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   Brian Wesbury
Chief Economist
 
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   Bob Stein
Deputy Chief Economist
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  Uncertainty Not All Bad
Posted Under: Europe • Government • Markets • Monday Morning Outlook

If you listen to elite policymakers around the globe, they all seem to agree on one thing: the need to avoid "uncertainty."  In their thinking the battle against uncertainty is a never-ending struggle, and if only the world were more certain the economy would be doing much better.

Which is kind of odd when you think about it, because if you really want certainty you couldn't get much more of it than in the old Soviet Union or present day North Korea.  Those economies minimize flexibility, choice, and freedom, while maximizing certainty.  It's the certainty of the prison cell, but it's certainty nonetheless.

By contrast, free-market capitalism is the opposite of a system built on certainty.  No one knows what will be invented or discovered next – otherwise it already would have been invented or discovered – or how consumer appetites will change in the future.  In free-market capitalism, uncertainty is a feature, not a bug.                  

Obviously, not all certainty is bad.  People are more industrious and more inventive when they can rely on the certainty that their property rights will be respected by both the government and their fellow countrymen.  That kind of certainty is good, and governments that respect the rule of law, while minimizing corruption and the impact of political correctness, help maximize the risk-taking that boosts standards of living.

In the end, it's really about "faith" more than "certainty."  If investors, entrepreneurs, and workers can operate with justifiable faith that the government will protect their freedom, they will always attempt to boost economic growth.              

That's why we think the recent vote by the UK to leave the European Union is not the problem some analysts and investors think.  The British people found themselves increasingly enmeshed in rules and regulations not of their own making, and lacking the representation of democratically elected leaders. 

For example, in the topsy-turvy world of bureaucratic double-speak, EU rules required the British government to treat immigrants seeking welfare similarly to British citizens seeking welfare, because to treat them differently was supposedly an infringement on the right of people to travel in the EU.

Yes, the coming weeks will bring angst over what the future holds.  But, ultimately, a freer and more independent Britain, one that has control over its own political destiny, is likely to be a more responsible and prosperous one as well.  The EU, which runs a large trade surplus with the UK, has every incentive to negotiate a free trade deal.  Meanwhile, the UK has an opening to expand free trade with the US and Canada, which the EU was making more difficult.

The recent sell-off in equities based on Brexit is a buying opportunity.  Look for the UK's position relative to the EU to evolve toward that of Norway or Switzerland, which have voted to not be members of the EU. So, the EU created a "social" membership in the European Economic Area, with free trade and easier border crossings, but a buffer from the political whims of Brussels.  The UK is bigger than Norway or Switzerland, which gives it more leverage.   The EU has created a bureaucracy which makes the costs of being a member greater than the benefits for the average citizen. Politicians, on the other hand, love big bureaucracies. This time the people spoke. And, that's why Brexit is good.

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

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Posted on Monday, June 27, 2016 @ 11:11 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, June 27, 2016 @ 7:43 AM • Post Link Share: 
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  New Orders for Durable Goods Declined 2.2% in May
Posted Under: Data Watch • Durable Goods • Europe

 

Implications: In case you missed it, the UK voted yesterday to leave the European Union.  As we wrote earlier this month, we view this as a positive development, a move towards freedom. The short-term volatility is a buying opportunity.  With that out of the way, on to the data. Durable goods orders declined 2.2% in May, following a combined 5.3% rise in March and April.  Military aircraft and motor vehicles led orders lower in May, although most major categories showed a pullback as well.  Even excluding the volatile transportation sector, orders fell 0.3% in May, coming in below the consensus expected rise of 0.1%.  Shipments of "core" capital goods - non-defense, excluding aircraft – declined 0.5% in May, but were down a more modest 0.2% including upward revisions to prior months. This is the measure that the government uses for calculating GDP.  If unchanged in June, these shipments will be down at a 0.8% annual rate in Q2 vs the Q1 average.  But that doesn't mean that we expect GDP growth slowed in the second quarter. The first estimate of Q2 growth is still a month off, but we are forecasting that the U.S. economy grew at around a 2.0% rate in the second quarter.  We also get a final reading on Q1 GDP next Thursday, which we expect will show the economy grew at a 1.1% annual rate, up from the 0.8% estimate released in May (the initial Q1 GDP release estimated growth of 0.5%).  Looking forward, we expect durable goods to rebound.  The biggest drag on orders in the past year has been machinery, but that should end soon given the bounce in energy prices.  In other words, business investment should pick up in the months ahead.  In addition, consumer purchasing power is growing with more jobs and higher incomes, while debt ratios remain very low, leaving room for an upswing in big-ticket spending.  While the Fed may cite the May slowdown in orders along with the UK exit vote and market volatility as reasons to hold off on a July (and possibly even September) rate hike, we think this puts too much emphasis on short-term events. The plow horse economy continues to move forward.

