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The biggest surprise in the revisions to first quarter GDP growth, released yesterday, was in the core PCE deflator.
All eyes will be on the core PCE deflator data today, in the wake of the upside surprise in the January core CPI, reported last week. The numbers do not move perfectly together each month, but a 0.2% increase in the core deflator is a solid bet, with an outside chance of an outsized 0.3% jump.
A steep drop in prices for financial services in January was a key factor behind the sharp slowdown in the rate of increase of the core PCE deflator in the first quarter, relative to the core CPI.
The downshift in core PCE inflation this year has unnerved the Fed, along with the intensification of the trade war and slower global growth.
Our base-case forecast for the May core PCE deflator, due today, is a 0.17% increase, lifting the year-over-year rate by a tenth to 1.9%.
The 0.18% increase in the core PCE deflator in December was at the lower end of the range implied by the core CPI. It left the year-over-year rate at just 1.5%.
It's pretty easy to spin a story that the recent core PCE numbers represent a sharp and alarming turn south.
Our base case forecast has core PCE inflation at 1.9% from November 2018 through July this year.
The rate of increase of the financial services and insurance component of the PCE deflator has slowed from a recent peak of 5.8% in May 2014 to 3.3% in June this year. This matters, because it accounts for 8.4% of the core deflator, a much bigger weight than in the core CPI.
Under normal circumstances, the 0.23% increase in the core CPI, reported earlier this month, would be enough to ensure a 0.2% print in today's core PCE deflator.
All eyes today will be on the core PCE deflator for January, following the unexpectedly large 0.3% increase in the core CPI.
For the past six years, the PCE measure of core inflation has undershot the CPI version. The average spread between the two year-over-year rates since January 2011 has been 0.3 percentage points, and as far as we can tell most observers expect it to be little changed for the foreseeable future.
The sudden downshift in core inflation at the consumer level since March, clearly visible in the CPI and the PCE, and shown in our first chart, has been accompanied by a steady increase in core producer price inflation.
We have argued recently that the year-over-year rates of core CPI and core PCE inflation could cross over the next year, with core PCE rising more quickly for the first time since 2010.
Fed policymakers surprised no one with their May 1 statement, which acknowledged the surprisingly "solid " Q1 economic growth--at the time of the March 19-to-20 meeting, the Atlanta Fed's GDPNow model suggested Q1 growth would be just 0.6%--but stuck to its view that low inflation means the FOMC can be "patient".
Today's producer price report for March likely will show a further increase in core goods inflation, which already has risen to 2.0% in February, from 0.2% in the same month last year. The acceleration in the U.S. PPI follows the even more dramatic surge in China's PPI for manufactured goods, which jumped to 6.6% year-over-year in February, from minus 4.9% a year ago. China's PPI is much more sensitive to commodity prices than the U.S. series, so there's very little chance that core U.S. PPI goods inflation will rise to anything like this rate.
We'd be surprised to see any serious shift in the tone of Fed Chair Powell's semi-annual Monetary Policy Testimony today compared to the FOMC statement and press conference just three weeks ago.
On the face of it, our forecast of higher core inflation by the end of this year is seriously challenged by the recent data.
In the absence of an unexpected surge in auto sales or a sudden burst of unseasonably cold weather, lifting spending on utilities, fourth quarter consumption is going to struggle to rise much more quickly than the 2.1% annualized third quarter increase.
In the excitement over the FOMC meeting--all things are relative--we ran out of space to cover some of this week's other data, notably the PPI, industrial production and housing starts. They are worth a recap, given that only the Michigan sentiment report will be released today.
When we argue that the Fed will have to respond to accelerating wages and core prices by raising rates faster than markets expect, a frequent retort is that the Fed has signalled a greater tolerance than in the past for inflation overshoots.
The upturn in core CPI inflation this year has passed by almost unnoticed in the markets and media. In the year to September, the core CPI rose 1.9%, up from a low of 1.6% in January. But that's still a very low rate, and with core PCE inflation unchanged at only 1.3% over the same period, it's easy to see why investors have remained relaxed. In our view, though, things are about to change, because a combination of very adverse base effects and gradually increasing momentum in the monthly numbers, is set to lift both core inflation measures substantially over the next few months.
The acceleration in real consumption over the past year reflects the upturn in real after-tax income growth. This, in turn, is mostly a story of falling gasoline prices, which have depressed the PCE deflator. Gross nominal incomes before tax rose 4.2% year-over-year in the three months to September, exactly matching the pace in the three months to September 2014. But real income growth, after tax, accelerated to 3.3% from 2.5% over the same period, as our first chart shows.
