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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  The First Estimate for Q1 Real GDP Growth is 0.5% at an Annual Rate
Posted Under: Data Watch • Employment • GDP


Implications:  Nothing in today's GDP report should change anyone's opinion about the Plow Horse Economy.  Although real GDP grew at only a 0.5% annual rate in the first quarter, it came in slightly above what we anticipated.  What we call the Q1 Curse struck again in 2016.  Real GDP grew at essentially the same rate in the first quarter of last year, and actually shrank in the first quarters of 2011 and 2014, without a recession or any change to the plow horse trend.  This time will be no different.  We expect a rebound in the growth rate later this year.  How can we be so confident about continued growth?  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, what we also call "core GDP."  That grew at a 1.2% annual rate in Q1, is up 2.6% from a year ago, and is up at a 3.1% annual rate in the past 2 years.  In particular, consumer spending grew at a moderate 1.9% rate in Q1 while home building boomed at a 14.9% rate.  This report suggests that the Federal Reserve should remain on course to raise rates in June.  Nominal GDP (real GDP growth plus inflation) grew at a 1.2% annual rate in Q1, is up 3.2% from a year ago, and is up at a 3.6% annual rate in the past two years.  All of these figures suggest the Fed can raise rates without hurting the economy.  In other news this morning, new claims for unemployment insurance rose 9,000 last week to 257,000.  However, the four week average fell to 256,000, the lowest since 1973.  Continuing claims declined 5,000 to 2.13 million, a new low for the current economic expansion.  There is still plenty of data to come that might change our forecast, but plugging today's figures into our models generates a payroll forecast of 240,000 in April, a very solid month.

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Posted on Thursday, April 28, 2016 @ 11:26 AM • Post Link Share: 
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  Fed Nudges Toward a June Rate Hike
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates


As we said back in March, mark your calendars for a rate hike on June 15.  Today's statement from the Federal Reserve signals that it intends to raise rates by 25 basis points at the next meeting, consistent with the projections it made in March that it would raise rates twice in 2016. 

Here's why we think the Fed is headed toward a June rate hike.

First, the Fed re-ordered the list of economic indicators it discusses in the first paragraph of its statement, making the labor market first and noting its continued improvement.  That's important because many key decision-makers at the Fed have said a tighter labor market will eventually lead to higher inflation. 

Second, although the Fed mentioned more moderate growth in consumer spending, it also noted "solid" growth in household income and "high" consumer sentiment.  In other words, the Fed expects growth in consumer spending to accelerate. 

Third, the Fed completely removed the language about "risks" due to "global economic and financial developments." Remember that it was exactly these risks that stopped the Fed from raising rates earlier this year.  We interpret the removal of this language to mean the Fed sees the risks to its March economic outlook as balanced, which means it's also comfortable with its March projection of two rate hikes.

In addition, like in March, the one dissent came from Kansas City Fed Bank President Esther George, who voted in favor of hiking rates by 25 basis points at today's meeting.

In our view, George was right and everyone else wrong.  Economic fundamentals warrant a rate hike.  The economy can handle higher short-term rates. The unemployment rate is already very close to the Fed's long-term projection of 4.8% and nominal GDP growth – real GDP growth plus inflation – is up at a 3.5% 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, April 27, 2016 @ 2:34 PM • Post Link Share: 
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  New Orders for Durable Goods Rose 0.8% in March
Posted Under: Data Watch • Durable Goods • Housing


