KEY DATA: ISM (Man.): +1.2 points; Orders: flat/ Sentiment: +2.5 points/ Consumption: +0.8%; Disposable Income: +0.1%; Prices: +0.4%; Ex-Food and Energy: +0.3%
IN A NUTSHELL: “With inflation and Delta running hot, it is beginning to look like we are in for an early deceleration in growth.”
WHAT IT MEANS: Lots of data and so little space to discuss the meaning. So, let’s start with the September reports. Manufacturing activity stayed strong in September. The Institute for Supply Management’s index rose, and the level is high. As for the details, they point to more of the same but no acceleration going forward. The order index was flat, the production measure signaled slightly slower growth, backlogs built more slowly, and prices of goods rose faster. Hiring turned positive but is not strong. The sector is in good shape and it should remain that way for a while.
As for consumers, there were two reports that spoke to their attitudes. First, the University of Michigan’s Consumer Sentiment Index rose a touch in September, but it remains depressed. Between the virus and inflation, there is not a lot to be happy about.
That sourness in consumer attitudes did not show up in August consumer spending, which surged. Most of that was from nondurable goods purchases, which was likely driven by rising gasoline prices. Indeed, the real story in this report was another jump in household’s costs. That was true even when food and energy were excluded. With incomes rising modestly, real or inflation-adjusted income actually fell sharply and the rise in consumption was cut in half.
On the construction front, residential activity was up decently, but that gain was wiped out by a similar decline in nonresidential construction. These data have been consistently revised upward, so before any judgment is made, let’s see what they look like in a month.
IMPLICATIONS:Today’s data dump was, for the most part, disappointing. It was nice to see that the manufacturing sector remains solid, but consumers are not a happy bunch and price increases are eating into their income gains, which is making them even more unhappy. That doesn’t mean the economy is about to crater. It’s just that we could see a deceleration toward trend growth occur sooner than expected. I have growth back to the low 2% range during the second half of next year, but I don’t rule out that happening in the spring, especially if the virus is still with us in earnest. But the real issue remains inflation and whether it is transitory of more persistent. The Fed has created the conceptual possibility that it could accept inflation funning in the 2.5% to even 3% range for five years. For the five and ten years ending 2020, the inflation rate, measured by the personal consumption expenditure deflator, averaged 1.5%. Inflation would have to average 2.5% for the next five or ten years to average out to 2%. The Fed has built itself a huge cushion when it comes to inflation.It can run hot for an extended period and still meet its stated goal of averaging 2%. That raises the questions, which I have discussed multiple times before: What happens to inflation expectations if inflation persistently runs above 2%; and is 2% the best inflation goal? Those are the issues we should be debating, not whether inflation will decelerate from current levels. It will, but where do we end up? I continue to believe that trend inflation will be closer to 2.5% than 2% when things ultimately settle down.