Implications:  Sales of existing homes weakened modestly in August as inventories continue to decline and prices trend higher.  Sales of previously owned homes fell 0.9% in August to a 5.33 million annual rate but are still up 0.8% from a year ago.  Despite today's sales pace being the second slowest of the year, we do not think this is the end for the housing market.  Housing is volatile from month to month, and 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 fell 3.3% in August, and have now fallen for fifteen 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 4.6 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 46% of properties in August sold in less than a month, pointing to further interest from buyers in the months ahead.  However, higher demand from the summer selling season also helped push the median price for an existing home up 5.1% versus ago.  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 to a new home, bringing more existing properties onto the market as well.   In other housing news this morning, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.5% in July and is up 5.8% from a year ago.  Another sign that supply remains limited and home builders have room to keep ramping up construction.  More broadly, new claims for unemployment benefits declined 8,000 last week to 252,000, marking the 81st consecutive week below 300,000. Continuing claims declined 36,000 to 2.11 million.  It's still early, but plugging these figures into our models suggests a September payroll gain of about 175,000, more than enough to keep the Fed back on track for higher rates in December.

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The Federal Reserve kicked the rate hike can down the road once again, but looks very likely to raise rates in December. 

The biggest news today wasn't the Fed's unwillingness to raise rates; if the Fed has been seriously considering a rate hike they would have made that clear to investors in the past few weeks.  Instead, today's biggest news was that three members dissented from the (lack of) policy action, all preferring a quarter-percentage point rate hike at today's meeting. 

How can we be confident about a December rate hike given how often the Fed has punted on rate hikes so far this year?  Because the new dot plot released today from the Fed shows that, with only two meetings left this year, fourteen of seventeen policymakers think rates will rise by at least 25 basis points by the end of 2016, with only three thinking rates will finish 2016 without any rate hike at all.  In addition, Fed Chief Yellen said at her post-meeting press conference that "most" policymakers (you can bet this group included her!) already think the time is appropriate for a rate hike, but that it wouldn't hurt to wait a little while before doing so.

Another way to think of it is that the three who dissented today will likely dissent in November as well, and then the Fed will swap dissenters in December, with the three who want to wait until at least next year for any rate hikes, finally finding themselves on the losing end of the policy decision.

So if the Fed is ready to raise rates, why not do it at the next meeting in November?  Because it's only six days before the election and we think the Fed would prefer to stay out of the limelight so close to Election Day.  

Other notable shifts by the Fed in its policy statement include:
(1) Recognizing a pick up in the growth of the economy,
(2) Saying the near-term risks to the outlook are "roughly balanced," rather than a "diminished" risk of downside developments, and
(3) Adding that the case for rate hikes has strengthened.

The Fed also made slight downward revisions to its projection for real GDP growth, both this year and for the long-term average.  As a result, the projection for the long-term average annual growth rate for nominal GDP (real GDP growth plus inflation) is now 3.8%. 

In terms of the pace of rate hikes, the median projection from policymakers is only two rate hikes in 2017.  With the long-term average remaining at 3.00%, that means more rate hikes in 2019-20, instead. 

In our view, economic fundamentals warranted a rate hike at the start of the year, and even more so today.  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 – real GDP growth plus inflation – has grown at a 3.3% annual rate in the past two years.  Moreover, we are starting to see early signs of accelerating inflation.  "Core" consumer prices are up 2.3% versus a year ago, tied with the largest increase since 2008.  Average hourly earnings are up 2.4% from a year ago, despite many highly paid and productive Baby Boomers exiting the workforce.
 
Slightly higher short-term rates are not going to derail US growth, 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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Implications:  Home building fell by more than expected in August as a large drop in construction in the South more than offset gains around the rest of the country.  Housing starts declined 5.8% to a 1.142 million annual rate in August, after robust months in June and July.  This is nothing new, home building often moves in a seesaw pattern.  To get rid of the monthly volatility and reveal underlying trends, we look at the 12-month moving average, which is now the highest since 2008.  The reason for the decline in starts in August was a 14.8% drop in the South, which will be short-lived for a couple of reasons.  First, the lower 48 states had more rain this August than any August since 1977, with much concentrated in the Southern states like Louisiana.  Second, permits for future single-family construction in the South rose 3.6% to a 404,000 annual pace in August, the strongest since 2007.  The general rise in home building that started in 2011 is far from over.  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 obviously 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, boomed to 65 in September from 59 in August. The September reading of 65 matches the highest level for the index so far in the economic recovery.  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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We get called perma-bulls, wrongly we think, because we were late to call 2008 a Panic, and because we've pushed back against the doom and gloom of the past 7 1/2 years.  Time and again over the past several years, we've argued the Plow Horse economy would continue to grow.

