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   Brian Wesbury
Chief Economist
 
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  Nonfarm Productivity Declined at a 2.2% Annual Rate in the Fourth Quarter
Posted Under: Data Watch • Productivity

 
Implications: Productivity growth in the fourth quarter was revised lower, consistent with last week’s downward revision to real GDP. According to the official data, nonfarm productivity declined at a 2.2% annual rate in Q4. Output continued to increase at a healthy clip, but hours climbed at the fastest rate since 1998, so output per hour declined. Productivity is down 0.1% from a year ago, but we suspect the government is underestimating output in the increasingly important service sector, which means growth and productivity are higher than the official data show. Do the data fully capture the value of smartphone apps, the tablet, the cloud...etc.? For example, many now deposit checks by using their phones, rather than going to the bank. This is just one example why we think the figures from the government miss the value of these improvements, which means our standard of living is improving faster than the official reports suggest. Note that on the manufacturing side, where it’s easier to measure output per hour, productivity is up 2.4% in the past year. From 1973 through 1995, overall productivity growth averaged 1.5% per year. In spite of the problems with measurement, we anticipate faster productivity growth over the next few years as new technology increases output in all areas of the economy. The declining unemployment rate and faster growth in wages should create more pressure for efficiency gains, while the technological revolution continues to provide the inventions that make those gains possible. Overall, for 2015-16, we look for faster productivity growth than in the past two years. In other news, new claims for unemployment insurance increased 7,000 to 320,000 last week. Continuing claims rose 17,000 to 2.42 million. Plugging these figures into our models suggests tomorrow’s employment report will show a nonfarm payroll gain of 240,000 for February, another solid month.

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Posted on Thursday, March 05, 2015 @ 10:23 AM • Post Link Share: 
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  Don’t Audit It: Reign It In
Posted Under: Government • Research Reports • Fed Reserve
Some in Congress want to “Audit the Fed.” But an audit, unless the word is used in a very broad sense, would be redundant and basically irrelevant. The Fed is already audited, by Deloitte & Touche LLP and it releases an annual report that includes the auditor’s opinion, each year.

Wild-eyed conspiracy theories have cropped up that suggest the Fed may not actually own the bonds it says it does or that it pays too much to certain banks when buying them. But none of this is true; there is no evil accounting going on. In a financial sense the Fed is almost certainly squeaky clean. The Fed doesn’t need another audit, what it needs is more responsible and effective oversight from Congress, a smaller balance sheet and less ability to interfere with private business decisions.

The Fed has become the biggest financial entity in the world, with bond holdings that have ballooned to $4.25 trillion. Fed assets, six years after the Panic of 2008 ended, exceed the annual budget of the US government and are equal to 24% of GDP.

During the Great Depression, 1930-39, the Fed’s balance sheet averaged 13.2% of GDP. It peaked at the end of the Depression, in 1940, at 16% of GDP and then averaged 12.6% from 1941-45, during World War II. If the Great Depression and WWII didn’t require balance sheets as large as the current one, then something has gone terribly awry.

What’s interesting is that during the boom years of the 1980s and 1990s, the Fed’s balance sheet averaged 5.2% of GDP. So, it’s impossible to make the case that the Fed needs such a large balance sheet in order for the economy to create jobs with low inflation.

Lest we forget, Congress already has oversight of the Fed, and the past six years happened under its watch. Only a few members of Congress have enough knowledge of monetary policy to be effective at oversight. The same is true of voters. The Fed typically wins political battles because most people find monetary policy boring, complicated and difficult to grasp.

Nonetheless, the simple fact that the Fed is bigger, more powerful and more intrusive than ever imagined by any of its creators in Congress suggests that the Fed needs to answer more questions from more people. This does not mean the press, which has a conflict of interest, due to the fact that it wants access. Critical questioning risks losing access.

Moreover, the Fed is about to embark on a rate hiking campaign even though there are still excess reserves in the banking system. This has never been done before. Typically, the Fed makes reserves scarce in order to drive up interest rates.

But because the Fed wants a bigger balance sheet, it is trying to have its cake and eat it too. The Fed thinks it can pay banks more interest on those reserves and through a process of reverse repos drain money from the system. In other words, the Fed thinks that it can keep the balance sheet huge and manipulate interest rates even though the banking system is swimming in excess liquidity.

The Fed does have a back-up plan. If banks won’t let the Fed sop up those reserves, and instead they decide to lend them, potentially creating inflation or bubbles, the Fed believes it can use “Macro-Prudential Policy Tools” to manage the money multiplying process. Macro-prudential tools would allow the Fed to stop banks from lending, by raising capital standards, or by limiting growth in certain types of loans or by certain types of banks. And, it allows the Fed to expand its reach to “systemically important financial institutions” that could potentially include insurance companies, brokerages, money managers and even hedge funds.

