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Brian Wesbury
Chief Economist
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Bob Stein
Deputy Chief Economist
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 | Industrial production declined 0.1% in May |
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| Posted Under: Data Watch • Industrial Production - Cap Utilization |
Implications: Overall industrial production dipped 0.1% in May. Manufacturing, which excludes mining and utilities, fell 0.4%. Both figures came in slightly below consensus expectations. However, industrial production is still up 4.7% from a year ago, growing more than twice as fast as the overall economy. The data we watch most closely is manufacturing production ex-autos. This figure fell 0.3% in May, but has risen in 9 of the last 11 months. That's a very good track record, given that manufacturing ex-autos usually falls three or four times a year even during normal economic expansions. In other words, it is much too early to read anything significant into the slippage in production in May. Given low inventories, particularly in the auto sector, we don't expect any persistent stagnation. Although capacity utilization declined in May, it is still up substantially from a year ago. As a result, companies have an increasing incentive to build out plant and equipment. Meanwhile, corporate profits and cash on the balance sheet show they have the ability to make these investments. In other news today, the Empire State index, a measure of manufacturing activity in New York, fell to +2.3 from +17.1 in May. This suggests growth continued in June, but at a slower pace than in May. However, these kinds of surveys are also influenced by corporate sentiment rather than actual activity, and, given news out of Europe, we would not be surprised if this were having a negative effect.
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| | The Consumer Price Index (CPI) fell 0.3% in May |
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| Posted Under: CPI • Data Watch • Inflation |
Implications: Gas prices plummeted in May. As a result, consumer prices fell 0.3% in May, coming in slightly below consensus expectations. Excluding energy, consumer prices were up across the board. "Core" inflation, which excludes food and energy, was up 0.2% again in May and is up 2.3% from a year ago, hovering near the largest 12-month gain since September 2008. In the past three months, core prices are up at a 2.7% annual rate. These figures are already above the Federal Reserve's supposed target of 2%. Meanwhile, monetary policy is very loose and housing costs (which are measured by rents, not asset values) are rising. Owners' equivalent rent was up 0.1% in May and is up 2.1% versus a year ago. The ongoing shift from home ownership toward rental occupancy should boost this inflation measure even more in the year ahead. With loose monetary policy and housing costs accelerating, it's hard to see core inflation getting back down to the Fed's 2% target anytime soon. On the earnings front, "real" (inflation-adjusted) wages per hour were up 0.3% in May. Although these earnings are down 0.1% from a year ago, the number of hours worked is up 1.8%, giving consumers more purchasing power. In other news this morning, new claims for jobless benefits increased 6,000 last week to 386,000. Continuing claims for regular state benefits declined 33,000 to 3.28 million. Recent data on claims suggest weak payroll growth in June, roughly 50,000 non-farm and 60,000 private, although data over the next two weeks may revise this forecast. Regardless, June payroll growth has been relatively weak the past few years, so don't read too much into those figures. Job growth should accelerate again in the second half of the year.
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| | The Producer Price Index (PPI) declined 1.0% in May |
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| Posted Under: Data Watch • Inflation • PPI |
Implications: Energy prices plummeted in May, dropping by the most in any month in more than three years. Almost completely as a result of this drop, overall producer prices were down 1% in May, coming in below the consensus expected decline of 0.6%. That's good news for companies making purchases, but no justification for another round of quantitative easing. "Core" prices, which exclude food and energy, and which the Federal Reserve claims are more important than the overall number, were up 0.2% again in May. Core prices are now up 2.7% from last year, which is much faster than the overall PPI. In the past three months, the core PPI is up at a 2.5% annual rate while overall prices are down at a 4.9% rate. In other recent inflation news, trade prices declined in May, with overall import prices down 1% and overall export prices down 0.4%. "Core" prices were also down in the trade sector in May, with imports ex-petroleum ticking down 0.1% and exports ex-agriculture declining 0.5%. Import prices are down 0.3% from a year ago, although up 0.3% excluding oil. Export prices are down 0.1% from a year ago, and up only 0.1% excluding agriculture. We do not expect the lull in inflation to last. With short-term rates being held near zero while nominal GDP is growing at about a 4% annual rate, monetary policy is loose. As a result, all these measures of inflation are very likely to move higher later this year. Be careful of all the stories you'll read in the near future about how the Federal Reserve was right all along and that inflation is not a problem. By later this year, the conventional wisdom will realize this was temporary.