Remember fears about adjustable-rate mortgage re-sets, or the looming wave of foreclosures that would lead to a double-dip recession?  Remember the threat of widespread defaults on municipal debt?  Remember the hyperinflation that was supposed to come from Quantitative Easing?  Or how about the Fiscal Cliff, Sequester, or the federal government shutdown?  Or the recession we were supposed to get from higher oil prices...and then from lower oil prices?  How about the recession from the looming breakup of the Euro or Grexit or Brexit?

In the end, none of these were reasons to fear a recession or to bail out of stocks.

But this doesn't mean we are "perma-bulls." It doesn't mean we will never be concerned about the prospects for recession.  Sooner or later, the US will have another recession.  And even though we've consistently pushed back against others' recession theories the past several years, we are always on the lookout for recession theories that make sense. 

And although we don't think a recession will happen anytime soon, there are some data we're concerned about.

In the past fifty years, one of the best signals of an impending recession has been medium and heavy truck sales.  Anytime that's dropped substantially – and the 31% drop since June 2015 certainly qualifies – a recession has started within two years of the peak in sales.  If that holds this time around, we'd be due for a recession starting by the middle of 2017.

Given the traditional role of these vehicles to the flow of commerce around the country, a drop should never be casually dismissed.  So, normally the drop since mid-2015 would give us serious concerns about the economy.     

This time, however, the drop in medium and heavy truck sales has come during a time of falling oil prices and less mining activity.  In addition, sales before mid-2015 may have been artificially high due to a new regulation on trucks' antilock braking systems.  Some sales appear to have been accelerated to avoid the new rule, which then went into effect.  There have been other regulations on emissions that affected sales as well.

Another data series we're watching closely is what we call "core" industrial production, which is industrial production excluding utilities, mining, and autos, all of which are very volatile.  The core measure is down 0.9% from a year ago.  Normally a decline of nearly 1% only happens in recessions or right after they end, but it also happened back in January 2014, so we think it's important to wait and see.  Once again, the absorption of lower oil prices and the huge drop in drilling activity in the energy sector may be holding down production.     

If truck sales and core industrial production continue to show weakness it would certainly get more of our attention.  But, for now, we think the weight of the data show continued Plow Horse growth.

Job growth continues at a healthy clip.  Initial unemployment claims have averaged 261,000 over the past four weeks and have been below 300,000 for 80 straight weeks.  Consumer debt payments are an unusually low share of income and consumers' seriously delinquent debts are still dropping.  Wages are accelerating.  Home building has risen the past few years even as the homeownership rate has declined, making room for plenty of growth in the years ahead.

Meanwhile, there haven't been any huge shifts in government policy in the past two years.  Yes, policy could be much better, but the pace of bad policies hasn't shifted into overdrive lately.
 
In other words, our forecast remains as it has been the past several years, for more Plow Horse economic growth.  But you should never have any doubt that we are constantly on the lookout for something that can change our minds.           

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

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Source: St. Louis Federal Reserve FRED Database

Implications:  Today's report of a 0.2% increase in consumer prices gives the Fed about as clean a look at the state of inflation as they could ask for heading into next week's meetings. The normally volatile food and energy components were both unchanged in August, but "core" consumer prices, which exclude those two components, rose 0.3%, the most in six months, and are now up 2.3% from a year ago.  Food prices are up just 0.1% in the past year.  Energy, which has been the key factor keeping the headline measure of inflation subdued, is down 9.2% in the past year. While the overall consumer price index has shown a modest 1.1% rise from a year ago, prices are up 2% in the past year excluding just energy.  Notice that as oil prices have rebounded off the February low, the pace of overall inflation has followed step, with consumer prices rising at a 2.2% annualized rate in the past six months.  The August rise in consumer prices was led by housing and medical care.  Owners' equivalent rent, which makes up about ¼ of the CPI, rose 0.3% in August, is up 3.3% in the past year, and will be a key source of higher inflation in the year ahead.  Medical care costs rose 1% in August, the most for any month since the 1980s.  Hospital service prices rose 1.7% while prescription drug prices increased 1.3%.  The worst piece of news from today's report was that "real" (inflation-adjusted) average hourly earnings declined 0.1% in August.  Real wages are up a respectable 1.3% in the past year and we think wages will generally rise faster than prices in the year ahead as employment keeps growing at a healthy clip     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 – you may think a green light for the Fed to raise rates at next week's meeting is a given, but the squeamish Fed has proven less and less "data dependent" with each passing month.  As a result, expect the Fed to kick the rate-hike can down the road, probably to December.

