May Employment Report

KEY DATA: Payrolls: +75,000; Private: 90,000; Revisions: -75,000; Unemployment Rate: 3.6% (Unchanged); Wages: +0.2%

IN A NUTSHELL:  “The lean, mean job machine has sand in its gears.”

WHAT IT MEANS: Welcome to the real world.  All those firms saying they couldn’t find qualified workers may have been true statements not fake news as job gains faltered in May.  And, the huge increase we thought we had in April now looks less robust while the solid March hiring turns out to have been only mediocre.  The three-month average job increase now sits at 151,000, which is reasonable given the labor market conditions.  In May, the data were remarkable in that there were no major outliers.  Retailers cut workers, but not at any huge pace.  Manufacturers and construction added workers at the expected modest rate.  Health care and professional service companies hired moderately and restaurants continued to add workers at a typical pace.  Government employment did drop, but that came after an even larger rise in April, so nothing surprising there either.  In other words, there were no usual unusual numbers that I love to pick on. 

As for the unemployment rate, it was unchanged as both the labor force and the number of employed rose at a moderate pace.  All good there.  The labor force participation rate was stable and the so-called “real” unemployment rate declined. 

If there was one weakness in the report, it was the wage data.  Hourly wages were up moderately but the growth rate over the year year continues to decelerate.  After peaking in February, it has been a steady downward path and that is not good for workers or the economy.MARKETS AND FED POLICY IMPLICATIONS: Over time, the economic data wind up matching what is reasonable given the economic conditions, and that is finally happening with the employment numbers.  Going into the year, most economists expected job gains to be in the 150,000 to 175,000 range, given the low unemployment rate and demographics.  Guess what: That is where we are.  The idea that we could add over 200,000 employees a month was unrealistic and reality is hitting home.  With the labor market so tight, the pace of increase is still quite decent.  It’s just that it isn’t anywhere near where the politicians hoped it would be.  There are some signs that the market may be faltering more than perceived.  This was the second month out of the past four that job gains were below 100,000.  In addition, the data are being revised downward, which means that the models are expecting job gains from the smaller to mid-sized businesses to be stronger than what we are seeing.  That matches the ADP results, which showed that small business hiring ground to a halt and mid-sized firm added workers modestly.  They just cannot compete with the larger companies who can pay up for workers and either they do without or they face rapidly rising wage costs.  For small firms, that is usually a disaster. And maybe the most disconcerting numbers of all came from the wage data.  Despite tight labor markets, wage gains continue to decelerate.  The combination of more modest payroll and compensation increases does not bode well for income growth or consumption.Investors cannot be happy with this report.  It warns of moderating growth ahead as more modest job gains are starting to become a trend.  As for the Fed, this is actually a good report.The economy is not falling off a cliff: It is just easing back.  Thus, there is no reason to cut rates. Wage inflation remains muted and that means that price inflation is not likely to surge unless the tariffs are put on all Chinese and Mexican products.  There is no reason to raise rates.  Patience can and is likely to rule!  The next meeting is June 18-19 and that is what is likely to be the stance, though the Fed will likely reiterate that it stands ready to support growth if conditions tank.  Right now, that is not happening, despite this one weak employment report.

May Private Sector Jobs, Non-Manufacturing Activity and Help Wanted OnLine

KEY DATA: ADP: 27,000; Construction: -36,000; Small Businesses: -52,000/ ISM (Non-Man.): +1.4 points: Orders: +0.5 point/ HWOL: -2.3%

IN A NUTSHELL:  “April’s employment surge may have been an aberration as May is looking a lot softer.”

WHAT IT MEANS:  When the April jobs report showed that 263,000 new positions were created, I warned that this might be just one of those temporary blips that we get in the data and that May’s number could be a lot weaker.  Well, we will know for sure on Friday, but the ADP estimate of private sector job gains seems to point to that being the case.  Businesses added few new workers in May and the details were pretty gruesome.  Small business payrolls shrank dramatically.  It’s not just that smaller companies cannot compete on wages in a tight labor market but the changing structure of retail demand is putting a lot of them out of business.  That said, there was only a minimal gain in mid-sized company payrolls, so not a lot of firms are finding it easy to hire.  There was also a huge drop in construction workers, but that came after a strong gain in April. 

