KEY DATA: Sales: -0.7%; 1-Family: -0.2%; Condos: -4.8%; Prices: +4.5%; 1-Family: 4.6%; Condos: 3.2%

IN A NUTSHELL: “The slowdown in the housing market continues.”

WHAT IT MEANS: The housing market has hit a rough spot. Existing home sales fell in July, the fourth consecutive month that demand was off. The level of home purchases was the lowest in over two years. Condo sales, which had been holding up, joined single-family units in the downward trend. Looking across the country, sales rose nicely in the West but were off sharply in the Northeast and declined modestly in the South and Midwest. As for prices, the rise is also trending downward. Condo price gains are modest, but the single-family price increase was not a whole lot faster. The deceleration in prices is occurring as inventory is finally expanding, even if it edged down a touch in July. Unfortunately, supply is still quite low on an historical basis.

MARKETS AND FED POLICY IMPLICATIONS: Rising prices and increasing mortgage rates, coupled with limited supply, are reducing affordability and slowing home sales. It is hard to believe those limiting factors will change anytime soon. Tomorrow we get new home sales and they were weak in June. Another decline would add to the belief that the housing sector may restrain growth not only in the third quarter but going forward. The markets are setting records as business fundamentals are strong, but investors need to start looking outward. Right now, job gains are solid but income increases are limited and that does not bode well for sustained strong consumer spending growth. There is uncertainty about the impacts of tariffs and how long they will last. Businesses continue to spend most of their tax gains on stock buybacks, dividends and mergers and acquisitions, rather than buildings, machinery, equipment or software. That raises questions about improved productivity. So, the beat goes on in the markets and while the economic fundamentals are solid, it would be nice if we start seeing better wage growth and more money piling into capital spending. The Fed, meanwhile, has to deal with the economic strength and the political pressures coming from presidential tweets. In order to maintain credibility, additional rate hikes and balance sheet reductions are likely.

KEY DATA: Sales: +0.5%; Excluding Vehicles: +0.6%/ IP: +0.1%; Manufacturing: +0.3%/ Productivity: +2.9%; Labor Costs: -0.9%/ NAHB: -1 point

IN A NUTSHELL: “The solid manufacturing sector and continued consumer spending hold out hope that third quarter growth will be good, though maybe not great.”

WHAT IT MEANS: Factors that drive and restrain growth are creating major uncertainties about the economy and even the data are unclear. Consider retail sales, which rose solidly in July. But that came after a sharp downward revision to the June numbers. That raises the possibility second quarter growth could be revised downward as well. The biggest increases were for food, both at home and at restaurants, gasoline and in department stores. Prices are rising in most of those categories. As for department stores, are sales really surging? There were strong online sales, which was not surprising given Amazon’s increase at its Prime Day sale. This was a good report, but it isn’t adjusted for inflation, so it is not clear just how fast consumer spending is growing, especially since vehicle sales were down in July.

One area which continues to do well is manufacturing. Output rose moderately in July after a robust production spurt in June. Rising vehicle assembly rates helped, but given the fall off in demand, that may turn around quickly. Still, most manufacturing sectors posted production gains, so this sector remains solid. Slowdowns in the mining and utility sectors reduced overall output gains.

With growth booming in the second quarter, it should not have been a surprise that productivity jumped by the fastest pace in over three years. Manufacturing productivity gains remain somewhat sluggish. While production surged, hourly compensation lagged well behind and that led to a sharp decline in labor costs. At least in part, the strong profit gains reflected those cost controls. Unless more of those profits find their way into compensation, the solid retail sales numbers may not be sustainable.

Homebuilders are not a happy bunch these days. Interest rates and input costs are rising while demand is moderating. Thus, the decline in the National Home Builders Associations index was expected. The level is the lowest in a year and is a warning that this component of the economy may continue to restrain growth.

