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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  September Hike Still on the Table
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

No one expected the Federal Reserve to make any changes to monetary policy at today's meeting and there were no surprises.

Although the Fed did not change interest rates, it did make some small changes to the language in the statement, upgrading its assessment of household spending, housing and especially the labor market, using stronger positive language such as: "labor market continued to improve", "solid job gains", and "declining unemployment." It also upgraded its view of labor market underutilization, finding that this underutilization has "diminished" compared to "diminished somewhat" at its last meeting.

The Fed continued to recognize both lower inflation (due to falling energy prices) and lower market-based measures of inflation expectations. The language about energy prices stabilizing was removed as oil has continued its downward slide. Ultimately, though, the Fed's forecast is that the eventual end of energy price declines as well as the improving labor market will push inflation back up toward its target of 2%, which we fully agree with.

One sign that the Fed is moving towards raising rates was a small language change in the statement from needing to see further improvement in the labor market to now only needing to see "some" further improvement.

That may be small, but it seems the Fed is getting to a point where it feels more comfortable with where the labor market is.

All of this adds up to the likelihood that the Fed will start hiking short-term rates in 2015. We think September, although it could come a little later and a rate hike in October shouldn't be casually dismissed.

Even though we were not expecting it, we believe the Fed should have raised rates today; the economy can handle it. Nominal GDP (real GDP growth plus inflation) has grown at a 3.5% to 4% annual rate for the past five years. That suggests a "neutral" monetary policy, one consistent with a stable general price level, would put the federal funds rate somewhere north of 3%. So even a 1% federal funds rate would leave monetary policy expansionary.

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Posted on Wednesday, July 29, 2015 @ 4:45 PM • Post Link Share: 
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  China Crash: Whaddaboutit!
Posted Under: Bullish • GDP • Government • Markets • Productivity • Video • Stocks • Wesbury 101
Posted on Tuesday, July 28, 2015 @ 10:54 AM • Post Link Share: 
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  New Orders for Durable Goods Rose 3.4% in June
Posted Under: Data Watch • Durable Goods

Implications: Don't get too excited about the big headline 3.4% gain in new orders for durable goods in June; the underlying details of the report were good, but not overwhelmingly so, signaling that the economy is still a Plow Horse. Although the increase in orders for durables was slightly stronger than the 3.2% the consensus expected, the gain was almost all due to the very volatile transportation sector, specifically a 66.1% jump in civilian aircraft orders, which brought the overall transportation sector up 8.9% in June. The good news was that orders excluding transportation rose 0.8% as most major categories showed small gains. Orders for durables have been facing downward pressure from the drop in energy prices since the middle of last year. But, we believe the worst is over in energy price declines, meaning an ease in the downward pressure from this sector on orders for durables outside the transportation sector. The worst news in the report was that "core" shipments, which exclude defense and aircraft, declined 0.1% in June and were down at a 1.0% annual rate in Q2 versus the Q1 average. Plugging these and other recent data into our models, we are forecasting real GDP grew at a 2.8% annual rate in Q2. Expect stronger gains in orders for durables 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 near long-term norms, leaving more room (and need) for business investment.

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Posted on Monday, July 27, 2015 @ 12:47 PM • Post Link Share: 
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  GDP Rebounds in Q2
Posted Under: GDP • Government • Housing • Monday Morning Outlook • Retail Sales • Trade • Spending
The US economy rebounded in the second quarter from the supposed decline in real GDP in Q1. We say "supposed decline" in Q1 because the government has had persistent problems seasonally adjusting GDP, tending to underestimate growth in the first quarter each year while overestimating growth in the middle two quarters.

Taking our own models at face value suggests real GDP grew at a 2.4% annual rate in Q2, very close to the consensus of 2.5% and exactly the same as the 2.4% generated by the Atlanta Fed's GDPNow Model.

But forecasting real GDP growth in Q2 is tougher than normal. Every year, the July report includes revisions going back quarter-by-quarter the past several years and the government says this year's revisions should fix some of the seasonal adjustment problems.