Supporting the possibility of a disappointing May jobs report was a solid decline in the Conference Board’s Help Wanted Online Index.  Every region and almost every state posted lower online ads for workers.  Similarly, reductions were seen in almost every occupation category, so you can say this was an economy-wide issue. 

While the job market seemed to falter in May, the nonmanufacturing portion of the economy continued to do okay.  The Institute for Supply Management reported its index rose as new order growth accelerated. Business activity in the service and construction segments of the economy improved quite solidly.  Unlike the other surveys released today, the ISM employment index rose.  The in the non-manufacturing segment, however, stands in contrast to the May manufacturing report, which declined, led by a sharp shrinkage in order books.  That does not bode well for future production.

MARKETS AND FED POLICY IMPLICATIONS: All eyes are on trade discussions, but the tariffs and threats of additional tariffs may already be starting to have an impact on growth.  I don’t expect the jobs report to come in at double digits, but a low triple-digit May jobs number is a real possibility.  That would bring the average for the three months close to expectations and show that the April number was foolish.  But given the equity markets’ sensitivity to any weak number, it could create an outsized impact.  Investors are counting on the Fed to bail out the economy but they are fooling themselves.  The Fed has limited ammunition to fight a slowdown.  Let’s face it, if the Fed has to go below one percent again, it will be in trouble.  The only reason to go that low is if the economy is in deep trouble and not a lot of businesses will be making major capital spending decisions or households buying big-ticket items under those circumstances.  Interest rate cuts would have limited impacts.  The Fed has a little more than one percentage point of rate cuts before it effectively runs out of ammunition. It would need a lot more than that to turn around a faltering economy.  And with the U.S. budget deficit nearing one trillion dollars, fiscal policy is in a straight jacket.  So we better hope that a major slowdown doesn’t occur anytime soon or to quote George H.W. Bush, we will be in “deep doodoo”.      

April Spending and Income and May Consumer Sentiment

KEY DATA: Consumption: +0.3%; Inflation-Adjusted: 0%; Income: 0.5%; Real Disposable Income: +0.1%; Inflation: +0.3%; Excluding Food and Energy: +0.2%/ Sentiment: +2.8 points

IN A NUTSHELL:  “It’s nice that income gains were strong, but it would be a lot better if more of the rise came from wages increases.”

WHAT IT MEANS:  The consumer remains the key to continued solid economic growth.  Do households have the wherewithal to keep spending?  Not as much as you might think.  Personal income soared in April, which was the good news.  The disappointing news was that wage and salary gains were not the driving force.  Yes, they were up decently, but it was a surge in interest income that created the jump in personal income.  It is not clear that consumers will be spending the interest surge or even how that rise was created.  As for consumption, a improving spending on nondurable goods demand offset the disappointing drop in vehicle purchases.  Adjusting for inflation, consumer spending was flat.  Still, given the enormous surge in demand in March, consumption looks on track to grow by at least two percent this quarter.  That may be the only thing that keeps the second quarter GDP number from being truly bad.  Speaking of inflation, the headline and core (excluding food and energy) numbers ran a bit hotter than they had been.  Over the year, though, both measures remain in the 1.5% range, which is well below the Fed’s 2% target.  As long as inflation remains in check, the tepid rise in wages should be enough to keep spending up.  And the rising savings rate means that households have some insurance if the economy falters. 