MARKETS AND FED POLICY IMPLICATIONS: The problems in Turkey are the focus of attention right now and rightfully so. We just don’t know how long the crisis will go and what kind of contagion effect will be created. This uncertainty is causing some rush to safety. Meanwhile, back in the United States, the economy may be moderating, but not faltering. Still, the president’s economists at the Office of Management and Budget just downgraded growth for this year and Congress’s economists at the Congressional Budget Office recently projected a sharp moderation in growth next year and a further slowdown in 2020. The CBO’s forecast is very much in line with most private sector forecasts. At the same time, most inflation forecasts are for the rate to exceed the Fed’s target of 2% for a number of years, though not significantly. But it takes the slowing growth to keep inflation from getting even hotter. The Fed continues to face an economy that has strong growth, rising prices but economic uncertainties, especially when the trade situation is factored in. Unless Turkey unexpectedly creates major economic and financial problems, there will be time to slow rate hikes down next year, so two more rate hikes remain the likely course of action.

KEY DATA: Imports: 0%; Nonfuel: -0.3%; Exports: -0.5%; Farm: -5.3%/ NFIB: +0.7 point

IN A NUTSHELL: “The strong dollar is helping keep import costs down, though it improves the competitiveness of foreign companies.”

WHAT IT MEANS: The dollar has been rising sharply, increasing about eight percent since its bottom early in the year. That is now showing up in softer import prices, which were flat in July despite a rebound in energy costs. Imported food prices were down solidly, as were capital goods and vehicle prices. Consumer durable good costs were up, possibly because of sharp increases in the prices of goods from Canada and Asia that have been subjected to tariffs. We can also see the impact of the trade skirmishes on export prices. Agricultural products suffered a huge drop in prices, as they are the targets of foreign tariffs and are starting to lose markets.

While the trade war may be battering some industries, small businesses seem to be as happy as they have ever been. The National Federation of Independent Business’s Index jumped in July to its second highest level on record. The record was set in July 1983, thirty-five years ago, which says a lot. Small business owners are hiring and looking for more workers, though the inability to find qualified workers remains a major problem. The confidence of small business owners can also be seen in the rise in the plans for capital spending.

MARKETS AND FED POLICY IMPLICATIONS: The economic expansion has reached into the small business sector, which now may be the most optimistic of any group. That is a positive indicator of near-term growth, as these firms don’t tend to make multi-year decisions. The strong hiring expectations should form a base for job gains. But these firms are starting to be pressured by the lack of workers and their compensation costs are rising. That may be good for their workers but not necessarily for their bottom lines and that could limit hiring. It is hard to pay a current workers less than a new worker, so pay increases reverberate through the small business quickly and extensively. Still, the small business optimism is good to see. On the other hand, the impacts of the trade skirmishes are not good to see. Tariffs may have been put on some products but a decline in the value of the dollar affects all imports, making all foreign firms in all industries more competitive. Also, the tariffs are essentially a sales tax that U.S. consumers have to pay. That is true not just for products imported into the U.S. Some of our exports, such as farm products, that go to other countries, face tariffs there. When they are turned into finished goods and sent back to the U.S., they face tariffs a second time. Who pays those costs? Consumers. So look for retail inflation to start accelerating as we move through the year. For now, though, the soft import price index provides some respite for the markets as investors didn’t see a surge in import prices that would spook bondholders or the Fed.

KEY DATA: GDP: 4.1%; Consumption: 4%; Business Investment: 5.4%; Consumer Prices (Quarterly): 1.8%; Over-Year: +2.8%/ Sentiment: down 0.3 point

IN A NUTSHELL: “The economy surged in the spring, led by business and consumer spending.”

WHAT IT MEANS: As expected, we got a big number for second quarter growth. The pace was the fastest since mid 2014, when second quarter growth was 5.1% and the third quarter expanded at a 4.9% rate. Most importantly, the gains were broad based. Consumers spent like crazy, especially on durable goods. Businesses also invested, especially on new buildings. A surprisingly large reduction in inventories restrained growth and that may have to be rebuilt going forward. Final sales to private domestic purchasers, a proxy for non-government, non-foreign demand, were up robustly as well. Export growth surged, likely in order to get ahead of the trade war and federal government spending ballooned. While the federal government tended to subtract from growth during the first half of the decade, it is now helping lead the way forward. On the inflation front, consumer price gains eased over the quarter, though it did accelerate when looking at the year-over-year numbers. The Fed considers both numbers when it evaluates what is happening to inflation.