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Posted on Friday, June 24, 2016 @ 11:36 AM • Post Link Share: 
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  New Single-Family Home Sales Fell 6.0% in May
Posted Under: Data Watch • Home Sales • Housing

 

Implications:  After surging in April to the fastest pace in eight years, new home sales took a breather in May, coming in slightly below consensus expectations, but still signaling continued strength.  In fact, even though sales of new homes fell 6% in May, today's number was still the second strongest reading since February 2008.  It's important to remember that home sales data are very volatile from month to month, so it's important not to get too carried away and to keep focusing on the trend, which remains positive.  We think there are a couple reasons to expect housing to remain a positive factor for the economy in the months ahead.  First, employment gains and the beginning of a thaw in mortgage financing.  Second, wage growth seems to be picking up, putting the prospect of buying a home in reach for more people.  Third, the homeownership rate remains depressed as a larger share of the population is renting, leaving plenty of potential buyers as conditions continue to improve.  And remember that, unlike single-family homes which are counted in the new home sales data, multi-family homes (think condos in cities) are not counted in this report.  So a shift back towards single family units will also serve to push reported sales higher.  The inventory of new homes rose 3,000 in May but remains very low by historical standards (see chart to right).  Moreover, the recent recovery in inventories has been led by homes where construction is still in progress, or has yet to begin.  As a result, homebuilders still have plenty of room to increase both construction and inventories. The median sales price of a new home fell 9.3% in May, but is still up 1.0% versus last year.  A change in the "mix" of homes sold toward the lower end of the market is hiding some of the increase in home prices. In other news this morning, new claims for unemployment insurance declined 18,000 to 259,000. Continuing claims fell 20,000 to 2.142 million. These figures suggest a rebound in job growth in June.

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Posted on Thursday, June 23, 2016 @ 11:55 AM • Post Link Share: 
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  Existing Home Sales Increased 1.8% in May
Posted Under: Data Watch • Home Sales • Housing

 

Implications:  Existing home sales continued to show strength in May, posting their third consecutive monthly gain, and coming in at the fastest pace since 2007.  Sales of previously owned homes rose 1.8% in May to a 5.53 million annual rate and are up 4.5% from a year ago. In a sign of a mild loosening of lending standards (finally!), non-cash purchases, where the buyer uses a mortgage loan, are up 7.3% from a year ago. This is encouraging, and we think the broader trend will continue to be upward, but there are still some headwinds. Tight supply and rising prices continue to hold back sales. While inventories rose 1.4% in May they are still down 5.7% from a year ago.  The months' supply of existing homes – how long it would take to sell the current inventory at the most recent selling pace – is only 4.7 months.  According to the National Association of Realtors® (NAR), anything less than 5.0 months is considered tight supply.  The good news is that demand was so strong in May that properties typically only stayed on the market for 32 days, the shortest duration since the NAR began tracking in May 2011!  In fact, 49% of properties in May sold in less than a month, pointing to further interest from buyers in the months ahead.  However, higher demand from the spring selling season also helped push the median price for an existing home to an all-time high, up 4.7% versus a year ago, and marking the 51st consecutive month of year-over-year price gains. While this may be pricing some lower-end buyers out of the market, it should help alleviate some of the supply constraints as "on the fence" sellers take advantage of higher prices and trade-up to a new home, bringing more existing properties onto the market.   Meanwhile, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.2% in April and is up 5.9% from a year ago.   In the year ending in April 2014, FHFA prices were up 5.6%.

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Posted on Wednesday, June 22, 2016 @ 11:47 AM • Post Link Share: 
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  Policy Stagnation
Posted Under: Government • Inflation • Monday Morning Outlook • Productivity • Fed Reserve • Interest Rates • Spending • Taxes

Back in the 1970s, President Jimmy Carter told us that we were just going to have to learn to live with less.  The mood among establishment economists in the late 1970s was gloomy.  The world was running out of oil; inflation was an odd phenomenon that was beyond our control.  Sure, we could get lower unemployment, but only by letting inflation get even higher.  Somehow, the US had lost its post-war economic mojo and just wasn't going to get it back.

