July Manufacturing Activity, June Construction, July Layoff Notices and Weekly Jobless Claims

KEY DATA: ISM (Manufacturing): -0.5 pt.; Orders: +0.8 pt.; Employment: -2.8 pts./ Construction: -1.3%; Private: -0.4%/ Notices: 38,845/ Claims: +8,000

IN A NUTSHELL:  “The manufacturing sector is not likely to do much until the trade issues are behind us.”

WHAT IT MEANS:  If you believe the Fed and Mr. Powell in particular, it is all about trade.  Trade wars are causing uncertainty, slowing world growth, U.S. business investment and exports and restraining manufacturing activity.  And there is little doubt that is the case.  In July, we saw that the industrial portion of the economy continued to moderate.  The Institute for Supply Management’s Manufacturing index eased to its lowest in three years.  Production and hiring increased significantly more slowly and order books thinned at a more rapid pace.  None of those are good signs and the modest increase in jobs points minimal help from manufacturing in tomorrow’s July employment report.  A similar measure, the IHS Markit Manufacturing Purchasing Managers’ Index, hit its lowest level in nearly a decade, so it does appear that manufacturing conditions have weakened significantly this year. 

Adding to the economy’s woes is the slowdown in construction, which declined sharply in June.  Most of that came from a large drop in government spending on education, highways and health care.  I guess we don’t need new schools, roads or hospitals.  But this report was not totally negative as private sector commercial and health care construction rose.  Still, commercial construction has not been great this year and there is little reason to expect that to change. 

As for the labor market data, the numbers did little to change the perception that conditions remain tight.  Challenger, Gray and Christmas reported that layoff notices continue to grow rapidly.  The weakest sector is industrial goods, consistent with the softening of the manufacturing sector.  The rise in unemployment claims last week only moves us back to more normal, but extraordinarily low levels.

MARKETS AND FED POLICY IMPLICATIONS: What will Mr. Powell and his band of monetary policy makers do next?  You tell me and we both know.  The economy is still expanding decently but the trade war issues are not going away.  With China showing it can be just as intransigent as Trump, don’t look for much to happen anytime soon.  The Chinese have decided to target agriculture and they are not buying our farm products.  How long farmers will be willing to stay on government welfare I don’t know, but it cannot be for too much longer. A lot of what is going on has to do with politics not economics, so the Chinese decision to hurt the politically important farm sector has to be recognized as an important factor in the negotiations to create true change in the bilateral relationship. Consequently, if a trade agreement with China occurs, it is likely to be mostly puff and little pastry.  But it would at least ease the uncertainty provide a short-term boost to growth.  Until then, the expansion should continue to moderate but not falter.  Chair Powell still claims the Fed is data dependent, which is hard to believe given the data didn’t support a rate cut.  I just don’t know what he is looking at and what he characterizes as weak enough to cut again.  If all he is worried about is world growth, he will probably get the data he needs to reduce rates again this year.  If growth and inflation are the keys, I am not sure the numbers will be as supportive.  And with the Fed clearly divided, forecasting what happens next has become a lot more uncertain, which is saying a lot given Mr. Powell’s penchant to change course on a dime.

July 30-31, 2019 FOMC Meeting

In a Nutshell:  “In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate…”

Decision: Fed funds rate target range reduced to 2.00% to 2.25%.

As expected, but not universally agreed with, the Fed cut interest rates by 25 basis points – one-quarter point – for the first time in a decade.  That occurred despite an economic statement that was the same as in June and an economy where the data have been better than expected.

So, why did the Fed reduce rates now?  The key factors appear to be a fear of too low inflation that could lead to an extended, Japanese-style deflationary slump and worries about the world economy that were largely created by trade policy. 

On the inflation front, it looks like inflation expectations are the key. Fed Chair Powell recognized that 25 basis points will not cure the problem of below target inflation.  Indeed, it is fairly clear that a quarter-point cut will have limited economic impacts.  But he believes that image matters and the reduction in rates and the end of the quantitative tightening process (which was also announced), should provide the confidence that inflation will ultimately move back toward target levels.  I guess the Fed once again is putting its stock in jawboning, a strategy that hasn’t worked well in the past. He also noted that it might take longer to get back to target.  That was likely noted so he can buy the Fed more time.

