next decade (per OMB) and it looks like they are in the process of coming to grips with that reality. Unfortunately, when everyone sees the same change at the same time, markets tend to overreact, which also seems to be happening. To me, we are just wiping out the exuberance. The question is, how far will that wipeout go? That is, how much of an overreaction will we get? Stay tuned.

In a Nutshell: “The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity…”

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

Faced with political pressure from the president to stop raising rates and panic on the part of investors who were seeing their massive capital gains disappear, the Fed could have punted. Instead, it decided to continue trying to win the game.

The FOMC, as expected, raised the fed funds target rate by a quarter point. And they had every good reason to do that. Indeed, if you look at the Committee’s description of the economy, there was no change: The economy is strong and inflation is near target. Indeed, in his press conference, Fed Chair Powell indicated there was little reason for the Fed to remain accommodative given its forecast for solid growth next year.

You would think that continued good growth and inflation under control would be good news for the markets. Wrong again. Unfortunately, with the president and the equity-focused commentaries demanding the Fed give up the rate normalization process, investors expected the Fed to announce that there would be no more rate hikes.

However, the Committee indicated that it expects to raise rates two times in 2019, down from the three projected at the September meeting. Only two moves are quite gradual and about as low as the Fed was likely to go. But that doesn’t mean we will get two increases. Last December, the FOMC indicated it expected three moves in 2018. We got four.

So how many rate hikes will there be? This is one of those “it depends” moments. The Fed marked growth down for 2019 but forecast it would still be above, or at worst at trend for the next three years. If we get more moderate growth, yes, we there might be only two increases. But you cannot rule out three if growth is stronger than projected. The tax cut might actually start working. Of course, if a trade war breaks out and the economy tanks, we might not see any at all.

Still, investors were not happy with the two-move projection and markets tanked. As I always say, markets may be efficient but that doesn’t insure they are rational. In this case, the knee jerk reaction made little sense given that the Fed indicated it was optimistic about growth. And as the Chair made it clear in his press conference, pressure, be it political or not, did not and will be a factor in decisions or even in the discussions. It’s all about the economy and the data will decide.

(The next FOMC meeting is January 29,30 2019.)