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   Brian Wesbury
Chief Economist
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   Bob Stein
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 Tuesday, October 25, 2016 @ 10:16 AM • Post Link Share: 
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  Growth Stepping Up
Posted Under: Bullish • GDP • Monday Morning Outlook

Real GDP has been soft in the past year, growing only 1.3% in the year ending in the second quarter.  In the four quarters before that, however, real GDP grew 3%.  That's what it's supposed to be like in a Plow Horse economy, with real GDP growth averaging around 2%, sometimes a little faster, sometimes slower.

Now, after going through a relatively soft period, it seems like the economy is starting to pick up again, clocking in at a 2.5% growth rate in the third quarter.  In addition, we expect growth to be around this rate in both the last quarter of the year as well as the full year ahead. 

Slightly faster growth shouldn't be a surprise.  Monetary policy is loose – and will remain loose even when the Fed raises rates in December – and tax rates have not moved up recently.  In addition, businesses have been shrinking inventories, and that leaves room for more growth as that process eventually comes to an end.

The problem is that the growth in the size and scope of government is offsetting the strides made by entrepreneurs and innovators.  Fixing that problem will take a major change in direction in Washington over the next several years.

Here's how we get to our forecast of a 2.5% annual real GDP growth rate for Q3.

Consumption:  Auto sales rebounded in Q3, growing at a 9.2% annual rate, but retail sales outside the auto sector rose at a tepid 1.2% pace.  Overall, it looks to us like "real" (inflation-adjusted) personal consumption of goods and services, combined, grew at a 2.5% annual rate in Q3, contributing 1.7 points to the real GDP growth rate (2.5 times the consumption share of GDP, which is 69%, equals 1.7).

Business Investment:  Business equipment investment looks like it declined at a 2% annual rate in Q3 while commercial construction was flat.  R&D probably grew around its trend of 5%.  Combined, we estimate business investment grew at a 1% rate, which should add 0.1 points to the real GDP growth rate (1.0 times the 13% business investment share of GDP equals 0.1).

Home Building:  Looks like residential construction declined for the second straight quarter, shrinking at about a 5% annual rate in Q3.  This doesn't mean the housing recovery is over, though.  A similar two-quarter lull happened in 2013-2014, with building re-accelerating afterward.  Expect the same this time.  In the meantime, we think the drop in Q3 will trim 0.3 points off of the real GDP growth rate.  (-5.0 times the home building share of GDP, which is 4%, equals -0.2).

Government:  Military spending spiked higher in Q3 while public construction projects declined.  On net, we're estimating that real government purchases rose at a 1.7% rate in Q3, which would add 0.3 percentage points to real GDP growth (1.7 times the government purchase share of GDP, which is 18%, equals 0.3).

Trade:  At this point, the government only has trade data through August, but the data so far suggest the "real" trade deficit in goods has gotten smaller.  As a result, we're forecasting that net exports add 0.6 points on the real GDP growth rate.

Inventories:  At present, we have even less information on inventories than we do on trade, but what we have suggests companies are still cutting inventories in Q3.  In part, this may be due to the same reason why trade will add to GDP: a slowdown in Christmas-season goods imports at West Coast ports due to temporary problems with storing extra containers after the bankruptcy of a major international shipper.  We're forecasting inventories fall at about the same pace as in Q2, which means no net impact on Q3 real GDP.

Put it all together, and we get a forecast of 2.5% for Q3, a modest acceleration from the previous year and well within the normal range for a Plow Horse economy.

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

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Posted on Monday, October 24, 2016 @ 11:16 AM • Post Link Share: 
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  Existing Home Sales Increased 3.2% in September
Posted Under: Data Watch • Home Sales • Housing