As for the world economy, the idea of cutting rates was to take out some insurance against a domestic slowdown induced by the trade issues.  Of course, he did not indicate how a rate cut would accomplish that goal.  That’s because it cannot.

As for future rate cuts, he hinted that this was the start of a process, but he tried to make it clear it would not be a long process.  In other words, we should expect another rate cut, though it is not clear if that might happen at the next meeting or one a little later.  Of course, if we keep getting solid data, who knows what this Fed will do. 

So, what should we make of this move.  The Fed has now become the economic mouth that is trying to roar.  That is, he thinks that when the Fed talks, everyone listens.  They do, but do they believe in what the Fed is saying?  That’s unclear because rates are already low, global factors are beyond the Fed’s control and low inflation has been an issue for years now and small rate adjustments can accomplish very little.

But to me, the real problem is the markets.  The Fed became the drug dealer of choice when it implemented and more importantly, sustained quantitative easing.  But the junkies, i.e., the markets, are now controlling the drug dealer.  When the markets get starved for more opiates, they scream and yell and ultimately, the Fed provides the drugs.  It did that in two ways today, by lowering rates and ending QT early. 

It is likely the markets will soon start demanding more.  Indeed, the huge decline in the stock indices in the first hour after the announcement and during Mr. Powell’s press conference, as well as the rise in the dollar, seemed to say that one 25 basis point cut will not do it.  As addicts will tell you, they can never get enough and the Fed is opening itself up to that potential problem, especially if the trade negotiations with China drag on. 

If Mr. Powell wants to delude himself by continuing to make the argument that this is just a “mid-cycle adjustment”, then so be it.  But he is now at the mercy of a mercurial president, foreign economies over which he has no control and economic/inflation perceptions rather than economic fundamentals.  As Oliver Hardy liked to say: “Well, here’s another nice mess you’ve gotten (us) into.”(The next FOMC meeting is September 17-18, 2019.) 

July Private Sector Jobs and Second Quarter Employment Costs

KEY DATA: ADP: 156,000; Small: 11,000; Large: 78,000/ ECI (Over-Year): +2.7%; Wages: +2.9%; Benefits: +2.3%

IN A NUTSHELL:  “Despite decent job gains, worker compensation gains continue to fade, which is a real conundrum.”

WHAT IT MEANS:  Our illustrious Fed Chair is concerned about the economy and since growth has depended on strong consumer spending, the focus has to be on job gains and worker compensation.  In both cases, conditions remain solid, though not nearly as strong as one would expect.  Take payrolls.  According to the employment services firm ADP, private sector hiring was solid in July, though nothing spectacular.  The issue is with small businesses, which are hardly hiring.  These firms are being battered by tight labor markets, which make it difficult to find workers.  Small companies tend to have limited or no be benefits and need part-time employees and if workers can find full-time jobs with benefits, they will take it.  That is usually with larger firms, who are hiring at a strong pace.  Small businesses are also facing the reality that demand is shifting to online purchases, a place where they have significant problems competing.  So it is not a surprise they are losing out.  But the implication is that most hiring will occur at medium to large-size companies, a change from the past.  The hospitality, health care and administrative services sectors continue to add workers solidly, though manufacturing and mining have weakened.

With the supply of workers is constrained by the low unemployment rate, we should be seeing income gains accelerating.  That is just not happening.  Compensation is decelerating.  The Employment Cost Index rose at a solid but slower pace in the second quarter, marking the second consecutive quarter that worker compensation moderated.  Both wage gains and especially benefits increases have faded.  That is a real surprise, especially the sharp drop in benefits growth.  Anecdotal stories have it that firms are using lots of non-monetary inducements to keep or attract workers.  It could be that those benefits are not being captured by the government’s survey. Indeed, government benefits remain high and the public sector is limited in its ability to be imaginative in retaining and attracting workers.  So, we may be getting an incomplete picture of the compensation situation.MARKETS AND FED POLICY IMPLICATIONS: The Fed’s rate decision will be coming out soon so the markets will be focusing more on what is in the statement and what Chair Powell says at his press conference than on any economic number.  But the data don’t point to a faltering economy, only a moderating one.  With the economy expanding at trend growth in the second quarter and with inflation at a pace in excess of the Fed’s 2% target, there is no reason to cut rates. But Mr. Powell put the Fed into a straight jacket and he has to loosen it at least a little today.  Where we go from here, though, is the real question and given the rapidity with which Whiplash Jay changes direction, I have little idea what the next move will be.

