KEY DATA: Phila. Fed (Manufacturing): -2.5 points; Orders: +5.8 points/ LEI: +0.9%/ Claims: -29,000
IN A NUTSHELL: “If the economy is softening, you cannot see it yet in the labor market, which remains drum-tight.”
WHAT IT MEANS: Another day, another set of economic numbers that should drive investors crazy. First, there was the Philadelphia Fed’s survey of manufacturers. The index eased back in the first part of August, which was hardly a surprise. Not because the index was anywhere close to the near-record high it reached in April, but because this index is crazy volatile. So, ups and downs are taken as a given and when the change is as small as it was in August, then you have to say that conditions didn’t change much. Indeed, the manufacturing sector in the Mid-Atlantic region is in pretty good shape. New orders grew much faster, hiring remained robust and pricing power improved solidly. If there was a warning in this data, it came from the special question section. Respondents expect that they will have to raise compensation by 4% over the next year but will be able to offset that by an even faster 5% increase in prices. These results are similar to the ones found in the May survey, except firms now think national inflation will run at a 5% pace over the next year rather than 4%. That seems to point to rising inflation expectations, something the Fed should be worried about.
If the Fed is going to start tapering, it should time it when the economy is still improving and it looks like we are in for more strong growth. The Conference Board’s Leading Economic Index rose sharply in July, as every component added to the gain. That is about as broad based as you can get. Given how much the index has risen this year, the Conference Board expects “real GDP growth for 2021 to reach 6.0 percent year-over-year”. It even thinks that 4% is likely in 2022. That hardly looks like much of a slowdown.
As for the labor market, new claims for unemployment insurance declined to a level that is very consistent with a strong economy and an unemployment rate at the current 5.4%. That is, the market churn, (hires versus fires, quits, retirements etc.) that determines initial claims is pretty normal.
IMPLICATIONS:Is the economy in good shape? Yes,but it is also true that it is not too hot, not too cold, and not just right. Forget Goldilocks, bring on confusion. Some of the data, including the housing and retail spending reports, have not been great. But the labor market data have been really great. And then there are the inflation numbers, which show no signs of subsiding. The reality is that the economy is in transition and that is the way it is going to be for quite a while. So, expect some volatility in the data, especially when we get to the fall, which is when the labor markets will be moving from government manipulation to private sector actions. For investors, uncertainty is never a good thing, so don’t be surprised if we get some big ups and downs. And that may be in part because the Fed continues to find itself in a tough spot. Clearly, the economy is better than the members expected it to be, while inflation is worse. That should mean it is a layup that tapering would begin this fall. But the weak housing and consumption reports, which might just turn out to be temporary aberrations, means that investors are getting worried about the sustainability to strong growth. If the Fed only had a dual mandate, maximum employment and stable inflation, then there would be no issue. But the Fed continues to operate under its self-imposed, but never stated, triple mandate, where stable and/or rising markets are also a major factor in its decision making. Chair Powell doesn’t want to spook the markets (i.e., investors), so he must get his timing right. Yet when all is said and done, the Fed is likely to start cutting back on its liquidity adds sometime in the next six months. The issue is not whether but how quickly, so the best thing is to assume it is going to happen and act accordingly.