KEY DATA: Imports: -1.2%; Nonfuel: -0.3%; Exports: -1.1%; Farm: -1%/ Claims: +7,000

IN A NUTSHELL: “Falling energy costs and the rising dollar are combining to keep the prices of imported goods and overall inflation down.”

WHAT IT MEANS: So much for inflation. The cost of imported goods fell again and declined even when fuel was excluded. Indeed, the nonfuel index has been either flat or down for the past seventeen months. Searching the details, it was hard to find any major or even sub-category that was up. Fish and beverages were about it. Since December 2014, nonfuel import prices have dropped 3.4%, while fuel is off a whopping 40.5%.

On the labor market front, unemployment claims rose last week, but the government has had trouble seasonably adjusting the weekly data early in the year. Regardless, the level, especially when using the smoothed, 4-week moving average, is still quite low, pointing to further tightening in the market.

MARKETS AND FED POLICY IMPLICATIONS: I guess if you do things long enough, you get to see just about everything. That is the case with inflation. It is amazing that I am sitting here writing about inflation being too low in the United States. But there it is. Clearly, part of the problem is the war going on in the energy sector, where the Saudi’s are trying to drive out U.S. competitors by keeping the production tap wide open and prices way down. That has not worked particularly well for the producers, but it has saved consumers hundreds of billions of dollars. That money is being used to bolster household and business balance sheets and is adding to demand for all types of products. But it has also caused energy-related companies to slash spending on just about everything. The net result has been lower prices and slower growth. The teensy weensy step the Fed took to raise rates, coupled with the U.S. economy being the strongest in the industrialized world, have led to a rising dollar that is also keeping prices down. That would not be a worry unless the price declines become entrenched in the system and inflation expectations fall. Reasonably well-anchored expectations have been the Fed’s security blanket, so any movement downward on perceptions would create concerns. A couple of months ago, before the latest down draft in oil prices, I commented that the inflation rate could move back toward the Fed’s target early this year. I was expecting oil prices to slowly filter upward, not crash and burn. That is likely what many Fed members projected as well. But now we have to wonder when energy prices will turn up. Until they do, the Fed will not have the comfort of accelerating inflation to go along with a tightening labor market. That could cause the members to become even more cautious. I still have a March hike in my forecast, but further declines in prices could push back the next increase.

KEY DATA: Payrolls: +292,000; Revisions: +50,000; Unemployment Rate: 5.0% (unchanged); Hourly Wages: -$0.01

IN A NUTSHELL: “With firms hiring like crazy, it is hard to believe the economy is not also growing solidly.”

WHAT IT MEANS: Wow! That is best word to describe the job growth during the last few months of the year. In December, the gain was huge, but it didn’t even match the 307,000 new positions added in October. Over the past three months, an average of 284,000 jobs were created. For the year, total payrolls rose by 2.65 million, the second best increase in the last fifteen years. Only last year’s 3.1 million gain was greater. In December, the hiring was widespread. Construction was up sharply, though warm weather probably hyped the increase a bit.   Manufacturers added workers, though there were cut backs in machinery and strangely, motor vehicles. We set a record for vehicle sales in 2015 so it is doubtful the cut backs were demand related. And, of course, the oil patch continued to shrink. It is amazing that we had such strong growth overall despite a huge 130,000 decline in mining. Where there was real strength in December and for most of 2015, was the services sector. Health care is booming again, restaurants are adding workers like crazy, professional and business services, especially temp help firms, are bulking up, financial firms are feeling good enough to expand and transportation firms are moving in a lot of new people. Interestingly, the large overall increase was not the result of holiday hiring as retail and wholesale were up modestly.

As for the unemployment rate, it was stuck on 5.0% for the third consecutive month. The labor force grew strongly and that caused the participation rate to rise. The labor force participation rate has basically stabilized, declining an insignificant 0.1 percentage point over the year. I think it is time to put that made up problem to bed. For the year, the number of people unemployed fell sharply and we are back to April 2008 levels.