One more sign that consumers will keep spending came from the University of Michigan’s July Consumer Sentiment Index release. The index fell minimally, which was surprising given all the trade war news. Indeed, it was reported that the share of respondents indicating that tariffs would have a negative impact surged in July and it was across all political groups, not just Democrats. It is hardly clear, though, that those fears will actually translate into changes in spending habits. I doubt it.

MARKETS AND FED POLICY IMPLICATIONS: This was a strong number that probably disappointed those who were looking for a number well above 4.5% – and many were. For those, I suggest chilling. The data will be revised, though I would not be surprised if the next number isn’t a little less robust. The huge increase in exports, which added greatly to growth, may not have been sustained in June and the June numbers were largely unavailable when this report was created. We get the June trade report at the end of next week. Looking forward, consumer spending will likely be good but not nearly as strong as in the second quarter. If the reports from the vehicle makers are to be believed, sales may be softening. (The July numbers come out next week.) With confidence high, the slowdown is not likely to be great. However, there is room for business spending to increase faster, especially on machinery, intellectual property and inventory rebuilding. On the trade front, it is all about the farmers and whether they can sustain their exports. Soybean exports exploded in the spring, as sellers tried to get things out to beat the trade war, and that could turn down sharply this quarter, slowing growth significantly. Other agricultural product sales may also have been curtailed. Putting it all together, the spring quarter could be the high water mark for growth. That said, there is every reason to expect that growth in the second half of the year will still be in the 3% range, a very solid pace. Investors should be happy but not exuberant over this report. It contains good news and some cautionary data. As for the Fed, inflation is not accelerating sharply and growth is strong but maybe not sustainable. I expect the Fed to raise rates again in September and if third quarter growth is in the 3% range, as I have, it is likely to hike again in December, especially if the strong growth causes inflation to continue to slowly accelerate.

KEY DATA: Home Sales: -0.6%; Over-Year: -2.2%; Median Prices (Over-Year): +5.2%

IN A NUTSHELL: “With supply limited and prices and mortgage rates rising, it is not surprising that housing sales are softening.”

WHAT IT MEANS: The key housing market is suffering from a major case of agita. Existing home demand, which makes up nearly ninety percent of all home purchases, declined again in June. That was the third consecutive monthly drop. Over the year, sales were off for the fifth month in the last six. In other words, demand has largely flatlined. In June, the decline was limited by a sharp rise in the Northeast that nearly offset drops in the South and West. Demand rose modestly in Midwest. Worse, there are some warning signs that indicate the market is not balanced and could be facing problems going forward. Sales of the units costing $250,000 or less are down quite sharply over the year, those in the middle, between $250,000 and $750,000 are up modestly while the highest priced homes are selling strongly. Entry-level buyers are having issues finding and affording homes, especially since prices continue to rise sharply – they hit an all-time high in June. About the only good news in the report was the continued increase in homes on the market. They have risen for the last six months. That said, the inventory level is still way too low.

In a separate report, the Chicago Federal Reserve’s National Activity Index rebounded in June and is now showing that that strong growth should continue. Not surprisingly, it was led by a jump in the production components of the index. Manufacturing is doing well and should support the economy for months to come.

MARKETS AND FED POLICY IMPLICATIONS: The overall economy is in great shape, but there are a few cracks in the armor. Those “weaknesses”, though, are being created, in part, by the strong growth. Rising interest rates and the surging cost of construction that are the direct result of the solid economy, are forcing up home prices and reducing affordability for the key entry level home buyers. The percent of all homes sold to first-time buyers is down from June 2017 and that segment makes up nearly a third of all sales. As I always say, no good economy goes unpunished and right now, it is the housing market that is suffering. As for investors, it is all about growth and earnings, which so far are generally really good. It would take an awfully bad situation for a company’s after-tax earnings to falter given the huge tax cuts. And the strong demand should be creating some decent top-line numbers. As for the president’s tweets and their impacts on the markets, they wilder they get, the less investors seem to take them seriously. Another favorite saying of mine is that the markets may be efficient but that doesn’t mean they are rational. When it comes to the tweets, they may just be doing the right thing – at least for now.

