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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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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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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve

Source: St. Louis Federal Reserve FRED Database
Posted on Monday, March 23, 2015 @ 7:45 AM • Post Link Share: 
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  Yellen Loses “Patience,” But Maintains Flexibility
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

The Federal Reserve is no longer committed to being “patient” before it starts raising rates. In Fed-speak, that means it will actively consider raising rates starting in two meetings, which will be in mid-June.

However, a June rate hike is not a fait accompli. Fed Chief Yellen appears to have bent over backward to make sure the Fed’s doves don’t feel like they’re being railroaded into supporting a rate hike at that meeting.

For example, the Fed reduced its projection for the unemployment rate over the long run to about 5.1%, which is about 0.25 percentage points below what it projected only three months ago. That change is important because the Fed’s economic models say a lower unemployment rate relative to the long-run average translates into higher inflation. So, by cutting the long-term average, the unemployment rate can go lower before the Fed’s models signal higher inflation.

In addition, there were some notable changes to the “dot matrix” showing where Fed policymakers think interest rates will go over the next few years. Back in December, the dots showed the median policymaker at the Fed thought short-term rates would rise 100 basis points this year and 125 – 150 bp in 2016. Now the median dots suggest rate hikes of only 50 bp this year and 125 bp next year.

Yellen herself appears to have participated in the downgrade of rate-hike expectations. There are 17 participants at the meeting and she is probably on the dovish side. So, with the highest dot being the most hawkish, we’re guessing Yellen is probably around dot number 12. Back in December, that dot suggested an increase of 75 bp this year and 125 bp next year. Now that same dot suggests 50 bp this year and 100 bp next year.

However, we would not read too much into these changes. Yellen is going to great lengths to make sure the extreme doves at the Fed – the ones who would prefer to go all year without a rate hike – feel like they’re being heard. Recent data on retail sales, manufacturing output, and home building have all been weak, so the Fed has room to recognize a moderation in the pace of economic growth. Our models suggest real GDP growth is tracking an annualized pace of 1% in Q1 and we bet the Fed’s models are showing something similar. But, like last year, we expect the pace of growth to bounce back rapidly by mid-year.

Ultimately, the Fed’s statement today was about being dependent on the data. We suspect Yellen understands a pick-up in growth is likely, just like last year, and by that time she will have the chance to alter her forecast, as will the others at the Fed. And, having recognized recent weakness at today’s meeting, she’ll have a better chance to get the more extreme doves to acknowledge a re-acceleration in growth by June.

The bottom line is that, although we’re not quite as confident as we previously were, we still think the Fed is on track to start raising rates in June. Nominal GDP – real GDP growth plus inflation – is up 3.6% in the past year and up at a 4.1% annual rate in the past two years. A federal funds target rate of nearly zero is too low given this growth. It’s also too low given well-tailored policy tools like the Taylor Rule.

Either way, once the Fed eventually raises rates, it’s unlikely to raise rates at every meeting, as was done in the past two prolonged rate hike cycles under Alan Greenspan in the late 1990s and Ben Bernanke in the middle of the prior decade. Instead, the Fed will probably raise rates at every other meeting for the first year, before embarking on a more aggressive path in the second half of 2016 and beyond.

Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist

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Posted on Wednesday, March 18, 2015 @ 4:03 PM • Post Link Share: 
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  Housing Starts Declined 17.0% in February
Posted Under: Data Watch • Home Starts • Housing

Implications: Don’t get bent out of shape about housing starts plummeting in February. Instead, take a moment to review the data for the month. Retail sales were weak, except for buying over the internet and by mail-order. Utilities soared at the fastest pace in more than 40 years, while manufacturing production fell. And now housing starts plummeted at the second fastest pace in the last twenty years. If it wasn’t obvious already, it should be now: the coldest February temperatures for the most people since 1979 had a huge (but temporary) effect on the economy. In fact, Americans in 23 states experienced a “top-10-coldest February” going all the way back to 1895! But, like last year, we expect a big bounce in growth in the months ahead. Housing starts fell 17% in February, the largest drop in four years. The Northeast had its second slowest pace of housing starts on record, going back to 1959. When it’s this cold and snowy it’s nearly impossible to break ground. However, in spite of the drop in starts, there are still signs the trend in home building is upward. The total number of homes under construction, (started, but not yet finished) increased 0.4% in February and are up 17.1% versus a year ago. Permits for future building rose 3% in February and are up 7.7% from a year ago, boding well for future gains in housing starts. Based on population growth and “scrappage,” housing starts should rise to about 1.5 million units per year over the next couple of years, 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, declined to 53 in March from 55 in February. Readings greater than 50 mean more respondents said conditions were good than bad. Expect more Plow Horse-like gains in housing in the year ahead.