It’s true that monetary policy should be independent of the political process. Whenever politicians take over the money supply, inflation results. But the corollary argument is just as important. Whenever bureaucrats take over the banking system, everything becomes political. Why? Because the bureaucrats are dependent on the politicians for their existence. The Fed must please enough members of Congress, and the right members, to keep new rules from passing that will limit its power.

The Fed missed the bubble in housing partly because Washington’s political mindset was focused on boosting homeownership any way it could. So, bubbles in politically-correct industries, like housing or green initiatives, are tolerated or even encouraged. Also, risk-taking in private decisions is discouraged because bank losses become political problems. In other words, the bigger and more powerful the Fed becomes, the more dependent it is on the political process.

The easiest way out of this mess is for Congress to force the Fed to sell its assets and limit the Fed’s power to bank oversight, not bank management and macro-prudential policy tools. Don’t audit the Fed, don’t create conspiracy theories, but reign in the overreach and force a smaller balance sheet. If we really want an independent Fed, make it smaller and less powerful. The bigger it gets, the more political, and less independent, it becomes.

Brian S. Wesbury, Chief Economist

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Posted on Wednesday, March 04, 2015 @ 12:09 PM • Post Link Share: 
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  The ISM Non-Manufacturing Index Increased to 56.9 in February
Posted Under: Data Watch • ISM Non-Manufacturing

 
Implications: After a surprise on the low side from the ISM manufacturing report, today’s ISM service sector report surprised to the upside. The February reading of 56.9 represents the 61st consecutive month above 50 (levels above 50 signal expansion; levels below 50 signal contraction), while the 56.8 average level over the past year represents the best twelve-month average going back to 2006. The strongest area in today’s report came from the employment index, which jumped 4.8 points to 56.4 from 51.6 in January, suggesting employment continued to expand in February in spite of harsh weather, a bullish sign for job growth for the foreseeable future. Both the business activity index and the new orders index declined, but remain at levels suggesting healthy economic growth. On the inflation front, the prices paid index rose modestly in February, but inflation continued to be depressed by the drop in energy prices. With oil prices now steady to slightly higher and monetary policy still loose, we expect this inflation measure to move upward over the coming year. In other news this morning, the ADP index, which measures private sector payrolls, increased 212,000 in February. Plugging this into our models suggests the official Labor Department report (released Friday morning) will show a nonfarm payroll gain of 241,000 for February. However, we won’t finalize our forecast until we see tomorrow morning’s report on unemployment claims. Either way, it looks like another solid month for job growth. In other recent news, cars and lights trucks were sold at a 16.2 million annual rate in February, a drop of 2.6% versus January but up 5.4% from a year ago. Given unusually brutal winter weather in February, look for a sharp rebound in March, to about a 17.0 million rate.

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Posted on Wednesday, March 04, 2015 @ 11:35 AM • Post Link Share: 
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  February Weather a Headwind for Economy
Posted Under: Bullish

 
February has come and gone, but plenty of economic data on February activity is still on its way. Vehicle sales and the ISM manufacturing reports are among the first February numbers to be reported, and they were reported a bit lighter than expected. Is this any reason to panic? We don’t think so. More likely is that unusually bad winter weather will hold back some data for February before a rebound this Spring.

Some analysts note that national average temperatures were just a little below normal in February. But the national average is weighted by region size (not population) and includes some normally temperate winter areas (like California, Nevada, and Arizona) being even warmer than normal. While the Midwest and Northeast experienced record low temperatures and major snow storms, the west coast experienced a warm front.

For economic purposes, it’s important to know that if an area that’s normally 65 degrees in the winter is instead 75, the extra warmth has very little effect on business. By contrast, if an area that normally averages 35 degrees, instead, averages 25, the negative impact can be large. In other words, “average” national temperatures can hide a problem, like the statistician who drowned in a river with an average depth of 2 feet.

Lucky for us, there is a better measure of temperatures for the purpose of estimating the impact on business activity. The National Oceanic and Atmospheric Administration (NOAA) calculates something called “Heating Degree Days (HDD),” which measures how much more heat we need to bring the whole country up to 65 degrees. So the higher the HDD index, the colder it is, or was, for the most people.

One reason HDD is so useful is that it completely ignores the regions where the weather is already good enough for normal business activity. The other reason it’s useful is that, unlike the national average temperature, the HDD index is weighted by population size. And what did NOAA say about February? That it had the highest HDD index (coldest temperatures) for any February going back to 1979. If you spent time in Cleveland or Detroit, you experienced the coldest February in more than 100 years. In New York? The coldest February in 80 years. And Boston not only saw their second coldest month on record, they have also been hit with over 100 inches of snow so far this winter. They’re still digging out.