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Implications:  After posting its largest gain in a year in July, industrial production took a breather in August, demonstrating the type of "fits and starts" recovery that has become familiar.  While the headline number is still down 1.1% from a year ago, it is unchanged from six months ago and up at a 2.7% annual rate in the past three months, an acceleration that signals the sector may be leaving behind the headwinds related to the drop in oil prices in the past couple of years.  One of the biggest drags on today's number was non-auto manufacturing, which fell 0.6% in July, its largest drop since 2014.  Auto output increased 0.5% in August, and is now up 30.5% at an annual rate in the past three months, hitting a new all-time record high. This helped curb the overall drop in manufacturing and signals strong auto sales in the months to come.  Perhaps the best news was that mining production posted its fourth consecutive month of gains, jumping 1% in August, and is now up at a 6.3% annual rate in the past three months.  This month's gain was driven by both metal ore mining and petroleum and natural gas extraction. In fact, oil and gas-well drilling jumped 3.2% in August, and is now up at 38.6% 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, rose to -2.0 in September from -4.2 in August.  Meanwhile, the Philly Fed index, a measure of sentiment among East Coast manufacturers, jumped to +12.8 from +2.0.  These reports signal we are not headed for a recession and the economy remains a Plow Horse.    

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Implications:  A disappointing number out of the retail sector today.  Overall retail sales declined 0.3% in August, the first decline in five months. Unless we get a very hot consumer inflation report tomorrow, these figures as well as soft data on industrial production mean the Fed is very unlikely to raise rates next week, despite our view that a rate hike is warranted by underlying economic conditions.  However, there's no reason to take today's news as a "doom and gloom" report.  A one-month slowdown doesn't make a trend.  Retail sales are up at a 3.2% annual rate in the past six months.  The weakest sectors in August were autos, building materials, and gas, all of which are very volatile month to month.  Sales at gasoline stations declined 0.8% in August, and are down 9.5% from a year ago. All of this is a function of lower oil prices, not people consuming less. In fact, vehicle miles driven in the United States are at the highest levels in history over the past twelve months.  Stripping out these volatile sectors leaves "core" sales, which were unchanged in August and up a respectable 3.4% from a year ago.  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.  In other news today, initial unemployment claims increased 1,000 last week to 260,000, the 80th consecutive week below 300,000.  Meanwhile, continuing claims increased 1,000 to 2.143 million.  Plugging these figures into our models suggests payrolls will be up about 170,000 in September, another solid month.

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Implications:  The Fed isn't likely to be swayed either way by today's report on producer prices.  After July's declines, producer prices were unchanged in August as falling prices for food, energy, and trade services (think margins received by wholesalers and retailers) were offset by rising prices for a broad range of services.  Excluding the drop in the volatile food and energy indexes, goods prices rose 0.1% in August and are up 0.6% in the past year, so the Fed should not have any fear that deflation is taking hold.  Excluding food and energy from the headline index, which includes both goods and services, "core" prices rose 0.1% in August and are up 1% in the past year.  The "core" measure is where the Fed places greater weight when making the decisions on monetary policy.  We get a report on consumer prices tomorrow morning, but unless that report shows inflation well above the 0.1% increase the consensus expects, don't be surprised if the Fed kicks the next rate hike to December.  We think they should raise rates at next week's meeting, but they have shown a tendency to be easily spooked by any data coming in below expectations, even though data is volatile from month to month and the trend shows an economy ready for higher rates.  In other recent inflation news, import prices declined 0.2% in August and are down 2.2% from a year ago.  The drop is mostly from petroleum, but not all of it; import prices are down 0.9% from a year ago even excluding petroleum.  Export prices fell 0.8% in August and are down 2.4% from a year ago.  Nonagricultural export prices declined 0.4% in August after five consecutive months of rising prices. We expect this measure to continue pushing higher in the months ahead, putting upward pressure on export prices.

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