June Producer Price Index and Industrial Production

KEY DATA: PPI: +0.4%; Goods: +0.5%; Goods less Food and Energy: +0.1%; Services: +0.3%/IP: +0.2%; Manufacturing: +0.1%

IN A NUTSHELL:  “The rise in wholesale consumer product costs may not lead to a large rise in inflation, but the upward trend needs to be watched.”

WHAT IT MEANS: As long as inflation remains well contained, the Federal Reserve can provide unlimited support to the economy.  We have seen a steady, but slow, upward drift in the inflation rate and the June data on wholesale costs indicate that the trend will likely continue.  The Producer Price Index rose sharply but much of that came from a jump in energy costs.  We already know that the upsurge in petroleum prices has already unwound so the headline rise in July will likely be lower.  But as usual, the real information is in the details and they tell a somewhat different story.  Costs at the finished goods levels are beginning to show some real signs of rising inflation.  Finished consumer goods prices have increased by over 3% during the past year even when you exclude energy.  Finished consumer food costs have jumped nearly 5%.  While not all of those increases make their way into retail prices, a lot do and that argues for additional pressure on consumers.  Services costs, though, have been more contained, increasing just under 2% over the year.

On the manufacturing front, output rose modestly in June, but that doesn’t tell the whole story.  The industrial sector rebounded from a terrible January, posting strong gains over the next four months.  Even with the limited increase in June, manufacturing production increased at a nearly 7% pace during the second quarter.  Despite a weather-restricted 1.4% first quarter increase, manufacturing output is rising at a better than 4% pace this year and that is an indication the economy is picking up steam.  Construction activity was solid in June and the output numbers were backed up by a jump in the National Association of Homebuilders’ Index which hit its highest level since January.  The winter is finally over as far as builders are concerned.

MARKETS AND FED POLICY IMPLICATIONS:  It is hard to get worked up over any producer price report as the pathway from wholesale to retail is hardly direct and frequently goes nowhere.  But the increases in finished goods costs are a warning that the days of putting inflation in the back of our minds may be coming to an end.  We are not talking about high inflation, just rising inflation.  We have seen that in the both the Consumer Price Index and Personal Consumption Expenditure Price Index.  The CPI is now over 2% while the PCE is closing in at that level, though excluding food and energy they are still below the Fed’s target.  The Fed probably wouldn’t mind a little acceleration in inflation. It is a lot higher that they worry about.  Right now there is little reason to fret but that may not be the case in by the end of the year.  Investors will probably not think much about today’s data as they are really non-threatening.

June Retail Sales and Import Prices

KEY DATA: Retail Sales: +0.2%; Excluding Vehicles: +0.4%/Import Prices: +0.1%; Excluding Fuel: -0.1%

IN A NUTSHELL:  “Consumer exuberance remains restrained and that raises questions about how strong the economy can or will grow.”

WHAT IT MEANS: The winter or our consumer discontent continued into the spring of our shopping boredom.  Most economists assumed that the weather drove down spending in the first part of the year but that would change dramatically as we got to the summer.  Well, spending is up but not nearly as robustly as forecast.  Retail Sales increased less than expected in June.  Strangely, vehicle sales fell.  I say strangely because unit sales hit their highest level in eight years in June.  After going crazy at the Home Depots of the world in April and May, demand for building supplies collapsed in June.   And since we weren’t shopping like crazy, we didn’t eat out a whole lot either.  But there were positive signs in the data.  Sales of food, clothing, sporting goods, health care products and appliances and electronics were up.  We shopped online and at general merchandise stores, so we really did spend some money.  These are the products that show up in the consumption component of GDP so we could see a decent spending number when the second quarter growth rate comes out on July 30th, the same day the next FOMC meeting ends.

Consumers can continue to buy lots of things, even with limited incomes, since inflation is well restrained.  We saw that again with the import price numbers.  The cost of foreign products rose minimally in June but most of the gains came from a jump in energy costs.  Food prices fell while the costs of consumer goods, capital equipment and vehicles were flat.  In other words, consumer purchasing power, at least when it comes to most imported products, is holding up.  On the export side, a similar pattern was observed as prices fell pretty much across the board.

