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   Brian Wesbury
Chief Economist
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Deputy Chief Economist
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve


Source: St. Louis Federal Reserve FRED Database

Posted on Monday, March 27, 2017 @ 10:32 AM • Post Link Share: 
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  The Fed is A Proxy for Government
Posted Under: Government • Monday Morning Outlook • Fed Reserve • Spending

Well, that was fun!  The GOP's attempt to reform healthcare hit a brick wall of politics.  Conservative Republicans wanted to completely "repeal" Obamacare, while moderates and leaders were willing to keep much of it as long as it cost less.  Moving one way or the other lost too many votes.  Democrats refused to participate.  So, the bill died.

The stock market rose when it looked like Speaker Ryan's bill would pass, and fell when prospects faded.  But US stocks remain undervalued.  Nothing, other than politics, has changed and we expect equity values to continue to rise.

There is a huge debate in America these days about the role of government in the economy.  This debate reached a fever pitch following the Economic Panic of 2008.

Republicans pushed TARP, which basically said "free markets cause problems and government must be used to fix them."  President Obama used that shift in philosophy to suggest government should run healthcare.

At the same time, the Federal Reserve cut interest rates to zero and massively increased the size of its balance sheet.  The key question is whether this is a permanent increase in the size and scope of government or can it be rolled back?  Will the Fed shrink its balance sheet?

The Fed's balance sheet grew from $800 billion before 2008 to $4.4 trillion today.  From 6% to 24% of GDP.  It's a bigger share of GDP today than it was during the Great Depression.

Quantitative Easing and the size of the Fed's balance sheet has completely changed the way monetary policy is managed.  It used to be that the Fed changed the size of its balance sheet to move interest rates.  If it wanted rates to fall, it would buy bonds (increase the size of its balance sheet) by printing new money.  That money would boost bank reserves and force the federal funds rate lower.  If it wanted rates to rise, it would sell bonds, shrinking the amount of reserves, driving up rates as banks competed for a smaller pool.

These days, with over $2 trillion of "excess reserves," the Fed manages monetary policy by changing the rate that it will pay banks to sit on those excess reserves.  The idea being that if the Fed pays enough then banks won't lend them out.  In other words, the Fed thinks it can control the money supply by encouraging or punishing banks.  This is the same idea behind the negative interest rate experiments in Europe and Japan.

The world is still in the very early stages of this experiment and no matter what anyone says, no one knows if it will work or not.  We believe that it's failing.  For example, negative interest rates did not boost growth in Europe.

Quantitative Easing did not boost inflation in the US, nor did it boost economic growth.  The reason:  with one hand the Fed was shoveling money into the economy, but with the other hand it was regulating banks like never before.  Higher capital requirements, Dodd-Frank, and heavy-handed regulation kept banks from expanding loans at the same time they had more reserves and capital.

If the Trump Administration reduces regulation, the money supply will increase even if the Fed pays more to banks for holding reserves.  The reason – loans are more profitable than Fed interest rates as long as the yield curve is upward sloping.  And as long as excess reserves exist, banks can increase loans and the money supply, which means inflation is a threat and the yield curve will likely remain upward sloping.

In other words, an upwardly sloping yield curve makes it virtually impossible to get a tight monetary policy as long as the Fed allows excess reserves.  In addition, with the Fed's balance sheet so large, even an inversion does not necessarily signal as much monetary tightness as in the past.

At the same time, the US federal government will find it virtually impossible to ever balance the budget again without getting control of spending.  The government has managed to make itself so big that its decisions in the next few years will have implications for decades.  Leaving excess reserves in the system is economically dangerous, just like not reforming entitlements.   

Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Posted on Monday, March 27, 2017 @ 10:07 AM • Post Link Share: 
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  New Orders for Durable Goods Rose 1.7% in February
Posted Under: Data Watch • Durable Goods


Implications:  Business investment is getting its mojo back.  New orders for durable goods rose once again in February following a healthy increase in January.  The February rise was due in large part to commercial aircraft orders, but strip out the volatile transportation sector and durable goods orders still rose 0.4%.  Non-transportation orders were led higher in February by primary metals, electrical equipment, appliances & components, and machinery.  These non-transportation orders have been steadily trending higher since mid-2016, and have risen in each of the last six months.  Meanwhile machinery orders rose once again in February and have not shown a monthly decline since April of last year.  This is, in part, a sign of continued improvements in the energy sector, which had been pulling down machinery investment since oil prices started declining in mid-2014.  Shipments of "core" capital goods - non-defense, excluding aircraft – rose 1.0% in February.  If unchanged in March, these shipments will be up at a 6.9% annual rate in Q1 versus the Q4 average.  This series is important for GDP and, despite a modest decline in new orders for "core" capital goods in February, should continue to be a positive contributor to growth in the quarters ahead. Taken as a whole, today's report on durable goods supports the pickup in manufacturing activity seen in other economic reports, and suggests that confidence from both consumers and companies is on the rise. 