June Retail Sales, Industrial Production and Import Prices

KEY DATA: Sales: +0.4%; Ex-Vehicles: +0.4%/ IP: 0%; Manufacturing: +0.4%/ Import Prices: -0.9%; Fuel: -6.5%; Non-Fuel: -0.3%

IN A NUTSHELL:  “With consumers consuming and manufacturers manufacturing, the only thing the Fed has to worry about is inflation.”

WHAT IT MEANS:  As Fed Chair Powell keeps saying, the economy is at risk.  Wrong again, at least when you look at the June economic numbers.  First there is the consumer, who seems to be quite willing to spend.  Retail sales rose more than expected in June and it wasn’t just vehicle purchases.   Most categories, including furniture, building materials and health care, posted solid gains.  We ate out and ate in and shopped online.  About the only thing we didn’t do was buy electronics and appliances.  While total gasoline purchases dropped, that was due to price declines. And it looks like second quarter consumption could be better than forecast as the so-called core sales measure, which tracks the GDP consumption number, was up sharply.  This excludes vehicles, gasoline, good services and building materials.  In other words, the consumer is alive and well. 

Meanwhile, the nation’s manufacturers are expanding output to meet the solid demand.  Manufacturing production rose strongly in June as most industries posted gains.  Only three of the eleven durable goods industries reduced output, while only two of the eight nondurable sectors were down.  As vehicle sales have moved back to very solid levels, the companies have boosted assembly rates sharply over the past two months.  There were some weak segments of note.  Machinery and electrical equipment and appliances reduced production sharply. 

As for inflation, if the costs of imports matter, and they do, it is going nowhere.  Import prices fell in June, which hardly surprised anyone given the sharp decline in energy costs.  But even excluding fuel, the cost of foreign products was down.  Looking at the details, most components were either flat or lower and those that were up rose minimally.  Over the year, import prices were off 1.4%.  In comparison, between June 2017 and June 2018, the cost of imports was up 1.5%.  As for exports, the hurting farm sector got a major reprieve as their prices surged.  But if you were a non-farm exporter, you had to sell at a discount. 

There were two other indicators released today that also point to solid growth.  The National Association of HomeBuilders’ index moved up in July, pointing to a small improvement in construction.  CoreLogic reported that in April, the mortgage delinquency rate hit its lowest level in more than twenty years.  That indicates household finances are in pretty good shape.

MARKETS AND FED POLICY IMPLICATIONS: Mr. Chicken Little Powell keeps telling us the sky is falling and that the Fed needs to act accordingly.  But while growth may be moderating it is not faltering.  That is a big difference that should not be difficult to comprehend.  But I guess the Fed Chair and his band of economic gurus don’t seem to get the point.  It will be interesting to see what the first print of second quarter GDP looks like.  It comes out on July 26th, just a few days before the next FOMC meeting, which is on July 30-31.  Remember, this number can be revised quite sharply and the government doesn’t have good data for numbers such as trade. We could get a growth rate that is better than expected, though I still am in the 2% range.  Indeed, as I asked last week, what does the Fed Chair say if the first estimate is closer to 2.5%?  Today’s numbers do not rule out that possibility.  The Fed seems committed to reducing rates and some economists are saying a half-point cut is possible.  There are Fed members who want a quarter point reduction, if only to take out some insurance.  I have no idea what model they are looking at, if they are looking at one at all.  My view is that a quarter-point reduction accomplishes nothing.  If you are worried about a slowdown, do something about it and cut at least a half-point.  Otherwise, stopped playing games. We shall see.

June Consumer Prices, Real Earnings and Weekly Jobless Claims

KEY DATA: CPI: +0.1%; Over-Year: +1.6%; Ex-Food and Energy: +0.3%; Over-Year: +2.1%/ Hourly Earnings: +0.2%; Over-Year: +1.5%/ Claims: down 13,000

IN A NUTSHELL:  “The tight labor market is not causing wages to surge, so inflation remains lower than expected.”