Implications: The volatility in durable goods orders continued in March, missing consensus expectations but rising 0.8% after February's 3.1% decline. Military aircraft led the headline higher, accounting for the full increase in March and more than offsetting declines in commercial aircraft and autos.  Excluding transportation equipment, durable goods orders fell 0.2%.  Orders for "core" capital goods - non-defense excluding aircraft – were unchanged in March, while core shipments rose 0.3%.  These shipments, which fell at a 9.6% annual rate in Q1 compared to the Q4 average, are what the government uses in its calculation of the business equipment investment component of GDP.  While R&D likely offset some of the decline in business equipment spending, a lack of overall business investment is likely to be a drag on growth in Thursday's GDP on the first quarter.  However, given the recent rebound in energy prices, business investment should start to revive soon.  The energy sector has been a major reason for weakness in equipment spending for the past year and a half.  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.  In other manufacturing news today, the Richmond Fed index, which measures mid-Atlantic factory sentiment, moved to a still very strong +14 in April from +22 in March, signaling continued expansion. Survey respondents noted increasing orders, rising employment, and moderate gains in wages, with a positive outlook on business conditions in the months to come.  In other news this morning, the national Case-Shiller home price index rose 0.4% in February and is up 5.3% from a year ago.  That's an acceleration from the 4.3% gain in the year ending in February 2015.  In the past twelve months, price gains have been led by Portland, Seattle, Denver, and San Francisco. 

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Posted on Tuesday, April 26, 2016 @ 11:10 AM • Post Link Share: 
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  OPEC and the Ash Heap of History
Posted Under: Monday Morning Outlook • Trade

Almost thirty-five years ago, President Reagan went to the British House of Commons and said "freedom and democracy will leave Marxism and Leninism on the ash heap of history."  Reagan chose his words carefully, using a phrase – the ash heap of history – very similar to the one used by the Russian Communist revolutionary Leon Trotsky against his political enemies.  Within a decade, the Berlin Wall was no more and neither was the Soviet Union.

Now it appears OPEC, another nemesis of the US from the prior century is heading for the ash heap of history as well, not because of geopolitics, but because of the hard work of engineers.

A combination of fracking, seismic imaging, and horizontal drilling has led to a huge reduction in the cost of drilling and an increase in the supply of oil and natural gas, not just in the US but around the world.

Case in point: in the past twelve months the US has run an $8.4 billion goods trade surplus with OPEC, including Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela.  What a difference from less than a decade ago.  Back in 2007-08, the US ran a $190 billion goods trade deficit with OPEC.  The reason for the change in the trade balance is that the US is importing much less from OPEC, $64.8 billion in the past twelve months versus $253.4 billion at the peak in 2007-08.    

No wonder so many of these countries are in turmoil.  They're losing money and also losing the political leverage they used to have over the US.

Although the media and other analysts focused on a recent attempt by some OPEC countries to limit production so they could try to raise oil prices, that effort failed and oil prices still ended up rising a little, which shows you how meaningless those negotiations were in the first place.  The oil market is much bigger than OPEC today, with prices much more likely to be altered by other factors.

This doesn't mean it's straight to the poorhouse for the Middle East elite.  Even at around $45 per barrel, they can generate substantial revenue.  Yes, their governments will run budget deficits and will be forced to cut spending.  More importantly, more of their revenue will come from China and Japan. 

What remains to be seen is how this change affects defense commitments around the world. The US simply doesn't have as large a direct interest in policing the sea lanes critical to the oil trade, unlike, say, China, and Japan, for example.

However, the US is going to have to grapple with whether it can just back away and let China gradually take its place.  Maybe China would police those sea lanes in just as evenhanded a way as the US has for the past couple of generations. 

Or maybe not.  An empowered China might also enjoy throwing its military weight around, extracting various forms of "tribute" from other countries for the "privilege" of the security China provides.  A Japan that depends on China's military instead of ours may be less likely to continue to cultivate a strong relationship with the US.    

Think of it like the end of the Cold War.  Throwing the Soviet Union on the ash heap of history was a huge victory for the world.  But it didn't mean history was over, it eventually led to new challenges.  We should all celebrate our newfound independence from OPEC, another sign of the resilience and strength of free-market capitalism.  But, in part because of this victory, new challenges surely await us in the future.   

