The Week That Was
Recent economic data reports, while mixed, continued to paint a picture of a strengthening economy in 2Q18. This improvement, expected to be seen in the GDP report to be released this Friday, partly reflects a rebound from a “soft” 1Q18. Averaging the two quarters should show a robust pace of growth in the first half of the year.
The June Employment Report
Nonfarm payrolls rose more than expected in June, but the unemployment rate rose and average hourly earnings rose moderately. That’s a seemingly sweet combination for investors. The economy remains strong, but not so much that the Fed has to slam on the brakes.
At the Turn
The year began with two key themes. The first was that the economy ended 2017 with a good deal of momentum that should have continued into early 2018. The second was that the outlook for the second half of the year was considerably more clouded, reflecting fiscal stimulus, more binding constraints in the labor market, and tighter monetary policy.
It was a relatively thin week for economic data. Housing starts rose 5.0% (±10.2%) in May – a strong gain, but not statistically significant. Single-family permits, the key figure in the residential construction report, fell 2.2% (±1.0%) in May, but were up 7.7% (±1.3%) from a year earlier.
As expected, the Fed raised short-term interest rates following the June 12-13 policy meeting. Investors were more concerned about the pace of future rate increases and the revised dot plot showed a median of four rate increases in 2018, although (as in the March plot), most fed officials were divided between three and four.
The May Employment Report
Nonfarm payrolls rose by 223,000 in the initial estimate for May, stronger than expected, but not statistically outside of the moderately strong trend of the last year. We need a little less than 100,000 jobs per month to absorb new entrants into the workforce. Hence, it’s no surprise that the broad range of data has indicated a further tightening in labor market conditions.
Oil and the Economy
The rise in oil prices is expected to have mixed effects on the U.S. economy. Higher gasoline prices will restrain consumer spending growth to some extent. However, increased energy exploration implies more capital spending, adding to GDP growth. For Federal Reserve policymakers, the key question is whether higher costs of transporting goods may be passed along to consumer prices.
The Job Market, Inflation, and the Fed
The April inflation reports were a bit on the soft side of expectations, reducing somewhat the fears that we’re on the verge of an upside breakout in inflation. There’s no sign that a strong economy is putting much upward pressure on consumer prices.
The April Employment Report
Nonfarm payrolls rose by a little less than one million in April – that is, prior to seasonal adjustment – up by 2.932 million from January to April (vs. +2.708 million for the same three months a year ago). Seasonally adjusted, the trend in private-sector payroll growth has remained strong in recent months.
GDP, ECI, ULC, and the FOMC
Real GDP rose at a 2.3% annual rate in the advance estimate for the first quarter, a bit stronger than anticipated (the median forecast was +2.0%), but “close enough for government work.” These figures will be revised, but the underlying story is unlikely to change much.
The Fed Policy Outlook
The Bureau of Economic Analysis will report the advance estimate of 1Q18 GDP growth on April 27. These figures will be revised, but the underlying story is not expected to change much. Growth was likely moderate, not horrible, but far short of the lofty expectations that some had put forth at the start of the quarter. Nobody appears too worried about that.
Like Sands Through the Hourglass…
The March reports remained consistent with the view that inflation will move toward the Fed’s 2% goal, perhaps sooner than expected. The FOMC minutes were not expected to surprise, but several Fed officials felt that it might be appropriate to move the federal funds rate above a neutral level for a time.
The March FOMC Meeting
Financial market participants took the Fed policy meeting outcome as “dovish,” but the end result was a little more hawkish. The Fed’s revised economic projections weren’t much of a surprise, but they illustrate the thinking behind the expected monetary policy outlook. Of course, there are risks, notably a major misstep on trade policy. Gulp!
Inflation Fears Are Overdone (again)
Recent stock market volatility was partly blamed on fear that inflation will soon “take off.” Simple supply and demand arguments would suggest that pressure on resource markets (labor mostly, but also raw materials) would lead inflation higher.
Rethinking the Fundamentals?
The recent uptick in average hourly earnings (+2.9% y/y) and the surge in the government’s borrowing needs ($1 trillion plus in the current fiscal year) have had some implications for the underlying fundamentals. However, the outlook hasn’t been tumultuous enough to explain multi-100-point intraday swings in the Dow. Something else is clearly going on.
Bond Yields and Government Borrowing
Last week, Treasury announced that it expects to borrow $617 billion in the first half of 2018, vs. $75 billion in the first two quarters of 2017, and announced increases in the sizes of its regular monthly auctions of notes and bonds. It should then be no surprise why bond yields are rising.