If the government completely fixed the seasonal issues, it'd probably say real GDP growth was near 1.5% in Q1 and a 2.4% forecast for Q2 would make sense. But we doubt the government is going to fix all the data problems right away. Instead, a partial fix is more likely, which means the -0.2% reported in Q1 gets revised to around +0.5% and Q2 is reported at 2.8%.

One way to avoid the adjustment problem and find the trend is to look at real GDP compared to the same quarter two years before. By that measure, the economy has been growing at a 2.4% annual rate, which is why we call it a Plow Horse.

Below is our "add-em-up" forecast for Q2 real GDP.

Consumption: Auto sales rose at a 12.4% annual rate in Q2. But "real" (inflation-adjusted) retail sales outside the auto sector were up at a 1.4% annual pace in Q2, and services, which make up more than 2/3 of personal consumption, grew at about a 1.8% rate. So it looks like real personal consumption of goods and services, combined, grew at a 2.6% annual rate in Q2, contributing 1.8 points to the real GDP growth rate (2.6 times the consumption share of GDP, which is 69%, equals 1.8).

Business Investment: Business equipment investment looks like it was unchanged in Q2. But commercial construction rebounded sharply from weather-related problems in Q1, growing at a 22% pace, while R&D probably grew around its trend of 5%. Combined, we estimate business investment grew at a 6% rate, which should add 0.8 points from the real GDP growth rate (6.0 times the 13% business investment share of GDP equals 0.8).

Home Building: Residential construction looks unchanged in Q2 after surprising growth in Q1 despite the weather. That means it neither added to nor subtracted from GDP (0 times the home building share of GDP, which is 3%, equals 0.0).

Government: Both military spending and public construction projects rebounded in Q2, suggesting real government purchases rose at a 2.8% rate in Q2, which would add 0.5 percentage points to real GDP growth (2.8 times the government purchase share of GDP, which is 18%, equals 0.5).

Trade: At this point, the government only has trade data through May, but the data so far suggest the "real" trade deficit in goods has gotten a little bigger. As a result, we're forecasting that net exports are a drag of 0.1 point 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 piled up inventories at a slightly slower pace than in Q1. We're forecasting inventories subtracted 0.2 points from real GDP in Q2.

Put it all together, and we get 2.8% as a forecast for Q2, consistent with our view that the Plow Horse economy remains alive and well. More important for investors, is that the report should keep the Fed on track to start raising rates in September.

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

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Posted on Monday, July 27, 2015 @ 12:28 PM • 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, July 27, 2015 @ 7:49 AM • Post Link Share: 
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  New Single-Family Home Sales Declined 6.8% in June
Posted Under: Data Watch • Home Sales • Housing

Implications: Hold off on housing for a moment. Initial claims for unemployment insurance fell 26,000 last week to 255,000, the lowest level since 1973. This, paired with a decline in continuing claims to the second lowest level since November 2000, signals continued improvement in the labor market and is consistent with payroll gains of 225K in July. Sales of new homes took a breather in June, falling 6.8% to a 482,000 annual rate, lagging even the most pessimistic forecasts. However, sales remain up 18.1% from a year ago. It's important to remember that monthly data is volatile, and what really matters is the trend. Despite the decline in June, new home sales over the past year have averaged the fastest pace going back to 2008. And new home sales have a strong correlation with housing starts, which are also trending higher. In fact, new home sales have been running slightly above the levels that would be expected with the pace of housing starts, so June's decline is likely nothing more than a reversion to the trend and sales should continue higher in the months ahead. While the month's supply of homes for sale rose to 5.4 months in June from 4.8 in May, the jump was in large part due to the slower sales pace and remains below the average of 5.6 over the past 20 years. Note, however, that the increase in inventories was not due to finished homes, but homes under construction or not yet started. As a result, builders still have plenty of room to increase both construction and inventories. Having made these points, don't forget that new home sales are still depressed relative to history. We think there are a few reasons for this. First, 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. Third, although we may be starting to see a thaw, financing is still more difficult than it has been in the past. The key idea to remember is that one poor month of sales is nothing to worry about. The trend is what matters, and the trend continues higher.

