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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Housing Starts Declined 14.4% in August
Posted Under: Data Watch • Home Starts • Housing

Implications: Forget about home building for a minute. The most important economic news today was new claims for unemployment insurance dropping 36,000 last week to 280,000, the lowest level in two months and the second lowest reading since 2000. Continuing unemployment claims fell 63,000 to 2.43 million. As a result, First Trust’s payroll models, which are rated the best in the business by Bloomberg, are tracking another solid month for job growth in September, with an increase of 216,000 nonfarm and 219,000 for the private sector. On the housing front, despite the decline in housing starts in August, don’t let anyone tell you the recovery in home building is over. The 14.4% drop in August comes on the back of a 22.9% gain in July. Starts are volatile from month to month, so to find the underlying trend we look at the 12-month moving average, which now stands at the highest level since October 2008. The total number of homes under construction, (started, but not yet finished) increased 0.6% in August and are up 21.6% versus a year ago. No wonder residential construction jobs are up 123,000 in the past year. Multi-family construction is taking the clear lead in the housing recovery. Single-family starts have been in a tight range for the past two years, while the trend in multi-family units has been up (although volatile). In the past year, 36% of all housing starts have been for multi-unit buildings, the most since the mid-1980s, when the last wave of Baby Boomers was leaving college. From a direct GDP perspective, the construction of multi-family homes adds less, per unit, to the economy than single-family homes. However, home building is still a positive for real GDP growth and we expect that trend to continue. Based on population growth and “scrappage,” housing starts will rise to about 1.5 million units per year over the next couple of years.

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Posted on Thursday, September 18, 2014 @ 10:23 AM • Post Link Share: 
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  Rate Hikes Approaching
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

We count five major takeaways from today’s activity at the Federal Reserve.

First, quantitative easing (QE) still looks on track for winding down at the end of October. As expected, the Fed announced it would cut its purchases of Treasury securities and mortgage-backed securities to $15 billion in October and expects to announce an end to QE at the next meeting, which is October 29th.

Second, the median view among Fed officials is for a slightly faster increase in short-term rates. Back in June, the consensus was for the top of the federal funds target range to be 1.25% at the end of 2015; now it’s 1.5%. Previously the consensus was around 2.5% for the end of 2016, now it’s 3%. As a result, it now looks like the Fed will start raising rates by April 2015, perhaps even as early as the first quarter. To confirm this, look for the Fed to dump the “considerable time” language later this year.

Third, once it starts raising rates, the Fed will try to control the federal funds rate by using the interest it pays banks for holding excess reserves. It will also use reverse repos to help control the funds rate, but only as much and as long as needed. The Fed says it won’t use reverse repos for other purposes.

Fourth, the Fed isn’t going to outright sell securities from its portfolio to unwind its bloated balance sheet. After starting to raise the funds rate, the Fed will eventually allow its balance sheet to shrink in a passive way, by letting securities gradually mature without full reinvestment. The Fed is particularly reluctant to sell mortgage-backed securities (MBS), but may eventually do so several years down the road to clean up some long-dated securities on its books that won’t mature anytime soon. Long-term, the Fed intends to go back to holding almost all Treasury securities, not a large portfolio of MBS.

Last, where there’s smoke, there’s fire. Two Fed officials dissented from the statement, both Philadelphia Fed Bank President Charles Plosser and Dallas Bank President Richard Fisher. More importantly, both dissents were from hawks, which suggests that if the Fed makes any changes in policy or projections at the next couple of meetings, it’s more likely to get more hawkish than more dovish.

The Fed also made some minor changes to the language in its statement, noting that the unemployment rate is little changed since the last meeting and the economy is expanding moderately after the downside surprise in Q1 and sharp rebound in Q2.

The bottom line is that the Fed has been and will remain behind the curve. Nominal GDP – real GDP growth plus inflation – is up 4.2% in the past year and up at a 3.7% 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.

Hyperinflation is not in the cards; the Fed will keep paying banks enough to keep the money multiplier depressed. But, given loose policy, we expect gradually faster growth in nominal GDP for the next couple of years. In turn, the bull market in equities will continue to prevail and the bond market is due for a fall.

