KEY DATA: Imports: +1%; Nonfuel: +0.4%; Exports: +0.8%; Farm: -0.1%/ Starts: +9.7%; 1-Family: +3.7%; Permits: +7.4%; 1-Family: -1.7%

IN A NUTSHELL: “Inflation pressures are building not just because domestic firms are raising prices but also because import costs increases are accelerating.”

WHAT IT MEANS: Another day of numbers, another sign that inflation is on the rise. This time it is from imports. The cost of foreign goods surged in January. Yes, energy prices jumped, but that was not the only reason the index was up so much. Excluding fuel, prices still rose rapidly. There was a surge in food, vehicles and a variety of industrial materials. On the positive side, consumer goods import prices were flat and capital goods costs went up modestly. Excluding fuel and even excluding food and fuel, import prices are up nearly 2%, the highest in nearly six years. On the export side, the only major sector that didn’t post a solid increase was agriculture. This sector has been struggling to find some pricing power and it just isn’t there.

Meanwhile, the December slowdown in home construction was probably due to weather issues. It is tough to seasonally adjust the data during the winter as deep-freezes and blizzards tend to come at random times. The rebound, though, in housing starts and permits in January was good to see. Both permit requests and housing starts were the highest in over nine years. Much of the gain, though, came from big jumps in the multi-family segment, which is always volatile. Regionally, construction fell in the Midwest but surged in the Northeast, South and West. While the number of homes under construction did increase, the level of activity was not a whole lot above what was going on in January 2017. It doesn’t look as if the shortage of inventory will be eased anytime soon.

One other key number came out today. The University of Michigan’s mid-month reading of consumer sentiment rebounded sharply in the early part of February. Consumers were more optimistic about the future and thought the economy was improving.

MARKETS AND FED POLICY IMPLICATIONS: Do interest rates matter? And if so, to whom do they matter? Despite rising inflation and an increase in the 10-year note of about 50 basis points and a 30 basis point jump in the 2-year note, investors don’t appear to be that concerned. The one-week retreat seems to have been shrugged off. But the inflation pressures are real and we haven’t seen any major economic acceleration from the tax cuts yet that could push up wage costs. Of course, businesses are probably looking forward to stronger, possibly excess demand, as that would give them the pricing power they have lacked for over a decade. And the ability to raise prices holds out hopes that earnings growth can be sustained at a decent level even after the post-tax cut base is put in place. But there is a downside to this thinking as the Fed will be free to raise interest rates back to more normal rates at just about any pace deemed necessary. Unfortunately, the discussion about what are “normal” rates hasn’t really begun. It needs to and soon. In two weeks the next PCE price index comes out and it could be hot. And three weeks later the FOMC meets. If the inflation data are as worrisome as I think is possible, look for the Fed to indicate it is putting inflation on the closely watched list.

KEY DATA: Sales: -0.3%; Excluding Vehicles: 0%/ CPI: +0.5%; Less Food and Energy: +0.3%/ Real Earnings (Monthly): -0.2%; Over-Year: +0.8%

IN A NUTSHELL: “In January, consumption cooled but prices heated up, which is not a good combination.”

WHAT IT MEANS: Did the consumer go on vacation? Are households waiting for their paychecks to increase as a result of the tax cuts before they start spending? I don’t know, but the decline in retail sales in January was the largest drop in nearly a year. We knew the number was not going to be great because vehicles sales were off, but this was well below expectations. And the decline in sales is actually worse than the headline number would have you believe. Gasoline purchases soared, but that was driven by a sharp rise in gasoline prices. Shoppers did buy more clothing, but that was about it.

In the “no good economy goes unpunished” category, the Consumer Prices Index jumped in January, led by the surge in energy costs. But even excluding energy, prices still rose solidly. The higher fuel prices drove up transportation expenses. Food and shelter prices rose moderately, but eating out cost a lot more. There was also an outsized surge in apparel prices, which happens periodically. Clothing costs are still down solidly over the year. As for health care, the spotlight on medical goods price increases may be working at they fell but medical services costs rose sharply. But maybe most importantly, consumer prices are up by 2.1% since January 2017, a touch over the Fed’s 2% target. Excluding food and energy, the so-called “core” index has risen 1.8%. The Fed prefers a different inflation measure, the Personal Consumption Expenditure (PCE) deflator, and that index could be close to the magic 2% pace when the data are release in a couple of weeks.