So it is no wonder economic activity in February may have taken a dip. Housing starts and manufacturing activity, in particular, may feel the chill, while utilities likely saw a boost. Whatever the impact from the snow, ice, and chill, we expect it to be temporary. When the spring thaw eventually comes – and it will – expect the Plow Horse to make up lost ground.
Posted on Tuesday, March 03, 2015 @ 3:26 PM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve

 
Source: Federal Reserve Bank of St. Louis FRED Database
Posted on Monday, March 02, 2015 @ 1:32 PM • Post Link Share: 
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  The ISM Manufacturing Index Declined to 52.9 in February
Posted Under: Data Watch • ISM

 
Implications: The ISM manufacturing index, which measures factory sentiment around the country, declined in February, but remained above 50 for a 21st consecutive month. Companies reported that the West Coast port strikes depressed activity and made it tougher for exporters to get their wares abroad. However, a labor agreement was reached late in the month and business should return to normal in the months ahead. We don’t believe the decline in the ISM index from 58.1 in August to the current reading of 52.9 is anything to worry about. The fundamentals of the economy have not changed in any significant way and we consider this normal volatility. According to the Institute for Supply Management, an overall index level of 52.9 is consistent with real GDP growth of 3.2% annually. This ISM-calculated relationship has over-estimated real GDP growth in the past several years, although mid-2014 real growth came close. As a result, we see today’s data as consistent with our forecast of a roughly 2% real GDP growth rate in Q1. On the inflation front, the prices paid index remained depressed at 35.0 in February, tied with January for the lowest level since April 2009. No major surprise here given the huge drop in energy prices since mid-2014. Although we still think inflation will move higher in the next couple of years, it’s going to be a long slog upward. The employment index dipped in February to 51.4, signaling continued growth, but at a slightly slower pace than recent months. Right now, we’re forecasting a nonfarm payroll gain of 253,000 in February, another solid month. Taken as a whole, this month’s report shows the Plow Horse continues to plod forward. In other news this morning, construction declined 1.1% in January, with a large drop in government projects and broad declines in commercial construction (particularly shopping centers/malls). These declines offset gains in new home building as well as manufacturing facilities.

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Posted on Monday, March 02, 2015 @ 11:46 AM • Post Link Share: 
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  Personal Income Increased 0.3% in January
Posted Under: Data Watch • PIC

 
Implications: Consumers are spending less money but getting more stuff. The total amount of consumer spending, in raw (nominal) dollar terms, dropped for the second consecutive month in January. However, due to the huge drop in energy prices, the smaller amount of dollars spent is translating into more purchases in inflation-adjusted terms. The PCE deflator, the Fed’s favorite measure of consumer inflation, fell 0.5% in January, the third consecutive decline. With the exception of the Panic back in late 2008, the drop in January was the steepest on record going back to 1959. Some analysts and investors might be concerned a rebound in overall inflation combined with continued softness in nominal spending will soon translate into weak real “inflation-adjusted” spending. But we think real spending will continue to trend upward. Payrolls are up more than three million in the past year while the number of hours per worker is up as well. As a result, private-sector wages & salaries are up a robust 5.5% in the past year. Total income – which also includes rents, small business income, dividends, interest, and government transfer payments – increased 0.3% in January and is up 4.6% in the past year, which is faster than the 3.6% gain in consumer spending. One part of the report we keep a close eye on is government redistribution. In the past year, government transfers to persons are up 5.9%, largely driven by Obamacare; Medicaid spending is up 11.8% versus a year ago. However, outside Medicaid, government transfers are up a more tepid 4.5% in the past year and unemployment compensation is at the lowest level since 2007. The bad news is that taken all together, government transfer payments – like Medicare, Medicaid, Social Security, disability, welfare, food stamps, and unemployment comp – don’t seem to be falling back to where they were prior to the Panic of 2008, when they were roughly 14% of income. In early 2010, they peaked at 18%. Now they are down to 17% but not falling any further. Redistribution hurts growth because it reallocates resources away from productive ventures. This is why we have a Plow Horse economy instead of a Race Horse economy.

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Posted on Monday, March 02, 2015 @ 11:29 AM • Post Link Share: 
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  Fed Has Less Patience For ZIRP
Posted Under: Government • Markets • Monday Morning Outlook • Fed Reserve • Stocks
Economic data will have something for everyone this week. The ISM reports (manufacturing and non-manufacturing) will likely be held down by unusually harsh weather and the Port closures. But, autos sales should remain strong and January jobs data are set for a gain close to 250,000.

Anyone who understands the Plow Horse economy is used to this schizophrenic data and won’t get swayed either way. Growth continues, and with it, the Federal Reserve should continue on its path to normalizing monetary policy. At its next meeting on March 18th, the reference to being “patient” before raising rates should be removed. Fed Chair Janet Yellen signaled this last week in testimony to Congress, noting that removing “patient” in March wouldn’t automatically trigger rate hikes. This is exactly what you’d expect her to say when the Fed is preparing to remove that language.