On the consumer confidence front, households remain exuberant.  The University of Michigan’s May Consumer Sentiment Index rose from the April reading but was down from the mid-month number.  The outlook for future growth rose sharply even as the view of current conditions faded a touch.  How the future growth number will react to the introduction of tariffs on Mexico will be interesting to see. MARKETS AND FED POLICY IMPLICATIONS:Headline numbers often mislead and the large gain in top line income growth was not indicative of what most workers are seeing.  Wage and salaries are what they watch and while compensation is growing decently, the percent change over the year has been steadily decelerating since August 2017.  The inflation-adjusted rise has been below 2% for the past year and that makes it awfully hard to sustain 3% overall growth.  The good news is that confidence has remained incredibly high.  The strong job market is driving that optimism but the view of current conditions may be on the downslide.  Over the year, Michigan’s current conditions index is now off.  A key number for second quarter consumption is May vehicle sales, which comes out next week. If we don’t see a major rebound from the April collapse, second quarter growth will likely be weaker than most economists had been expecting.  And then there is the announcement of tariffs on Mexican products.  This has to raise questions about not only the US-Mexico-Canada agreement but also the likelihood of an agreement with China.  If having an agreement doesn’t stop the U.S. from imposing tariffs on a country’s goods, why have an agreement at all?  Tariffs are now viewed by this administration as a cudgel to secure actions from other countries that may or may not have anything to do with fair trade practices.  That cannot be good news for investors who now have to worry not only when, but if a China-U.S. agreement will occur.  In addition, rising consumer and business costs due to tariffs on both Chinese and Mexican products can only slow growth further.   We have entered a period of major uncertainties and that cannot be good for the markets, which were already reeling from the Chinese trade war.  Can we really fight two trade wars at the same time?  We shall see.

April Durable Goods Orders

KEY DATA: Orders: -2.1%; Ex-Nondefense Aircraft: -1.0%; Capital Spending: -0.9%

IN A NUTSHELL:  “The growing signs that manufacturing is softening cannot be overlooked and it looks like second quarter growth could be weaker than expected.”

WHAT IT MEANS:  Summer may be coming, but it’s beginning to look like winter in the manufacturing sector.  Durable goods order collapsed in April, though that was expected.  Boeing is seeing basically no new orders and that led to a huge 25% drop in aircraft demand.  But if you take out the nondefense aircraft segment, orders were still off one percent, so we are not looking at a growing demand for big-ticket items.  Still, this report was not uniformly weak.  There were increases in orders for computers, fabricated metals and electrical equipment and appliances.  More than offsetting those gains were declines in communications equipment, vehicles and primary metals.  As for the proxy for business investment – nondefense capital goods orders excluding aircraft – orders also declined sharply.  This segment has been slowing for quite some time now and it is becoming clear that whatever boom the tax cuts may have created, if they did much at all, is largely gone.  And finally, backlogs declined and over the year, order books are filling much more slowly.  That does not bode well for future production.

MARKETS AND FED POLICY IMPLICATIONS:  A long weekend could not have come at a better time, as long as investors don’t look at their phones.  I am sure there will be a whole slew of “fascinating” tweets coming out of the White House.  There will be plenty of time next week to panic and then breath deeply and then panic again.  But there are some patterns emerging.  The first is that the manufacturing sector is flattening out.  The second is that the progress that was supposed to have been made on a trade agreement with China was mostly puff with little pastry.  The third is that it appears that households don’t really care that much, as long as jobs are plentiful.   It’s that last point that needs to be watched, as often, changes in confidence, up or down, are not followed by modifications in spending habits.  Remember, first quarter consumption was tepid, at best.  It was initially assumed that the extreme weakness in durable goods spending would dissipate in the spring, but the pathetic April vehicle sales pace raises questions about whether that will happen.  The May vehicle numbers are ten days out, so we can still harbor some hopes for consumers, but I am not so sure.  As for the other weak link in the first quarter GDP report, business investment, it looks like it continues to go nowhere.  The economic fundamentals are not strong despite solid job growth and until that disconnect is ended, we have to assume growth will moderate.  Investors, though, continue to be jerked around by the president’s tweets and until that changes, all I can do is point out what the economic data mean, not what the markets may do.  As for the Fed, the members’ comments show there is little agreement on what to do.  So, the best thing is to punt, which is what they are planning to do.Have a safe and enjoyable Memorial Day weekend!

April New Home Sales and Weekly Jobless Claims

KEY DATA: New Home Sales: -6.9%; Over-Year: +7%; Prices: 8.8%/ Claims: -1,000

IN A NUTSHELL:  “The new home market is doing better than the existing home sector, but neither is in great shape.”