Consumer spending power continues to go nowhere as real, or inflation-adjusted wages dropped again in January. For the entire year, workers compensation rose modestly. Actually, the data are even more disappointing when you remove supervisory employees from the numbers. Real hourly wages were essentially flat over the year and even with hours worked up a touch, the weekly income increase was limited.

MARKETS AND FED POLICY IMPLICATIONS: The initial thought is that is that consumers must have been all tapped out from their holiday shopping, which explains the weak spending to start to the year. That would be nice if it were true. Retail sales were flat in December, which means there were two consecutive months of soft demand. The reason may be simple: Labor compensation continues to go nowhere. Once again, let me repeat that it is difficult to get strong overall economic growth without strong consumer spending. To maintain solid demand, households need the income to spend. They just don’t have it. As a result, as I keep harping on, the savings rate is near record lows. That might force families to use some of the tax cuts to rebuild household balance sheets rather than purchasing new goods. And then there is inflation. Reality seems to be setting in that the days of low inflation and therefore low interest rates are likely over. It appears we are moving back toward more normal levels of inflation and that is driving the increases in rates, also toward more normal levels. We will get the February CPI and the January PCE reports before the next FOMC meeting, which will be held on March 20-21. If the inflation pressures don’t turn around, it is likely that Chair Powell will raise rates.

KEY DATA: Payrolls: +200,000; Private: +196,000; Revisions: -24,000; Unemployment Rate: 4.1% (Unchanged)

IN A NUTSHELL: “If the labor market is this strong and the tax cuts have yet to kick in, what will it look like when households and businesses actually start spending the money?”

WHAT IT MEANS: I know it was called the Tax Cuts and Jobs Act, but why we needed more jobs is a mystery to me. Payroll gains were strong in January and the increases were pretty much spread across the entire economy. Construction hiring was robust and manufacturers continued to add workers at a solid pace. Retail employment rebounded after a down month in December and the warehousing industry just keeps expanding to meet the needs of the delivery economy. The improving real estate sector is also hiring heavily, as did health care and restaurants. Even federal and local governments padded their payrolls, and it wasn’t even in education. In other words, this was a really broad based employment increase. Over the past three months, an average of 192,000 new positions were added. That exceeds the 181,000 monthly average posted in 2017. Keep in mind, that lower pace of job gains was still robust enough to drop the rate from 4.7% in December 2016 to 4.1% in December 2017.

On the unemployment front, the rate held steady for the fourth consecutive month. The annual revisions to the data makes it not possible to directly compare December 2017 with January 2018 on some of the figures, but suffice it to say that there really wasn’t a softening in the unemployment and labor force numbers. Indeed, there may be a tightening in labor markets. Wage gains accelerated and the increase over the year hit 2.9%, the highest since the end of the Great Recession.

MARKETS AND FED POLICY IMPLICATIONS: The tax cuts should slowly start kicking in as we move through the first half of the year. We really have no idea how much of a boost to growth will occur. On the business side, it isn’t clear how much of the surge in after-tax profits will go toward new capital spending and higher wages rather being used to increase dividends, buy-back stock and/or increase management compensation. On the household side, with the savings rate low, it is also uncertain how much of the tax cuts and bonuses/wage increases will go to new spending rather than repairing deteriorating balance sheets. All that said, there will be growing household demand for goods and services and additional investment on the part of businesses. That faster growth will require more workers. So far, and despite their claims that they cannot find qualified workers, firms seem to be doing just that: They are hiring robustly. Is that pace sustainable? If the unemployment rate declined by 0.6 percentage point last year, what will it fall to this year? Even if you don’t like the unemployment measure, it is hard to see that the current hiring pace can be sustained. Massive fiscal policy piled on top of an economy that was growing solidly and has limited labor availability has not been tried before. How this “Grand Fiscal Experiment” affects wage and price inflation is something Fed has to be worried about. The rise in the 10-year Treasury note to its highest level in four years indicates the markets are getting worried about it as well. As I like to say, “no good economy goes unpunished” and the punishment may already be starting to be meted out.

