KEY DATA: IP: +0.2%; Manufacturing: -0.1%/ LEI: +0.3%/ Claims: -12,000

IN A NUTSHELL: “Softening vehicle sales are weighing down the manufacturing sector.”

WHAT IT MEANS: The Federal Reserve released the “minutes” of the last FOMC meeting yesterday and it seems there is a lot of uncertainty about what to do next and when to do it. In particular, there was great debate about the slowdown in inflation, why it is happening and what that means for the pace of rate hikes and balance sheet reduction. It is no longer clear that in September, the Committee will announce when it will be starting the process of balance sheet normalization. It had been the consensus that we would get something next month.

If the Fed is to start the reducing its bond holdings and continue raising rates, the economy and inflation may have to pick up steam. If or when that will happen remains uncertain after today’s data. While industrial output rose moderately in July, it was largely due to improving utility and energy production. Weak vehicle sales, which led to a sharp reduction in assemblies, are holding back not only transportation but also those sectors, such as metals, that feed into vehicle production. Large increases in apparel output (likely an anomaly) and chemicals kept total output from tanking. Basically, the manufacturing sector may be expanding but it is hardly booming.

While the industrial production data didn’t point to any major improvement in growth, the Conference Board’s Leading Economic Index did indicate that activity should pick up. After posting a large rise in June, the index rose solidly in July, led by rising financial indicators. As the press release noted, “the U.S. economy may experience further improvements in economic activity in the second half of the year”.

As for the labor market, unemployment claims fell sharply last week, reaching record low levels when adjusted for the size of the labor force. The labor market is tight but wage gains are not rising, which is confusing to an economist – or at least me.  

MARKETS AND FED POLICY IMPLICATIONS: So, we have uncertainty in manufacturing, but strength in financial indicators pointing to stronger growth. However, yesterday’s report on July housing starts and permits was a real downer. Both fell, which was a surprise. This segment of the economy had been showing signs of strength. Well, maybe not. When you put it all together, it is hardly clear whether we can get to the administration’s goal of 3% growth for more than even one quarter. We might see something close to that in the current quarter, but unless incomes growth faster, that pace would not be sustainable. And if we continue on the 2.25% growth path, businesses may be able to hold the fortress against faster wage gains. The potential for greater labor cost pressures, in conjunction with the unwinding of some temporary factors that the Fed believes is currently restraining inflation, is what has driven the belief that the normalization process can continue unabated. But for some at the Fed, patience is running thin and they are saying that maybe the process should be slowed. The next meeting is September 19-20 and that one may take on even greater importance, as we need further guidance on what the Fed’s normalization schedule might look like. This might also be Janet Yellen’s last meeting before a new Fed Chair is nominated. If, as expected, it is not Yellen, that could introduce another dynamic into the discussions.