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

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Posted on Wednesday, September 17, 2014 @ 3:44 PM • Post Link Share: 
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  The Consumer Price Index Declined 0.2% in August
Posted Under: CPI • Data Watch • Inflation

Implications: Yellen and the doves could not have asked for a better inflation report for the day of their FOMC statement. After rising for 15 consecutive months, consumer prices took a breather in August, declining 0.2%. However, all of the drop was due to energy and one month by itself does not make a trend. So although today's report comes as welcome news to the doves, we do not believe it will change the Fed's plans for continued tapering, which will be announced later this afternoon. America’s booming energy production continues to subdue the rise in consumer prices. The index for energy declined 2.6% in August, led by a 4.1% decline in the cost of gasoline, which subtracted 0.3% from the overall index. Core prices, which exclude food and energy, were unchanged in August, the first time that the core index has failed to show an increase since late 2010. Despite the August data, since the start of 2014, consumer prices are up 1.8% at an annual rate versus the 1.5% pace in first eight months of 2013. Owners’ equivalent rent, which makes up about ¼ of the overall CPI, rose 0.2% in August, is up 2.7% over the past year, and will be a key source of the acceleration in inflation in the year ahead, in large part fueled by the shift toward renting rather than owning. The best news in today’s report was that “real” (inflation-adjusted) average hourly earnings rose 0.4% in August, the largest monthly gain in over a year. Plugging today’s CPI data into our models suggests the Fed’s preferred measure of inflation, the PCE deflator, probably declined 0.1% in August. If so, it would be up 1.4% from a year ago, still below the Fed’s target of 2%. We expect this measure to hit and cross the 2% target later this year or very early next year, consistent with our view that the Fed starts raising short-term interest rates in the first half of 2015. In other news this morning, the NAHB index, which measures confidence among home builders, rose three points to 59 in September, the best reading in nine years. Looks like a broad pick-up in both sales and foot traffic around the country.

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Posted on Wednesday, September 17, 2014 @ 11:08 AM • Post Link Share: 
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  The Producer Price Index was Unchanged in August
Posted Under: Data Watch • PPI

Implications: Inflation is still in a long-term rising trend, but that process is going to be gradual, with many stops and starts along the way. Booming energy production is a key reason why headline inflation hasn’t moved up more quickly. Producer energy prices fell 1.5% in August and are up only 0.2% from a year ago, a testament to fracking and horizontal drilling. Largely as a result, producer prices were unchanged in August and are up a modest 1.8% from a year ago. Still, through the first eight months of 2014, producer prices are up at a 2% annual rate, well above the 1.1% rate over the same period in 2013. The Federal Reserve should take note that rising inflation is more apparent in the services sector, where prices are up at a 2.6% annual rate in the past three months versus a 1.9% gain in the past year. Prices further back in the production pipeline (intermediate demand) do not yet confirm a continued acceleration in inflation. Prices for intermediate processed goods are up at a 1% annual rate in the past three months, slightly below the 1.2% gain over the past year. Prices for unprocessed goods saw a sharp 3.3% decline in August and are down at a 24.7% annual rate in the past three months. But intermediate demand prices are highly volatile and we expect prices to move higher over the coming months. Taken as a whole, the trend in producer price inflation continues to hover around 2%, suggesting the Fed should continue on the path of ending quantitative easing by the end of October. The problems that ail the economy are fiscal and regulatory in nature; continuing to add more excess reserves to the banking system is not going to boost economic growth. Loose monetary policy will eventually gain traction.

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Posted on Tuesday, September 16, 2014 @ 10:47 AM • Post Link Share: 
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  "Low" Foreign Rates Won't Keep US Rates From Rising
Posted Under: Europe • Government • Monday Morning Outlook • Fed Reserve • Interest Rates
Let’s imagine a college basketball team had a 13-1 record in conference play and was 26-4, overall, going into the NCAA tournament. You might assume it gets a top seed in the tourney and is favored to go deep, maybe even reach the Final Four. But what if we told you the team was Harvard?

They got a 12th seed in the tourney. No one is, or was, knocking Harvard. The Crimson had an awesome team last year, bumping off Cincinnati (a 5th seed) and then holding their own, until finally succumbing, to Michigan State. Everyone knows the12th seed Harvard was given made sense…it’s never just about the win-loss record.

Why bring this up? Because we keep hearing comparisons about US interest rates versus foreign interest rates. Some investors think long-term US rates can’t possibly go up, and might even fall, because many foreign interest rates are lower than US rates. The 10-year US Treasury yield is 2.6%, Japan is at 0.6%, Germany is 1.1%, and France is 1.4%. Italy is at 2.5% and even Spain has just a 2.3% yield. All these countries have much higher default risk than the US.