Implications:  Driven by strong demand from first-time buyers, sales of existing homes rebounded strongly in September, reversing the slump that began back in July.  Sales of previously owned homes rose 3.2% in September to a 5.47 million annual rate and are now up 0.6% from a year ago. The share of first-time buyers was a big contributor to this month's gain, rising to the highest level since 2012. As demographics shift, and millennials age, this group will continue to be a source of strength in the future.  However, it's important to remember housing is volatile from month to month. That being said, we think the broader trend will continue to be upward, although there are still some headwinds.  Tight supply and rising prices continue to hold back sales.  Inventories have now fallen for sixteen consecutive months on a year-over-year basis.  Further, the months' supply of existing homes – how long it would take to sell the current inventory at the most recent selling pace – is only 4.5 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 that 44% of properties in September sold in less than a month, pointing to further interest from buyers in the months ahead.  However, this higher demand has also driven up median prices, with September marking the 55th consecutive month of year-over-year gains.  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, bringing more existing properties onto the market as well.   In other news this morning, new claims for unemployment insurance rose 13,000 last week to 260,000, the 85th week in a row below 300,000.  Continuing claims increased 7,000 to 2.057 million.  Plugging these figures into our models suggests payrolls are growing close to 200,000 in October.  On the manufacturing front, the Philadelphia Fed index, which measures factory sentiment in that region, came in at 9.7 for October, a decline from 12.8 in September but still positive and signaling continued growth.

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Posted on Thursday, October 20, 2016 @ 11:46 AM • Post Link Share: 
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  Housing Starts Declined 9.0% in September
Posted Under: Data Watch • Home Starts • Housing


Implications:  If the only thing you read about housing starts today is the large headline drop, you'll get a very distorted picture about home building.  Housing starts fell 9% in September to a 1.047 million annual rate, coming in well below even the most pessimistic forecast by any economics group.  However, the drop was entirely due to the volatile multi-family sector, where starts plunged 38%, the steepest downward move since 2009.  Meanwhile, single-family starts rose 8.1% in September and are up 5.4% from a year ago.  In addition, building permits for future construction increased 6.3% in September, with gains for both single-family and multi-family units. The broad gain in permits signals that the September plunge in multi-family starts is not going to last.  Look for a rebound in that sector in the months ahead.  That said, some shift toward single-family building is welcome.  When the housing recovery started, multi-family construction generally led the way.  But the share of all housing starts that are multi-family appears to have peaked in 2014-15 and single-family building is starting to persistently climb more quickly.  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; the general rise in home building that started in 2011 is far from over.  It won't be a straight line higher, but expect the housing sector to keep adding to real GDP growth in 2017.  In other recent housing news, the NAHB index, which measures sentiment among home builders, declined to a still strong 63 in October from 65 in September.  More jobs and faster wage growth are making it easier to buy a home and builders will respond in the months and quarters to come. 

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Posted on Wednesday, October 19, 2016 @ 11:17 AM • Post Link Share: 
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  The Consumer Price Index Increased 0.3% in September
Posted Under: CPI • Data Watch • Inflation


Implications:  This is why the Fed is going to raise rates in December and should have already.  Consumer prices rose 0.3% in September, the largest monthly increase in five months, and are now up 1.5% from a year ago.  That is a significant move higher compared to the reading of no change in prices for the twelve months ending September of 2015.  Energy prices led the index higher in September, as gasoline prices jumped 5.8%. While energy prices remain volatile from month to month, the recent trend has been toward rising prices and the yearly change is likely to turn back positive in the coming months. This will put continued upward pressure on the headline index which is up at a 1.8% annual rate in the past three months.  While food prices have remained unchanged in the past three months, they have also been a slight drag on inflation in the past year.  Stripping out the volatile food and energy components, the "core" consumer prices rose 0.1% in September and are up 2.2% in the past year.  The September increase in "core" consumer prices was led by housing.  Owners' equivalent rent, which makes up about ¼ of the CPI, rose 0.4% in September, is up 3.4% in the past year, and will be a key source of higher inflation in the year ahead.  Medical care costs rose 0.2% in September, the smallest monthly increase since March, but are up 4.9% in the past year and have shown acceleration over the past three and six-month periods.  The worst piece of news from today's report was that "real" (inflation-adjusted) average hourly earnings declined 0.1% in September.  But real average wages per hour are still up 1.0% in the past year.  At the end of the day - given a consistent pace of "core" inflation above 2%, continued employment gains, and an acceleration in the headline consumer price index – the Fed has the data they need to raise rates in November, but expect the Fed to find a reason to avoid a rate hike the week before the election and to kick the rate-hike can down the road, probably to December.