WHAT IT MEANS:  Yesterday Fed Chair Powell signaled that rates would be coming down, probably at the end of the month.  So we have almost three weeks to see if his fears about weak inflation and a slowing economy are founded.  On the inflation front, his worst concerns were not matched by the June Consumer Price Index report.  Costs rose modestly, but that was largely due to the more volatile food and energy components, which were flat or down.  Excluding those elements, prices rose at the fastest pace in over a year.  Costs of shelter and medical care, not surprisingly, are driving up the index.  In June, though, the biggest increases were in used vehicles and clothing.  I am not sure those two will play a major role going forward. 

The number of new claims for unemployment insurance fell sharply last week and you would think that move signals further tightening in the labor market.  It probably does, but that doesn’t seem to be doing much for wages.  Hourly wages, adjusted for inflation, rose moderately in June.  Over the year, they have increased by a pace, 1.5%, that can hardly be described as strong.  And if the Fed gets inflation to accelerate, spending power could rise even less.      

MARKETS AND FED POLICY IMPLICATIONS:  Yesterday, Mr. Powell sent clear signs that he was worried about the economy and would be willing to lower interest rates.  Unfortunately, his logic is flawed.  A major concern is trade, which is slowing world growth.  Under normal circumstances, lower interest rates might be expected to increase growth, but that doesn’t seem likely right now.  First, cutting rates would not change the factors that are harming world growth.  They are tariffs and the fears of a further expansion in the trade war with China.  Lowering rates does not change those concerns or reduce the costs of tariffs. So, why would businesses change their investment or expansion plans?  Got me.  Meanwhile, the interest sensitive sectors, such as housing and vehicles, are not likely to be helped much by a quarter or half point cut.  Rates are already low and it isn’t the cost of funds that are restraining the markets. So what the Fed Chair expects to accomplish is beyond me.  But he persists.  On the inflation front, the Consumer Price Index, which is not the favored inflation measure but one that is watched nonetheless, is not showing major problems.  Other, less volatile measures created by the Cleveland and Atlanta Fed Banks show inflation at an even higher rate.  But he persists.  I am guessing that Mr. Powell is counting on a sub-2% second quarter GDP growth rate to bolster his position.  And that is quite possible.  But one thing we know about GDP reports, they often surprise.  So, what does he do if a 2.5% growth rate prints?  That would hardly argue that the economy is currently being greatly affected by the trade issues.  The Fed Chair is on shaky grounds and while we are likely to get a rate cut at the end of the month, it would be nice if Fed policy was not being based so much on guesses and issues, such as trade policy, that monetary policy cannot influence.

June Employment Report

KEY DATA: Payrolls: +224,000; Private: 191,000; Health Care: +35,000; Manufacturing: +17,000; Unemployment Rate: 3.7% (up 0.1 percentage point); Wages: +0.2%; Over-Year: +3.1%

IN A NUTSHELL:  “When you smooth out the wild swings in job gains, it is clear the economy and the labor markets remain solid.”

WHAT IT MEANS:  It looks like there is lots of noise not just on Twitter. The economic data continue to show lots of volatility as well.  After a truly weak May employment report, questions were being raised about the strength of the economy. Never mind.  Conditions are just fine.  Job growth was strong in June and the increase was across the board.  The health care and professional services were the key drivers of the job gains. Despite all the trade problems, manufacturers added lots of workers, a real surprise.  But the wild card in this report was government, which added workers heavily after having reduced payrolls in May.  Look for that to unwind in July.  Similarly, there was a sharp increase in construction, a sector that was largely flat the previous two months. 

As for the unemployment rate, it rose modestly.  The strong labor market is drawing in more workers and the labor force was up as was the participation rate, so don’t read anything into the increase.  The one major concern in this report was wages. Despite the low unemployment rate, wage gains continue to decelerate.  I seem to write that every month, as this is a trend that has been with us since the increase over the year peaked in February.  And, as I like to point out, without strong income increases, it is hard to sustain solid consumer spending. 