WHAT IT MEANS:  Earlier this week we saw that existing home sales dropped in April, despite easing mortgage rates and today it was reported that new home demand also dropped.  However, the decline in new home sales came after a huge jump in March, so what we really have is a movement back toward a more realistic level.  Unfortunately, that level is not particularly high.  Indeed, we need about a fifteen percent rise in purchases before we can categorize the new home sales pace as strong.  Nevertheless, sales are on the upswing and we could see a double-digit increase over the 2018 totals. So far this year, total sales were up nearly seven percent and given how soft they were in the second half of last year, it would take a collapse in demand not to get at least a ten percent rise.  As for the April report details, the one region reporting a rise was the Northeast, but that area makes up only about five percent of the total.  The other three regions were down sharply.  The median price jumped, but I would be cautious about the number.  The distribution of sales across the price ranges has been strangely volatile the last few months, so let’s see what happens when things settle down.  

New unemployment claims remain at incredibly low levels, a sign that the labor market remains extremely tight.

There were a couple of other reports released today that need to be looked at carefully.  The April IHS Market manufacturing index fell to its lowest level since September 2009 while the services index dropped to its lowest point in over three years.  We’ve known for a while that manufacturing is hurting but services may be following in its footsteps.

MARKETS AND FED POLICY IMPLICATIONS:  The new home market may be outperforming the existing home market, but together, housing is not really doing much for the economy.  In addition, more and more data are pointing to troubles in manufacturing, in no small part because of trade issues.  And welfare payments are holding up the farm sector, which could get crushed once again by the tariff war.  Yet the labor market continues to boom and CEO surveys point to business leaders being almost irrationally exuberant.  In addition, households are pretty happy as well.  So, what is going on?  I guess it is time for my favorite saying: “You tell me and we both know!”  I have growth below two percent this quarter but I am somewhat below consensus.  On the other hand, I haven’t seen a whole lot of 3% estimates.  Households continue to hold the key to the economic kingdom.  April vehicle sales were pathetic and if we don’t see a sharp rebound in May, consumption could be really disappointing.  That would make it extremely hard to get to two percent growth, so I am sticking with my forecast.  The minutes of the last FOMC meeting indicated the members were more upbeat about growth.  Even so, they don’t expect to raise rates this year and a slowing in growth would only support that.  It would likely take at least two consecutive sub-two percent quarters to create a rate cut groundswell.  So, rates are likely to remain steady for quite some time. 

April Existing Home Sales and May Philadelphia Fed NonManufacturing Activity

KEY DATA: Sales: -0.4%; Median Prices (Over-Year): +3.6%/ Phil. Fed: -3.7 points; Orders: -14.8 points

IN A NUTSHELL:  “Despite months of declining mortgage rates, the housing market is just not coming around.”

WHAT IT MEANS:  It just doesn’t seem to be happening in the housing market.  Mortgage rates, which hit their highest rate in nearly eight years in November, have declined steadily since then.  Yet there are no signs that buyers have reacted significantly to the drop.  The National Association of Realtors reported that sales of existing homes eased in April.  That makes two months in a row now that demand was off.  Two months doesn’t make a pattern, but when you look at sales over the year, it was off by 4.4%, which is not good news.  Indeed, so far this year, the sales pace is running about 2.5% the rate posted in 2018.  That is really discouraging since mortgage rates have been below last year’s average.  In April, moderate weakness in the Northeast and a modest decline in the Midwest were largely offset by a relatively mild increase in the West.  In other words, there were no regions that showed either large increases or decreases, indicating that sales were not greatly impacted by the dreaded “weather issue”.  As for prices, they continue to rise, but the gains are moderate.  There was one good piece of data in the report: Inventories are rising.  Since so much has been made of the last of supply holding down sales, maybe with more homes on the markets, buyers will be able to find the home of their dreams – or at least one they can live with or in.

With manufacturing output faltering, it is imperative that the service side of the economy holds up if growth is to remain solid.  Well, it is not clear how much that is happening. The Philadelphia Fed’s nonmanufacturing index was down during May, led by somewhat slower growth in new orders.  But this report was not all negative.  Employment and investment remained strong and optimism increased sharply.  Indeed, about 65% of the respondents expect their own business activity to grow over the six months while only 8% expect it to decline.