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Posted on Friday, March 24, 2017 @ 10:12 AM • Post Link Share: 
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  New Single-Family Home Sales Increased 6.1% in February
Posted Under: Data Watch • Home Sales • Housing


Implications:  New home sales surprised to the upside in February, coming in at the second fastest pace since 2008.  Sales increased 6.1% in February and are now up 12.8% versus a year ago, demonstrating strength despite month-to-month volatility as well as the increase in mortgage rates since late 2016.  Meanwhile, despite a 4,000 increase in unsold new homes, inventories remain low by historical standards (see chart to right) and are not a headwind to future construction.  All of the gain in inventories in February was due to homes that were either under construction or had yet to start, with the inventory of completed homes actually declining.  Going forward, we expect housing to remain a positive factor for the economy.  First, employment gains continue, which should put upward pressure on wage growth.  Second, credit standards in the mortgage market are starting to thaw.  Third, the homeownership rate remains depressed as a larger share of the population is renting, leaving plenty of potential buyers as economic conditions continue to improve.  Unlike single-family homes which are counted in the new home sales data, multi-family homes (think condos in cities) are not counted.  So a shift back toward single family units will also serve to push reported sales higher.  Look for overall gains in home sales in the year ahead as these factors combine to drive expansion, and any headwind created by an increase in mortgage rates is offset by expectations of faster future economic growth.  In other news this morning, new claims for unemployment insurance increased 15,000 last week to 258,000.  The four-week moving average is 240,000.  Continuing claims fell 39,000 to 2.00 million.  It's still early, but we expect a payroll gain of 150,000 for March, a healthy pace but partial payback from unusually strong job growth in January and February.   

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Posted on Thursday, March 23, 2017 @ 10:54 AM • Post Link Share: 
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  Existing Home Sales Declined 3.7% in February


Implications:  After starting the year at their fastest pace since 2007, existing home sales took a breather in February.  Sales of previously-owned homes fell 3.7% in February to a 5.48 million annual rate, but are still up 5.4% from a year ago.  It is important to remember home sales are volatile from month to month and we expect the general upward trend of the past several years to keep going.  That being said, tight supply and rising prices remain headwinds.  In fact, inventories have now fallen on a year-over-year basis for 21 consecutive months.  The months' supply of existing homes – how long it would take to sell the current inventory at the most recent sales pace – was only 3.8 months in February.  According to the NAR, anything less than 5.0 months is considered tight supply.  The good news is that demand for existing homes was so strong that 42% of properties in February sold in less than a month, pointing to eagerness from buyers.  Higher demand has also driven up median prices, which have now risen for 60 consecutive months on a year-over-year basis. While this may temporarily price some lower-end buyers out of the market, it should ultimately help alleviate some of the supply constraints as "on the fence" sellers take advantage of higher prices and trade-up or trade-down to a new home.  Although some analysts may be concerned about the impact of higher mortgage rates, it's important to recognize that rates are still low by historical standards, incomes are growing, and the appetite for homeownership is eventually going to move higher again.  In other housing news this morning, the FHFA Index, which measures prices for homes financed with conforming mortgages, remained unchanged in January and is now up 5.7% from a year ago. In the year ending in January 2016, FHFA prices were up 6.2%.

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Posted on Wednesday, March 22, 2017 @ 11:21 AM • Post Link Share: 
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  Health Care: Free Markets vs Government

The debate over healthcare reform is in full swing, with forces aligning on all sides.  From our perch, House Speaker Paul Ryan's health care bill has some appeal.  It eliminates roughly $900 billion of Obamacare taxes over the next 10 years, including the extra 3.8% tax on dividends and long-term capital gains, as well as an extra 0.9% tax on high earners.

In addition, mainly through reforms to Medicaid, (which saw large increases in enrollment due to Obamacare), it reduces spending by roughly $1.2 trillion.  These reforms rearrange a dysfunctional financial arrangement where states chose what gets covered by Medicaid, but the federal government picks up most of the tab.  As a result, states have little incentive to find more efficient ways to deliver health care to the poor.

Ryan's plan also raises the contribution limit on health savings accounts, to make them work better when paired with catastrophic insurance.  In general, the Ryan plan reduces spending, cuts taxes, and brings more market forces to bear.