KEY DATA: GDP: +2.6%; Consumption: +3.8%; Imports: 13.9%; Consumer Prices: +2.8%/ Orders: +2.9%; Excluding Aircraft: +1.4%; Capital Spending: -0.3%

IN A NUTSHELL: “The economy expanded at a solid pace last year and with orders rising and tax cuts kicking in, we should see better growth this year.”

WHAT IT MEANS: So, how did the economy do in 2017? Pretty well. Fourth quarter GDP growth came in a little less than expected, but the headline number hides the true strength. Consumers, businesses and even the government spent money like crazy. Demand for durable consumer goods surged by double-digits as did residential construction. Businesses poured tons of cash into capital goods and technology. So, why did the economy not break the 3% pace as it had in the previous two quarters? Well, you have to get the goods from somewhere and it looks like we got a lot of it from two sources: foreign companies and warehouses. Imports surged and inventories shrunk. Together, those two components reduced growth by 1.8 percentage points. A measure of internal demand, sales to domestic purchasers, was up significantly. As for prices, they rose sharply, especially for consumer products. That is something the Fed is going to have to watch carefully.

Orders for big-ticket items accelerated in December. Durable goods orders jumped, led by sharply rising aircraft demand. Excluding aircraft, the increases were not spread widely across the economy. Demand for metals, machinery and vehicles rose, but orders for electrical equipment, communications equipment computers were off. And the measure that most closely mirrors business capital spending also declined. So, this was a decent, but not great report.

MARKETS AND FED POLICY IMPLICATIONS: The GDP numbers point to an economy that is in very good shape. But they also show how hard it will be to expand by 3% or more for any extended period. The 2.25% pace posted in 2017 was the same as was averaged the previous seven years. There was no acceleration. Yes, it was faster than the 1.5% in 2016, but also less than the 2.9% in 2015. Looking forward, there are some concerns. A lot of the additional purchases came from foreign companies and that is not going to change much in the next few years. The capacity to meet sharply rising demand is just not there. Yes, industrial production should strengthen, but we will also have to get a lot of the rising demand from the rest of the world. So, expect imports to grow rapidly and the trade deficit to widen. There is doubt about the ability of households to continue spending like crazy. Yes, tax cuts will help. However, the minimal savings on the part of low and moderate-income households raises questions about the use of their fatter paychecks. Will they use the money to buy more goods and services or pay down debt and rebuild balance sheets? Given that most of the tax cuts will go to upper income households, who tend to invest, the prospects of a rise in consumer demand anywhere near what we saw in the last quarter are not great. It will take an awful lot of business capital spending to offset those factors and right now, we haven’t heard that companies are making plans to spend a large amount of their windfall profits on building new plants, warehouses or investing in technology. There will be an increase, but how much is just not certain. Then there is the rising rate of consumer inflation. It is not at a threatening level yet, but the falling dollar, increasing energy costs and surging imports imply inflation will accelerate further this year. And that is before we get into the need to pay more for workers. The economy is moving ahead solidly and this year growth should be a lot better, probably around 3%. But unless there is a massive increase in productive capacity and/or a sudden surge in labor supply, much of the new growth will not be met domestically. That means overall economic activity could have an upper bound, which when approached, could translate into higher prices rather than stronger growth. And if that happens, Jerome Powell will have to make some really tough decisions about interest rates.

KEY DATA: Sales: -3.6%; Annual: +1.1%; Median Prices (Over-Year): +5.8%; FHFA Prices (Over-Year): +6.5%

IN A NUTSHELL: “Sales of existing homes continue to lag, but that may be due to the incredibly low level of supply.”