Neither the strength in October consumption nor the softness of core PCE inflation, reported yesterday, are sustainable.
The rate of growth of real personal incomes is under sustained downward pressure, slowing to 2.1% year-over-year in December from 3.4% in the year to December 2015. In January, we think real income growth will dip below 2%, thanks to the spike in the headline CPI, reported Wednesday. Our first chart shows that the 0.6% increase in the index likely will translate into a 0.5% jump in the PCE deflator, generating the first month-to-month decline in real incomes since January last year.
Housing rents account for some 41% of the core CPI and 18% of the core PCE, making them hugely important determinants of the core inflation rate.
The spike in the May core CPI, and its likely echo in the core PCE, won't stop the Fed easing at the end of this month.
The biggest surprise in the recent inflation numbers has been the surge in the PCE measure of hospital services costs, where the year-over-year rate has jumped to 3.8% in February, an eight-year high, from just 1.3% in September.
The most striking feature of the Fed's new forecasts is the projected overshoot in core PCE inflation at end-2019 and end-2020, which fits our definition of "persistent".
The modest overshoot to consensus in September's core PCE deflator won't trouble any lists of great economic surprises, but it did serve to demonstrate that the PCE can diverge from the CPI, in both the short and medium-term.
All eyes today will be on the core PCE deflator for August, which we think probably rose by a solid 0.2%.
We have tweaked our third quarter GDP forecast in the wake of the September advance international trade and inventory data; we now expect today's first estimate to show that the economy expanded at a 4.0% annualized rate.
The rate of growth of Covid-19 cases outside China appears to have peaked, for now, but we can't yet have any confidence that this represents a definitive shift in the progress of the epidemic.
It would be astonishing if the Fed doesn't raise rates today, and Chair Powell is not in the astonishment business; they will hike by 25bp.
We were terrified by the plunge in the ISM manufacturing export orders index in August and September, which appeared to point to a 2008-style meltdown in trade flows.
The spread of the Covid-19 virus remains the key issue for markets, which were deeply unhappy yesterday at reports of new cases in Austria, Spain and Switzerland, all of which appear to be connected to the cluster in northern Italy.
need to add docMea culpa: We failed to spot the press release from the Commerce Department announcing the delay of the release of the advance December trade and inventory data, due to the government shutdown.
We're nudging down our estimate of Q2 GDP growth, due today, by 0.3 percentage points to 1.8%, in the wake of yesterday's array of data.
the past few observations make clear. Real spending jumped by 0.5% in March, rebounding after its weather-induced softness in February, before stalling again in April. Then, in May, the s urge in new auto sales to a nine-year high lifted total spending again, driving a 0.6% real increase.
Forecasting the health insurance component of the CPI is a mug's game, so you'll look in vain for hard projections in this note.
Core durable goods orders in recent months have been much less terrible than implied by both the ISM and Markit manufacturing surveys.
The astonishing 86% annualized plunge in capital spending in mining structures--mostly oil wells--alone subtracted 0.6 percentage points from headline GDP growth in the first quarter. The collapse was bigger than we expected, based on the falling rig count, but the key point is that it will not be repeated in the second quarter.
The definition of "yesbutism": Noun, meaning the practice of dismissing or seeking to diminish the importance of data on the grounds that the next iteration will tell the opposite story.
The Fed will do nothing to the funds rate or its balance sheet expansion program today.
We learned last week that the U.S. no longer has a coherent dollar policy.
It seems reasonable to think that manufacturing should be doing better in the U.S. than other major economies.
Recent export performance has been poor, but the export orders index in the ISM manufacturing survey-- the most reliable short-term leading indicator--strongly suggests that it will be terrible in the fourth quarter.
Today's wave of data will bring new information on the industrial sector, consumers, the labor market, and housing, as well as revisions to the third quarter GDP numbers.
The disappearance from the FOMC statement of any reference to global risks, which first appeared back in September, was both surprising and, in the context of this cautious Fed, quite bold. After all, one bad month in global markets or a reversal of the jump in the latest Chinese PMI surveys presumably would force the Fed quickly to reinstate the global get-out clause. So, why drop it now?
The Fed will soon have to step in to try to put a firebreak in the stock market.
We're expecting to learn today that the economy expanded at a 2.6% annualized rate in the first quarter, rather better than we expected at the turn of the year--our initial assumption was 1-to-2%--and above the consensus, 2.3%.