Ask an academic economist how this can happen and he’d probably say something about “interest-rate parity” and “forward currency markets.” This theory says that if we adjust interest rates by expected changes in the value of a currency, then, in fact, interest rates are equal around the world. So, if you can earn a higher rate, you will pay for it with a falling currency. Do the math, and rates are always at “parity.”

But this “blackboard economics” doesn’t work. The Euro and yen have been declining versus the dollar and should stay on that course as the Europeans and Japanese loosen up monetary policy at the same time the Federal Reserve moves gradually towards tightening and higher short-term rates.

Instead, we think economic fundamentals can explain the current foreign interest rate conundrum, while also pointing to rising US rates. Nominal GDP growth in the Eurozone – real GDP growth plus inflation – is 1.2% annualized in the past two years. In this context, it makes sense that German and French long-term rates are 1.1% and 1.4% respectively, very close to where the fundamentals say they should be.

Interest rates in Italy (2.5%) and Spain (2.3%) are about 100 basis points higher than in Germany and France. Why? These countries have even slower nominal GDP growth than Europe as a whole. The answer is “default risk.”

In other words, once adjusted for the fundamentals, European interest rates aren’t really “low,” just like a 12th seed in the NCAA tourney for Harvard wasn’t a slap in the face.

It also makes sense for Japan. Although nominal GDP is up at a 1.3% annual rate in the past two years, Japan has actually experienced a contraction in total nominal output over the past 20 years. Investors are still waiting to see whether “Abe-nomics” can permanently break this long term decline. You may think Japan should have a higher bond yield, but its longer-term growth data say a 0.6% yield is reasonable.

By contrast, US nominal GDP is up at a 3.7% annual rate in the past two years (and 4.4% annually over the past 20 years). But long-term rates are only 2.6%. In other words, on a relative basis, adjusted for the fundamentals, US rates look really, really low and should move higher in the next few years.

The bottom line is that comparing the level of interest rates across countries with no reference to other economic data risks coming to a very wrong conclusion. You can’t just look at a won-loss record, you can’t just look at yield. Once we adjust for fundamentals, we think rates are headed higher.

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Posted on Monday, September 15, 2014 @ 11:25 AM • Post Link Share: 
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  Industrial Production Declined 0.1% in August
Posted Under: Data Watch • Industrial Production - Cap Utilization

Implications: No, the sky is not falling on the US economy. Although industrial output slipped 0.1% in August, falling short of the 0.3% consensus expected gain, the decline was all due to the highly volatile auto sector. It was the first monthly drop since January and only the second monthly drop in the past year. During economic expansion, it’s normal for industrial production to decline two or three times per year, and this is no different. July had the largest monthly gain for automakers since September 2009, and August simply saw a return to the pre-existing trend for that sector. Excluding July, auto production was the highest on record in August and up 8% from a year ago. Outside the auto sector, manufacturing grew 0.1% in August. We expect continued growth in the industrial sector in the year ahead. The housing recovery is still young and both businesses and consumers are in a financial position to ramp up investment and the consumption of big-ticket items, like appliances. In particular, note that the output of high-tech equipment is up 7.4% from a year ago and up at a 13.2% annual rate in the past six months, signaling companies’ willingness to upgrade aging equipment. Despite a drop in August, capacity utilization still stands at 78.8%, right around the average of 78.9% over the past twenty years. Further gains in production in the year ahead will push capacity use higher, which means companies will have an increasing incentive to build out plants and equipment. In other news this morning, the Empire State index, a measure of manufacturing sentiment in New York, soared to 27.5 in September versus 14.7 in August. The index is now the highest in more than four years and signals robust growth ahead for the industrial sector.