WHAT IT MEANS: The housing market is in good shape, especially if you are a seller. Yes, according to the National Association of Realtors, existing home sales fell in December and for all of 2017, the gain was modest. But the sales number is misleading, at least to an extent. The inventory of homes for sale is extraordinarily low. Also, the months supply, which is the number of months at the given sales place needed to clear the market, dropped to its lowest level since 1999, when the number was created. If you cannot find the home you want, you don’t buy a home and with few houses on the market, that is the case for many buyers. With demand outstripping supply, prices rose solidly over the year. Regionally, every part of the nation posted a decline in December. For all of 2017, compared to 2016, sales were flat in the Northeast and Midwest and were up modestly in the South and West.

The Federal Housing Finance Agency’s index of home prices rose again in November, though the gain was limited. Home prices in the West continue to surge but are not rising very quickly on the East Coast. Over the year, housing costs are up significantly. Indeed, nationally, home prices have increased at an average pace of 6.2% for the past six years.

MARKETS AND FED POLICY IMPLICATIONS: With baby-boomers retiring and Millennials entering the home buying years, you would think that housing sales would be growing more rapidly. But demand is going unmet because households are just not moving and putting their houses up for sale. Equity values in many parts of the nation have climbed above their housing-bubble peaks, so it is hard to blame under-water properties for the lack of inventory. What will induce people to sell is unclear and that raises some concerns. To the extent that housing costs are reflected in consumer inflation, the rapidly rising home prices will continue to drive the consumer price indices up faster. Indeed, shelter is one of the fastest growing segments of the Consumer Price Index. That gets piled on top of the rise in energy costs, which is likely to continue given that growth should be strong this year. And if Treasury Secretary Mnuchin’s hopes come true and the dollar weakens, we could see import prices rise faster. Jerome Powell has been confirmed as the next Fed Chair and while he doesn’t face the difficult issues his last two predecessors confronted, it doesn’t mean he comes in with no potential problems on the horizon. Expansionary fiscal policy in a time of solid growth and low unemployment has not been tried. Add that to building underlying inflationary pressures and the new Fed Chair’s job might turn out to be a lot more daunting than people currently think. I am sure Mr. Powell hoped to be Chair. Well, he got it. I wish him luck. He will need it.

KEY DATA: Starts: -8.2%; 1-Family: -11.8%; Permits: -0.1%; 1-Family: +1.8%/ Phila. Fed (Manufacturing): -5.7 points/ Claims: -41,000

IN A NUTSHELL: “It has been a tough winter and the weather may have been a major factor in the construction slowdown.”

WHAT IT MEANS: I am already tired of winter and it is still the middle of January. Ugh! But there are only 27 days until the Phillies start spring training, so there is something to look forward to – my annual father/son trip to Clearwater. Builders across the nation had trouble coping with the weather in December. Housing starts plummeted, led by a double-digit drop in single-family construction. Every region posted a fall off in building activity. But the decline is likely to be temporary, as permits were largely flat and they increased for the key single-family segment. Over the last three months of 2017, permit requests ran over 4% higher than starts, so there is a lot of potential activity in the pipeline. If we ever get some good weather, those permits will be used.

While the economy seems to be accelerating, manufacturing activity is not gaining a lot of traction. Yesterday we saw that manufacturing production rose minimally in December. Today, the Philadelphia Fed’s survey of manufacturers indicated that there was not pick up in the first half of January. Activity was still decent, but the trend has been down, not up in the Middle Atlantic region. The details also supported the headline number. New orders expanded much less quickly, inventories built and order books thinned. Optimism about the future was also down. The only good elements of the report were the labor market numbers. Hiring held up and the workweek expanded. Employment expectations also remained solid.

Last week I said the jobless claims data were surprisingly soft and we needed to watch them. Well, never mind. New claims for unemployment insurance fell to one of their lowest levels ever. These data are seasonally adjusted on a weekly basis and that is really impossible to do. What we are probably just seeing is volatility due to weather and other factors that the adjustment factors are not built to account for. The labor market is tight and that is all that needs to be said.  