The speculation is over: 3.283 million people filed a new claim for unemployment benefits last week, nearly double the 1.7M consensus forecast, which looked much too low.
It's hard to read the minutes of the April 30/May 1 FOMC meeting as anything other than a statement of the Fed's intent to do nothing for some time yet.
The two key planks of the argument that a substantial easing of fiscal policy won't be inflationary are that labor participation will be dragged higher, limiting the decline in the unemployment rate, while productivity growth will rebound, so unit labor costs will remain under control.
The Atlanta Fed's GDP Now estimate for second quarter GDP growth will be revised today, in light of the data released over the past few days. We aren't expecting a big change from the June 24 estimate, 2.6%, because most of the recent data don't capture the most volatile components of growth, including inventories and government spending. The key driver of quarterly swings in the government component is state and local construction, but at this point we have data only for April; those numbers were weak.
Now that the Fed has abandoned the idea of raising rates this year, despite 3.8% unemployment and accelerating wages, it is very exposed to the risk that the bad things it fears don't happen.
Last week, the Atlanta Fed updated its median hourly earnings series with new October data, showing wage growth accelerating to an eight-year high of 3.9%. That's a full percentage point higher than the increase in this measure of wages in the year to October 2015, and it follows a spring and summer during which wage growth appeared to be topping-out at just under 3½%.
Our forecast of significantly higher core inflation over the next year has been met, it would be fair to say, with a degree of skepticism.
For some time, the Fed has been locked in a loop of endless inaction. Every time the economic data improve and the Fed signals it is preparing to raise rates, either markets--both domestic and global-- react badly, and/or a patch of less good data appear. The nervous, cautious Yellen Fed responds by dialling back the talk of tightening, and markets relax again, until the next time.
The FOMC did the minimum expected of it yesterday, raising rates by 25bp--with a 20bp increase in IOER--and dropping one of its dots for 2019.
The average FICO credit score for successful mortgage applicants has risen in each of the past four months.
The tone of Fed Chair Powell's opening comments at the press conference yesterday was much more dovish than the statement, which did little more than most analysts expected.
We would be very surprised if the Fed were to raise rates today. The Yellen Fed is not in the business of shocking markets, and with the fed funds future putting the odds of a hike at just 22%, action today would assuredly come as a shock, with adverse consequences for all dollar assets.
This is the final U.S. Economic Monitor of 2017, a year which has seen the economy strengthen, the labor market tighten substantially, and the Fed raise rates three times, with zero deleterious effect on growth.
In the absence of any significant data releases today, we want to take a closer look at the outlook for wage growth, and the implications of an acceleration in hourly earnings for inflation.
Over the past few days we have written about the difference between the Fed's tactics--signalling rate hikes and then choosing not to act in the face of weaker data--and its strategy, which is to normalize rates in the expectation that inflation will head to 2% in the medium-term.
While we were out last week, market nervousness over the Covid-19 outbreak intensified, though most key indicators of the spread of the infection continued to improve.
Yesterday's stock market bloodbath stands in contrast to the U.S. economic data, most of which so far show no impact from the Covid-19 outbreak.
It's going to be very hard for Fed Chair Powell's Jackson Hole speech today to satisfy markets, which now expect three further rate cuts by March next year.
For now, we're happy with our base-case forecast that growth will be nearer 3% than 2% this year, and that most of the rise in core inflation this year will come as a result of unfavorable base effects, rather than a serious increase in the month-to-month trend.
Here's something we didn't expect to write: The CPI measure of goods prices, excluding food and energy, rose in the three months to January, compared to the previous three months. OK, the increase was marginal, a mere 0.3%, but conventional wisdom has assumed for some time that the strong dollar would push goods prices down indefinitely.
With Fed officials now in pre-FOMC meeting blackout mode, this week will not bring a repeat of Friday's confusion, when the New York Fed felt obligated to issue a clarification following president William's speech on monetary policy close to the zero bound.
On a trade-weighted basis, sterling has dropped by only 1.5% since the start of the month, but it is easy to envisage circumstances in which it would fall significantly further.
The weaker is the economy over the next few months, the more likely it is that Mr. Trump blinks and removes some--perhaps even all--the tariffs on Chinese imports.
The rate of growth of third quarter consumers' spending was revised up by 0.3 percentage point to 3.3% in the national accounts released yesterday.
We expect to see a 160K increase in June payrolls today, though uncertainty over the extent of the rebound after June's modest 75K increase means that all payroll forecasts should be viewed with even more skepticism than usual.