MARKETS AND FED POLICY IMPLICATIONS: I keep saying we cannot get strong growth until we get strong income growth and so far we don’t have either.  Part of the problem with the expected rebound in spending is that some of the demand was lost forever.  If we didn’t go out to eat in February, we were not going to make up for that in June.  But another, longer-term change may be in the wind: The long-lasting, slow recovery may be eroding the “shop ‘till you drop” mentality.  People may be discovering they really can live without all the things they used to think were necessary.  Doing without for a short time may cause only temporary reductions in demand but cutting back for an extended period could change habits.  We will see what happens when income growth gets back toward decent levels, but we have to consider that the Great Recession and the Not-So-Great Recovery have modified spending patterns. With the Fed worried about disappointing growth, the decline in non-fuel import prices provides further cover to keep rates low for an even longer period of time.  Inflation is hardly a threat right now.  As for the markets, the focus of attention is where it should be, on earnings.

May Job Openings and Labor Turnover Survey

KEY DATA: Openings: +171,000; Hiring: -52,000; Quits: +60,000

IN A NUTSHELL:  “Rising openings and increasing labor turnover is another sign that the labor market is improving rapidly.”

WHAT IT MEANS: Despite the robust June jobs report, skepticism about the strength of the labor market remains.  And the basis for that uncertainty is valid: Wages continue to rise minimally.  That more work needs to be done before firms are forced to start bidding for workers is clear, but that time may not be far off.  The monthly reading on job opening and labor turnover was a pretty good one.  Jobs openings jumped.  Since May 2013, they are up a nearly 20%.  Hiring has clearly not kept pace, in part because business leaders are not raising compensation so workers are not coming out of the woodworks to take the jobs.  But changes are in the air as the number of people quitting is rising.  Given all the uncertainty about the labor market, it takes a lot of guts to leave a job and since last May, there has been a nearly 15% increase in the number of people willingly leaving their jobs.

MARKETS AND FED POLICY IMPLICATIONS: The JOLTS data are my favorite non-payroll numbers and members of the Fed, including Fed Chair Yellen, also watch them closely.  I like the quits data the most as it really gets to the heart of the uncertainty that workers have been facing: The inability to get another job.  In this world, job security, as I have noted many times before, can be defined as “the ability to walk across the street and get another job”.  That is still not readily possible, but the rise in people quitting and the jump in openings provide the basis for my belief that turnover rates could start to increase rapidly over the next six months.  Businesses, though, don’t believe that is likely.  They still complain about a lack of qualified workers but refuse to raise offers.  I call that the Einstein Insanity Defense: They continue to do the same thing, not raising wages, and keep getting the same results, no qualified workers at the prevailing wage.  It is as if there is only one curve in the labor market: the demand curve.  Business demand workers and workers are supposed to appear magically.  But there is a supply curve as well and that means that wages need to rise to attract the needed workers.  We will see how long it takes for businesses to recognize that fact.  But when they do, wages will jump and those that were slow in seeing that happening, as well the Fed, will have to scramble to catch up.

June Supply Managers’ Non-Manufacturing Index and Weekly Jobless Claims

KEY DATA: ISM (Non-Manufacturing): -0.2 points: Orders: +0.7 point: Hiring: +2 points/Claims: 315,000 (up 2,000)

IN A NUTSHELL:  “The service sector remained solid in June and with orders strong, that should continue.”

WHAT IT MEANS: Normally, the Institute for Supply Management’s surveys take center stage, but on a day where we got a huge employment report, this is probably a tree falling in the forest: It makes noise but few hear it.  The service sector grew in June but not quite as strongly as it had been over the previous few months.  Still, two key components of the index, new orders and employment, rose solidly.  Indeed, the orders index is quite high, indicating that not only has there been no slowdown in demand, but activity should accelerate in the months to come.  Firms are gearing up for that as their hiring is increasing.  We saw that in the payrolls number.  This bodes well for job gains going forward.  But this was not a uniformly strong report.  Business activity eased and backlogs grew more slowly, so we may not be seeing a rapid pick up in activity.