MARKETS AND FED POLICY IMPLICATIONS:  This was a solid report that creates issues for both the Fed and investors.  For the Fed, the members now need to have some weak economic numbers to honestly argue that the economy needs help. I have warned countless times that you cannot read much into any one economic number.  But apparently, Fed Chair Powell doesn’t agree.  Too bad, since we are seeing just how volatile the data can be.  All this talk about the need to cut rates to help the economy simply got no support in June.  Job growth was solid and while vehicle sales may have been down a bit from the robust May pace, they were still very solid.  The consumer has not abandoned hope.  There are a lot of reports that will come out before the next FOMC meeting at the end of the month, but the big one will likely be second quarter GDP.  It could be the weakest in three years.  But that would not necessarily mean the economy is falling apart enough for the Fed to actually start cutting rates.  We often get a number well above or below the underlying trend and this is likely to be the case.  It has to do with the volatility of the data.  But Mr. Powell needs a soft growth rate to make the excuse to cut rates, since he seems to be operating on a “what have you done for me lately” approach. The Fed looks like it is operating in an economic intelligence vacuum.  We have a Fed Chair who wobbles with every economic number.  We have a Fed bank president who wants to take out some insurance by cutting rates a quarter point, which would do absolutely nothing to the economy.  We have a whole group of members who change their view of conditions between every meeting.   And we have investors, who root for weak numbers so the Fed will cut rates, rather than hope for strong numbers that show growth remains solid.  Indeed, there seems to be a perverse view that good is bad and bad is good.  Strong data raise questions about Fed cuts while weak ones confirm the beliefs that a reduction is coming.  Really?  Is it better to have a soft economy and rate cuts than a strong economy and no rate cuts?  That makes no sense to me, as implies the Fed can fine-tune the economy.  The only thing a rate cut would do is sustain the Fed’s role as drug supplier to the equity markets.  But since it appears that Fed Chair Powell likes being a pusher and investors like being junkies, I suspect both roles will be sustained at the end of the month.

June Manufacturing Activity and May Construction

KEY DATA: ISM (Manufacturing): -0.4 points; Orders: -2.7 points; Employment: +0.8 points/ Construction: -0.8%; Private: -0.7%; Residential: -0.6%

IN A NUTSHELL:  “The manufacturing slowdown continues and it is being mirrored by moderating construction activity.”

WHAT IT MEANS:  The trade battles are supposed to create a more level playing field for manufacturers and lead to a faster growing sector, but for now, the opposite is occurring.  Manufacturing activity continues to fade.  The Institute for Supply Management’s Manufacturing index eased again in June, dropping to its lowest level since October 2016.  That is not to say the sector is not expanding, it is, but the pace has decelerated fairly consistently over the past year.  In June, the decline was led by faltering orders, which were flat.  This was the first time in nearly 3½ years that demand was not expanding.  With output increasing faster, order books continued to shrink, which is not good news for future production.  There was one good number in the report: Employment expanded faster.  Manufacturing payrolls may not restrain job gains in Friday’s June employment report, though I still think we could see a negative manufacturing number.

Construction, the other major non-service sector, also looks to be weakening.  Activity dropped in May as both public and private sector and the softness was pretty much across the board.  Both residential and nonresidential spending were down.  Compared to May 2018 levels, private sector construction activity dropped over 6% as residential fell by double-digits.  Non-residential was off minimally.  MARKETS AND FED POLICY IMPLICATIONS:Now that we have cease-fire in the U.S./China trade war – which should have surprised approximately no one – it is time to focus on the economic fundamentals.  Well, maybe we shouldn’t.  There have not been a whole lot of good reports recently and today’s numbers continue to paint a picture of an economy continuing to moderate. Manufacturing has been battered by the trade war fears and the weekend’s news wasn’t particularly helpful.  The reality is that nothing changed other than the hope that additional tariffs will not be put in place in the near term.  The Chinese got what they wanted and the U.S. put off imposing tariffs that could drive the economy into recession.  I guess you can say that is good but future tariffs have not been ruled out and thus there really is no reason for anyone to feel that this situation is close to being resolved.  It was said that an agreement was 90% complete, which is downright scary.  Anyone who has been involved with major negotiations knows that the last few percentage points are the toughest ones and ten percent is a large number.  So, don’t expect an agreement anytime soon, which means that ultimately, the threats of new tariffs will likely rear their ugly heads.  As for the Fed, the focus is on Friday’s jobs report (yes, there is a jobs report on Friday!), which should be decent but hardly great.  I categorize 150,000-175,000 as decent.  Don’t be surprised if the unemployment ticks up.  Until we get that number, even with additional data being released before then, the best thing that can be said is that the economy is expanding, but at a more trend-like manner, which is somewhere in the 2% range. 