Fed Chair Powell yesterday said about as little as he could without appearing to ignore the turmoil in markets since the President announced his intention to apply tariffs to imports from Mexico: "We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective."
We're very comfortable with the idea that the coronavirus is a broad deflationary shock to the U.S. economy.
Fed Chair Yellen's speech Friday was remarkably blunt: "Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate."
The Fed surprised no-one yesterday, leaving rates on hold, saying nothing new about the balance sheet, and making no substantive changes to its view on the economy. The statement was tweaked slightly, making it clear that policymakers are skeptical of the reported slowdown in GDP growth to just 0.7% in Q1: "The Committee views the slowing in growth during the first quarter as likely to be transitory".
The March employment report didn't tell us what we really want to know. The underlying trend in wage growth remains obscured by the calendar quirk which depresses reported hourly earnings when the 15th of the month--pay day for people paid semi-monthly -- falls after the payroll survey week.
In the wake of April's 0.2% increase in real consumers' spending, and the upward revisions to the first quarter numbers, we now think that second quarter spending is on course to rise at an annualized rate of about 3.5%.
Our Chief Eurozone Economist, Claus Vistesen, is covering the Italian situation in detail in his daily Monitor but it's worth summarizing the key points for U.S. investors here.
We are struggling to make sense of the third quarter GDP numbers. The reality is that the massive surge in soybean exports--which we estimate contributed 0.9 percentage points, gross, to GDP growth--mostly came from falling inventory, because the soybean harvest mostly takes place in Q4.
It would be astonishing if the May and June payroll numbers looked much like April's strong data, at least in the private sector.
If the current rate of contraction continues, the U.S. onshore oil industry will cease to exist in the third week of January next year. Over the past six weeks, the number of operating rigs has dropped by an average of 8.5, and 362 rigs were running last week. At the peak, in early October 2014--just 18 months ago--the rig count reached 1,609.
We just can't get away from the deeply vexed question of wages; specifically, why the rate of growth of nominal hourly earnings has risen only to just over 2.5%, even though the historical relationship between wage gains and the tightness of the labor market points to increases of 4%-plus.
Fed Chair Powell did not specify how many bills the Fed will buy in order boost bank reserves sufficiently to remove the strain in funding markets, but we'd expect to see something of the order of $500B.
The run of soft core CPI numbers is over. The average 0.18% increase over the past two months probably is a good indication of the underlying trend -- the prints would have been close to this pace in both months had it not been for wild swings in the lodging component -- and the other one-time oddities of recent months' have faded.
Today brings only the preliminary Michigan consumer sentiment data for January so we want to take some time to look at how recent changes to Medicare Part B premiums, which cover doctors' fees, are likely to affect inflation over the next few months.
The reported drop in mortgage applications over the holidays is now reversing, not that it ever mattered.
Core PPI inflation has risen steadily this year, with month-to-month increases of 0.3% or more in five of the past six months.
The headline hourly earnings data for May were dull, showing the year-over-year rate unchanged at 2.5%. That's up from 2.1% in the year to May 2015, but it's not an alarming rate of increase. But the Atlanta Fed's median hourly earnings data, which track the wages of individuals from year-to-year, show wages up 3.4% year-over-year, the fastest rate of increase since February 2009.
The delay in the processing of personal income tax refunds this year appears not to have had any adverse impact on retail sales, so far. Indeed, the Redbook chainstore sales survey suggests that sales have accelerated over the past few weeks.
The June employment report pretty much killed the idea that the Fed will cut rates by 50bp on July 31.
The most important number, potentially, in today's wave of economic reports is the Employment Costs Index for second quarter.
Chair Yellen's final FOMC meeting today will be something of a non-event in economic terms.
The Fed likely will do nothing today, both in terms of interest rates and substantive changes to the statement. We'd be very surprised to hear anything new on the Fed's plans for its balance sheet.
The Fed pretty clearly wanted to tell markets yesterday that inflation is likely to nudge above the target over the next few months, but that this will not prompt any sort of knee-jerk policy response beyond the continued "gradual" tightening.
The Fed's statement yesterday was unsurprising, acknowledging a "sharp" decline in economic activity and a significant tightening of financial conditions, which has "impaired the flow of credit to U.S. households and businesses."
We already have a pretty good idea of what happened to consumers' spending in March, following Friday's GDP release, so the single most important number in today's monthly personal income and spending report, in our view, is the hospital services component of the deflator.