There was one very disappointing number in the report, though. The average hourly wage fell a penny, which was a major surprise. It is hard to see how the labor market can be this strong without wages increasing consistently, but that is what the Bureau of Labor Statistics is claiming. Over the year, wages are up a 2.5%. While that is a solid acceleration from the 1.8% increase posted last December, it is still less than hoped for.

MARKETS AND FED POLICY IMPLICATIONS: This was a strong report, though without any wage increase, it was not as great as it could have been. Still, it clearly shows that the domestic economy is in very good shape. The report should buoy investors’ confidence, which has been battered by the China Syndrome fears. Since the U.S. economy is not greatly dependent on exports to China, it should continue to do well. Where problems arise is for those companies dependent on China for sales and especially earnings. But that is an equity market problem for some firms, not a fundamental economic issue for the U.S. economy. Therefore, while the Fed may worry about China, the strong U.S. economy is what should determine future policy. Indeed, without the China overhang, this report would likely have cemented a March rate hike, which I still believe will happen. The Chinese situation shows how the Fed has left itself without any policy options. Right now, because rates are so low and the Fed has been so cautious in raising rates, the only policy option available is to not raise rates further! What can the Fed do if China is in real trouble? More QE? Enough said.

KEY DATA: ISM (Manufacturing): -0.4 point: Orders: +0.3 point; Employment: -3.2 points/ Construction: -0.4%; Private: -0.2%

IN A NUTSHELL: “The manufacturing sector continues to wander aimlessly and firms have slowed hiring as a result.”

WHAT IT MEANS: The first major number of the year, the Institute for Supply Management’s Manufacturing Index, fell in December. The sluggish industrial portion of the economy remains just that – sluggish. Actually, activity contracted for the second consecutive month and that is causing firms to rethink their hiring practices. Employment declined for the second time in three months. If there was any good news in this report, and there wasn’t much, it was that the drop in new orders decelerated and the production reduction that we saw in November largely disappeared. That does not mean the sector is positioned to start growing strongly, but maybe it can get back to a slow expansion.

Construction activity fell in November, the first decrease since June 2014. But the data were far from showing a major problem in this sector. The residential component rose decently but commercial building was off sharply. The public sector didn’t help at all. The federal government decided not to spend very much at all and state and local governments slowed their construction activity as well. Government construction spending can be very volatile, especially in these days of tight budgets. Even with the November decline, total construction was still up a strong 10.5% over November 2014 levels and private activity soared a robust 12.1%.

MARKETS AND FED POLICY IMPLICATIONS: Today’s economic data, even if they were strong, would likely have done little to take investors minds off of the economic issues in China. Having soft numbers, though, didn’t help. Still, the market reaction to weak Chinese economic data, while not a surprise, is hardly comforting. I don’t know how many times I have noted that if anyone believes the Chinese data, I have a bridge I am willing to sell them. While our economic numbers bounce around like crazy, theirs move in steady patterns. Does anyone think that China has smooth changes in their economic performance on a monthly or even yearly basis? I have frequently noted that the markets might be efficient, but not necessarily rational. That has drawn a lot of criticism from fellow economists. Well, the data are disseminated rapidly and effectively, but garbage in gets you garbage out. The Chinese economy has been slowing and will likely continue to do so as it transforms into a more consumer-dependent economy. Just as it is wrong to say that lower energy prices is bad for the U.S. economy in the long run because in the short run, the energy companies adjust faster than consumers, it is wrong to argue that the transformation in China implies major problems for the country because exporters are forced to adjust faster than consumers can make up for the decline. Assuming that a group of central planners can manage the transition seamlessly was not rational, which is why I have my view of the rational nature of investment activity. The Chinese economy will be fine, just not right away.

KEY DATA: LEI: +0.4%/ Phila. Fed: -7.8 points/ Claims: down 11,000

IN A NUTSHELL: “Except for the manufacturing sector, the economy is in good shape, but that is a significant but.”