But no matter how many Republicans say so, it's not a true free-market reform of the health care system.  It basically codifies the Obamacare philosophy of healthcare as a "right" for Americans, while changing the methods of financing it, and attempting to reduce its overall cost.

Much of this is based on the idea that Obamacare "worked."  Many people who had no insurance, and went to emergency rooms, now have insurance. 

But Obamacare isn't a smartphone.  It isn't magic, making better health care descend from heaven.  It's just redistribution.  Through a politically-complicated transfer scheme of taxes, fines, subsidies, and support to insurance companies, it taxes one group of people to pay for another group of people.

Those who receive the transfers get insurance, while those who pay for it have less after-tax income.  The Ryan plan reduces and shifts the redistribution, but the heart of the system stays. 

The reason the Ryan plan leaves the system mostly intact is because the budget process of the US Senate won't allow (without 60 votes) a move to a true free market plan.  Moreover, while the Ryan plan cuts spending and taxes, a future Congress could reverse those moves.  It's this potential for future Congresses to just boost the size of Medicaid payments to the states that has some politicians thinking of ways to change it.  Senator Ted Cruz has an intriguing proposal that could allow true free market healthcare to be adopted; it would overcome filibusters and the 60 vote rule.

Normally, bills that deal with taxes and spending, like Ryan's bill, have to stick within the narrow confines of budget-related issues.  If they do, they can pass the Senate with only a simple majority.  But if part of a bill isn't really budget-related any Senator can object, by appealing to the Senate parliamentarian, who would then require 60 votes to keep that part of the bill.  That's a very high hurdle, which means free market reform legislation can't pass the Senate.

However, Senate rules also allow Vice President Mike Pence, as "president" of the Senate to overrule the parliamentarian.  If the Senate chose this path, a GOP majority could do pretty much anything it wanted with 51 votes.
To say this proposal is controversial would be a massive understatement.  Democrats would accuse the GOP of "going nuclear."  In effect, the 60-vote filibuster would be dead and some GOP lawmakers say this would lead to both sides taking advantage of this maneuver whenever they controlled the House, Senate, and White House at the same time.

This is a hugely controversial proposal.  But Senator Cruz makes the point that once an entitlement becomes entrenched, current budget rules make it nearly impossible to reverse – no matter how inefficient and costly it becomes.  This is one key reason government never shrinks and free market plans are never truly implemented.

Cruz's point is that if the GOP really believes Obamacare is a disaster and that true free market healthcare would be cheaper and better than government healthcare, then it should also believe that once voters get a taste of their system, support for a single-payer system would dwindle.

We doubt this road will be taken, but it does exist.  For good or bad, depending on what side of the political spectrum you reside, choosing not to take it codifies government's role in healthcare for a very long time, maybe forever.

Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Posted on Monday, March 20, 2017 @ 9:58 AM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve


Source: St. Louis Federal Reserve FRED Database

Posted on Monday, March 20, 2017 @ 7:54 AM • Post Link Share: 
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  Industrial Production Unchanged in February, Capacity Utilization Declines
Posted Under: Data Watch • Industrial Production - Cap Utilization

Implications:  Smart investors should completely disregard the headline weakness in industrial production in February, which was unchanged versus a consensus expected gain of 0.2%.  Unusually warm weather held back utility output, but outside that sector activity continues to rise, with manufacturing beating consensus expectations and mining up as well.  February was unusually warm in the lower-48 states, resulting in lower demand for heat and the lowest utility output in more than a decade.  Meanwhile, manufacturing, which excludes mining and utilities, rose 0.5% in February, boosted by a 0.8% rise in auto production.  We like to follow "core" industrial production, which is manufacturing excluding autos, and this measure increased 0.5% in February as well and has been accelerating lately.  Even though "core" industrial production is only up 1.1% in the past year, it's up at a 5.2% annual rate during the past three months.  We think the acceleration in core production is, in part, a lagged effect of the rebound in oil prices, which adds to the production of machinery used in the energy sector.  Higher energy prices are also having a direct effect on mining, which jumped 2.7% in February.  Oil and gas-well drilling posted its ninth consecutive gain in February, jumping 7.1%, and now up at a massive 162% annual rate in the past three months.  Based on other commodity prices, we think oil prices are close to "fair value" range, which should keep mining in recovery after the problems of the past two years.  Although weak overseas economies will continue to be a headwind for production, we expect solid growth in the year ahead.