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| | Retail sales declined 0.2% in May, up 5.3% versus a year ago |
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| Posted Under: Data Watch • Retail Sales |
Implications: Retail sales were relatively soft in May, but do not signal a broader economic slowdown. Given the financial problems in Europe, some downbeat analysts are eager to fit every negative piece of news about the US economy into that framework. Instead, we think the tepid sales reports of the last couple of months are caused by much more mundane factors. The leading cause of the decline in May was a steep drop in gas prices. Excluding sales at gas stations, retail sales rose 0.1%. The second weakest category of sales in May was building materials, which fell 1.7%. This past winter was unusually mild. As a result, home construction (on a seasonally-adjusted basis) picked up quickly during that period and so did retail sales related to that construction. Now, those kinds of sales are reverting toward the underlying trend, which is still up 5.3% from a year ago. In addition, a combination of the mild winter, which made it easy to shop, and the earliest Easter in the past few years, may be skewing the seasonal adjustment factors in the Spring, making sales look good through March and worse – temporarily – in April/May. Regardless, "core" sales, which exclude autos, building materials, and gas, were essentially unchanged in May (+0.02%) and have only dropped once in the past twenty-two months, a remarkably consistent record of sales gains. Even if these sales are unchanged in June, they will be up at a 2.1% annual rate in Q2 versus the Q1 average, which is also what we are estimating for the growth of "real" (inflation-adjusted) personal consumption in Q2 (including goods and services). Don't be fooled by statistical noise. The US economy continues to grow.
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| | Bet Against QE3 |
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| Posted Under: Government • Inflation • Monday Morning Outlook • Fed Reserve |
Since the financial crisis in 2008 the Federal Reserve has done extraordinary things – lowered interest rates to essentially zero, increased the size of its balance sheet by $2 trillion and announced Operation Twist.
With unemployment still relatively high and real GDP growing at a 2% rate in the past year, there are many on (and off) the Fed who think more should be done.
If we thought liquidity was a problem, we might agree, but it's not. The reason the economy is growing more slowly than many Americans would like is because of bad fiscal policy. We are anti-Keynesians...we think government spending (when it has gone beyond the things government can actually do efficiently) is a drag on economic growth. The bigger the government, the smaller and less dynamic is the private sector.
But our belief will not sway the Fed. It apparently wants to act again, but does not have anything close to unanimous support. As a result, we think QE3 is extremely unlikely unless some kind if international contagion emanating from Europe were to occur. But, given essentially zero percent short-term interest rates in the US and the absence of mark-to-market accounting, we just don't find this a plausible scenario.
As a compromise we could see the Fed extending Operation Twist beyond the end of June, which means it will continue to sell short-term Treasury bills and buy longer-term Treasury notes and bonds. This action does nothing for monetary policy. In fact, it is really more of a "fiscal" activity, no different than if the Treasury Department decided to sell more short-term bills and fewer longer term securities.
More importantly, we don't think quantitative easing made a dime's worth of difference for the economy.
From late 2010 through mid-2011, during QE2, the Fed bought $600 billion in Treasury securities from the banks. In that time, excess reserves held by the banks went up from slightly more than $1 trillion to more than $1.6 trillion. In other words, all of the money the Fed injected came right back to the Fed and did virtually nothing. Excluding excess bank reserves, the Fed's balance sheet is actually smaller than it was in late 2008 and has been little changed in the past three years.
Of course, the Fed likes to say that QE2 and Op Twist lifted stock prices, but if this were really true then price-earnings ratios would be higher. They aren't. In fact, the ratio of the S&P 500 to operating earnings was 13.3 in May 2012, exactly the same level it was in August 2010 when QE2 started. P/E ratios are lower today than they were back in 2006, 2007, 2008 or 2009. Unless the Fed can magically lift corporate earnings without boosting economic growth above 2% or pulling unemployment below 8%, we don't see the connection.
It's time we stopped looking to the Fed as our economic savior. Loose monetary policy cannot fix every economic problem. Imagine if Congress suddenly boosted the minimum wage to $50 per hour! Unemployment would skyrocket and real GDP would plummet. Obviously the Fed couldn't stop the short term pain.
In the end, if we want more growth, there is no substitute for reducing government spending and excessive regulation. And that's just not the Fed's job.
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These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.
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