MARKETS AND FED POLICY IMPLICATIONS: In 2005, I was in Phoenix for a presentation to a venture capital company on the real estate market. I read in the Phoenix newspaper that housing prices in the region had risen over 20% over the year and that realtors believed that prices could increase that much or more over the next year. It was at that point that I started writing about housing bubbles. I admit, I had no idea how bad things would get, but that experience was something I have not forgotten. Consider the current environment. Stock indices were up 20% to 25% last year and have surged to start off this year. The Dow is up over 30% in a little over a year and has already jumped about 5.5% in just the first two weeks of this year. The S&P 500 has surged nearly 5% so far this year. And what are people saying? There is no reason to think that we cannot get another 20% plus increase this year. Sound familiar? Are there bubbles in the equity markets? In the immortal words of Alan Greenspan, “… it was very difficult to definitively identify a bubble until after the fact — that is, when it’s bursting confirmed its existence.” Apparently, we will have to wait until this bubble bursts, if it does, to confirm we are in an equity bubble. And along those lines, it is worthwhile to repeat a quote attributed to George Santayana: “Those who cannot remember the past are condemned to repeat it”. Just something to think about.

KEY DATA: IP: +0.9%; Manufacturing: +0.1%/ NAHB: down 2 points/ Vitality Index (Over-Year): +4.0%

IN A NUTSHELL: “The energy-sector rebound is helping accelerate the economy.”

WHAT IT MEANS: In 2015, the economy expanded at a very strong 2.9%. But conditions faded in 2016, with growth coming in at a tepid 1.5%. What was one of the biggest reasons for the slowdown? The collapse of energy prices and the energy sector!   Well, conditions changed last year and the energy sector is now leading the way again. Industrial production surged in December, and for the year as a whole, but not because of manufacturing. Manufacturing activity ticked up minimally in the last month of the year. There was no consistency in the sector, with almost as many industries posting large declines as those showing solid gains. For the year, manufacturing was up a solid, but not spectacular 2.4%. On the other hand, the mining sector surged in December and was up double-digits over the year. The large rise was driven by a 40% rise in oil and gas drilling for the year. With energy prices continuing to increase, I expect that the energy industry will help lead the way again this year.  However, the vehicle sector, which was largely stagnant in 2017, may see both lower sales and output.

Homebuilders have been ecstatic about conditions lately and that really didn’t change despite a decline in the National Association of Home Builders’ Index in January.   The level is very high and has rarely been seen except at the peak of both the dot.com and housing bubbles. I am not saying that we are in another bubble, just that you have to have really good economic conditions for developers to feel this euphoric.

ADP’s Workforce Vitality Index was up again in the fourth quarter, which should surprise no one. This report is worth following because it is one of the more comprehensive reports on wage gains we have. It breaks down wage changes by region, industry, age of worker, tenure in job, company size, by full-time vs. part-time and whether workers switched jobs or held them. Obviously, it is too extensive to easily summarize, but it can be said that wage gains are accelerating, especially in the resource and mining and hospitality and leisure industries. Job switchers are doing better than job holders and that has led to a further rise in the turnover rate. It is now over 50% in leisure and hospitality. If firms want to hire stable workers, they should look to those over 55, not those under 35. Of course, that is not what they do, but that is a topic for another commentary.

MARKETS AND FED POLICY IMPLICATIONS: Today’s reports really don’t change much for anyone. We are in earnings season. Investors are either going to love a lot, or a love a lot more, the earnings report. It will likely take a lot of terrible reports to get the animal instincts under control. And the data are not so strong as to cause any of the Fed members to rethink their views on rate hikes. Sometime this month the Senate will confirm Jerome Powell as the next Fed Chair, but that is a formality. Right now, doing something that is largely noncontroversial is not something most Senators want to do. Instead, they will focus on how to keep the government running. The supposedly World’s Greatest Deliberative Body has devolved into a Tower of Partisan Babel, so what will happen is anyone’s guess.