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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  The ISM Non-Manufacturing Index Increased to 57.8 in April
Posted Under: Data Watch • ISM

Implications: Despite the pullback in energy drilling, the service sector looks healthy, a sign of a rebound in economic growth in the second quarter. The ISM service sector report showed strength in April while signaling continued robust growth in the months ahead. The April reading of 57.8, which beat the estimates of all 78 economists who submitted a forecast, represents the 63rd consecutive month above 50 (levels above 50 signal expansion; levels below 50 signal contraction). Meanwhile, the 57.3 average over the past year is the best twelve-month average going back to 2006. Of the eighteen industries reporting, fourteen showed growth in April while four showed declines, led by mining. That’s not a surprise given the steep drop in energy prices since mid-2014. The business activity index, which has a stronger correlation with economic growth than the overall index, rose to its highest level of 2015, while the new orders index, the most forward looking measure of service sector activity, rose 1.4 points in April to a robust 59.2. Expect activity to remain strong over the coming months as companies move to fill the new orders coming in. The employment index also ticked higher in April to 56.7, signaling that firms continued to hire, and at a slightly faster pace. On the inflation front, the prices paid index fell 2.3 points in April to 50.1. So prices are continuing to rise, but at a very modest pace. A decline in pork, dairy, and medical supply prices more than offset higher costs for beef and chicken. Over the coming months, rising fuel costs will likely push the index higher. As a whole, today’s report suggests the economy is picking up the pace in Q2 after the lull in Q1. In other recent news, automakers reported that they sold cars and light trucks at a 16.5 million annual rate in April, down 3.5% from March but up 3.1% from a year ago.

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Posted on Tuesday, May 05, 2015 @ 11:23 AM • Post Link Share: 
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  The Trade Deficit in Goods and Services Came in at $51.4 Billion in March
Posted Under: Data Watch • Trade

Implications: This is what happens when a major port strike comes to an end. The trade deficit in goods and services surged in March as imports increased by $17.1 billion, the largest monthly increase ever recorded going back to 1992. The West Coast port strikes ended in late February, and all the ships sitting for weeks, some for months, out in the Pacific were finally unloaded, causing a huge short-term surge in imports. The total number of inbound containers rose 32% from a year ago at the Port of Los Angeles and 42% at the Port of Long Beach. Because imports are a negative in GDP statistics, it now looks like real GDP declined in Q1 at about a 0.5% annual rate, a downward revision from the first estimate of +0.2% growth. Obviously a contraction in real GDP is not good news. But, like last year’s contraction at a -2.1% annual rate in the first quarter, this is not something to worry about. In the first quarter of 2014, the problem was the weather. This year, it was a combination of weather, the port strikes, and a rapid drop in exploration and drilling for energy due to lower oil prices. But all of these effects are temporary and we expect a rebound, just like last year. Looking past month-to-month volatility, the trade deficit has been relatively stable over the past few years, with a smaller trade deficit in oil and a slightly larger deficit in other goods, powered by growing purchasing power among US consumers and businesses. We expect to revert to this trend in the year ahead.

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Posted on Tuesday, May 05, 2015 @ 10:17 AM • Post Link Share: 
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  @WSJopinion vs. @BenBernanke
Posted Under: GDP • Government • Inflation • Monday Morning Outlook • Fed Reserve
The Wall Street Journal’s editorial page and former Fed Chair Ben Bernanke are in a tiff. In a nutshell, the WSJ says growth is slow (which is true) and the Fed has overestimated economic growth (true, too); therefore, monetary policy is not working. Interestingly, after saying this, the WSJ says it does think quantitative easing (QE) has boosted the stock market.

Bernanke defends the Fed by saying real GDP has been weak due to slow growth in productivity and the lingering effects of the financial crisis. If we want more growth, Bernanke suggests more infrastructure projects. But, don’t kid yourself he says, the unemployment rate has dropped because of the Fed’s “aggressive actions” – namely QE.

There seems to be only one thing the WSJ and Bernanke agree on – that the world is best understood through “Fed-centric glasses.” Through these spectacles, anything that QE can explain, the stock market to the WSJ, the jobless rate to Bernanke, they use it. When it can’t explain it, they both find other scapegoats.

But we think both sides make key mistakes. First, the WSJ made a basic factual error, using the wrong GDP numbers to assess the Fed’s forecasts. Real GDP grew 3.1% in 2013 (Q4/Q4), beating the Fed’s prediction of 3% or less, so the Fed’s track record is not as biased upward as the WSJ portrays.

But, more importantly, the WSJ provides no explanation for how QE lifted stocks, but not economic growth. The most important reason for the bull market is profits, not a rise in P-E ratios. How does QE raise profits, but not economic growth?

That’s not the only pretzel the WSJ twists itself into. The WSJ says QE1 was “necessary” and “worked,” but QE2 and QE3 did not. We understand how the WSJ could think that QE1 was reasonable during the panic. But, looking back, the stock market fell another 40% after QE1 began in September 2008. So, we ask: how did it work? It wasn’t until after mark-to-market accounting rules were loosened in March 2009, well after QE started, that the rebound in equities began.