KEY DATA: IP: +0.6%; Manufacturing: +0.8%; Vehicles: +7.8%; Excluding Vehicles: +0.3%/ NAHB: 68 (Unchanged)

IN A NUTSHELL: “Manufacturing rebounded in June, but it was largely due to a surge in motor vehicle assemblies.”

WHAT IT MEANS: It is hard to focus on the fundamentals of the economy when there is chaos in Washington, but that has to be done. While we are highly confident that second quarter growth was strong, the issue of sustainability remains. Today’s data only muddy the waters further. Industrial production jumped in June, led by a strong showing in manufacturing and mining. But the manufacturing upturn came after an even larger decline in May. In both cases, the changes were due to a vehicle assembly whiplash: Sharply down then up. For the first six months of the year, vehicle production has run just slightly above last year’s average, which indicates we really shouldn’t expect this sector to lead the way. Excluding vehicles, manufacturing output increased moderately, which is the way we should look at the monthly numbers unless we start seeing a sustained rise in vehicle sales. Otherwise, the details were decent but not spectacular. Energy drilling continues to soar and aerospace, machinery, computers and electronics increased solidly. Capital spending is increasing and supporting those gains. We are also starting to see a ramping up of defense product production, a result of the massive rise in the Defense Department’s budget.

With mortgage rates up, is the housing market getting hurt? Not so far. The National Association of Home Builders/Wells Fargo Housing Market Index was flat in July but it is at a fairly high level. Still, the index has largely gone nowhere this spring and is down from the winter. The sector no longer looks like it is accelerating.

MARKETS AND FED POLICY IMPLICATIONS: Fed Chair Powell testified in front of Congress today and in his prepared remarks, he made it clear that it’s steady as it goes. As he stated: “With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that–for now–the best way forward is to keep gradually raising the federal funds rate.” So look for rates to increase in September and December. The Fed is also continuing QT – quantitative tightening – and its balance sheet is slowly shrinking. That process will pick up some steam, though not a huge amount. That will also pressure rates. Rates across the yield curve should rise, though the trade tensions make forecasting the changes more difficult since it affects international capital flows. Today’s numbers point to a strong economy but not one that is accelerating. So, if second quarter GDP does come in at or above 4%, don’t expect that to be repeated in the quarters ahead. Indeed, that is my forecast and most other economists’ forecasts: Growth should be very good but not spectacular in the second half of the year. What all that means for investors is unclear. There seems to be a willingness to look through the trade war statements and dismiss any issues regarding inflation and weak wage growth. But we are in the second half of 2018 and that means investors should be thinking about next year, which is why I keep harping on the idea that “the future ain’t what it used to be” (thanks, Yogi). Six months ago, we were forecasting strong growth six months out and that is likely to be the case. That same forecast for the first half of 2019 is less clear.

June Retail Sales

KEY DATA: Sales: +0.5%; Ex-Vehicles: +0.4%; Ex-Vehicles and Gasoline: +0.3%

IN A NUTSHELL: “The consumer spent heavily in the spring and that implies second quarter growth should be quite strong.”

WHAT IT MEANS: Wages might not be rising very quickly but that is not stopping households from spending money. Retail sales rose solidly in June after surging in May. The May level was revised upward sharply, so the two months together point to really good demand. Looking at the June report, vehicle demand led the way, which we pretty much knew from the sales data. But there was another strong month of sales at building materials and garden stores, as homeowners seem to be improving their properties. And while they are doing that, they are going out to eat like crazy once again. Restaurants had been seeing modest sales gains for quite a while by that seems to be changing. People shopped online and bought lots of furniture and health care products, indicating that sales were spread between big-ticket and smaller purchases. Rising gasoline sales also helped. Declines in purchases at supermarkets, sporting goods stores and department stores restrained the gains. It should be kept in mind that these data are not price adjusted, so some of the ups and downs may be due to price changes.