Also lost in the employment report was the weekly jobless numbers.  Claims inched upward but the level is still consistent with payroll increases in the 225,000 to 250,000 range.  I suspect we will stay at that job gain pace during the summer and accelerate in the fall and winter.

MARKETS AND FED POLICY IMPLICATIONS:  It was a good day for economic numbers.  The economy is indeed as strong as I have been arguing but not as strong as we want.  But that time is coming and sooner rather than later.  The equity markets should be focusing on the better growth not the coming jump in interest rates, but rationality and efficiency are two vastly different things.  Markets are efficient, not necessarily rational.  That said, we have been sent into the July 4th weekend with lots of things to celebrate, so let me end by simply saying:

Have a Great July 4th Weekend!

June Employment Report

KEY DATA: Payrolls: +288,000; Private Sector: +262,000; Unemployment Rate: 6.1% (down 0.2 percentage point); Hourly Earnings: +0.2%

IN A NUTSHELL:  “Anyone still doubt that the labor market is strengthening?”

WHAT IT MEANS: After being way out on a very thin limb for months now, saying that the labor market is a lot better than the talking heads would have you believe, we have some pretty convincing evidence that is the case.   Payrolls soared in June and the gains were across the board – 65% of the industries posted increases.  I expected about 250,000 but I made one big mistake: The bad winter meant a lot of schools were open longer than normal, boosting the education jobs.  State and local education payrolls rose by 20,000.  Even adjusting for that artificial rise, which will come out in July, the hiring boom was impressive.   We averaged 272,000 new workers over the past three months and 255,000 private sector positions as both April and May were revised upward.  Manufacturing increases were solid but not spectacular and construction rose less than expected.  But it was in the service-producing component where we really saw the hiring occur.  The only major category was “other services”, which includes repair and maintenance, laundries and membership associations.  In other words, we didn’t take our vehicles to the local shop or get our clothes cleaned.  Horrors!

The strong job gains are helping drive down the unemployment rate, which at 6.1% was the lowest since September 2008.  The labor force grew and the labor force participation rate stayed stable for the third consecutive month, both good news.  The only negative news was a rise in those who could only find part-time work.  But that number is extremely volatile and the change over the year has been pretty stable for a couple of years.  It would be better if the level was declining.  Despite the decline in the number of people unemployed, it is down 2.3 million over the year, wage pressure remain tame.  I still believe that will change in the fall or early winter.

MARKETS AND FED POLICY IMPLICATIONS: It is hard to argue that the labor market remains moribund.  Unemployment claims are low, layoffs, as reported by Challenger, Gray and Christmas, are flat and hiring is picking up.  But the missing link remains wages.  My argument has and still is that businesses still don’t believe they have to bid for workers so they are holding the line for as long as possible.  But the longer they delay, the bigger the retention and attraction problem becomes and when that dam breaks, it could mean a lot faster gains in wages than anyone expects.  By year’s end, we could be fairly close to the full-employment level of about 5.5%.  Does anyone believe that wages remain stable when workers are not available?  I don’t.  And that is the conundrum the Fed faces.  If, after six years of not having to think about compensation, executives are being stubborn about making wage adjustments, the Fed could be find that a key indicator, compensation, is lagging even longer than in the past.  That could cause the FOMC to wait longer than it should to start raising rates.  As for the markets, if slow job growth was good for equities, will strong job gains be worrisome?  Who knows?  But lots more jobs are better than just a few more jobs and the real issue will be interest rates: They are likely to rise a lot faster than expected.