What Bernanke skips over is an explanation for QE bringing down the unemployment rate. The Fed has stuffed the banking system with about $2.5 trillion in excess reserves that banks are sitting on instead of lending. But if these monies aren’t being lent, they can’t be generating any extra economic growth, which is what’s needed to push down the unemployment rate. And if QE were really creating jobs, wouldn’t that extra money floating around have generated higher inflation by now?

In sum, Bernanke cherry picks the good data (lower unemployment) and ties it to QE, while disregarding the lack of solid economic growth, and ignoring the inflation that would have resulted if QE were really having an impact.

In other words, all the Fed-centric explanations of the post-panic world, by both the WSJ and Bernanke, eventually hit intellectual dead ends they can only explain by resorting to alternative, and highly suspect, theories.

Instead, investors need to stay focused on what matters: entrepreneurs and profits. Yes, things would be even better if the government was spending less, taxing less, and easing up on many regulations, but the US continues to heal and better times are ahead even though QE4 is a figment of the imagination.

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

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Posted on Monday, May 04, 2015 @ 10:47 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, May 04, 2015 @ 7:54 AM • Post Link Share: 
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  War: @WSJopinion Vs. @BenBernanke
Posted Under: GDP • Government • Productivity • Video • Fed Reserve • Interest Rates • Spending • Wesbury 101
Posted on Saturday, May 02, 2015 @ 1:42 PM • Post Link Share: 
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  The ISM Manufacturing Index was Unchanged in April at 51.5
Posted Under: Data Watch • ISM

Implications: While the ISM manufacturing index, which measures factory sentiment around the country, was unchanged in April, the underlying details show growing strength. In April, fifteen of eighteen industries reported growth, an improvement from the ten industries reporting growth in March. In addition, the two most forward looking indexes, new orders and production, showed their largest gains since late last year. We don’t believe the decline from 58.1 in August to the current reading of 51.5 is anything to worry about. Remember that the economy was unusually strong in the summer of last year as it recovered from bad weather in the first quarter of 2014. On the inflation front, the prices paid index remained depressed at 40.5 in April, as firms continue to report low energy costs and depressed raw materials prices. The employment index dipped in April to 48.3, the first slip into contraction territory in nearly two years. However, other data on the economy, which we put more confidence in, signals that job creation was strong in April. These include the drop in both initial and continuing claims to the lowest level since 2000, as well as continuing increases in consumer spending. Taken as a whole, this month’s report shows the Plow Horse continues to plod forward. In other news this morning, construction declined 0.6% in March, below consensus expectations for a gain of 0.5%. A drop in single-family home building as well as a slower pace of government projects (highways and schools) offset stronger commercial construction, which was led by manufacturing facilities, communications infrastructure, and offices. Look for a rebound in the next couple of months as weather patterns return to normal.

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Posted on Friday, May 01, 2015 @ 11:58 AM • Post Link Share: 
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  Personal Income was Unchanged in March
Posted Under: Data Watch • Employment • Government • PIC • Fed Reserve

Implications: Hold off on personal income and spending for a moment. The biggest news this morning was that new claims for jobless benefits fell 34,000 last week to 262,000. Continuing claims dropped 74,000 to 2.25 million. Both initial and continuing claims are now the lowest since 2000. Plugging these figures into our models suggests nonfarm payrolls rose about 280,000 in April, well above the current consensus estimate of 220,000. This is consistent with our view that the economy is rebounding quickly from the lull in Q1 and the Federal Reserve will have the justification it needs to start lifting short-term rates in June. Some analysts may be dismayed by today’s headline of no change in personal income, but this was mostly the result of a drop in dividend and interest income after a spike upward in February. The underlying trend remains positive, with overall personal income up 3.8% in the past year and private wages & salaries up a more robust 4.3%. This trend in income is why consumer spending can keep rising as well, which it did by 0.4% in March. Expect more gains in the months ahead, powered by income gains as well as savings from lower energy prices. In the meantime, lower energy prices helped hold down commercial construction in Q1. Detailed numbers on that sector arrived this morning and showed that 70% of the large drop in commercial construction in Q1 was due to less exploration and drilling for oil and natural gas. In other news this morning, the Employment Cost Index, a useful measure of worker earnings, increased 0.7% in Q1 and is up 2.6% in the past year, the largest gain since 2008. This kind of wage acceleration boosts the case that the Federal Reserve has room to start raising rates. On the housing front, pending home sales, which are contracts on existing homes, increased 1.1% in March, suggesting existing home sales, which are counted at closing, will rise again in April. On the manufacturing front, the Chicago PMI, a measure of factory sentiment in that key region came in at 52.3, above the consensus forecasted 50.0. As a result, we are forecasting that the national ISM index will come in at 52.2, a respectable gain from 51.5 in March.

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Posted on Thursday, April 30, 2015 @ 10:45 AM • Post Link Share: 
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  Key Seven Weeks Starts Now
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

Don’t be confused by the Federal Reserve acknowledging the obvious slowdown in economic growth in the first quarter. The door to a June rate hike is still open. Not wide open, but much more open than most analysts and investors think.