May Spending and Income and June Consumer Sentiment

KEY DATA: Consumption: +0.4%; Income: +0.5%; Prices: +0.2%; Ex-Food and Energy: +0.2%/ Sentiment: -1.8 points

IN A NUTSHELL:  “Decent income gains are supporting continued consumer spending, but weakness in wage increases remains a threat to growth.”

WHAT IT MEANS:  Until the trade wars are resolved, businesses will remain under pressure, so we have to look at consumers to keep things going.  And it looks like that is happening.  Household spending jumped in May, led by a surge in vehicle sales.  Services demand also was up solidly, which overcame weakness in soft goods purchases.  Still, the increase in spending, when added to the rise in April, means that second quarter consumption should be solid if not strong.  Of course, that depends upon June vehicle sales and we will not know them until next week.  Can households continue to spend?  That is a good question.  On the surface, the answer is yes, as disposable (after tax) income rose strongly.  But wage and salary gains were tepid, at best.  Workers did not see a whole lot of increase in their paychecks and that is worrisome.  Proprietors’ income jumped and interest payments surged (don’t ask me why, I have no idea), creating the strong income increase.  The savings rate was up again, possibly indicating that households are becoming more conservative in their spending patterns.  As for inflation, it rose moderately even when the volatile food and energy components (the core rate) were removed.  Over the year, price gains remain below the Fed’s 2% target.

Consumer confidence continues to fade, but by no means can it be said that people are depressed.  The University of Michigan’s Consumer Sentiment Index eased in June less than expected.  The overall measure remains quite high as do the current conditions and expectations indices.  The report noted that: “June’s small overall decline was entirely due to households with incomes in the top third of the distribution, who more frequently mentioned the negative impact of tariffs”.  That is not likely to lead to much of a change in overall spending.MARKETS AND FED POLICY IMPLICATIONS:We are on Fed Watch.  Will the FOMC cut rates at the next meeting, that end July 31st?   The markets still seem totally convinced that it will happen, but I am not.  Consumer spending is holding up and that means second quarter growth could come in at around 2%.  The Fed raised rates when the economy was expanding not much more than 2%, so why should 2% growth require a rate cut?  Keep in mind, most economists believed and still do that 3% growth is not sustainable and we would ease back to trend, which is in the 2% range.  As for inflation, which seems to worry the Fed as much or more than growth, it too is not really falling apart.  On a quarter-over-quarter annualized basis, top line inflation is running at a 2.3% annualized pace while core inflation is more muted, at 1.7%.  While the year-over-year numbers are both below 2%, the Fed should also be looking at the recent pattern.  If the quarter-over-quarter rates are near the Fed’s target, wouldn’t it be reasonable to remain patient and see what happens?  Growth around 2% and inflation just below 2% are not data points that demand a rate cut.  If we get one, my conclusion would be that it’s the equity markets that matter the most right now.  That would imply the Fed has a triple mandate that includes maximizing equity values, not just maximizing employment and stabilizing inflation.  Ugh!

June 18,19, 2019 FOMC Meeting

In a Nutshell:  “… uncertainties about this outlook have increased.”

Decision: Fed funds rate target range remains at 2.25% to 2.50%.

The Fed kept interest rates steady today, but signaled a rate cut could be coming. 

The view of economic conditions was largely unchanged from the last meeting, when the FOMC indicated it would remain “patient” when it came to determining the direction of policy.  While investment was viewed as “soft”, consumption “picked up”.  That is largely a wash.  Labor market conditions were still considered to be “strong”.   And, the forecast for 2020 ticked up a little, form 1.9% to 2.0%.  So, it can be said that if the Fed was signaling weakness, it had little to do with the economy.

What did change was the categorization of inflation.  The statement noted that “Market-based measures of inflation compensation have declined…” It also stated, in the context of its views on both growth and inflation, that “uncertainties about (the) outlook have increased.”  Therefore, the Fed, instead of being patient, will “closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion…” 

Despite the lack of data pointing to a weak economy, of the seventeen board and bank presidents who provided forecasts, eight expect the funds rate to be cut this year and seven think it will be reduced twice.  On the other hand, eight think that rates will not change this year.  In addition, while only one member thought there would be rate hike this year, three expect it to go up next year!  That is a pretty fractured Fed. 