WHAT IT MEANS: With the rate hike behind us, it is time to start focusing on the economy and inflation. Inflation outside the energy sector is slowly accelerating, a reality the Fed has accepted, if not embraced. It gives them some breathing room to move gradually. But as long as that acceleration continues, the rate hikes will follow. As for the economy, its strength will ultimately determine how fast labor shortages appear, wages rise and firms are forced to start raising prices. The Conference Board’s Leading Economic Index is pointing to very solid growth ahead. After jumping in October, it rose strongly in November. These back-to-back large gains are hinting that growth should accelerate going forward. I hope so, since my forecast has that. Current conditions are not that strong and that supports most economists’ views that fourth quarter growth will be good but not great.

The one sector that has been under pressure lately is manufacturing and that softness doesn’t look like it is going away. The Philadelphia Federal Reserve’s December Manufacturing Index plunged into negative territory after having crawled out of the red in November. Falling orders, shrinking backlogs and declining prices don’t indicate any strength in this sector. Interestingly, though, hiring and the workweek picked up. That seems to show that the slowdown may be viewed as temporary. The labor numbers need to be watched carefully as I believe that will be the source of cost pressures and ultimately price pressures. There were questions asked about 2016 cost projections and the respondents expect wages and benefits to rise by about 3.5%. Those that expect costs to rise faster next year and those that expect them to rise at the same pace they did this year were evenly split. Very few firms expect labor costs to rise slower in 2016.

Speaking of the labor markets, weekly unemployment claims dropped back to what is now the “usual” level last week. Of course usual is not normal as the level is consistent with further tightening in what is already a tight labor market.

MARKETS AND FED POLICY IMPLICATIONS: The Fed cleared easily the first hurdle in the process of moving back toward normal interest rates. The pathway, however, is hardly clear. The members, in their forecasts, point to moves every other meeting. The markets don’t quite agree and think there will be fewer increases. I don’t agree either, but I think there will be five, not four increases. The key, as I mentioned in my commentary yesterday, is inflation. Through most of 2015, the year-over-decline in oil prices had hovered between 40% and 50% down. Before the latest downdraft in prices, I had expected those drops to largely disappear in the first quarter of next year and the top line inflation number to move above 2%. If we stay below $40/barrel, that will take longer. I expect the core rate to hit 2% by the fall part and stay there. So, will the Fed worry about oil? Probably not. But what may concern them is the downward pressure created by declining import prices. If the dollar keeps strengthening, it will take even longer for the headline inflation number to get to 2%. That said, I would be surprised if it didn’t happen during the second half of 2016, which is why I have five moves next year.

KEY DATA: CPI: 0%; Excluding Food and Energy: +0.2%; Excluding Energy: +0.1%/ Real Earnings: +0.1%

IN A NUTSHELL: “The steady rise back to normal inflation continues, adding ammunition to the Fed’s view that it is just a matter of time before its target is reached.”

WHAT IT MEANS: Inflation remains the one issue, or non-issue, when it comes to raising interest rates. But that concern is starting to fade, at least when you take out energy. Consumer prices were flat in November, led by another decline in gasoline costs. That downward pressure on the index by energy is continuing, though it is hardly clear that lower energy costs are a problem. Yes, they hurt the energy sector and all the companies that feed into it, but over time, the economy will be better off with the lower energy costs. Sometimes it just takes some pain to get some real gain. Excluding energy, consumer prices were up minimally. But more importantly, over the year, they are right at the Fed’s 2% target. However, all prices, including volatile food and energy, have risen only modestly since November 2014. While commodity prices keep falling, services, which are 63% of the index, keep accelerating. They rose solidly in November and are up by 2.5% over the year. It is unclear how much further energy prices will fall and if or when they will start to rise again, but the huge declines we saw in 2015 will dissipate as we go through 2016. And when that happens, even the headline number will move back toward and likely above the Fed’s target.