MARKETS AND FED POLICY IMPLICATIONS:  Eventually, the economic data will actually matter again, but I suspect for a while only the really major and wildly unexpected reports will make a sound in the market forest.  The puppet master has control and investors have tunnel vision.  That is fine as long as the economy continues to grow decently.  And there is every reason to think that will be the case for quite a while.  Job gains are strong, incomes are rising and inflation is not destroying spending power completely.  Meanwhile, dividends are hitting record highs and coupled with the massive buybacks, the crutches supporting the markets continue to keep things from falling apart.  But the buybacks are waning and the ability to maintain the dividends will depend upon earnings and that means the economy could come back into play, maybe sooner than many believe.  That should give investors pause.  Strong growth is needed and that means wage gains will be key.  There is little reason to think that with companies already having committed so much of their tax cuts to buybacks and dividends, capital spending will surge.  In addition, fiscal policy is largely off the table, especially given the war between the president and the Democrats.  But if wage gains don’t accelerate, and they have been decelerating lately, consumer demand will not surge.  That means earnings could falter.  And if they do rise faster, margins could narrow.  In other words, there are real risks to market values and I haven’t even mentioned the Long March on trade the Chinese say they have started. The Chinese have long memories and even if an agreement is reached, be it more puff than pastry or not, they will not allow themselves to be put in a position of weakness again.  Over the next few years, they are likely to de-link themselves s from key relationships and that cannot be good for some U.S. companies or sectors. 

Early May Consumer Sentiment and April Leading Indicators

KEY DATA: Sentiment: +5.2 points; Expectations: +8.6 points; Current Conditions: +0.1 point/ LEI: +0.2%

IN A NUTSHELL:  “Hopes for the future run high, but that was before the trade war went nuclear, so let’s wait and see where things stand.”

WHAT IT MEANS:  Consumers will drive this economy and it looks like they are quite exuberant – maybe.  In the first part of May, the University of Michigan’s Consumer Sentiment Index hit its highest level in fifteen years, led by a surge in the expectations index.  But the report indicated that most of the data were collected before the trade talks collapsed.  The numbers coming in afterward were a lot different, with expectations much weaker.  This is especially important since the current conditions component was largely flat.  So, before we celebrate a consumer that is as happy as can be, let’s see what happens when the final numbers come out on May 31st

Looking ahead, the Conference Board’s Leading Economic Index rose moderately in April.  After having pretty much flattened early in the year, the index is moving back up.  However, the rate of rise points to more moderate growth in the near future, which is in line with what most economists and the data are forecasting.

MARKETS AND FED POLICY IMPLICATIONS:  The markets reacted quite negatively to the raising of tariffs and will likely do the same if the tariffs on Chinese goods are broadened.  But after thinking it over, investors seemed to decide that it was just a “never mind” moment.  I am not sure what investors are thinking or even consumers and that is a concern.  Do people think that tariffs don’t matter?  Really?  If so, then you can describe the current consumer confidence numbers and the behavior of the markets as showing signs of irrational exuberance.  Even worse, if tariffs don’t matter, what would stop our trading partners from putting tariffs on our goods and why would we not do the same with Europe and/or Japan.  Those nations may not be as egregious in their trade restrictions as China, but they have some pretty significant ways of controlling trade as well.  Do we really want to go down that road?  The trade situation undoubtedly will add even more volatility to the already volatile data.  That makes the Fed’s “data dependency” not much different than a roller coaster.  The Fed members need to buckle up, because things could get really crazy in the next few months.  

April Housing Starts, May Philadelphia Fed Manufacturing Survey and Weekly Jobless Claims

KEY DATA: Starts: +5.7%; 1-Family: +6.2% Permits: +0.6%; 1-Family: -4.2%/ Phil. Fed: +8.1 points; Orders: -4.7 points/ Claims: -16,000

IN A NUTSHELL:  “The housing market is coming back a little, another sign the economy continues to expand at a decent pace.”

WHAT IT MEANS:  If you believe the bond market, where rates have been plummeting, you would think that the economy is in deep trouble.  But that is just not the case.  Housing starts rebounded in April, which really should not have surprised anyone.  The levels we had been seeing over the previous two months were way below where they should have been.  Why do I say that?  Because permit requests, which also rose, had been and still are running above the level of actual construction.  That had to change and there still is more to come.  For the past three months, permits have averaged nine percent more than starts, which means there is a backlog of construction that will likely be filled in the next few months.  In April, construction activity showed what was likely the effects of weather.  Starts skyrocketed by 85% in the Northeast and by 42% in the Midwest, but fell by roughly 5.5% in both the South and the West.  Wet weather may play havoc with activity in May, so any result should be viewed accordingly.  One issue for the economy that comes out of this report is that the number of homes under construction declined for the third consecutive month.  Building activity is what really matters for economic growth and right now, that is softening.