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Posted on Friday, July 24, 2015 @ 12:17 PM • Post Link Share: 
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  Existing Home Sales Increased 3.2% in June
Posted Under: Data Watch • Home Sales • Housing

Implications: The market for existing homes continued to heat up in June, hitting the fastest sales pace in over 8 years despite tight supply and record high prices. Sales of previously owned homes increased to a 5.49 million annual rate in June, beating consensus expectations and representing the fastest sales pace since February 2007. Sales were up in every major region of the country and should continue to trend upward. All-cash buyers accounted for 22% of sales in June, down from 32% a year ago. As a result, while total sales are up a healthy 9.6% from a year ago, non-cash sales (where the buyer uses a mortgage loan) are up a more robust 25.7%. So when all-cash sales eventually bottom out, total sales will start rising at a more rapid pace. The gain in mortgage-financed sales suggests a long-overdue thaw in lending. What's interesting is that the percentage of buyers using credit has increased as the Fed tapered and then ended QE. Those predicting a housing crash without more QE were completely wrong. In fact, rising rates appear to be increasing the pace of sales, as buyers look to lock in terms before the looming fed rate hikes push borrowing costs higher. The details of today's report were solid as well. Rising prices are bringing sellers to market (inventories rose for a fifth consecutive month in June), but supply hasn't been able to keep pace with demand. In fact, the average time it took to sell a home in June decreased to 34 days from 40 in May, the fastest pace since recording began in 2011. Look for more inventory to come to market in the year ahead as "on-the-fence" sellers move to take advantage of higher prices. In other housing news this morning, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.4% in May and was up 5.7% from a year ago.

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Posted on Wednesday, July 22, 2015 @ 12:17 PM • Post Link Share: 
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  Gold is Not a Safe Haven
Posted Under: GDP • Gold • Video • TV • CNBC
Posted on Tuesday, July 21, 2015 @ 4:11 PM • Post Link Share: 
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  Tax Cuts on the Horizon
Posted Under: Government • Markets • Monday Morning Outlook • Taxes
The one key reason for being bullish on equities the past several years has been valuation. Stocks are cheap based on profits and interest rates.

However, one additional reason to be bullish is that tax policy is very likely to improve after the next presidential election. For very different reasons, the election of either a Republican candidate or Hillary Clinton should generate tax cuts.

It's easy to see why the election of a Republican would lead to tax cuts. One of the few issues on which the vast majority of Republican voters agree is that tax rates matter and lower tax rates generate more economic growth. Almost all of the major candidates have a plan, or at least an inclination, to cut tax rates, particularly those that stifle economic growth the most, such as on corporate profits and income from investment.

At present, companies pay a base federal tax rate of 35% on corporate profits. Combined with an average state tax rate of about 4%, the US rate is the highest for any advanced country in the world.

Then shareholders pay an additional layer of tax when those after-tax profits generate dividends or capital gains. That second layer of tax can be as high as 20% for the highest earners (23.8% including a surtax created by Obamacare). In addition, companies that invest in plant and equipment have to take years to depreciate those costs instead of expensing them for tax purposes the year they make them.

Marco Rubio would cut the corporate tax rate to 25% and completely eliminate the second layer of taxes applied when shareholders earn dividends and capital gains. He'd also let companies fully expense business investments the year they make them. Chris Christie would cut the corporate rate to 25% as well, although he'd maintain a second layer of tax on capital gains and dividends, instead cutting tax rates deeper than Rubio on high income workers.

Rand Paul would replace the corporate profits tax with a European-style 14.5% valued added tax and move to full expensing of capital purchases, eliminating depreciation. Meanwhile, shareholders would pay that same 14.5% rate on capital gains and dividends. That would bring the effective tax rate on corporate profits to 27%, essentially the same as Rubio's 25%.