In a different report, the New York Fed’s Empire State Index, which measures local manufacturing activity, declined slightly in early July, but it remained at a very high level. Almost every component of the current conditions and futures indices was down, but not significantly. Essentially, manufacturing in the New York region remains solid. Of course, this area is not a huge industrial area, so not much should be made of the changes, on way or another.

MARKETS AND FED POLICY IMPLICATIONS: The first reading of second quarter GDP growth will be released on July 27^th and right now it looks to be a really good one. It would not be surprising if it had a 4-handle, which would mean that the economy expanded by about 3% during the first half of the year. That is pretty much in line with expectations. The robust growth is also not a surprise given the massive tax cut and the beginnings of additional government spending. When you implement one of the largest fiscal stimulus’s on record, you better get strong growth at least for a while. Which means we should see solid growth, at a minimum, for the rest of the year. But, as I keep asking, what happens when the sugar high wears off? Will businesses keep investing at higher rates or settle back into previous capital spending levels? Right now, they are not shopping for new equipment ‘till they drop by any means. And once the tax cuts increase consumer spending to a higher level, how can households increase their spending levels without any significant change in purchasing power? It is great that 2018 should be a great year, but what about going forward? That is always the worry when you hype things and it is no different right now. For example, after the Obama stimulus package hit, growth accelerated. In the second quarter of 2010, it hit 3.9%, but faded afterward. With inflation heating up and wages not following, with businesses spending lots of money on mergers and acquisitions, stock buy backs and dividends but little on new capital, and with trade becoming a major uncertainty, it is not a lock that strong growth will be sustained.

KEY DATA: PPI: +0.3% Over-Year: +3.4%; Goods: +0.1%; Services: +0.4%

IN A NUTSHELL: “Wholesale cost increases are accelerating and with more tariffs being announced, it is hard to see how consumer inflation will not accelerate as well.”

WHAT IT MEANS: Is inflation a problem? Maybe not yet, but it is hard to see that it will not be a real issue very soon. Wholesale prices rose solidly in June even with a sharp decline in food costs. Excluding foods, it was up at a concerning rate. I point out foods because a large part of the trade war is being fought over agricultural products and a loss of foreign markets would create surpluses in the U.S. and price declines. To the extent the price increases were due to bumper crops, those declines would likely be temporary. So, we should focus on the goods excluding foods and those were up pretty much across the board. Energy prices are rising as well and that is not good news for consumers, especially since they are helping drive a sharp rise in transportation costs.

Over the year, producer prices are up the fastest since December 2011. That is a warning and if we look into the pipeline to see if cost pressures will accelerate of slow, it is clear that they are likely to worsen. At the intermediate level, non-food and energy goods costs are soaring. Processed materials less food and energy were up by nearly five percent over the year and much of that will likely be passed through to finished goods. And the sharp rise in energy costs we saw in June is likely to be as great this month.

MARKETS AND FED POLICY IMPLICATIONS: Wholesale costs are accelerating and now we have threats of further tariffs on China that can only ramp up inflation fears. Of course, they are only wholesale costs. By that I mean the pathway from producer to consumer price increases is hardly straight. But we are getting to wholesale inflation levels that will be hard to absorb without materially reducing earnings. That is a warning for investors that the sugar high from the tax cuts may start wearing off, as businesses have to show increases that are not simply tax related. Higher producer costs, regardless of the source of the cost pressures, are not good news for the markets. If earnings come under pressure, it is likely that at least some of those cost increases will start showing up in the consumer price measures. That cannot make the Fed happy. So, today’s report is not good news as it provides warnings that inflation is likely to rise further and corporate earnings could weaken as we go through the second half of the year.

KEY DATA: ISM (Manufacturing): +1.5 points; Orders: -0.2 point/ Construction: +0.4%; Residential: +0.8%/ Ads: -51,000

IN A NUTSHELL: “Robust industrial activity should keep the economy strong for quite a while.”