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Posted on Friday, March 17, 2017 @ 10:49 AM • Post Link Share: 
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  Housing Starts Rose 3.0% in February to a 1.288 Million Annual Rate
Posted Under: Data Watch • Home Starts

Implications:  February was a good month for home building.  Housing starts rose 3% overall, led by a surge in single-family starts to the highest level since 2007.  Although multi-family starts fell in February, this is a very volatile series from month to month and is still up 13% from a year ago.  Part of the reason for strength in February was unusually warm weather last month, but the underlying trend in homebuilding remains up as well.  Although permits for new homes declined in February, all of the decline was due to the volatile multi-family sector; permits to build single-family homes rose 3.1% to the highest level since 2007.  In other words, don't expect the drop in overall permits in February to lead to a decline in the future pace of home building.  Based on population growth and "scrappage," housing starts should eventually rise to about 1.5 million units per year, so much of the recovery in home building is still ahead of us.  Moreover, like in January, the "mix" of construction has been generally shifting toward single-family building.  The shift toward single-family is a positive sign for the economy because, on average, each single-family home contributes to GDP about twice the amount of a multi-family unit.  In other recent housing news, the NAHB index, which measures sentiment among home builders, rose to 71 in March, the highest reading for the index since 2005.  More jobs, faster wage growth, and, for at least the time being, optimism about more market-friendly policies from a Trump Administration, are encouraging both prospective home buyers and builders.  More broadly, new claims for jobless benefits fell 2,000 last week to 241,000.  Continuing claims declined 30,000 to 2.03 million.  It's still early, but it looks like nonfarm payrolls will be up in the 175,000 to 200,000 range in March, another solid month.  On the manufacturing front, the Philadelphia Fed index, which measures factory sentiment in that region, fell to a still very strong 32.8 in March from a stellar 43.3 in February.  Despite the decline, the March number still represents the second highest reading since late 2014 and continues to signal optimism about a major positive shift in economic policies.  With figures like these, investors should not casually dismiss the possibility of a fourth rate hike later this year, despite yesterday's news that the Fed is still projecting only three rate hikes in 2017.

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Posted on Thursday, March 16, 2017 @ 11:08 AM • Post Link Share: 
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  A Dovish Rate Hike
Posted Under: Government • Inflation • Research Reports • Fed Reserve • Interest Rates


Considering that the Federal Reserve raised short-term interest rates by a quarter point, today's Fed statement was surprisingly dovish. 

The dovish elements include: 
(1)  adding language on "core' inflation (which excludes food and energy prices) running at less than 2%,
(2)  characterizing its inflation goal as "symmetric," which means inflation can run above 2% as long as the Fed doesn't think the overshoot will be persistent, and 
(3)  a dissent in favor of keeping rates unchanged at today's meeting
In addition, while some analysts thought the Fed might increase the pace of projected rate hikes in 2017 and beyond, the Fed left those projections essentially unchanged, with median expectation of three 25 basis point rate hikes in each of 2017 and 2018.  In particular, five of the seventeen Fed decision-makers think there should be four or more rate hikes this year, no different than back in December.  

The lack of change in the "dot plot" describing short-term rate projections was underscored by almost no change in the economic forecasts for real GDP growth, unemployment, or inflation. 

However, the statement wasn't all dovish.  After all, the Fed did raise the range for short-term rates by 25 basis points to 0.75% - 1.00%. The Fed also noted a firming in business investment and that its favorite measure of inflation (the PCE price index) was close to the goal of 2%.

From a long-term policy standpoint, we're disappointed by today's statement.  We'd like to see the Fed maintain inflation in the 0% to 2% range.  By contrast, today's statement reiterates that the Fed is more comfortable with a range centered on 2%, meaning it doesn't have to hasten the pace of rate hikes later this year if PCE inflation hits 2.5%-plus, so long as the Fed's economic projections show it eventually coming back down to 2%.   We think that risks a mistake that could lead to much faster rate hikes later on if inflation runs above Fed forecasts. 

We still expect the Fed to raise rates three times total in 2017, with the odds of a fourth rate hike more likely than the Fed stopping at two.  Economic fundamentals suggest the Fed is already behind the curve and the economy can handle a faster pace of rate hikes.  Employment gains remains healthy and nominal GDP – real GDP growth plus inflation – has grown at a 3.2% annual rate in the past two years.  Moreover, we are seeing signs of accelerating inflation, with the Fed's favorite measure poised to hit 2.1% when February data arrive at the end of the month.

The bottom line is that the Fed took a big step in the right direction earlier today.  Unfortunately, the Fed's language suggests it probably won't take as many of these steps as it should before the year is through.     
Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist

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Posted on Wednesday, March 15, 2017 @ 4:14 PM • Post Link Share: 
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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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