The chance of a self-inflicted, unnecessary weakening in the economy this year, and perhaps even a recession, has increased markedly in the wake of the president's announcement on Friday that tariffs will be applied to all imports from Mexico, from June 10.
We want to revisit remarks from Fed Vice-Chair Clarida last week.
We learned yesterday that the patchy but widespread reopening of the economy is triggering the first wavelet of rehiring.
The stock market loved Fed Chair Powell's remarks on the economy yesterday, specifically, his comment that rates are now "just below" neutral.
We aren't convinced by the idea that consumers' confidence will be depressed as a direct result of the rollover in most of the regular surveys of business sentiment and activity.
Markets remain convinced that the U.S. faces no meaningful inflation risk for the foreseeable future.
In the wake of the robust July data and the upward revisions to June, real personal consumption--which accounts for 69% of GDP--appears set to rise by at least 3% in the third quarter, and 3.5% is within reach. To reach 4%, though, spending would have to rise by 0.3% in both August and September, and that will be a real struggle given July's already-elevated auto sales and, especially, overstretched spending on utility energy.
The stage is set for the Fed to ease by 25bp today, but to signal that further reductions in the funds rate would require a meaningful deterioration in the outlook for growth or unexpected downward pressure on inflation.
Cast your mind forward to late October 2018. The Fed is preparing to meet next week. What will the economy look like? The key number is three.
Yesterday's relatively good news--we discuss the implications of the August trade data below--will be followed by rather more mixed reports today. We hope to see a partial rebound, at least, in the September Chicago PMI, but we fully expect soft August consumer spending data.
It's a myth that the 10-ye ar decline in the unemployment rate has not driven up the pace of wage growth.
The November ADP employment report today likely will show private payrolls rose by about 180K. We have no reason to think that the trend in payroll growth has changed much in recent months, though the official data do appear to be biased to the upside in the fourth quarter, probably as a result of seasonal adjustment problems triggered by the crash of 2008. We can't detect any clear seasonal fourth quarter bias in the ADP numbers.
The recent sell-off in Treasuries has not yet reached significant proportions.
Yesterday's FOMC , announcing a unanimous vote for no change in the funds rate, is almost identical to December's.
We were nervous ahead of the GDP numbers on Friday, wondering if our forecast of a 1.5 percentage point hit from foreign trade was too aggressive. In the event, though, the trade hit was a huge 1.7pp, so domestic demand rose at a 3.5% pace.
Markets expect the Fed will fail to follow through on its current intention to raise rates twice more this year and three times next year. Part of this skepticism reflects recent experience.
If we're right with our forecast that real consumers' spending rose by just 0.1% month-to-month in February -- enough only to reverse January's decline -- then it would be reasonable to expect consumption across the first quarter as a whole to climb at a mere 1.2% annualized rate.
We'd be very surprised to see anything other than a 25bp rate cut from the Fed today, alongside a repeat of the key language from July, namely, that the Committee "... will act as appropriate to sustain the expansion".
It's hard to know what will stop the correction in the stock market, but we're pretty sure that robust economic data--growth, prices and/or wages--over the next few weeks would make things worse.
Monthly core CPI prints of 0.3% are unusual; June's was the first since January 2018, so it requires investigation.
In March, CPI rents--the weighted average of primary and owners' equivalents rents--rose by 0.35% month- to-month.
If the Phase One trade deal with China is completed, and is accompanied by a significant tariff roll-back, we'll revise up our growth forecasts, but we'll probably lower our near-term inflation forecasts, assuming that the tariff reductions are focused on consumer goods.
The FOMC did mostly what was expected yesterday, though we were a bit surprised that the single rate hike previously expected for next year has been abandoned.
Today brings the April PPI data, which likely will show core inflation creeping higher, with upward pressure in both good and services. The upside risk in the goods component is clear enough, as our first chart shows.
At least some investors clearly were expecting Fed Chair Powell yesterday to offer a degree of resistance to the idea that a rate cut at the end o f this month is a done deal.
The Fed will raise rates by 25 basis points on Wednesday, but as usual after a widely-anticipated policy decision, most of our attention will be focused on what policymakers say about their actions, and how their views on the economy have changed.
We already know that the key labor market numbers in today's May NFIB survey are strong.
Whatever happened to consumers' sentiment in March, the level of University of Michigan's index will be very high, relative to its long-term average.
Today's rate hike will be accompanied by a new round of Fed forecasts, which will have to reflect the faster growth and lower unemployment than expected back in September.
The Fed won't raise rates today, or substantively change the wording of the post-meeting statement. In September, the FOMC said that "The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives."