WHAT IT MEANS: With trade issues starting to slowly, but steadily spiral out of hand, we need to know if the key sectors can withstand the potential problems that a trade war could bring.  Last week we saw that household income, especially wages and salaries, was not growing significantly. Today, though, it became clear that the industrial sector is in very good shape. The Institute for Supply Management reported that its manufacturing index rose in June. Orders continue to increase sharply, though not quite as quickly as they had been. Still, the expanding demand was large enough to force production to rise and order books to continue to fill (though also less rapidly). Both producer and customer inventories are low and that bodes well for future production. Finally, hiring continues at a very solid pace as well. All in all, it looks like the manufacturing sector should be able to lead the way for the rest of the year.

It is also looking like construction is starting to accelerate. Activity jumped in May, led by a surge in residential building, both private and residential. Office construction was also up sharply. However, excluding office, nonresidential construction was weak, which is something that needs to be watched. The economy needs a broad based strong construction to help offset any weakness that the trade battles may create.

MARKETS AND FED POLICY IMPLICATIONS: Can the U.S. economy withstand the counter-tariffs being put on by Europe, Canada, Mexico and China as well as the higher costs created by our tariffs? Right now, given that the level of the tariffs is not huge, it looks that way. That is not to say some industries will not be hurt badly or that growth will not slow, but unless things deteriorate further, a recession will not likely follow just from the current trade skirmishes. However, the longer the tariff mini-war continues, the greater the damage and the slower the economy will grow. That is causing investors to lose some of their exuberance and maybe even creating some caution in the market. But this week contains Employment Friday and some of the concerns about the future course of the economy could be either dispelled or heightened, depending upon the size of the report. The consensus is for strong gain in the 200,000 range. I don’t think that is likely. However, I do think the wage number could be hotter than expected. That would create worries. Regardless:

Have a wonderful and safe July 4^th!

KEY DATA: GDP: 2.0% (from 2.2%)/ Claims: +9,000

IN A NUTSHELL: “A disappointing first quarter expansion is likely to be followed by robust second quarter growth.”

WHAT IT MEANS: Is the economy weak or strong? Did the tax cuts add to growth or do little? The answer to both those questions is, of course, yes. The third estimate of first quarter growth came in a little less than expected. The economy grew decently, but consumers did not spend a whole lot of money, especially on big-ticket items, restraining the expansion. Indeed, consumption grew at the slowest pace in five years. But the major reason for the downward revision to GDP came from less inventory building. Firms added to stocks at slower pace than previously thought. That, though, actually is a positive for second quarter growth. The data are indicating that both businesses and households picked up the spending pace in the spring. With less stock in the warehouses, production had to rise even more to meet the emerging jump in demand.

Corporate profit estimates were also revised and they grew robustly, to say the least. When taxes and certain adjustments are taken into account, profits were up nearly 17% over the level posted in the first quarter of 2017. Look for those numbers to get even bigger as we go through the year. Now if we can only get businesses to invest even more of those dollars, the economy would be in great shape.

Jobless claims jumped last week but that is hardly unusual. Smoothing out the ups and downs, the level remains extremely low. Conditions are so tight the firms are once again hiring teenagers. Challenger, Gray and Christmas reported that teenage hiring in May was up 73% over May 2017 levels.

MARKETS AND FED POLICY IMPLICATIONS: The economy does not grow in a consistent manner. Some quarters are disappointments while some exceed even the most optimistic forecasters’ estimates. So don’t make much of the first quarter number. Indeed, we could see second quarter growth at double the first quarter pace. Of course, averaging those two out would put us at where most economists expect growth to be this year: roughly 3%. Given the huge tax cuts, the massive surge in after tax profits, large increases in government spending and an already solid economy, that pace would be a disappointment. Three percent growth is what the president’s economists say is the sustainable level over the next ten years. That is in their forecasts. But if we can only get roughly three percent when you hype the economy at a pace maybe never seen before, you have to be concerned. The impacts of the tax cuts will wear off over the next twelve to eighteen months, so where do we go from there? Businesses may be at a much higher level of activity, but they still have to grow from that level and that means consumer spending will have to be a lot better. And that will require wage growth to accelerate sharply. But we have had no sign that will happen and if it does, what will happen to inflation and interest rates? If you are wondering why so many economists are raising their probability that a recession could start in late 2019 or the first half 2020, that is why.