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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  The ISM Manufacturing Index Declined to 51.5 in March
Posted Under: Data Watch • ISM

Implications: The aftermath of the west coast port shutdowns, unusually cold winter weather and a drop in oil drilling continue to weigh on manufacturing activity across the country. The ISM manufacturing index, which measures factory sentiment around the country, declined in March, but remained above 50 for a 27th consecutive month. We don’t believe the decline from 58.1 in August to the current reading of 51.5 is anything to worry about. Remember that the economy was unusually strong in the summer of last year as it recovered from bad weather in the first quarter of 2014. The fundamentals of the economy have not changed in any significant way. According to the Institute for Supply Management, the average overall index level of 52.6 seen through the first three months of 2015 is consistent with real GDP growth of 3% 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 1% real GDP growth rate in Q1. The ISM report shows 10 industries expanded in March, while 7 contracted, but the pace of decline in oil drilling dragged the index down. On the inflation front, the prices paid index remained depressed at 39.0 in February. No major surprise here given the continued pressure on energy prices over the past month. The employment index dipped in March to 50.0, signaling no change in manufacturing employment over the past month. Taken as a whole, this month’s report shows the Plow Horse continues to plod forward. In other news this morning, construction declined 0.1% in February, exactly as the consensus expected. A drop in government projects (power plants and water supply) as well as a slower pace of single-family home building, offset stronger commercial construction, which was led by manufacturing facilities, offices, and hotels. Look for a rebound in the next couple of months as weather patterns return to normal. On the housing front, the Case-Schiller index, a measure of national home prices, increased 0.6% in January and is up 4.5% versus a year ago. All twenty major metro areas are up in the past year, led by Denver, Miami, and Dallas. In broader economic news this morning, the ADP index, a measure of manufacturing payrolls, increased 189,000 in March. Plugging this into our models suggests Friday’s official report will show nonfarm payrolls up 225,000, another solid month.

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Posted on Wednesday, April 01, 2015 @ 11:01 AM • Post Link Share: 
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  Personal Income Increased 0.4% in February
Posted Under: Data Watch • PIC

Implications: Consumer spending rose less than expected in February, largely due to bad winter weather. However, incomes keep growing and should translate into faster spending in the months ahead. Payrolls are up more than three million in the past twelve months and wage growth is starting to accelerate as well. As a result, private-sector wages & salaries are up a robust 5.1% in the past year. Total income – which also includes rents, small business income, dividends, interest, and government transfer payments – increased 0.4% in February and is up 4.5% in the past year, noticeably faster than the 3.3% gain in consumer spending. This is why consumers have enough income growth to keep on lifting their spending without getting into financial trouble. 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 11.7% versus a year ago. However, outside Medicaid, government transfers are up a more tepid 4.5% in the past year and unemployment compensation is very close to the lowest level since 2007. The bad news is that taken all together, government transfer payments – 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. Plugging today’s data into our models suggests “real” (inflation-adjusted) personal consumption expenditures grew at a 2% annual rate in Q1 and overall real GDP grew at a 1% annual rate. The PCE deflator, the Fed’s favorite measure of consumer inflation, rose 0.2% in February, the first gain since October. Although that measure is only up 0.3% from a year ago, it’s been held down by falling energy prices. The “core” PCE deflator, which excludes food and energy, is up 1.4% from a year ago, not far below the Fed’s 2% inflation target. Now that energy prices have stopped falling, look for overall inflation to move up toward “core” inflation over the rest of the year. As a result, we still believe the Fed will start raising rates in June. In other news, pending home sales, which are contracts on existing homes, increased 3.1% in February following a 1.2% gain in January. These figures signal that existing home sales, which are counted at closing, will be up about 2% in March.

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Posted on Monday, March 30, 2015 @ 11:42 AM • Post Link Share: 
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  Rate Hikes Won't Kill Housing
Posted Under: Government • Housing • Monday Morning Outlook • Fed Reserve • Interest Rates
Home building plummeted in February, which made perfect sense; this February was the coldest for the most Americans since 1979. What no one expected was that new home sales would soar. Bad winter weather usually doesn’t hurt new home sales as much as it hurts housing starts, but it typically has an impact. This time, though, new homes sales spiked 7.8%, hitting the highest level in seven years.

The new home sales report confirms what we’ve been saying for the past few years: the housing recovery still has much further to go. It won’t be in a straight line, the monthly reports are volatile, but expect more home building and sales in the year ahead than in the past twelve months.