Yet, we think the Fed will raise rates in June, ending its Zero Interest Rate Policy (ZIRP). Yellen focuses on jobs and her testimony last week led off with an upbeat assessment of employment. Meanwhile, Yellen’s right-hand man, Stanley Fischer, the Fed’s Vice-Chair is saying financial markets are underestimating the amount of rate hikes over the next few years. We doubt Fischer would say this unless there was a Fed consensus in favor of hikes starting relatively soon.

We expect gradualism in the early stages of any rate hike cycle. Under Greenspan and Bernanke, rates rose by 25 basis points at every meeting from mid-2004 through mid-2006. This time we expect a rate hike of 25 bps at every other meeting. This kind of gradualism will make it easier to overcome dovish objections about a June move.

Starting in June and then moving very gradually – rather than waiting longer but moving faster once rate hikes start – would also give the Fed the chance to test out its new system for lifting rates in an era of bloated balance sheets, using the interest it pays banks on reserves as well as reverse repos. Right now, no one knows for sure if the system will work as planned, and that includes the Fed itself.

Assuming it does, we aren’t worried about how the initial phase of rate hikes will impact the economy or equity markets. It would take a federal funds rate of 3%, or above, to slow the economy. Until then, the Fed won’t be tight, just less loose. Plow Horse growth and rising stock prices haven’t depended on QE and ZIRP. Ending these policies won’t alter our outlook.

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Posted on Monday, March 02, 2015 @ 10:48 AM • Post Link Share: 
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  Real GDP was Revised to a 2.2% Annual Growth Rate in Q4
Posted Under: Data Watch • GDP

 
Implications: Real GDP growth was revised down for the fourth quarter, but still beat consensus expectations and presented a better “mix” for growth in 2015. The reason today’s report is better for the economic outlook is that all of the downward revision came from inventories, which leaves more room to fill shelves and showrooms in future quarters. Meanwhile, business investment in equipment, intellectual property, and structures were all revised higher. Overall, what we have here is another plow horse report. Expect another report just like this for Q1, with unusually harsh East Coast weather and a West Coast port strike (now resolved) holding growth a little below what we think is a trend of 2.5% to 3%. Note that nominal GDP (real growth plus inflation) is up 3.6% from a year ago and up at a 4.1% annual rate in the past two years. These figures signal that a federal funds target rate of essentially zero is too loose. As a result, we think the Fed is still on track to start raising rates in June. In other news this morning, the Chicago PMI, a survey of manufacturing sentiment, fell to 45.8 in February from 59.4 in January. We think the drop reflects weather (a lot), the port strike (a little), and will rebound sharply next month. However, we’re now forecasting that Monday’s national ISM manufacturing report will decline to 52.0 from 53.5 in January. Also today, pending home sales, which are contracts on existing homes, increased 1.7% in January. Plugging this into our models suggests existing home sales (counted at closing) increase to 4.93 million in February.

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Posted on Friday, February 27, 2015 @ 10:08 AM • Post Link Share: 
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  New Orders for Durable Goods Increased 2.8% in January
Posted Under: Data Watch • Durable Goods

 
Implications: New orders for durable goods started off January on a positive note, increasing for the first time in three months. However, the gains were led by civilian aircraft, which are very volatile from month to month. Outside the transportation sector, orders were up a very Plow Horse-like 0.3%, led by machinery. Orders ex-transportation are up a healthy 4.5% from a year ago. The worst news in today’s report was that “core” shipments, which exclude defense and aircraft, declined 0.3% in January. However, these shipments are still up 5.3% from a year ago and unfilled orders for “core” capital goods rose 0.3% in January, hit a new record high, and are up 8.1% from a year ago. So the report suggests an impending rebound in shipments over the next few months. Although lower oil prices may hurt the Oil Patch, we expect to see higher production outside the oil sector. Orders and shipments for durables should accelerate in the year ahead. 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. Meanwhile, profit margins are high, corporate balance sheets are loaded with cash, and capacity utilization is breaching long-term norms, leaving more room (and need) for business investment. In other news this morning, new claims for unemployment insurance rose 31,000 last week to 313,000. The four week average is now 294,500. Continuing claims for regular state benefits fell 21,000 to 2.40 million. Plugging these figures into our models suggests another solid month of job growth in February, with payrolls expanding around 250,000. On the housing front, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.8% in December, the largest gain since May 2013. In the past year, the FHFA index is up 5.4% versus a gain of 7.7% in the year ending in December 2013. We expect further gains in home prices in 2015, although at a slower pace.

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Posted on Thursday, February 26, 2015 @ 10:49 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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