On the manufacturing front, conditions there may be firming a little as well.  The Philadelphia Fed’s survey of regional manufacturing activity jumped in early May.  Keep in mind, this measure is wildly volatile, so the surge we saw was not really out of the ordinary.  Indeed, the details don’t consistently argue that conditions are improving significantly.  For example, while employment improved a touch, new orders expanded at a less rapid pace.  Looked forward, expectations were largely the same, though firms are thinking that hiring may pick up.  As for inflation, which was in the special question section, firms say their prices may rise a little less than had been thinking in February, but that overall consumer inflation would run a little hotter. 

Jobless claims declined back to more typical, at least for this tight labor market, last week.   MARKETS AND FED POLICY IMPLICATIONS:  In a normal world, where it is all about the economy, concerns should be minimal.  However, this is not a normal world.  Fighting a full-fledged trade war with China and a shooting war with Iran at the same time should be enough to unnerve investors.  But it appears as if many don’t believe that will be the situation.  How else can you explain the cratering and unwinding of that decline that has occurred over the past week?  Maybe investors are starting to understand they are mere puppets and the strings are being pulled by the tweeter in chief?  I make that statement not because I think those risks are not real; I believe they are.  But at some point, you have to start seeing it to believe it.  And then you have to determine the extent to which the economy will be harmed.  Right now, it is all fear and little analysis, so expect volatility to hold sway. As for the Fed, the uncertainty plays right into its hands.Why do anything until you know what direction policy will take us?  The difficulty, though, is that economic data tend to tell us what happened or is happening, not necessarily what will happen.  Being data dependent in an uncertain world where the data – and the markets – can be whipped around is an awfully risky approach to take.

April Consumer Prices and Real Earnings

KEY DATA: CPI: +0.3%; Ex-Food and Energy: +0.1%; Food: -0.1%; Energy: +2.9%/ Real Hourly Earnings: -0.1%; Over-Year: +1.2%

IN A NUTSHELL:  “Inflation is neither too hot nor too cold, but for the Fed, it is hardly just right.”

WHAT IT MEANS:  Normally, news about inflation would take center stage and it should.  So let’s keep it there, even though there are now higher tariffs on Chinese imports.  Consumer prices rose solidly in April, but much of the gain came from a surge in energy costs.  Meanwhile, food prices dipped.  Netting out those two volatile sectors, prices rose modestly for the third consecutive month.  Over the year, both headline and core prices were up about two percent, so the Fed’s target has been reached, at least for this measure.  The details of the report were a bit odd.  Clothing prices cratered again, but there was a change in the data collection process, so maybe we should also exclude clothing.  And there was a large drop in used vehicle costs, but it is unclear why that is happening given all the vehicles coming off of lease.  Maybe we should exclude that too.  And while I am at it…  Okay, just kidding around.   Not really.  There is a serious point in saying we should exclude most components.  The Fed claims there are transient factors restraining inflation and we have to determine which ones they are referring to and how much of an impact they are having.  Right now, core – i.e., non-food and energy – prices rose at a less than two percent pace over the past three months.  How long will the Fed wait to see if the impacts are indeed transient?  The one factor that we can agree is not transient is the continued surge in housing costs.  Those should remain high for an extended period.

With prices up solidly but hourly and weekly earnings rising more slowly, real, or inflation-adjusted earnings fell in April.  Consumer spending power has grown about one percent over the year and that is hardly enough to support strong consumption growth. 