My problem with the statement and the forecasts is that taken together, they are inconsistent.  Why signal that rates need to be cut when growth might actually be a little better than expected and in any event, is not showing signs of faltering?  And do those who want to ease really believe that a half point reduction in the funds rate will cause inflation to accelerate?  I am not sure what model would show that.

If inflation is the great concern, which it appears to be, then it is likely to take a lot more than 50 basis points to drive up inflation significantly.  It is not as if growth has been weak over the past year.  However, it doesn’t look as if the Fed is prepared to go that route. 

So why did the Fed signal a rate cut could be coming in the near term?  The only explanation I have is that the markets told them to say that.  A failure to remove the word patient from the statement could have been greeted quite negatively by investors.  So the Fed gave the markets what they wanted – for now. 

Ultimately, though, the data will prevail.  If the economy is as decent as I think it is, it will be hard for the Fed to cut rates without further declines in inflation, even if a growing number of members are no longer patient.  (The next FOMC meeting is July 30-31, 2019.) 

May Housing Starts and Permits

KEY DATA: Starts: -0.9%; 1- Family: -6.4%; Permits: +0.3%; 1-Family: +3.7%

IN A NUTSHELL:  “Housing continues to wander along, not doing much better but not weakening a whole lot.”

WHAT IT MEANS:  If the housing sector was the canary in the mine, it would not be falling over nor would it be singing away.  It would just be sitting there.  Housing starts faded a touch in May, led by a sharp decline in the key single-family segment.  Multi-family activity was up double-digits, but not enough to stop the bleeding.  Three of the four regions posted declines, with only the South keeping things from looking really ugly.  On the other hand, permit requests rose a touch.  Single-family permit demand increased, but that may have due to an unusually low April level.  The May number was similar to what we saw during the first three months of the year.  Permit requests are still running above actual starts, so there is some room for construction activity to improve.  The backlog of homes to be built is thinning as the number of homes permitted but not started is falling.  If construction increases, the rise should not be that great.

Supporting the view that housing has likely entered a stable stage was yesterday’s National Association of Home Builders Housing Market Index report.  The overall index eased as all three components – present and future conditions and traffic – were down.  The Northeast and West were off sharply, but there was a rise in the Midwest and the South was flat.

MARKETS AND FED POLICY IMPLICATIONS:  As the data for this quarter mount, it appears that growth will be somewhere in the 2% range.  I have it a little lower, but given the wild revisions in the retail sales data, it is hard to know what consumers are thinking.  If the housing numbers are an indirect way of looking at household exuberance, it looks like they are shopping but not dropping.  And that may not be bad.  We have had three consecutive quarters of growth that was above sustainable levels, so if we have a fourth one that is pretty much at trend, it would be hard to say the economy is weakening.  There is a big difference between a soft economy and one that is easing back to more realistic growth rates.  That seems to be happening.   Whether Jay Powell and his band of scaredy-cats see it that way is another story.  There is no reason to change anything right now.  Indeed, now, more than ever, the term patience makes the most sense.  The fundamentals of the economy remain good.  It is the overarching political issues that are so threatening.  But as long as those threats don’t turn into reality, the economy does not need any additional help.  Since we will not know where things are going for a while, the best thing for the Fed to do is punt, that is, remain patient.  The markets are expecting the Fed to lose that term when the FOMC meeting ends tomorrow and the statement is released.  If the members don’t keep it in, it would be a mistake as they would be taking a big risk that actual second quarter growth comes out at or below expectations, not above it.  How do you square a message saying a rate cut is coming when the economy remains solid?  I don’t know.  I would argue that if the Fed signals that a cut could happen soon, it will have basically moved to a single mandate which contains neither full employment nor stable inflation, which we have.  It would be essentially saying that its purpose is to maximize markets.  When it comes to turning points, and a move to lower rates would represent one, it is the Fed’s job to lead, not follow.  That is what previous Chairs did.  They then followed the markets up or down until they decided to signal that enough was enough.  It would be a terrible change in strategy to not only allow the markets to lead during an easing or a tightening, but also to determine when the easing or tightening should stop and when it should be reversed.  That would be an abdication of the Fed’s responsibility.

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