And then came the 1980s and 1990s and these ideas were blown out of the water.  We had faster growth, lower unemployment, and lower inflation.

The real problem in the late 1960s and 1970s was a series of blunders by the government.  Monetary policy got too loose and social spending grew too high.  Inflation pushed more workers into higher marginal tax brackets.  The Great Society had laid some very bad eggs and eventually the chickens came home to roost.  The solution was tighter monetary policy, deregulation, and lower tax rates.      

But now, after several years of Plow Horse economic growth following a very deep recession, these theories about slow growth are making a comeback.  They're not exactly the same.  No serious economist claims we're about to run out of oil anymore; just the opposite, they worry fossil fuel prices are too cheap!  But they have theories about why the economy has been relatively slow and they think we may have to accept slower growth over the long run as a result. 

Combined, they go under the banner of "secular stagnation."  This was the spirit that animated last week's Fed meeting as well as Fed Chief Yellen's press conference that followed.  Productivity growth has fallen and it can't get up. 

Former Treasury Chief Larry Summers has been arguing that savings are just too great given available investment opportunities, making monetary policy ineffective.  Professor Robert Gordon says the good stuff has already been invented or discovered and we just have to settle for slower growth in living standards.  

Supporters of the secular stagnation theory do have one strong point.  The Baby Boom generation is retiring, which means the labor market is starting to lose many high-skilled workers.  But we think the main problem with growth has nothing to do with this demographic shift.  Instead, once again, the real culprit behind sub-par growth is wrongheaded government policies.      

In a world with extraordinarily low interest rates, the federal government should be enacting deep supply-side tax cuts.  Cutting taxes on capital investment should pay for itself and even if doesn't, financing it with very long-term debt would be easy.  The economy is already growing faster than the level of interest rates.  

The welfare state, in all of its forms, has become much too big again.  Disability benefits are too easily available.  For many workers, it's become a transition to retirement benefits rather than a response to a real physical need.  The expansion of Medicaid under Obamacare makes it easier for low-income workers to not work and creates a huge disincentive to earn more money.   

More states and local governments are "experimenting" with higher minimum wages that will only result in less hiring and lower economic growth.

In many states, our K-12 education system is under the hammerlock of government worker unions that think the schools operate for their benefit rather than the long-term interests of their students.  At the college level, subsidies supposedly meant to make it easier for students to pay for a higher education have become a way for the government to funnel money to college professors and administrators.  In turn, these colleges often teach subjects that don't increase their students' market value or, even worse, proselytize for a worldview hostile to the market and western civilization itself.    

So the next time you hear about limits to growth or about a new era of stagnation, think about all the hurdles to growth that political elites have set up.  Slow growth doesn't just happen; it's been a choice made by policymakers.  But just like in the early 1980s, eventually policymakers can get it right.  

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

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Posted on Monday, June 20, 2016 @ 11:32 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, June 20, 2016 @ 7:43 AM • Post Link Share: 
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  Housing Starts Declined 0.3% in May
Posted Under: Data Watch • Home Starts • Housing

 

Implications:  Home building continues to be a bright spot for the US economy.  After a large gain in April, housing starts were basically unchanged in May, declining 0.3%, but beating consensus expectations.  Housing starts are now up 9.5% from a year ago and are clearly in an upward trend, with improvement in both single-family and multi-family construction.  To help get rid of the monthly volatility, we look at the 12-month moving average, which is the highest since 2008.  Within that upward trend, we're seeing a better "mix" of home building.  When the housing recovery started, multi-family construction generally led the way.  The number of multi-family units currently under construction is the highest since the early 1970s.  But the share of all housing starts that are multi-family appears to have peaked last year and single-family building is starting to climb more quickly.  This trend should continue.  Single-family building permits are up 4.8% from a year ago while multi-family permits are down 28.1%.  The shift in the mix of homes toward single-family units is a positive because, on average, each single-family home contributes to GDP about twice the amount of a multi-family unit.  Based on population growth and "scrappage," housing starts should rise to about 1.5 million units per year, so a great deal of the recovery in home building is still ahead of us.   It won't be a straight line higher, but expect the housing sector to keep adding to real GDP growth in 2016-17.  In other recent housing news, the NAHB index, which measures sentiment among home builders, rose to 60 in June, the highest level since January.  More jobs and faster wage growth are making it easier to buy a home and builders are responding. 