June ADP Payroll Estimate and Help Wanted Online

KEY DATA: ADP: 281,000; Small: 117,000; Medium: 115,000; Large: 49,000/Online Ad Demand: up 155,900

IN A NUTSHELL:  “Hiring is strengthening and that, more than anything else, is pointing to much better growth ahead.”

WHAT IT MEANS: It’s the week of the employment report, which will come out tomorrow and that means we get the first attempt at estimating the number with the ADP report.  The employment services company looks at private sector payroll numbers and came up with a huge increase in June.  The details were quite positive.  Firms of all size added lots of new workers.  The big gains in small firms indicate that the expansion is quite broad based.  That is confirmed with the industry data, where hiring was good in manufacturing, construction and all service-related firms.  

Another report that points to a strengthening of the labor market was The Conference Board’s Help Wanted Online Survey, which showed that openings rose solidly in June.  Every one of the occupational categories was up.  Geographically, strong gains were posted in the Northeast, South and West.  The only weakness was in the Midwest, where demand was essentially flat.  Eighteen of the twenty metro areas also showed increases with only one down and one flat.  There was a caution raised in the report.  Over the year, demand for professional workers was down while ads for lower-wage workers rose. 

MARKETS AND FED POLICY IMPLICATIONS:  The ADP report has been somewhat underestimating the Bureau of Labor Statistics numbers recently so it is possible the June number makes up for that shortfall.  But the widespread nature of the payroll gains in the ADP report implies that the consensus of about 215,000 may be too low.  I have been in the 250,000 range so I will keep my estimate, but I have tended to be a bit aggressive.  Nevertheless, I expect tomorrow’s report to be quite good and if the unemployment rate does decline, as the low unemployment claims point to, it would create a very positive buzz going into the July 4th weekend.  Those thinking that the Fed will be on hold not only through this year but next year and into 2016 may have to rethink their forecasts as the unemployment rate will be closing in on full employment.  Indeed, the ratio of unemployed to job openings is falling to a level that is indicating the emergence of labor shortages in some regions and metro areas.  The markets and the Fed have not shown any inclination to believe that wage pressures could build anytime soon.  That may be a mistake.  But today we can conjecture: Tomorrow we get the numbers, so it is wise to wait and see.

June Supply Managers’ Manufacturing Index and May Construction

KEY DATA: ISM (Manufacturing): down 0.1 point; Orders: up 2 points: Employment: flat/ Construction: up 0.1%

IN A NUTSHELL: “Manufacturing activity remains solid and the sharp rise in demand points to improvement going forward.”

WHAT IT MEANS: We know the economy went backwards sharply during the winter, but where are we now and where are we going?  It looks like the economy is accelerating, but maybe not as rapidly as most of us had hoped.  The Institute for Supply Management’s June measure of activity eased a touch but the May level was the highest in five months.  In other words, the winter wipeout has been wiped out.  On the positive side, new orders surged and that is good news for future production, which moderated.  However, the level of the production index remained quite high, so we are not talking about any major retrenchment.  Export demand continued to grow, but less robustly while imports accelerated.  Despite the new orders growth, backlogs fell and that may be the reason that hiring didn’t pick up.  We get the employment report on Thursday and it should be really good, but manufacturing may not be the prime driver of the gains.

In a separate report, construction activity increased less than expected in May as residential activity declined.  The good news is that the government is back building infrastructure again as spending on roads, water and sewer projects, power and transportation needs were all up solidly.

MARKETS AND FED POLICY IMPLICATIONS: Last week we saw that consumer spending was nothing special in May and that has raised some questions about how strong growth was in the just completed second quarter.  We know that households bought lots of motor vehicles.  Indeed, it looks like the June numbers will be even better than projected.  But spending on most other goods was moderate, at best.  Disturbingly, demand for services, the largest component of demand, was up minimally.  Maybe the warm June caused utility demand to jump, but right now, it is hard to see growth above the four percent growth pace I have been forecasting.  But that doesn’t mean the economy is weak or soft or not accelerating.  The manufacturing sector is not doing well because the rest of the world is growing rapidly.  It is doing well because domestic demand is on the rise.  So I still think it is possible that the second half of the year will see strong to robust growth, but until that happens, it will remain a hope.  And the Fed is not operating on hopes and prayers.  Chair Yellen may not be from Missouri but she seems to believe in the state’s nickname of  “Show Me”.  Until growth really does hit its stride, the Fed will be keeping rates low.  As for investors, it’s the first day of the new quarter and they also seem to be willing to believe that rates will remain low and the markets can rise until they are shown that is not the case.