President Trump blinked again yesterday, delaying tariffs on some $150B-worth of Chinese consumer goods until December 15.
The Fed will raise rates by 25bp today, but we expect no change in the median expectation-the dotplot-for two rate hikes both next year and in 2018. We fully appreciate that fiscal easing on the scale proposed by President-elect Trump, or indeed anything like it, very likely would propel inflation to a pace requiring much bigger increases in rates.
As a general rule, faster productivity growth is always good news.
The core CPI inflation rate rose in April to 2.1% from 2.0%, thanks to unfavorable rounding, despite the below consensus 0.14% month-to-month print.
The falling unemployment rate and the threat it poses to the inflation outlook mean that the labor market numbers in the NFIB small business survey attract more attention than the other data in the report.
Jim Bullard, the St. Louis Fed president, said last week that Phillips Curve effects in the U.S. are "weak", and that nominal wage growth is not a good predictor of future inflation.
Today's February CPI report is very unlikely to repeat January's surprise, when the core index was reported up 0.3%, a tenth more than expected.
Core PPI inflation has risen relentlessly, though not rapidly, over the past two-and-a-half years.
First things first: Payroll growth likely will be sustained at or close to November's pace.
The outcome of the Trump-Xi meeting at the G20 summit was as good as we expected.
A quick rebound in growth, after the slowdown to a reported 2.6% in the fourth quarter, is unlikely.
We're expecting the April ISM report today to bring yet more evidence that the manufacturing cycle is peaking, though we remain of the view that the next cyclical downturn is still some way off.
All the regional PMI and Fed business surveys we follow suggest that today's national ISM manufacturing report for November will be weaker than in October
The Fed shifted its stance significantly in June, so we're expecting only trivial changes in today's statement.
Today's September ISM manufacturing survey is one of the most keenly-awaited for some time. Was the unexpected plunge in August a one-time fluke--perhaps due to sampling error, or a temporary reaction to the Gulf Coast floods, or Brexit--or was it evidence of a more sustained downshift, possibly triggered by political uncertainty?
Whatever you do, don't fret over the apparent loss of momentum in the wages numbers; it's a classic statistical head fake, as we pointed out in Friday's Monitor, before the report. When the 15th of the month--payday for people paid semi monthly-- falls after the employment survey week, the BLS fails properly to capture their income, and hourly earnings are under-reported.
The headline number in today's NFIB survey of small businesses probably will look soft. The index is sensitive to the swings in the stock market and we'd be surprised to see no response to the volatility of recent weeks. We also know already that the hiring intentions number dropped by four points, reversing December's gain, because the key labor market numbers are released in advance, the day before the official payroll report.
The FOMC meeting today will be a non-event from a policy perspective but we are very curious to see what both the written statement and the Chair will have to say about the unexpected strength of the economy in the first quarter.
We expect to see a 70K increase in October payrolls today.
A reader sent us last week a series of five simple feedback loops, all of which ended with the Fed remaining "cautious". For example, in a scenario in which the dollar strengthens--perhaps because of stronger U.S. economic data--markets see an increased risk of a Chinese devaluation, which then pummels EM assets, making the Fed nervous about global growth risks to the domestic economy.
Today's March CPI ought to provide further support for the idea that the trend rate of increase in the core index is running at about 0.2% per month, an annualized rate, if sustained, of about 2.5%.
We see clear upside risk to the inflation data due before the FOMC announcement, from three main sources.
After three straight 0.3% increases in the core CPI, we are in agreement with the consensus view that September's report, due today, will revert to the 0.2% trend.
The headline April CPI, due today, will be boosted slightly by rising gasoline prices.
The obsession of markets and the media with the industrial sector means that today's ISM manufacturing survey will be scrutinized far more closely than is justified by its real importance.
The softening in payroll growth in November appears mostly to be a story about short-term noise, rather than a sign that tariffs are hurting or that the broader economy is slowing.
Judging from our inbox, the idea that the Fed might switch to some form of price level targeting, replacing its current 2% inflation target, is the big new idea for 2018.
The 0.242% increase in the January core CPI left the year-over-year rate at 2.3% for the third straight month.
Since January 2015, Core CPI inflation has risen to 2.3% from 1.6%, propelled by a combination of accelerating rents, a substantial rebound in the rate of increase of healthcare costs, and a modest-- though unexpected--upturn in core goods prices. It's always risky, though, simply to extrapolate recent trends and assume you now have a clear guide to the future.