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Posted on Monday, September 15, 2014 @ 10:51 AM • Post Link Share: 
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  Retail Sales Increased 0.6% in August
Posted Under: Data Watch • Retail Sales

Implications: A very solid report out of the retail sector today. Retail sales rose 0.6% in August, increasing for the seventh consecutive month, and rising by the most in four months. Sales continue to grow at a healthy clip from a year ago, up 5%. Moreover, the “mix” of retail sales was even better news than the headline, as gas station sales dropped 0.8% due to lower gas prices. Gas prices are also down 0.8% from a year ago. The widespread use of fracking and horizontal drilling is making this possible, which means consumers can take the money they save on filling their tanks and spend it on other things. “Core” sales, which exclude autos, building materials and gas, increased 0.4% in August and 0.8% including upward revisions to June and July. “Core” sales have now been positive in eleven of the last twelve months. These sales are a key input into GDP calculations and, if unchanged in September, the sales will grow 4.7% at an annual rate in Q3 versus Q2. Once we include other spending (on services and durables), our expectation is that “real” (inflation-adjusted) consumer spending, goods and services combined, will grow at a 2% annual rate in Q3. We expect consumer spending to accelerate in the year ahead, as lower unemployment means an acceleration in income gains at the same time that consumer debt service is hovering near multiple-decade lows. In other news this morning, no consistent sign yet of inflation in trade prices. Import prices fell 0.9% in August, although they declined only 0.1% excluding oil. Export prices slipped 0.5% in August and declined 0.3% excluding agriculture. In the past year, import prices are down 0.4% while export prices are up 0.4%. In other recent news, new claims for unemployment insurance increased 11,000 last week to 315,000. Continuing claims rose 9,000 to 2.50 million. These figures are consistent with our early forecast that payrolls are growing roughly 200,000 in September.

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Posted on Friday, September 12, 2014 @ 10:36 AM • Post Link Share: 
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  Why Do Stocks Keep Rising?
Posted Under: Bullish • Markets • Monday Morning Outlook • Stocks
So far this year, the S&P 500, including dividends, has returned 10.1% to investors. The NASDAQ, including dividends, is up 10.7%.

This has happened even though the Federal Reserve has tapered bond purchases from $85 billion per month, to the current $25 billion. And everyone knows, QE will fall to $15 billion after September 17th and zero after the Fed’s meeting in late October.

The market is up in spite of Vladimir Putin invading Ukraine, the rise and rapid spread of ISIS in Iraq and Syria, and even volcanoes in Iceland. It’s up even though Ebola is spreading in Africa, there are upcoming Congressional elections in the US, and some members of the Fed are publicly speaking about the need to raise interest rates sooner than next year.

The stock market is up even though some previously bullish analysts have turned skeptical or even bearish. It’s up even though it had a little hiccup back in July and even though the 5-year Treasury yield is up 100 basis points since early 2013.

This continues a trend that started sixty-six months ago on March 9, 2009. Since then, the S&P 500 is up at annualized average of 24% (including dividends). And the things the market has worried about in the past year don’t hold a candle to the fears stirred up over those previous five years.

During those five years, pundits on many business TV shows, after hearing that we thought stocks could go even higher and that the economy would keep growing, always asked “yeah, but what about ______”?

You can fill in the blank with a hundred things…they certainly did…the Sequester, Greece, Dubai, Cypress, the Fiscal Cliff (twice), part-time jobs, and on and on. This incessant pessimism, the constant belief that things were bound to go wrong seems almost surreal. How can somebody stay negative for so long, but convince themselves that they are always right?

Maybe this is why CNBC viewership is falling. According to Zap2it.com, it’s fallen to a 2-year low (click here).

It’s important to remember that many people watch business TV at work and ratings services do not do a good job of capturing this viewership. Nonetheless, if these data capture any type of decline at all, it’s a real shame.

The 21st century is an amazing period of entrepreneurial activity. Fracking, 3-D printing, robotics, biotech advances, the Cloud, wireless communication technologies, smartphones, tablets, and apps are just a few of the areas of massive advancement.

The business world is vibrant, productive and massively efficient. One broad measure of profits has grown 20% at an annual average rate between Q4-2008 and Q2-2014. How come TV can’t capture that vibrancy in a way that attracts more viewers?

The good news is that TV does not drive stock prices, profits do. Rising profits prove that resources are being utilized more efficiently and when resources are used more efficiently, they become more valuable.

One problem the pessimists have is that they look back at 2008 and see a failure of markets and the success of government. But TARP and QE never saved the economy. Stock markets fell an additional 40% after TARP was passed.

But once mark-to-market accounting rules were changed in March/April 2009, the crisis ended and a recovery began. That recovery has been real, not a “sugar high,” built on government action.

It may not have been the strongest recovery ever, but in those areas driven by, or that utilize, new technology, it has certainly been profitable.

That’s why stocks keep rising in spite of all the negative news that circulates. Understanding profits is the key to understanding why stocks keep rising.