Most importantly, the upward trends will continue even as the Federal Reserve starts to raise rates. In theory, higher rates should dampen housing activity. But this version of “chalkboard economics” ignores too much other information.

First, based on population growth and scrappage (knockdowns, fires, floods, hurricanes, tornadoes…etc.), we’re headed to about 1.5 million housing starts per year by 2016-17, about 50% higher than in 2014. Second, job growth has picked up. Payrolls look ready to rise about 3.5 million in the next year, the best since the 1990s. Third, wage growth is picking up. Average weekly earnings are up 2.6% in the past year, versus a gain of 1.8% in the prior year.

Fourth, home prices are likely to continue upward, but not as quickly. When home prices finally bottomed in 2011, they were undervalued relative to the level of rents. Meanwhile, home building was slow, limiting supply. As a result, home prices rebounded rapidly in the early stages of the recovery. The national Case-Shiller index increased at an 8.6% annual rate in 2012-13. But prices rose a slower 4.6% last year. And now that home prices are fairly valued relative to rents and construction is up, prices may rise even more slowly.

Last, potential homebuyers are not only interested in mortgage rates, they’re also affected by how fast rents are rising. For example, a tenant looking forward to rent increases of 4% per year will buy a home faster than someone who foresees 2% rent hikes.

For that reason, it’s important to compare mortgage rates to the growth in rents. In the past twenty years, the conventional 30-year fixed mortgage rate has averaged about 3 percentage points higher than the growth rate of rents. Now, that gap is almost zero. So, unless mortgage rates suddenly skyrocket, expect continued growth in rents to gradually make homeownership more attractive again.

The housing recovery is not bullet-proof and one day will come to an end. But given general economic improvement and rent growth, that day is not yet on the horizon.

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

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Posted on Monday, March 30, 2015 @ 11:21 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, March 30, 2015 @ 9:33 AM • Post Link Share: 
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  Real GDP Growth in Q4 was Unchanged at a 2.2% Annual Rate
Posted Under: Data Watch • GDP

Implications: It’s hard to get more mediocre than the top-line number on Q4 GDP. Real GDP growth for Q4 was unchanged from last month’s reading, up at a 2.2% annual rate. That fell slightly short of the consensus expected 2.4% rate. However, the “mix” of GDP was slightly more favorable for future quarters as inventories were revised down, leaving more room for re-stocking on shelves and in showrooms in future quarters. Personal consumption also rose 4.4% at an annual rate in Q4, the best since the first quarter of 2006. Today was our first glimpse on economy-wide corporate profits for Q4 - they declined 1.4% and are down 0.2% from a year ago. The decline was all due to profits from the “Rest of the World” which fell 8.8%, most likely due to the stronger US dollar. Excluding those, “Domestic Profits” rose 0.3% in Q4 and are up 2.7% from a year ago. Nothing in today’s report changes our view that the Federal Reserve has plenty of reason to start raising short-term interest rates. Nominal GDP (real growth plus inflation) is up 3.7% from a year ago and up at a 4.1% annual rate in the past two years. For comparison, the average annual growth for nominal GDP is 3.5% in the past ten years and 4.4% in the past twenty years. In other words, we’re not that far from normal growth in nominal GDP, but short-term interest rates remain far below normal. Look for a temporary slowdown in real GDP growth in Q1 due to the unusually harsh winter weather in February along with the delays from the west coast port strikes. Right now, we’re forecasting real GDP to grow about 1% at an annual rate in the first quarter. Yet, like last year, real GDP growth should rebound in Q2 and beyond. In other news yesterday, new claims for unemployment insurance declined 9,000 last week to 282,000. Continuing claims for regular state benefits fell 6,000 to 2.42 million. Plugging these figures into our models suggests nonfarm payrolls grew 241,000 in March, another solid month.