If we're right in our view that the strength of the dollar has been a major factor depressing the rate of growth of nominal retail sales, the weakening of the currency since January should soon be reflected in stronger-looking numbers. In real terms--which is what matters for GDP and, ultimately, the lab or market--nothing will change, but perceptions are important and markets have not looked kindly on the dollar-depressed sales data.
If the rate of increase of the core CPI in the second half of the year matches the 0.19% average gains in the first half, the year-over-year rate will rise to 2.3% by December. In December last year, core inflation stood at just 1.6%, following a run of soft second half numbers. We can't rule out a slowdown in the monthly increases in the second half of this year too, given the evidence suggesting a small bias in the seasonal adjustments.
The next couple of rounds of business surveys will capture firms' responses to the Phase One trade deal agreed last week, though the news came too late to make much, if any, difference to the December Philly Fed report, which will be released today.
From a bird's-eye perspective, the argument for continued steady Fed rate hikes is clear.
Fed Chair Powell delivered no great surprises in his semi-annual Monetary Policy Testimony yesterday, but he did hint, at least, at the idea that interest rates might at some point have to rise more quickly than shown in the current dot plot: "... the FOMC believes that - for now - the best way forward is to keep gradually raising the federal funds rate [our italics]."
Markets usually ignore the monthly import price data, presumably because they are far removed, especially at the headline level, from the consumer price numbers the Fed targets.
Higher gasoline prices will lift today's headline October CPI, which should rise by 0.3%. Unfavorable rounding could easily push it to 0.4%, though, and year-over-year headline inflation should rise to 1.6% or 1.7%, from 1.5% in September and just 0.2% a year ago.
Boeing's announcement that it will temporarily cut production of 737MAX aircraft to zero in January, from the current 42 per month pace, will depress first quarter economic growth, though not by much.
The Fed will hike by 25 basis points today, but what really matters is what they say about the future, both in the language of the statement and in the dotplot for this year and next.
The Fed will leave rates unchanged today.
At the October FOMC meeting, policymakers softened their view on the threat posed by the summer's market turmoil and the slowdown in China, dropping September's stark warning that "Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term." Instead, the October statement merely said that the committee is "monitoring global economic and financial developments."
The Fed will do nothing and say little that's new after its meeting today. The data on economic activity have been mixed since the March meeting, when rates were hiked and the economic forecasts were upgraded, largely as a result of the fiscal stimulus.
The Fed yesterday acknowledged clearly the new economic information of recent months, namely, that first quarter GDP growth was "solid", with Chair Powell noting that it was stronger than most forecasters expected.
For most of the decade since the whole-economy average hourly earnings numbers were first published, the year-over-year rate of increase has run faster than the ECI measure of private sector wages and salaries, excluding incentive-paid occupations. But in the first quarter of this year, the ECI measure rose 2.5% year-over-year, the fastest increase in six years, while hourly earnings rose 2.3%. That difference might not sound like much, but it matters a good deal when put into context.
Perhaps the single strongest U.S. economic data series in recent months has been construction spending, which has risen by more than 1%, month-to-month, in four of the past five months.
Fed Chair Yellen speaks to the Economics Club of Washington, D.C., at 12.25 Eastern today, a day before she appears before the Joint Economic Committee of Congress at 10.00 Eastern. These will be her last public utterances before the FOMC meeting on December 16. Dr. Yellen won't say anything which could be interpreted as seeking to front-run the outcome of the meeting; that's not her style. But we expect her clearly to repeat that the Fed's decision will depend on whether progress has been made since October towards the Fed's twin objectives of maximum employment and 2% inflation.
Everyone is familiar by now with the conundrum in the labor market: How come wage gains have barely increased over the past few years even as the unemployment rate has fallen to very low levels, and business surveys scream that employers can't find the people they want? To give just one visual example of the scale of the apparent anomaly, our first chart shows the yawning gap between the headline unemployment rate and the rate of growth of hourly earnings, compared to previous cycles.
The Fed headlines yesterday carried no real surprises; rates were cut by 25bp, with a promise to take further action if "appropriate to sustain the expansion".
We're reasonably happy with the idea that business sentiment is stabilizing, albeit at a low level, but that does not mean that all the downside risk to economic growth is over.
Evidence in support of our view that the U.S. industrial slowdown is ending continues to mount, though nothing is yet definitive and the re-escalation of the trade war is a threat of uncertain magnitude to the incipient upturn.
The shortfall in nominal wage growth, relative to measures of labor market tightness, remains the single biggest mystery of this business cycle.