May Consumer Price Index and Housing Starts

KEY DATA: CPI: +0.4%; Excluding Food and Energy: +0.3%/Real Earnings: -0.2%/Starts: -6.5%; Permits: -6.4%

IN A NUTSHELL:  “Rising consumer prices continue to sap consumer spending power and that is not helping the housing market either.”

WHAT IT MEANS: I’ll admit that I am an optimist about the economy.  I believe that growth is strong enough to create the tight labor conditions that will cause wages to rise and the economy to surge.  But the pathway to nirvana remains slow.  Consumer prices jumped in May and it wasn’t all energy or food, which were up sharply.  Costs of a variety of services such as shelter, medical care and transportation also increased.  On the positive side, most non-food or energy commodity prices were well contained, so consumers had at least some respite from the insidious costs of inflation. That said, the jump in consumer prices, coupled with more modest gains in earnings meant that consumer spending power went down again.  Since May 2013, real weekly earnings have declined, yes declined, by 0.1%.  Any further questions about why the economy is not growing rapidly?   “The fault, dear business community, is not at the Fed or in Washington, but it is in ourselves, that we don’t pay our underlings”. (My apologies to Shakespeare and Cassius.)

As for the housing market, it took a bit of a step backward in May as housing starts moderated.  That said, the pace of construction so far this quarter is up by double-digits over the weather restrained first quarter total, so housing should add to growth, possibly significantly.  Permits were off as well, but they had been running well above the start rate for most of the year and now they are more closely aligned.  Continued increases in the number of homes under construction raises a warning that additional gains in starts may be limited unless sales pick up a lot.

MARKETS AND FED POLICY IMPLICATIONS: These were not reports that anyone was hoping for.  Indeed, it would have been nice if inflation was more moderate and construction was more robust, but that just was not the case in May.  I am not that worried about the housing sector, as conditions seem to be moving forward, though hardly at a breakneck pace.  It is inflation that concerns me.  The Fed has been not been overly worried about inflation, except to note it is below target and expectation are stable.  The issue is spending power, which remains the missing link in the recovery.  Softer wholesale food prices hold out hope that consumer prices may moderate but Iraq is hardly helpful when it comes to energy costs.  With that as a background, the Fed is meeting and will have to figure out what is happening.  Tomorrow’s statement, projections and press conference should be very interesting.

May Industrial Production and June Empire State Index

KEY DATA: IP: +0.6%; Manufacturing: +0.6%/Empire State: +0.2 point; Orders: +8 points

IN A NUTSHELL: “With manufacturing accelerating, there is every good reason to believe that the economy is beginning to hit its stride.”

WHAT IT MEANS: So much for the winter.  Spring is just about gone and summer holds great hope that we will see consistently solid if not strong growth.  Why am I so optimistic?  The nation’s manufacturing sector is accelerating.  Output soared in May the third month out of the last four where production rose robustly.  Indeed, so far this quarter, manufacturing production has expanded at a 4.7% annualized pace and that does not assume any increase in June.  The winter collapsed activity in January and the sector has made strong progress since.  Most of the rise in manufacturing output was in the durable goods segment with vehicles, furniture, aerospace, electrical equipment and appliances as well as computers and electronic products all posting robust gains.  In addition, while most nondurable goods manufacturers slowed production, there were big gains in plastics, chemicals and petroleum products.  In other words, only nondurable consumer good firms showed weakness.  Capacity utilization hit its highest level in over six years, but in a global economy, this measure has relatively modest value.