Wage gains seem to have eased once again. Hourly earnings increased moderately in November but when inflation is factored in, the gain was modest. We may still be a few months away from when firms feel so stressed by the lack of available workers that they actually have to start paying for new employees. But unless the law of supply and demand in the labor market has been repealed, the lack of workers and the growing number of job openings will have to lead to rising costs – no matter how hard and long businesses fight it.

MARKETS AND FED POLICY IMPLICATIONS: The FOMC meeting starts today and will likely end with tomorrow’s announcement that for the first time since June 29, 2006, the fed funds rate has been increased. The consumer price data only add to the confidence of those at the Fed who believe it is prudent to start the process of raising rates back toward more normal levels. The Fed has a lot of work to do. We are at least three percentage points below where we should be if the economy was growing solidly and inflation was at a reasonable level. The modest inflation pressures allow the Fed to move back to where they should be at a conservative pace. But with inflation, excluding energy, at the Fed’s target and with the annual declines fading, any price pressure that rising wages may create would move the inflation rate above target. Don’t be surprised if that happens sometime during the first half of next year. The Fed will argue that it will stop, look and listen before crossing the street to the next move, but that is likely to happen in March and every other FOMC meeting until late fall. Regardless, we are just one day away so let’s just sit back and wait.

KEY DATA: Imports: -0.4%; Fuel: -2.5%; NonFuel: -0.2%; Exports: -0.6%; Farm: -1.1%/ Claims: Up 13,000

IN A NUTSHELL: “The broad based declines in imported goods prices should keep inflation at bay for a while.”

WHAT IT MEANS: Inflation has been well contained and one of the big reasons is that import prices have cratered. That trend continued in November. Led by another drop in energy costs, the prices of imported products fell sharply. But it wasn’t just oil. Non-energy prices were also down. Indeed, you have to look long and hard to find any category where imported goods costs rose over the month. About the only area was in building materials, especially wood. Cocoa and sugar costs rose, but hopefully that will not cause cookie and cake prices to increase. We shall see. Otherwise, there was basically nothing but red numbers in the report. Over the year, nonfuel prices are down 3.2%, which puts sizeable pressure on domestic firms to keep their prices in line. On the export side, the results were similar as prices fell largely across the board. The farm sector is hurting almost as much as the energy sector. Export prices dropped again in November and are now down by nearly 13% over the year. Ugh!

On the labor market front, unemployment claims jumped last week but that is not a concern. The data bounce around and the 4-week moving average remains quite low. We seem to have hit bottom on claims, but adjusting for the size of the labor force, we remain at record lows.

MARKETS AND FED POLICY IMPLICATIONS: The Fed looks ready to move next Wednesday. The economy is strong enough that a small rise in rates really shouldn’t have any negative impact on growth. And the members will likely to continue to hike rates slowly for a couple of years. But for rates to return to normal levels, inflation has to rise faster and the strong dollar is causing the pathway to 2% to be slow. The latest down draft in oil should keep the headline inflation number well below target. Still, as we move through the first part of next year, the large declines in energy will disappear, so look for inflation to accelerate. Excluding energy, the rise should be much slower, helped by the strong dollar and low import costs. That said, labor remains the biggest part of most businesses costs and the unemployment claims number does nothing to change my thinking that labor shortages are becoming widespread enough that wages will have to rise a lot faster in 2016. Unless firms can figure out how to improve productivity, which has been lagging, there may be no choice but to start increasing prices. The latest Blue Chip consensus forecast, of which I am a part, has the economy expanding again by 2.5% in 2016. I think that is low because of my view on wages. Higher salary increases should generate stronger consumption and the faster growth could provide domestic firms with some pricing power. This is important since it is doubtful that once inflation hits 2% it will stay there. More than likely, we will see it go into the 2.5% to 3% range. And if that is sustained for any length of time, as I suspect, the Fed will not dawdle. But that is a year from now. Let’s just start with one rate hike next Wednesday.