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Posted on Tuesday, October 18, 2016 @ 10:16 AM • Post Link Share: 
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  Industrial Production Increased 0.1% in September
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  After suffering a setback in August, industrial production rose modestly in September, continuing to demonstrate the type of "fits and starts" recovery that has become familiar.  Industrial production rose 0.1% in September but is still down 1% versus a year ago.  Some pessimistic analysts will point out that the rate of industrial production has begun to slow, down from a 1.6% annualized growth rate in the past six months to unchanged in the past three.  However, this is transitory and primarily due to corresponding weakness in utilities output, as demand for air conditioning which hit a record high in the third quarter wanes due to cooling temperatures.  One source of strength in today's report was a rebound in manufacturing, which posted a gain of 0.2%. This was led by the volatile auto sector posting its fourth consecutive gain, increasing 0.2% in September, as well as a 0.1% gain in non-auto manufacturing.  As a result, the overall index was lifted into positive territory.  Perhaps the best news was that mining production rose 0.4%, and is now up at a 1.9% annual rate in the past three months, despite still being down 9.5% in the past year.  This month's gain was driven by both nonmetallic minerals and coal mining.  Further, oil and gas-well drilling posted its fifth consecutive gain in September, jumping 5.1%, and is now up at a 66.3% annual rate in the past three months. While mining (and energy in general) has been a drag on production over the past year, we expect activity in that sector to grow in the year ahead as energy prices are well off the lows.  Based on other commodity prices, oil prices should average at higher levels over the next several years.  Although we don't expect overall industrial production to boom any time soon – weak overseas economies will continue to be a headwind – we do expect solid growth in the year ahead.  In other recent news, the Empire State index, a measure of manufacturing sentiment in New York, fell to -6.8 in October from -2.0 in September, signaling that the improvement in the factory sector will not be a straight line. That's what we should expect in Plow Horse Economy.

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Posted on Monday, October 17, 2016 @ 12:22 PM • Post Link Share: 
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  Does Growth Kill or Is There No Growth?
Posted Under: GDP • Government • Monday Morning Outlook • Productivity

Two weekend articles, in major US newspapers, left us shaking our heads.  The Washington Post wrote that "economic growth actually kills people," while The Wall Street Journal published a piece saying, ironically, we should get used to slow growth - it's normal.

Both are ridiculous.

First, The Washington Post cited statistical studies that blame premature death on economic growth (more pollution, more work and more risk).

The statisticians found that pollution and alcohol were the #1 and #2 causes of death as economic growth accelerated.  We couldn't help but think about the Soviet Union, where pollution and alcoholism were rampant in the 1970s and 1980s, but economic growth was non-existent.  Economic growth does not cause pollution; to say it does is a red herring.  The air in Boston was much worse in the 1800s when wood-burning fireplaces were used to heat homes.  Public health was a serious problem before sewage systems and water purification.

Statisticians have also tied faster economic growth to more driving, and more driving to more accidental death.  But, more people driving provides massive benefits that are never counted.

Second, The Wall Street Journal published excerpts from a new book by Marc Levinson.  The book, "An Extraordinary Time: The End of the Postwar Boom and the Return of the Ordinary Economy" says a drop in productivity after the 1973 oil embargo ended a post WWII boom.  Since then, the US economy has grown more slowly – at least according to Levinson and his productivity data.

Levinson claims different government policies can't help.   He says big government in the 1970s didn't hurt, and that it "is tempting to think that we know how to do better, that there is some secret sauce that governments can ladle out to make economies grow faster than the norm. But despite glib talk about "pro-growth" economic policies, productivity growth is something over which governments have very little control."

These two pieces, from The Post and The Journal end up in the same place.  Those who argue that growth kills people ask for more "equality" a bigger "safety net," and more "regulation."  Those who argue government policy doesn't make a difference call for the same thing.

But this clever spin is misleading. 