The FOMC delivered no great surprises in the statement yesterday, but the new forecasts of both interest rates and inflation were, in our view, startlingly low. The stage is now set for an eventful few months as the tightening labor market and rising inflation force markets and policymakers to ramp up their expectations for interest rates.
Treasury Secretary Mnuchin's five-line letter to House Speaker Pelosi on last Friday--copied to other Congressional leaders--which said that "there is a scenario in which we run out of cash in early September, before Congress reconvenes", introduces a new element of uncertainty to the debt ceiling story.
We expect the Fed to leave rates on hold today, but the FOMC's new forecasts likely will continue to show policymakers expect two hikes this year, unchanged from the March projections. We remain of the view that September is the more likely date for the next hike, because we think sluggish June payrolls will prevent action in July.
Markets are beginning to grasp that President-elect Trump's economic plans, if implemented in full--or anything like it--will constitute substantial inflationary shock to the U.S.
The near-term U.S. inflation outlook is benign, but it is not without risk.
The Fed was more hawkish than we expected yesterday.
Small businesses remain extremely positive about the economy, but some of the post-election gloss appears to be wearing off. To be clear, the headline composite index of small business sentiment and activity in February, due this morning, will be much higher than immediately before the election, but a modest correction seems likely after January's 12- year high.
It's hard to know what to make of the October CPI data, which recorded hefty increases in healthcare costs and used car prices but a huge drop in hotel room rates, and big decline in apparel prices, and inexplicable weakness in rents.
The Fed will hike by 25 basis points today, citing the tightening labor market as the key reason to press ahead with the process of policy normalization. We think the case for adding an extra dot to the plot for both this year and next is powerful.
The January core CPI numbers are consistent with our view that the U.S. faces bigger upside inflation risks than markets and the Fed believe.
Your correspondent is headed to the beach for the next couple of weeks, with publication resuming on Tuesday, September 4.
The November industrial production numbers will be dominated by the rebound in auto production following the end of the GM strike.
The "Phase One" China trade deal announced late last week is a step in the right direction, but a small one. With no official text available as we reach our deadline, we're relying on media reporting, but the outline of the agreement is clear.
We have been quite bullish on U.S. economic growth this year.
Core CPI inflation is heading for 2½% by the end of this year, and perhaps sooner. The trend in the monthly numbers is now a solid 0.2%, and that's before the weaker dollar arrests the decline in goods prices. Goods account for only a quarter of the core CPI, and right now they are the only part of the index under downward pressure. If--when--that changes, core inflation could rise quite rapidly.
The strong dollar is pushing down goods prices, but not very quickly. As a result, the sustained upward pressure on rents is gradually nudging core CPI inflation higher. It now stands at 1.9%, up from a low of 1.6% in January, and even relatively modest gains over the third quarter will push the rate above 2% by year-end. We can't rule out core CPI inflation ending the year at a startling 2.3%.
The further improvement in labor market conditions and the jump in core inflation means that the economic data have given the Fed all the excuse it needs to raise rates today. But the chance of a hike is very small, not least because the fed funds future puts the odds of an action today at just 4%, and the Fed has proved itself very reluctant to surprise investors-- at least, in a bad way--in the past.
Having panicked at the January hourly earnings numbers, markets now seem to have decided that higher inflation might not be such a bad thing after all, and stocks rallied after both Wednesday's core CPI overshoot and yesterday's repeat performance in the PPI.
Back in September, after the Fed decided to hold fire in the wake of market turmoil, we expected rates to rise in December and again in March. We forecast 10-year yields would rise to 2.75% by the end of March. in the event, the Fed hiked only once, and 10-year yields ended the first quarter at just 1.77%. So, what went wrong with our forecasts?
In one line: Core PCE deflator back on track; Q2 consumption headed for 3%.
In the September forecasts, the median forecast of FOMC members for the long-term fed funds rate was 3.5%. Their long-term inflation forecast is 2%-- it has to be 2%, otherwise they would be forecasting permanent failure to meet their policy objectives -- implying a real rate of 1.5%. This is well below the long-run average; from 1960 through 2005, the real funds rate--the nominal rate less the rate of increase of the PCE deflator--averaged 2.4%.
In one line: Consumption rocketing; core PCE deflator returning to target on a quarterly annualized basis.
In one line: Solid income and spending, and rising core PCE inflation before the virus. But...
In one line: Consumption and core PCE inflation will both rebound in Q1.
In one line: No overall PPI threat, but airline fares jump will lift the core PCE deflator.
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