MARKETS AND FED POLICY IMPLICATIONS:  Today’s news on inflation may disappear in the uproar about the raising of tariffs on Chinese imports and the threats to broaden them to all Chinese products.  But consumer prices are something that need to be watched.  It’s not that inflation is likely to soar; there is little reason to believe that.  It is that the tariffs are passed through to consumers.  The tariffs affect only a small percentage of the economy, so the pass though of the costs should not raise consumer prices significantly.  But the impacts don’t fall evenly across income groups.  In addition, inflation-adjusted earnings are growing modestly and the combination of higher tariffs and slow spending power does not bode well for consumption going forward.  First quarter household spending was weak and April’s vehicle sales were really soft, so second quarter consumer demand may not be that much better.  Meanwhile, the tariffs only make the Fed’s job more difficult.  They slow growth but may raise inflation enough to keep it near the Fed’s target.  Yet any agreement would unwind those impacts, whipsawing the data.  With no clear idea where the economy and inflation are going, the Fed will likely stay on hold for a long time.   

April Producer Prices, March Trade Deficit and Weekly Jobless Claims

KEY DATA: PPI: +0.2%; Goods: +0.3%; Services: +0.1%/ Deficit: up $0.7 billion; Exports: +1%; Imports: +1.1%/ Claims: -2,000

IN A NUTSHELL:  “It looks like the big bump the economy received from a narrowing trade deficit in the first quarter will disappear in the spring.”

WHAT IT MEANS:  The events swirling around the economy continue to create chaos but economists still have to make sense of the economic data.  Wish me luck.  Let’s start with inflation, since that is the key to Fed behavior.  As long as inflation remains near the target, there is not likely to be any change in rates.  Well, that is likely to be the case.  Wholesale prices rose moderately in April, led by another sharp increase in energy prices.  Offsetting that, though, was a decline in food costs.  As a result, producer goods prices, excluding food and energy, were largely flat.  Since April 2018, business costs are up between 2% and 2.5%, depending upon which special index you look at.  As for the pipeline, there appears to be some pressure building in the cost of food.  Those higher prices tend to be passed through.  Still, given that the path from wholesale to retail prices is not straight and is often a dead end, it is hard to make the case that inflation will accelerate significantly due to rising costs of production.   That is especially true given that the trend in services inflation, which had been leading the way, is down.   

Meanwhile, all is not quiet on the trade front, even before the president made his threat to impose higher tariffs on Chinese imports.  The trade deficit widened somewhat modestly in March, in line with what would have been expected given the data in the GDP report. But while I don’t expect a major revision to the trade numbers for the first quarter, it looks like the narrowing we saw has largely disappeared.  At least in March, the numbers were actually heartening, despite the widening.  Both exports and imports rose, which is what should happen when the economy is strong and the rest of the world is growing.  On the export side, the soybean farmers were back in the market, as sales surged.  But that could change quickly if the tariffs are imposed.  Energy exports were also up.  On the other hand, aircraft exports cratered. As for imports, higher prices and growing demand led to a rise in demand petroleum-related productsIndeed, imports of just about everything else rose, the major exceptions being cell phones and televisions. 

Jobless claims remained slightly elevated, but there are few signs the labor market is weakening.    MARKETS AND FED POLICY IMPLICATIONS:The latest research makes it clear that consumers are paying the cost of the tariffs.  But the volume of goods being taxed is small given the size of the economy, so there is little pressure on prices.  That is likely to be the case if the tariffs in Chinese products are raised.  But the threats, their imposition, their relaxation, new threats and on and on just makes it impossible to determine where the trade deficit is going.  Clearly, given sufficient lead-time, firms will expand imports in the months before the tariffs are imposed and lower them afterward.  Just the threats change patterns.  With companies now making decisions on what to order for the holiday shopping season, the uncertainty over when and how much to order is heightened. If new tariffs do come on, as is likely to be the case, then firms could hesitate importing goods, hoping that the tariffs will be rescinded.  On the export side, the Chinese will be true to their word and respond in kind. I suspect the farmers are not a very happy bunch.  Since trade flows have been modified by politics, it is necessary to look at growth excluding this crucial sector.Trade added one full percentage point to growth and could add nothing or even subtract from growth this quarter.   That could help create an artificially low growth rate in the second quarter, just as it created an artificially high number in the second quarter.  As for inflation, there is no reason to think it will accelerate or decelerate, which is good news for the Fed.  Finally, while today’s data are important, the trade threats matter and until some of the fog of trade war lifts, uncertainty will likely drive investment decisions.  And that is rarely good for the markets.

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