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Posted on Friday, June 17, 2016 @ 11:09 AM • Post Link Share: 
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  The Consumer Price Index Increased 0.2% in May
Posted Under: CPI • Data Watch • Inflation

 

Implications:  Energy and housing led the consumer price index higher in May, to the fastest three-month pace of inflation since 2013.  Energy prices rose 1.2%, as prices for gasoline and fuel oil more than offset declining electricity costs.  While oil prices have moderated in June, the trend in higher energy costs looks likely to continue in the months ahead.  Excluding just energy, consumer prices are up 2.0% in the past year.  In other words, as energy prices rise, the headline index will follow at a faster pace than many are expecting.  Food prices fell 0.2% in May as all major grocery store categories showed declines. "Core" consumer prices, which exclude the volatile food and energy components, rose 0.2% in May and show annualized readings near or above 2% over the past three, six, and twelve-month periods.  While the Fed kicked the can once again at yesterday's meeting, this consistent pace of "core" inflation around 2% – paired with continued employment gains – shows the economy is ready for the next rate hike.  The increase in the core CPI in May was led by housing rents, medical care and apparel.  Owners' equivalent rent, which makes up about ¼ of the CPI, rose 0.3% in May, is up 3.3% in the past year, and will be a key source of higher inflation in the year ahead.  One negative piece of news in today's report is that the rising CPI offset wage gains, leaving "real" (inflation-adjusted) average hourly earnings unchanged in May.  However real wages are up 1.4% in the past year and we think wages will rise faster than prices in the months ahead as employment continues to grow at a healthy clip. In other news this morning, new claims for unemployment benefits rose 13,000 to 277,000 while continuing claims increased 45,000 to 2.16 million.  Plugging these figures into our payroll models suggests June will show a substantial rebound from May's modest report. On the manufacturing front, the Philadelphia Fed index, a measure of sentiment in East Coast manufacturing, came in at 4.7 in June versus -1.8 in May, a stronger-than-expected reading that signals manufacturing in that region may be turning a corner. 

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Posted on Thursday, June 16, 2016 @ 11:09 AM • Post Link Share: 
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  Fed Projects Very Slow Path for Rate Hikes
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

 

At her post-meeting press conference Fed Chief Janet Yellen emphasized that it's important not to "overreact" to one or two reports on the economy.  But that's exactly what the Fed did by refraining from raising rates at today's meeting and notably altering its projections for future rate hikes.

Although the Fed stuck to its projection of two 25 basis point rate hikes in 2016, the projected path for future years came down.  Back in March, the median forecast at the Fed suggested at least 2 percentage points (200 basis points) of rate hikes in 2017 and 2018, combined.  Now the median forecast is for an increase of 1.5 percentage points (150 basis points) over the same time frame. 

In addition, the Fed once again brought down its estimate of the long-term average for the federal funds rate.  As recently as December, the Fed pegged the long-term average at 3.5%.  That came down to 3.25% in March and is now only 3%.

What's odd about the changes in the expected path for rate hikes is that it was not accompanied by any significant changes in the economic outlook.  Real GDP growth was downgraded very slightly for 2016-17, but the inflation forecast was revised up slightly, leaving the pace of nominal GDP growth essentially unchanged. 

The Fed made some changes to the language in its official statement, but nothing earthshattering.  The Fed acknowledged slower improvement in the labor market but faster growth in the overall economy, exactly the opposite of what it said back in April, consistent with recent economic reports.  On the hawkish side, the Fed noted better household spending and less of a drag from exports.  However, the Fed pleased the doves by mentioning lower market-based measures of inflation compensation.     

The bottom line is that it's hard to read today's statement as anything other than the Fed getting spooked by the recent employment report.  Even Kansas City Fed Bank President Esther George, who voted to hike rates by 25 basis points in April, voted in favor of today's official statement. 

We still think the Fed is headed for two rate hikes later this year, one in either July or September, and another in December.  However, it now looks like September is a better bet than July and, given how easily and often the Fed has been spooked by economic reports and market fluctuations in the past several years, it's plausible they won't raise rates again until 2017.  

But a slower path for rate hikes is not good for the US economy.  Overly loose monetary policy will create financial and economic imbalances that will cost the economy in the long run.    

The economy can handle higher short-term rates. The unemployment rate is already below the Fed's long-term projection of 4.8% and nominal GDP growth – real GDP growth plus inflation – is up at a 3.6% annual rate in the past two years.  Slightly higher short-term interest rates are not going to derail the US expansion, but will help avoid the misallocation of capital that's inevitable if short-term rates remain artificially low.   

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

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Posted on Wednesday, June 15, 2016 @ 3:37 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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