This Too Shall Pass (maybe)
The economic impact of the partial government shutdown will depend on how long it lasts. Government workers will still get paid, but those supporting government workers (food service, etc.) will not. Economic data reports and Treasury auctions may be delayed.
Raising the Stakes
Retail sales figures for December showed a relatively strong trend in 4Q17, although part of that reflects a rebound from hurricane effects in 3Q17. Core CPI inflation was a bit higher than anticipated in December, but that doesn’t mean that the low inflation trend is over.
The Job Market Outlook
Nonfarm payrolls rose by 148,000, less than expected, in the initial estimate for December, but the increase was hardly “weak.” There is a fair amount of noise in the monthly figures, but the underlying trend is lower. Despite a tight job market, average hourly earnings were up just 2.5% year-over-year.
The Fed’s Outlook
Four times per year, at every other Federal Open Market Committee meeting, senior Fed officials submit projections for growth, unemployment, and inflation. They also put forth their expectations of the “appropriate” federal funds rate for the end of the next few years. What do the dots in the dot plot tell us about the course of policy action? Not a lot.
The Fed, the Job Market, and the Risks
The appointment of Jerome “Jay” Powell as Fed chair should result in a smooth transition for monetary policy into early 2017. However, other personnel changes mean greater policy uncertainty as one looks beyond the middle of next year. This comes at a time when the risks of a policy error are increasing.
The Importance of Productivity Growth
Economists view the growth in labor productivity, or output per worker, as the single most important variable in an economy. It’s what lifts the standard of living, helps keep prices low, reduces government budget strains, and drives corporate profits. Over the next few decades, achieving faster productivity growth will be key as labor force growth slows. The outlook is encouraging, but uncertain.
The October Employment Report
As expected, nonfarm payrolls rebounded from hurricane-related effects. The unemployment rate edged lower, but that may have been noise. Leisure and hospitality was the sector most affected by Hurricane Irma, which might explain the choppiness in average hourly earnings (up 0.5% in September, flat in October).
Through the Noise: More of the Same
Beyond all the twists, turns, and quirks in the economic data reports, the overall picture appears largely the same. Growth remains on a moderate track, somewhat beyond a long-term sustainable rate (as the job market continues to tighten).
The September Employment Report
As expected, hurricanes Harvey and Irma had a significant impact on the nonfarm payroll data. However, it’s impossible to say exactly how much. The distorted September payroll figures were never going to be a factor in the Fed policy outlook. There will be two more employment reports before the mid-December policy meeting and we can expect a recovery from hurricane effects.
Inflation and Consumer Spending
Investors don’t pay much attention to the monthly report in personal income and spending. We already have a good handle on income from the employment report. Unit auto sales and the retail sales data tell us a lot about consumer spending.
Fed Policy: Balance Sheet Normalization
As expected, the Federal Open Market Committee left the federal funds target range unchanged (at 1.00-1.25%) after its September 19-20 policy meeting. The FOMC also announced the beginning of balance sheet reduction. The Fed had outlined how this would work in mid-June, and officials did a good job of telegraphing when it would start.
In her post-FOMC press conference, Federal Reserve Chair Janet Yellen is expected to provide a concise evaluation of the current economic situation. That includes a discussion about the recent trend in low inflation and the economic impact of hurricanes Harvey and Irma. She is not expected to signal what the Fed will do with short-term interest rates in the months ahead.
The exodus of CEO support following President Trump’s response to Charlottesville shook the foundations, but the stock market outlook has remained constructive. Every administration has its share of difficulties early on, many self-inflicted, before settling down.
Inflation and Productivity
The July CPI data were a bit softer than anticipated, due partly to a drop in the price index for lodging away from home. Granted, if you exclude everything that went down, the CPI always looks higher, but the underlying trend is not far from the Fed’s earlier expectations (of a gradual move toward the 2% goal).
Looking Back, Looking Ahead
The advance GDP report for 2Q17 contained few surprises. Growth was largely in line with expectations, leaving growth for the first half of the year at a 1.9% annual rate. Recent reports suggest some loss of momentum for the consumer, but rising real wages ought to provide support.
A Steady Monetary Policy Course, for Now
Fed Chair Janet Yellen covered no new ground in her monetary policy testimony to Congress, but that didn’t stop financial market participants from trying. While the CPI report drew a closer focus, past inflation figures don’t tell us a lot about future inflation.