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Posted on Monday, September 08, 2014 @ 10:49 AM • Post Link Share: 
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  Nonfarm Payrolls Increased 142,000 in August
Posted Under: Data Watch • Employment

Implications: Remember back in 2011 when the first jobs report for August showed zero payroll growth? Commentators on both right and left said the economy was going back into recession. But revisions over the next two months took that number up to 104,000. The same thing happened in August 2012 and August 2013: a weak initial report followed by big upward revisions. That’s why the First Trust economic group had a weaker forecast than anyone else and why we came closer than anyone else to today’s tepid payroll numbers. Payrolls grew 142,000 in August, well below the consensus expected 230,000, but we anticipate substantial upward revisions over the next couple of months. Meanwhile, the unemployment rate ticked down slightly, to 6.1%, as expected. The decline in the unemployment rate was due to a 64,000 drop in the labor force while civilian employment, an alternative measure of jobs that includes small business start-ups, grew 16,000. The drop in the labor force pushed the participation rate back down to 62.8%, tying the lowest level since the late 1970s. The survey on the labor force is volatile from month to month, so it’s important to look at longer term trends. In the past year, the labor force is up 524,000 while civilian employment is up 2.2 million, driving the jobless rate down to 6.1% from 7.2% a year ago. The aging of the Baby Boomers will keep putting downward pressure on the participation rate but, even so, we expect the participation rate to remain roughly flat to slightly up in the next year as improvement in job opportunities temporarily offsets population aging. If you listen carefully, you should notice the deafening silence from those who obsess about part-time workers. That extremely volatile series was down 370,000 in August and down 400,000 from a year ago. Perhaps the best news in today’s report was that average hourly earnings and total hours worked continued to increase and are both up 2.1% from a year ago. As a result, total cash earnings are up 4.2% from a year ago, more than enough for consumers to keep increasing spending. The bottom line is that it’s important not to read too much into the August report. Recent years have seen big upward revisions in subsequent months and we think this time will be no different. In the past year, nonfarm payrolls are up 207,000 per month while civilian employment is up 182,000 per month. We expect the employment data to accelerate in the year ahead as payrolls continue to show healthy gains.

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Posted on Friday, September 05, 2014 @ 10:45 AM • Post Link Share: 
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  The ISM Non-Manufacturing Index Increased to 59.6 in August
Posted Under: Data Watch • ISM Non-Manufacturing

Implications: Another strong reading from the service sector as the ISM services index jumped to 59.6 in August, beating the forecast from all 74 economic groups that made a prediction and coming in at the highest reading since August 2005. The ISM service sector has now shown expansion for a 55th consecutive month. Paired with the strong ISM manufacturing report from Tuesday, it’s clear the economy is continuing to bounce back from the harsher than normal winter that slowed activity at the start of the year. The business activity index– which has a stronger correlation with economic growth than the overall index – rose 2.6 points in August to 65.0, the highest reading for the index in close to ten years. New orders dipped slightly, but remain at a very robust reading of 63.8, suggesting production should continue to pick up in the months ahead. After the drop back in April, the employment index has expanded for each of the past four months and, with this month’s reading of 57.1, has moved above the average reading of 56.5 seen over the past five years. As employment continues to expand, expect income growth to boost consumer spending and business revenue, which, in turn, will help support even more job growth in the future. In other words, the growth in the economy is self-sustaining and should remain that way until monetary policy gets tight, which is at least a few years away. On the inflation front, the prices paid index dropped to a still elevated 57.7 in August from 60.9 in July. No sign of runaway inflation, but given loose monetary policy, we expect this measure to either stay elevated or move upward over the coming year. Once again, we have a report showing the Plow Horse economy may be starting to trot. In other recent news, Americans bought cars at a 17.5 million annual rate in August, much higher than the consensus expected and the fastest pace since January 2006. Sales were up 6.4% versus July and up 10% from a year ago. These figures suggest a strong rebound in retail sales in August after no change in July.

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Posted on Thursday, September 04, 2014 @ 11:21 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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The Trade Deficit in Goods and Services Came in at $40.5 Billion in July
Nonfarm Productivity Increased at a 2.3% Annual Rate in the Second Quarter
The ISM Manufacturing Index Surged to 59.0 in August
Labor's Great, Capital is Key
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New Orders For Durable Goods Boomed 22.6% in July
Tapering Has Not Hurt The Economy
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