Supporting the view that manufacturing is booming was the gain in the June Empire State Index, which is produced by the New York Fed.  This measure of manufacturing activity rose modestly but there was a sharp increase in new orders.  Hiring slowed a bit.  While optimism faded a touch, it is still at a solid level.

MARKETS AND FED POLICY IMPLICATIONS:  If the Fed is looking for signs that growth is picking up, all it has to do is look at its own data.  Manufacturing production is soaring and the improvement in the June New York Fed’s report point to the gains being sustained.  Production is rising for big-ticket consumer goods such as furniture and motor vehicles, business equipment and products, such as chemicals and plastics that go into the production of other goods.  The likelihood that manufacturing would be growing at an accelerating pace but the economy expanding weakly, is not particularly great.  It really looks like second quarter GDP could be up by more than 4%.  But it would take strong third and fourth quarter growth rates to put to rest the view that we are in a new world where growth meanders along at a 2% to 2.5% pace.  I expect that to happen, but I am in a minority, at least right now.  Though investors should love these numbers, the chaos in Iraq and the uncertainty in the energy markets could overshadow everything else.

May Producer Price Index and Mid-June Consumer Sentiment

KEY DATA: PPI: -0.2%; Goods: -0.2%; Excluding Food and Energy: 0%; Services: -0.2%/Michigan Sentiment: 81.2 (down 0.7 point)

IN A NUTSHELL: “Producer inflation pressures took a holiday in May, but it is unclear if that is just a temporary lull or a movement back to a trend of modest wholesale cost increases.”

WHAT IT MEANS: Inflation pressures, what inflation pressures?  After two months of sharp increases in wholesale prices, there were growing concerns that we might be in for some acceleration in inflation.  Those fears were eased, at least to some extent, with the May decline in the Producer Price Index.   The retrenchment was in both goods and services.  Food costs, which had been skyrocketing, reversed field and fell.  The huge volatility in this segment is not unusual but it does create some caution in determining future trends.  On the energy side, the reduction we saw is likely to turnaround as the craziness in Iraq is roiling the oil markets.  While food and energy prices have been changing wildly, consumer costs remain tame.  There was one place where rising prices have to be watched closely.  Transportation services costs are jumping and to the extent they represent rising economic activity – and the growing need to move goods and people – the increase in this component could be signaling that improving conditions could trigger some grab for higher prices.  Looking into the future, there does not appear to be any major pressures building that would be a cause for alarm.

In a separate report, the Thompson Reuters/University of Michigan mid-June reading of consumer sentiment dipped again.  It is interesting to note that in the May report, people felt reasonably good about the economy.  However, they are becoming more and more depressed about their incomes as they don’t expect to see any gains this year.  There is a real disconnect in the business community.   They are doing everything possible to keep wages from rising but then they complain that consumers are not buying.  It is hard to buy more goods when your income is stagnating.  I have said this many times and now we see that the hard cap on wage gains is affecting confidence.

MARKETS AND FED POLICY IMPLICATIONS: Inflation is not likely to be a major issue for the Fed for quite some time.  While wholesale costs are rising at a moderate pace, firms are not passing much of that through and consumer inflation is below the Fed’s desired level.  It will take a lot stronger growth for an extended period for inflation to become a problem.  That allows Fed Chair Yellen to have free reign to keep rates low.  Confidence, wages and consumer spending will remain in its death trap until firms are forced to start bidding for workers.  At that point, spending will pick up and improving confidence will boost it.  But don’t expect anything spectacular until the unemployment rate gets below 6%.   At that point, labor shortages should be widespread enough that wages will start rising fast enough to trigger not only better growth but also words of warning from the Fed about rate hikes.  That time may not arrive until later this year.  Investors will likely be more concerned with Iraq than May wholesale prices. I am not sure how much sense that really makes, as it is not clear there will be any major dislocation of oil supplies.  It is an excuse, though, to take prices up.

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