The Fed’s statement mentioned slower growth in output, consumer spending, business investment, exports, and job creation. But it also hinted at faster growth ahead by mentioning how lower energy prices mean faster gains in “real” (inflation-adjusted) incomes.

Other analysts may point to Fed language that the recent slowdown only “in part” reflects “transitory factors.” In turn, they may argue this means the Fed thinks some of the recent slowdown may be longer lasting. But the Fed said almost the same thing last year, stating the slowdown last winter was “in part” due to “adverse weather conditions.” That’s right before real GDP expanded at a 4.8% annual rate in the middle two quarters of 2014. In other words, we think the Fed is just hedging its bets.

One subtle change in the statement was removing the sentence from the March statement where the Fed said “an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting.” If the Fed was already convinced a June rate hike won’t happen, they could have just replaced “April” with “June.” But they didn’t, which means the Fed is still set to consider a rate hike at the meeting in seven weeks.

Also notice that the Fed thinks that maintaining the large size of its balance sheet is a form of accommodation, which means slightly higher rates is only one way of making the Fed less loose and the other way of making the Fed less loose won’t happen for some time after it starts lifting rates.

Between now and the Meeting in June, we will get two more reports on the employment situation, two more reports on retail sales, plus lots of other data. If the economy doesn’t rebound then the Fed won’t raise rates in June. If the economy does rebound, as we expect, then we still think a June rate hike is more likely than not.

The Yellen Fed is data dependent and its statement makes it clear the Fed is willing to start raising rates when it is “reasonably confident” the labor market and inflation are heading up. Moreover, we believe the data already say the economy can handle higher rates. Nominal GDP is up 3.6% annualized in the past two years, not much below the 4.4% annual pace of the past 20 years, when the federal funds rate has averaged 2.8%. A federal funds target rate of nearly zero is too low given this growth. It’s also too low given well-tailored policy tools like the Taylor Rule.

Keep in mind, though, if the Fed starts raising rates soon, it’s unlikely to raise rates at every meeting, as was done in the past two prolonged rate hike cycles under Alan Greenspan in the late 1990s and both Alan Greenspan and Ben Bernanke in the middle of the prior decade. Instead, the Fed will probably raise rates at every other meeting for the first year, before embarking on a more aggressive path in the second half of 2016 and beyond.

Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist

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Posted on Wednesday, April 29, 2015 @ 3:49 PM • Post Link Share: 
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  The First Estimate for Q1 Real GDP Growth is 0.2% at an Annual Rate
Posted Under: Data Watch • GDP

Implications: Don’t say we didn’t warn you. We were forecasting a below-consensus 0.7% annualized GDP growth rate and, as we recently wrote, “anytime a forecast…is so slow, it’s well within the realm of possibility the economy actually shrank.” And, wow, did it come close. Real GDP grew at a scant 0.2% rate in Q1. However, temporary factors played a major role and we think real GDP will grow at an average rate of 3% for the rest of the year. First, the weather was unusually bad; this February was the coldest for the most people since 1979. Second, West Coast port strikes disrupted supply channels. And third, the huge drop in energy prices has dampened drilling activity before the benefits of lower prices affected other sectors. We’ll have to wait until tomorrow for details, but commercial construction fell at a steep 23% rate in Q1, suggesting a big effect from bad weather and energy. The bottom line is that investors should look at Q1 like they should have looked at Q1 last year, when even worse weather generated a 2.1% annualized drop in real GDP, followed by an average growth rate of 4.8% in Q2 and Q3. To check the underlying trend in real GDP growth, we like to take out inventories, international trade, and government spending, none of which can be relied on for long-term growth. What’s left are consumer spending, business investment, and home building. Those grew at a 1.1% annual rate in Q1, are up 3.3% from a year ago, and up at a 3% rate in the past two years. With the Federal Reserve meeting today, everyone’s talking about how the GDP report will affect the path of short-term rates. Our answer is simple: not at all. The Fed is well aware of the temporary factors hurting the economy and will be focused on data over the next seven weeks before the June meeting. Over that time, we’ll get two reports each on employment and retail sales, plus lots of other data. If they show the rebound we expect, the Fed will have no problem starting rate hikes in June. In the meantime, nominal GDP (real GDP growth plus inflation) grew at only a 0.1% rate in Q1 but is still up 3.9% in the past year and up at a 3.6% annual rate in the past two years, suggesting the Fed can raise rates without harming the economy. In other recent news, the Case-Shiller index shows home prices increased 0.4% in February and are up 4.2% in the past year, led by Denver, San Francisco, Miami, and Dallas. Expect more price gains in the year ahead, but at a slightly slower rate. On the manufacturing front, the Richmond Fed index, which measures mid-Atlantic factory sentiment, rose to -3 in April from -8 in March. That, combined with other reports, suggests slow growth in manufacturing nationwide in April.

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Posted on Wednesday, April 29, 2015 @ 11:34 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 Tuesday, April 28, 2015 @ 10:16 AM • 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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