The Great Society started in 1964.  Prior to that, non-defense government spending was just 7% of GDP.  Today, non- defense government spending is 17% of GDP.  Why researchers ignore this is a mystery.

Every dime in government spending is paid for by borrowing, or taxing, the profits and income that come from entrepreneurial growth.  And every dime that is "removed" from the entrepreneurial process is a dime that can't be reinvested.  When government started to grow in the late 1960s and 1970s and then again starting in 2000, the US economy slowed.  Moreover, to say productivity, and the economy, didn't pick up in the 1980s is misleading.  It did, even though measuring the benefit of computers is so difficult.

Government, after a point, and especially with redistribution, slows growth and slower growth means less innovation.    Less innovation means less progress in medicine and technology and that's a risk for citizens.

The more researchers use statistics to move a policy, the more researchers ignore data that are readily available and correlations which make theoretical sense, the greater the risk to economic growth.

Accepting a point of view that says progress is dangerous or that progress is impossible is a recipe for the same government policies which have caused slower growth in the first place.  One can only hope these dour philosophies don't gain traction.

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

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Posted on Monday, October 17, 2016 @ 11:47 AM • Post Link Share: 
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  Retail Sales Rose 0.6% in September
Posted Under: Data Watch • Retail Sales


Implications:  Retail sales rebounded at a robust pace in September, finishing the third quarter on a strong note.  Sales rose 0.6% in September, led by volatile components, such as autos and gas stations.  However, the gains were also broad, with ten of thirteen major categories of sales growing in September.  "Core" sales, which exclude autos, building materials, and gas, rose 0.2% in September and are up 3.1% from a year ago.  Although sales at gas stations rose 2.4% in September, they're still down 3.4% from a year ago due to lower oil prices; vehicle miles driven in the United States are at the highest levels in history over the past twelve months.  In other words, weakness at gas stations signals the ability to consume elsewhere.  Incorporating today's data into our models, we now estimate that "real" (inflation-adjusted) consumer spending on goods and services, combined, rose at about a 2.5% annual rate in Q3.  As a result, we're now forecasting that real GDP grew in the 2.0-2.5% annual rate range in Q3.  We'll be looking at the numbers more closely this weekend and then generate a detailed forecast in next week's Monday Morning Outlook.  Either way, look for continued growth in both real GDP and real consumer spending in the months ahead.  Employment continues to expand, while wage growth is accelerating and consumer debt service obligations are low by historical standards.  Overall, the economy remains a Plow Horse, but consumer purchasing power and, therefore, spending, should remain one of the bright spots.  An even brighter spot is the labor market.  Yesterday, it was reported that initial unemployment claims remained unchanged last week at 246,000, tying the lowest level since November 1973 and the 84th consecutive week below 300,000.  Meanwhile, continuing claims declined 16,000 to 2.046 million, a new cycle low.  Plugging these figures into our models suggests payroll growth in the 200,000 to 225,000 range for October, which will keep the Fed firmly on track for raising rates by the end of the year. 

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Posted on Friday, October 14, 2016 @ 11:04 AM • Post Link Share: 
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  The Producer Price Index Rose 0.3% in September
Posted Under: Data Watch • Inflation • PPI


Implications:  Producer prices rose nearly across the board in September, as energy prices led the index higher.  Energy prices jumped 2.5% after two months of declines, accounting for nearly half of September's 0.7% rise in goods prices, while food prices also moved higher, rising 0.5%.  But even stripping out the upward pressure from these volatile categories, "core" producer prices rose 0.2% in September and are up 1.2% in the past year.  This modest 1.2% pace remains below the Fed's 2% inflation target, but represents a pickup from the 0.7% rise through the twelve months ending September 2015.  And overall producer prices, up 0.7% in the past year, are showing the largest twelve month gain since late 2014.  Service prices rose 0.1% in September and are up 1.3% in the past year, more than offsetting the 0.4% decline in goods prices over the same period.  September's rise in service prices was led by securities brokerage, dealing, and investment advice (perhaps due to the DOL rule on retirement accounts), while airline passenger services and hospital care also moved higher.  The Fed isn't likely to be swayed either way by today's report on producer prices.  Assuming the Fed holds off on action in November (they meet less than a week before the election), they will still have a hand full of inflation and employment reports before the December 14th announcement.  We believe that, barring any significant surprises to the downside, the Fed has their eyes set on a December hike.  In other recent inflation news, import prices rose 0.1% in September but are down 1.1% from a year ago.  The drop is mostly from petroleum, but not all of it; import prices are down 0.8% from a year ago even excluding petroleum.  Export prices increased 0.3% in September but are down 1.5% from a year ago.  Nonagricultural export prices rose 0.4% in September and have increased in six of the past seven months.  We expect this measure to continue pushing higher in the months ahead, putting upward pressure on overall export prices. 