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

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Posted on Monday, April 25, 2016 @ 11:19 AM • Post Link Share: 
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  New Single-Family Home Sales Declined 1.5% in March
Posted Under: Data Watch • Home Sales • Housing


Implications:  New home sales dropped slightly in March, posting their third consecutive decline, and coming in below consensus expectations.  However, in spite of the 1.5% slip in March to a 511,000 annualized pace, sales are still up 5.4% versus last year and we expect the general upward trend to restart very soon.  Home sales data are very volatile from month to month, which is why it's important to look at the trend, which continues to be positive.  We think there are a couple broader reasons for this.  First, employment gains and the beginning of a thaw in mortgage financing are starting to have a positive effect.  Second, wage growth seems to be picking up, putting the prospect of buying a home in reach for more people.  Despite this, sales remain low relative to where they should be.  Why?  First, the homeownership rate remains depressed as a larger share of the population is renting.  Second, buyers have shifted slightly from single-family homes, which are counted in the new home sales data, to multi-family homes (think condos in cities), which are not counted in this report.  We think this will change gradually over the next few years and new home sales will continue on an upward trend.  Although the inventory of new homes rose 5,000 in March, it still remains very low by historical standards (see chart to right).  Moreover, the gain 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. Although the median price of a new home is down 1.8% from a year ago, that reflects a shift in the "mix" of homes sold toward lower priced regions or smaller homes, not an outright decline in home prices.  Most data show prices rising, including the FHFA index, which measures prices for homes financed with conforming mortgages, which is up 5.6% in the past year. The Case-Shiller index is up 5.4% in the past year as well.  Last week, new claims for unemployment insurance declined 6,000 to 247,000, the lowest since the 1973.  Continuing claims fell 39,000 to 2.137 million.  These figures suggest robust job growth in April.    

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Posted on Monday, April 25, 2016 @ 11:14 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, April 25, 2016 @ 7:41 AM • Post Link Share: 
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  Main St vs Wall St on the Economy
Posted Under: Bullish • GDP • Government • Home Starts • Markets • Retail Sales • Video • Fed Reserve • Spending • Taxes • TV • CNBC
Posted on Wednesday, April 20, 2016 @ 4:06 PM • Post Link Share: 
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  Existing Home Sales Increased 5.1% in March
Posted Under: Data Watch • Home Sales • Housing


Implications:  Existing home sales bounced back in March, beating consensus expectations, and showing healthy demand headed into the spring selling season.  Sales of previously owned homes rose 5.1% in March to a 5.33 million annual rate, and are now up 1.5% from a year ago. Even though this month's gain didn't completely reverse February's drop we think the broader trend will continue to be upward. That being said, tight supply and rising prices continue to be the main factors holding back sales. While inventories rose 5.9% in March they are still down 1.5% from a year ago. In fact, 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.  According to the National Association of Realtors anything less than 5.0 months is considered tight supply. The good news is that demand was so strong in March that properties typically only stayed on the market for 47 days, down from 59 days in February. In fact, 42% of properties in March sold in less than a month, pointing to further interest from buyers in the months ahead. The median price for an existing home is up 5.7% versus a year ago, marking the 49th 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.

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Posted on Wednesday, April 20, 2016 @ 11:57 AM • Post Link Share: 
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  Housing Starts Declined 8.8% in March
Posted Under: Data Watch • Home Starts • Housing


Implications:  After a large gain in February, housing starts pulled back in March, falling well short of consensus expectations.  However, in spite of the 8.8% drop in March to a 1.089 million annual rate, housing starts are still up 14.2% from a year ago, powered by a surge in single-family units.  We believe the housing recovery is still alive and well and the trend will be higher in the months and years to come.  The rapid gain in single-family starts over the past year is important because, on average, each single-family home contributes to GDP about twice the amount of a multi-family unit.  Since the housing recovery started, multi-family construction has 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 as single-family building has recently accelerated.  This doesn't mean multi-family construction is declining for good, just that it will likely grow more slowly from here as single-family construction grows more quickly.  To help get rid of the monthly volatility in overall starts, we look at the 12-month moving average, which is the highest since 2008.  Meanwhile, although permits slipped in March, they're still up 4.6% versus a year ago while single-family permits are up a strong 13.2%.  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.   In other recent housing news, the NAHB index, which measures confidence among home builders, remained unchanged at 58 in April.  Readings greater than 50 mean more respondents report good market conditions.  One year ago, the overall index was at 56.  It won't be a straight line higher, but expect the housing sector to keep adding to real GDP growth in 2016. 