(Here's the math on Paul's plan: under a VAT, labor income and capital income both pay 14.5% at the corporate level, leaving 85.5% to shareholders, who pay a 14.5% rate on that remaining 85.5% when they earn dividends or gains. That leaves 73% of the original profit, which means the effective tax rate is 27%.)

Ben Carson and Ted Cruz have said they'd like to see a flat tax of some sort. Scott Walker hasn't issued any particulars yet, but we're confident he will propose a tax plan that's very aggressively pro-growth as well.

In the end, with Republicans in Congress chomping at the bit to cut taxes the past several years, whomever the Republicans nominate, including Jeb Bush, is likely to run on tax cuts to boost economic growth.

But even a Democrat could deliver pro-growth tax cuts. If a center-left Democrat wins the next election (in contrast to far-left candidates and potential candidates like Bernie Sanders or Elizabeth Warren), one of the first things her Keynesian economic advisers will privately say is that the economic recovery is "long in the tooth" and that the odds of a recession before a re-election battle in 2020 are pretty high. (We may disagree with that analysis, but it's how they think that matters.)

As a result, we think Hillary Clinton would look for ways to compromise with Republicans and cut taxes out of political self-interest, to try to prolong the expansion past re-election. Just last week, Clinton said she'd like to "reform capital gains taxes to reward longer-term investment." Meanwhile, many big-dollar Democratic donors know the US corporate rate is too high and there's ample room to reform the system by cutting the 35% tax rate on profits if a Democratic president is so inclined,...even if the inclination is guided by electoral politics rather than free market philosophy.

Nothing in politics is guaranteed. But if you look carefully, and don't let your personal politics interfere with your analysis, you should start to see better tax policies looming out on the horizon. Just another reason the bull market has further to run.

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Posted on Monday, July 20, 2015 @ 11:37 AM • Post Link Share: 
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  The Consumer Price Index Increased 0.3% in June
Posted Under: CPI • Data Watch • Inflation

Implications: Consumer prices increased in the second quarter at the fastest pace since 2011. Not just overall prices, driven by a rebound in energy prices, but "core" prices as well, excluding both food and energy. At 3.5%, the three-month annualized rate of overall inflation is well above the Federal Reserve's 2% long-term target. Even core prices are up at a 2.3% annual rate in the past three months and the past six months as well. Either way, the recent pace of inflation has been running above the Fed's 2% target and should eventually put pressure on the Fed to raise rates faster than the market expects. Overall consumer prices rose 0.3% in June and showed positive year-over-year growth for the first time in 2015. The lack of headline inflation in the past year is due to energy prices, which rose 1.7% in June (following a 4.3% increase in May) but remain down 15% from a year ago. Core prices increased 0.2% in June, are up 1.8% in the past twelve months, and have risen at a 2.3% annualized since the start of the year. In other words, core prices are gradually accelerating upward. With core prices so close to the Fed's two percent inflation target, policymakers should remain concerned about future increases in inflation, even with overall inflation near zero in the past twelve months. Core consumer prices in June were led higher by housing. Owners' equivalent rent, which makes up about ¼ of the CPI, rose 0.4% in June, is up 2.9% in the past year, up at a 3.6% annual rate in the past three months, and will be a key source of higher inflation in the year ahead. While some scaremongers warn about deflation, others stoke fears of hyperinflation. But the truth is that neither is a threat at present. What we have is low inflation that is likely to gradually work its way upward over the next few years. On the earnings front, "real" (inflation-adjusted) average hourly earnings declined 0.4% in June, but are up a moderate 1.7% in the past year. Taken as a whole, recent trends in both consumer and producer prices suggest that the long awaited rise in inflation is starting to take shape, adding further credence to calls for a September rate hike from the Fed.

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Posted on Friday, July 17, 2015 @ 10:42 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.
Search Posts
Housing Starts Increased 9.8% in June
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End of an Era
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