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Posted on Tuesday, March 17, 2015 @ 10:19 AM • Post Link Share: 
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  Industrial Production Rose 0.1% in February
Posted Under: Data Watch • Industrial Production - Cap Utilization

Implications: Today’s report on industrial production was buffeted by three major issues: bad weather, west coast port strikes, and lower oil prices. Lucky for us, the effects of these issues will be temporary. According to the government’s weather service, this February was the coldest for the most people since 1979. As a result, utility output surged 7.3%, the largest monthly gain ever recorded going back to 1972! But, while raising utility production, harsh winter weather made it tougher on the manufacturing sector. Manufacturing fell 0.3% as auto output dropped sharply and the rest of manufacturing showed no change. The west coast port strikes hurt manufacturing as well. For example, Honda said they had to stop or reduce production on multiple days at six facilities because of parts shortages in February. The third key issue is lower oil prices, which helped cut mining (which includes oil and gas exploration) by 2.6%, the largest drop in any month since the Panic of 2008. Indexes for coal mining as well as oil & gas well drilling and servicing accounted for the majority of the drop. Energy prices remain low, but even if they stay here, mining production should soon bottom out. And if energy prices bounce at all, mining will bounce as well. Given the end of the port strikes and a return to more normal weather patterns, industrial production is very likely to snap back in March and continue growing in the year ahead. Companies are sitting on huge cash reserves and profits are at record highs. In addition, at 78.9%, capacity utilization remains higher than the average of 78.6% over the past twenty years, so further gains in production will give companies an incentive to build out plants and buy equipment. In other manufacturing news today, the Empire State index, a measure of manufacturing sentiment in New York, came in at a moderate 6.9 in March versus 7.8 in February.

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Posted on Monday, March 16, 2015 @ 11:53 AM • Post Link Share: 
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  Resist the Rate-Hike Huff
Posted Under: GDP • Government • Monday Morning Outlook • Fed Reserve • Interest Rates
In June 2013, then-Federal Reserve Chair Ben Bernanke hinted the time to “moderate” quantitative easing was approaching. The press called this “tapering”. The Fed would end QE gradually, by slowly shrinking its asset purchases rather than going cold turkey.

What happened? Within a week, US equities had sold off about 5% and the 10-year Treasury yield shot up about 40 basis points, from 2.2% to 2.6%. It’s known widely as the “taper tantrum” and that phrase is used by some pessimists to show how vulnerable the market is, or was.

Many believed the economic recovery couldn’t possibly continue without the support of the Fed. Others went so far as to say emerging markets would collapse.

The Fed held off for a while, but started tapering in 2014, and appointed a new Chair, Janet Yellen, who finished tapering at the end of October 2014.

And what happened? The unemployment rate fell from 6.7% to 5.6%, the US created 3 million new jobs and real GDP expanded by 2.4% in 2014 (roughly equal to the 2.3% growth rate of the current recovery). Equity investors soon caught onto the economy’s resilience, and the S&P 500, including dividends, rose 13.7% to an all-time high.

In an eerily similar pattern, some investors are in a “rate-hike huff” because the Fed is heading toward a modest first rate hike in June. We fully expect the Fed to begin the process this week by removing the word “patient” from its policy statement. Projecting further out, we expect rate hikes to be very gradual and modest for about the first year, with increases of about 25 basis points per calendar quarter, or only one full percentage point in the first year.

Like tapering, this will not hurt economic growth. Nominal GDP – real GDP growth plus inflation – has been expanding near a 4.0% annual rate for the past few years, which is easily good enough to justify higher short-term interest rates. Short-term rates would have to rise to 3.5% or above before we became concerned, and for any real worriers out there, the M2 money supply has accelerated recently suggesting that the Fed is not even close to tight.

In a repeat of last year, there will be another temporary slowdown in GDP growth and other data during the first quarter of this year. The good news is that we have seen this movie before and we know the ending.

Even though it seemed so obvious, many thought weather had little or nothing to do with the 2.1% annualized drop in real GDP in the first quarter of 2014. Some said they thought the weather was a Soviet-style lame excuse for weaker-than expected earnings or other data. Some argued the Fed would be forced to change course and do another round of QE.

Then came a sharp rebound in growth in the middle two quarters of 2014, showing it was the weather after all.

This year seems to be following a miniature version of that same pattern. The National Oceanic and Atmospheric Administration (NOAA) – no, they can’t part the seas – uses a measure called Heating Degree Days (HDDs) to measure temperature.

What this data shows is that February 2015 was the coldest February, for the most people, since 1979. Add in a port strike on the West Coast, and we’re now anticipating a tepid growth rate of just 1% for the first quarter, with a bounce back in the middle of the year, just like last year.

And just as last year’s data slowdown in Q1 didn’t stop the Fed from tapering, this year’s volatility and weak data won’t stop the Fed from raising rates by mid-year.

The best news is that equities rebounded in 2014, despite continued tapering. We expect the same this year as the Fed launches its first rate-hike-cycle since 2004. And weakness now is a head-fake caused by a “hike-huff.”

Brian S. Wesbury - Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Posted on Monday, March 16, 2015 @ 11:38 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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