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Posted on Friday, October 14, 2016 @ 9:58 AM • Post Link Share: 
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  Inflation Ready to Rise
Posted Under: Government • Inflation • Monday Morning Outlook • Fed Reserve • Interest Rates

One of the key excuses for the Federal Reserve to hold off raising rates again and again, and to raise them very slowly, is that inflation remains extremely low.

The consumer price index is up only 1.1% in the past year.  The Fed's preferred measure of inflation – for personal consumption expenditures, or PCE – is up 1.0%.  The US doesn't face deflation, but the overall inflation statistics are, and have remained, low.

But the money supply is accelerating, the jobs market looks very tight, and underneath the calm exterior, there are some green shoots of inflationary pressure.

The "core" measures of inflation, which exclude volatile food and energy prices, are not nearly as contained as overall measures.  And before you say everyone has to eat and drive, realize that both food an energy prices are volatile and global in nature.  They don't always reveal true underlying price pressures.

The 'core" CPI is up 2.3% in the past year, while the "core" PCE index is up 1.7%.  In other words, a drop in food and energy prices has been masking underlying inflation that is already at or near the Fed's 2% target.  Energy prices have stabilized and food prices will rise again.  As a result, soon, overall inflation measures are going to be running higher than the Fed's target.             

Just look at housing costs – a non-traded good – which makes up one-third of the CPI.  Government statisticians measure this as "Rent of Shelter," which includes normal rents, hotel costs, and owners' equivalent rent (the rental value of owner-occupied homes).  It's up a whopping 3.4% in the past year and has accelerated in each of the past six years.     

Housing makes up a smaller share of the PCE price index, but medical care costs make up a larger share of that index.  Government data show medical care costs up 4.9% in the past year, the fastest increase since 2007.

Although some (usually Keynesian) analysts are waiting for much higher growth in wages before they fear rising inflation, the fact is that wage growth is already accelerating.    Average hourly earnings are up 2.6% in the past year versus a 2.0% gain only two years ago.  Moreover, as a paper earlier this year from the San Francisco Fed pointed out, this acceleration is happening in spite of the retirement of relatively high-wage Baby Boomers and the re-entry into the labor force of workers with below-average skills.

But we don't think wages cause inflation – money does.  Inflation is too much money chasing too few goods.  The Fed has held short-term interest rates at artificially low levels for the past several years while it's expanded its balance sheet to unprecedented levels.  Monetary policy has been loose.

But banks have held most of the Fed's Quantitative Easing (QE) as excess reserves.  Banks have record loans on their books, but they also hold $2.2 trillion in excess reserves.  Most people believe QE was, and is, temporary.  So banks have been reluctant to lend it out.  After all the Fed could withdraw the reserves, unwind QE, and banks would be forced to "call" their loans.

But as the Fed has postponed the process of reducing its balance sheet, banks have started to expand the M2 money supply.  M2 grew roughly 6% annualized between January 2009 and December 2015.  But, so far this year, from January to September, M2 has expanded at an 8.6% annualized rate.  More money brings more inflation.            

None of this means hyperinflation is finally on its way.  In the past, inflation has taken time to build, leaving room for the Fed to respond by shrinking its balance sheet and getting back to a more normal monetary policy.

In the meantime, this will be the last year in a long while, where we see inflation below the Fed's 2% target.  Look for both higher inflation and interest rates in the years ahead. 

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

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Posted on Monday, October 10, 2016 @ 10:32 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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