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Posted on Tuesday, April 19, 2016 @ 9:45 AM • Post Link Share: 
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  The Q1 Curse Strikes Again
Posted Under: Bullish • GDP • Government • Home Sales • Housing • Monday Morning Outlook • Retail Sales • Trade • Spending

Remember the recession of 2011, or 2014, or 2015?

Each of those years started out with either a contraction or anemic first quarter economic growth. But despite these slowdowns, the US economy didn't fall into recession. Instead, it was just more Plow Horse growth.

Since the end of the recession in mid-2009, real GDP has grown at a 2.1% annual rate. The average annualized growth rate across 2011, 2014, and 2015? You guessed it: 2.1%. In other words, first quarter weakness was meaningless.

Keep this in mind when you hear the US barely grew in the first quarter of 2016. It may have even shrunk. The first quarter curse is an ongoing problem where the government has trouble seasonally-adjusting the economic data, making the first quarter look artificially slow, but making the remaining quarters look artificially fast.

You don't need to look much further than the labor market to see that the US is not in a recession. Payrolls grew 209,000 per month in Q1 and initial jobless claims averaged the lowest for any quarter since the early 1970s. As a result, we expect a pickup in the pace of GDP growth through the rest of 2016.

To cut through the noise, we like to focus on "core" GDP. By subtracting the volatile, less growth-oriented, categories (Government, Inventories, and International Trade) from GDP, a clearer picture of trends in investment and consumer spending emerges. That measure appears to have grown at a 1.2% annual rate in Q1, which means it was up a respectable 2.6% in the past year. This is part of the reason we think real GDP will continue to grow at a Plow Horse pace and may even accelerate over the next couple of years.

Below is our "add-em-up" forecast for Q1 real GDP.

Consumption: After surging late last year, auto sales fell at a 14.6% annual rate in Q1. But "real" (inflation-adjusted) retail sales ex-autos rose and services, which make up more than 2/3 of personal consumption, probably helped push overall real consumer spending on goods and services combined to a 1.8% growth rate, contributing 1.2 points to the real GDP growth (1.8 times the consumption share of GDP, which is 69%, equals 1.2).

Business Investment: Investment in equipment looks like it fell at about an 8% annual rate in Q1, led lower by the energy sector, while commercial construction declined at about a 3% rate. But R&D likely offset some of the decline, so overall business investment fell at about a 3% annual rate, subtracting 0.4 points from the real GDP growth rate. (-3 times the business investment GDP share, which is 13%, equals -0.4).

Home Building: The home building recovery continued in Q1. Residential construction looks to have grown at a 6% annual rate, which should add 0.2 points to the real GDP growth rate (6 times the home building GDP share, which is 3%, equals 0.2).

Government: An increase in public construction probably offset a large decline in military spending in Q1, suggesting real government purchases rose at a 0.4% rate, which would add 0.1 percentage points to real GDP growth (0.4 times the government purchase share of GDP, which is 18%, equals 0.1).

Trade: At this point, the government only has trade data through February, but the numbers so far suggest the "real" trade deficit in goods has gotten bigger due to weaker economies abroad. As a result, we're forecasting that net exports are a drag of 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 added to inventories at a slightly slower pace than in Q4. As a result, we're forecasting inventories subtracted 0.1 points from real GDP in Q1.

Put it all together, and we get a 0.4% forecast for real GDP growth in Q1. But, with the components that make up the "core" adding a total of 1.0 points, and those components making up roughly 85% of total GDP, the growth rate for those core components appears to be a slightly more respectable 1.2%. Sorry for the extra math, but if 85% of GDP grows at a 1.2% rate, then the contribution to overall GDP growth is 1.0 points.

None of this is to excuse the state of the economy. Even if statistical quirks are behind problems in the first quarter, government bean-counters aren't responsible for bad policies that have kept the economy from reaching its true growth potential. Hopefully, that will change in November. In the meantime, investors should expect more Plow Horse growth ahead.

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Posted on Monday, April 18, 2016 @ 10:40 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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