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Posted on Friday, March 27, 2015 @ 10:29 AM • Post Link Share: 
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  New Orders for Durable Goods Declined 1.4% in February
Posted Under: Data Watch • Durable Goods

Implications: An ugly report on durable goods from February. Orders fell 1.4%, much weaker than the expected 0.2% increase. However, this is not the end of the economic expansion. Three special factors have held orders back – less drilling activity, West Coast port strikes, and abnormally cold winter weather. Most of the decline was in the transportation sector – particularly aircraft – which is extremely volatile month to month. Still, orders excluding transportation declined 0.4% and have now dropped for five consecutive months. This is no different than what happened in 2012, when orders also fell for five consecutive months, yet real GDP accelerated in 2012 from 2011. Despite recent declines, orders ex-transportation still remain up a Plow Horse 2.3% from a year ago. “Core” shipments, which exclude defense and aircraft, rose 0.2% in February and are up 4.6% from a year ago. Still, if unchanged in March, “core” shipments will be down at a 0.9% annual rate. Plugging these data into our models for overall real GDP puts our forecast for Q1 at a 1.0% annual rate. Moving forward, we expect to see a rebound in orders and shipments as temporary headwinds recede. 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.

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Posted on Wednesday, March 25, 2015 @ 10:57 AM • Post Link Share: 
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  New Single-Family Home Sales Rose 7.8% in February
Posted Under: Data Watch • Home Sales • Housing

Implications: New home sales soared in February, defying the nasty winter weather and beating even the most optimistic forecast from any economics group. Sales of new homes rose 7.8% to a 539,000 annual rate in February, the fastest pace in seven years. Overall sales are up 24.8% from a year ago, and have clearly been improving as the chart to the right shows. One possible reason for the big gain may be all the talk about the Federal Reserve raising rates later this year, which may be getting some buyers into the market sooner thinking they can avoid paying higher rates in the future. This is consistent with existing homes sales data, which show fewer all-cash buyers and more financed purchases. The other piece of good news was that the inventory of new homes declined 3,000 in February, and still remains very low. The months’ supply is 4.7, the lowest level since June 2013. As a result, homebuilders still have plenty of room to increase both construction and inventories. But despite the strong gains, sales still remain 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. Each of these is beginning to change. Recently, single-family housing starts have grown faster than multi-family starts, suggesting builders (the quintessential entrepreneur) see a larger appetite for homeownership and single-family home purchases. The median sales price of a new home in February was up 2.6% from a year ago. Also on the home price front, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.3% in January. In the past year, the FHFA index is up 5.1%, a solid gain but a smaller one than the 7.4% increase in the twelve months ending January 2014. We expect further gains in home prices in 2015, although at a slower pace than previous years. In other recent news today, the Richmond Fed index, which measures manufacturing sentiment in the mid-Atlantic, declined to -8 in March from 0 in February. For now, we think the drop reflects the unusually harsh weather in that region this winter.

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Posted on Tuesday, March 24, 2015 @ 10:50 AM • Post Link Share: 
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  The Consumer Price Index Increased 0.2% in February
Posted Under: CPI • Data Watch • Inflation

Implications: Coming off the largest three-month decline since the Panic in 2008-09, broad-based gains led the consumer price index higher in February. Almost every category showed rising prices for the month, but the largest contributor was energy, which rose 1%, the first increase in energy prices in eight months. “Core” prices, which exclude food and energy, increased 0.2% in February and are up 1.7% from a year ago, which is why the Federal Reserve should remain concerned about future increases in inflation even though overall consumer prices are unchanged from a year ago. The reason overall consumer prices are unchanged is that energy prices have dropped 18.8% in the past year. Excluding energy, prices are up 1.9%, very close to the Fed’s 2% target for inflation. Some analysts will use the fact that overall prices are unchanged since a year ago to warn about “Deflation.” But true deflation – of the kind we ought to be concerned about – is caused by overly tight monetary policy and price declines that are widespread, not isolated to one sector of the economy. Think of the Great Depression. While energy has declined steeply, there are sectors where prices are rising faster. Food prices have risen 3% in the past 12 months, so if you only use the supermarket to gauge inflation, we understand thinking the headline reports are too low and “true” inflation is higher. In addition, housing costs are going up. Owners’ equivalent rent, which makes up about ¼ of the CPI, rose 0.2% in February, is up 2.7% in the past year, and will be a key source of higher inflation in the year ahead. The worst pieces of news in today’s report was that “real” (inflation-adjusted) average hourly earnings declined 0.1% in February. However, these earning are up a healthy 2.1% in the past year and have been growing at a faster 3.9% over the past six months, signaling that consumer purchasing power continues to grow.

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Posted on Tuesday, March 24, 2015 @ 10:31 AM • Post Link Share: 
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  Existing Home Sales Increased 1.2% in February
Posted Under: Data Watch • Home Sales • Housing

Implications: Nothing shows the Plow Horse Economy better than housing. Sales of existing homes increased 1.2% in February, and the underlying fundamentals are slowly but surely improving. Sales have gained on a year-to-year basis for five consecutive months and are now up 4.7% from a year ago. And this gain comes in the face of a drop in distressed and all-cash-sales. Distressed homes (foreclosures and short sales) now account for only 11% of total sales, down from 16% a year ago. All-cash buyers are down to 26% of sales from a high of 35% in February 2014. As a result, even though total sales are up 4.7% from a year ago, non-cash sales (where the buyer uses a mortgage loan) are up 19.2%. What this means is that when distressed and all-cash sales eventually bottom out, total sales will start rising at a more rapid pace. So even though credit (but, not liquidity) remains relatively tight, we see evidence of a thaw, which suggests overall sales will climb at a faster pace in the year ahead. 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. One of the reasons for the tepid recovery in existing home sales so far is a lack of inventory. Inventories are down 0.5% from a year ago and remain at very depressed levels relative to history. However, the median sales price of an existing home rose to $202,600 in February, up 7.5% from a year ago. As a result, in the year ahead, we expect the higher level of home prices to bring more sellers into the market, which should help generate additional sales. Either way, whether existing home sales are up or down, it’s important to remember these data, by themselves, should not change anyone’s impression about the overall economy. Existing home sales contribute almost zero to GDP, which counts “new” production, not re-sales of old property.

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Posted on Monday, March 23, 2015 @ 11:02 AM • Post Link Share: 
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  Don't Fret Student Debt
Posted Under: Government • Housing • Inflation • Monday Morning Outlook • Spending
For the past six years, investors have faced one fear after another. One of those fears has been the more than $1 trillion of student loan debt outstanding. This debt is up 160% since the start of 2006 (and growing) while the share of student loans with payments 90 days late, or longer, has risen from 6.4% to 11.3%.

Look, we're not thrilled with this debt. Just like with low-income housing loans, the government is pushing hard, providing subsidies and creating avenues to avoid paying it back. The worst problem is that much of it is financing education with little chance of increasing future earnings. But the lack of quality, or productive, education would be a problem even if it was fully paid for with cash up front, with no borrowing at all.

The lack of a quality, earning-enhancing education is a legitimate long-term structural issue that can stifle productivity growth and therefore the growth potential of the US economy for decades into the future. Also, the easy availability of student loans tends to depress labor force participation among young people. Students are less likely to work than their friends who aren’t going to school. And because student aid has become more generous, students are less likely to work than students from a generation ago.

However, the effects of student loans on long-term productivity growth and labor force participation are not a short- or medium- term cyclical issue for the economy. They won’t derail the current expansion. Moreover, defaults on student debt, while rising, are still a small burden relative to the size of the economy.

It’s important to remember that, like other forms of debt, student loans re-arrange purchasing power. They don’t create or destroy purchasing power. Yes, students who graduate (as well as those who drop out) with larger debt loads will have more trouble buying a home as long as the debt burden exists.

However, the stakeholders in the college or university they attended – the professors, administrators, and other employees – view that student loan money as income. They buy homes, too.

Second, the financing burden of all consumer obligations combined – mortgages, rent, car loans and leases, student loans and other consumer loan obligations – was 15.3% of after-tax income in 2014, the lowest on record going back to 1980. So, yes, the burden of student debt is higher, but the burden of all consumer debt combined is much lower than usual.

Third, many student borrowers are starting to take advantage of loopholes designed to ease their burden, like income-based repayment plans and taking public sector jobs that can result in some “loan forgiveness.” This doesn’t mean we like these loopholes – trust us, we don’t. But, in effect, it means a portion of student loan debt won’t get repaid, which means the government has to absorb the cost, adding to government debt.

As usual, bad government policy is a key driver behind the big increase in student loan debt. Government subsidies encourage over-borrowing and lead to schools charging more for tuition and fees. As costs rise faster than inflation, and subsidies encourage the use of debt, students pursue loans more aggressively.

One idea we’ve heard would be to make schools guarantee some portion (we think 25% would be perfect), of all student loans used to pay tuition at their school. That kind of shift would be a game changer. Schools would have an incentive to teach real skills that can help students lift their future earnings.

A change like that will probably take several years. In the meantime, the huge increase in student loans is likely to remain a headwind for students who didn’t get value for their money, not for the economy as a whole.

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

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Posted on Monday, March 23, 2015 @ 10:43 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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