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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  The First Estimate for Q4 Real GDP Growth is 2.6%
Posted Under: Data Watch • GDP

Implications: Today’s report on GDP confirms that six years into the recovery the economy remains a Plow Horse. Ultimately, we believe the key reason is the expansion of government transfers in the past decade or so, which has lowered the growth potential of the US economy toward (but not fully to) a more European pace. After a weather-related plunge in the first quarter of last year, real GDP growth roared back at a 4.8% annual rate in the middle two quarters of 2014. But with real growth at a 2.6% annual rate in Q4, we’re right back near the trend, which includes a 2.5% growth rate in 2014 and a 2.3% rate since the recovery started in mid-2009. The best news in the report was “core” GDP (real GDP excluding inventories, trade, and government, none of which can be relied on for long-term growth). It grew at a robust 3.9% annual rate in Q4 and was up 3.2% in 2014, exactly matching the pace in 2013. The worst news was that inventories added 0.8 percentage points to the real GDP growth rate in Q4. This pace will be very tough to sustain. However, the government estimated that net exports were a drag of a full percentage point. We believe as actual data comes in that this drag will be smaller. On net, we still expect growth in the 2.5 – 3% range for 2015. In terms of monetary policy, today’s report should keep the Federal Reserve on track to raise rates in June. Nominal GDP (real GDP plus inflation) rose at a tepid 2.5% annual rate in Q4, but was up 3.7% in 2014 and at an annual rate of 4.1% in the past two years, not much below the average of 4.4% in the past twenty years. Nominal GDP is growing too fast for a short-term interest rate near zero. The Fed is also watching the Employment Cost Index, which grew 2.3% in 2014, the fastest pace since 2008. In other recent news, new claims for jobless benefits fell 43,000 last week to 265,000. That’s in part related to MLK Day, but it’s still the lowest level since 2000 and there’s an MLK Day every year. Continuing jobless claims fell 71,000 to 2.39 million. As a result, our models now suggest a January nonfarm payroll gain of 245,000, another solid month. Meanwhile, the Chicago PMI, a measure of manufacturing sentiment in that region, increased to 59.4 in January from 58.8 in December. On the housing front, pending home sales, which are contracts on existing homes, slipped 3.7% in December, suggesting existing home sales, which are counted at closing, will be down in January.

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Posted on Friday, January 30, 2015 @ 11:04 AM • Post Link Share: 
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  Initial Jobless Claims Plummet
Posted Under: Bullish • Employment
Late last year, the consensus (and the media) started turning more bullish on the economy. We welcomed them aboard the less pessimistic train. But durable goods orders and retail sales were both weak in December. Then there were the Greek elections, rising fears of deflation and recession in Europe, a slowdown in China, and a few big-name companies reported weaker than expected profits. This all adds up to many of the “newly bullish” starting to doubt themselves.

They shouldn’t.

Today we got a look at initial claims for unemployment insurance for the week ending January 24th. This is the closest thing we get to “real-time” economic data and we have found it to be a great leading indicator of the economy and labor market conditions. After a few weeks of rising claims, today’s data (which is really from last week) dropped to 265,000, a decline of 43,000 from the prior week, and the best level since April 15, 2000. This is the lowest reading so far in this recovery or during the expansion in 2001-07.

Yes, Martin Luther King Jr. Day may have played some role, but the 4-week moving average is now 298,500. This is not the lowest we have seen this year, but it is down from 335,250 the same week a year ago (which also included the holiday). With initial jobless claims running under 300,000 per week, and remaining at very low historical levels compared to total employment, we see little evidence of any serious slowdown in the economy.

As a real-time indicator, we watch initial claims closely. So, even though there is evidence of global turmoil, the U.S. economy remains relatively healthy.

Posted on Thursday, January 29, 2015 @ 1:39 PM • Post Link Share: 
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  Rate Hikes Still A Few Meetings Away
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. The Fed continued to say it would be “patient” before raising short-term interest rates, which means the Fed is very unlikely to raise rates through at least April.

However, the Fed did make some noticeable changes to the language in the statement, upgrading its assessment of both economic growth and the labor market, while recognizing both lower inflation (due to falling energy prices) and lower market-based measures of inflation expectations. 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%.

Unlike the past several meetings, this one appears to have been much less contentious. Three voting members dissented at the December meeting; this time, no one dissented, the first time that’s happened since the meeting in June 2014. Both the hawks and doves who previously dissented are no longer voting members this year.

All of this is consistent with our view that the Fed is still on track to start raising rates in June. It is 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.

Another issue is when the Fed’s balance sheet will go back to normal. We’re still forecasting that the Fed will keep reinvesting principal payments from its asset holdings to maintain the balance sheet at roughly $4.4 trillion through at least late 2015.

The bottom line is that while the Fed is still behind the curve, it’s at least finally pointed in the right direction, and, barring some major shift in its outlook for the economy, the clock is ticking on rate hikes. Nominal GDP – real GDP growth plus inflation – is up 4.3% in the past year and up at a 4.0% 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.

In the meantime, 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 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, January 28, 2015 @ 3:24 PM • Post Link Share: 
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  New Orders for Durable Goods Declined 3.4% in December
Posted Under: Data Watch • Durable Goods

Implications: It’s certainly not good when orders for durable goods decline rather than rise, but we would take the 3.4% drop in December with a big grain of salt. Almost all of the decline was in the transportation sector, led by aircraft, orders for which are extremely volatile from month to month. Outside the transportation sector, orders still slipped 0.8%, but are up 3.8% from a year ago. Orders ex-transportation are down three months in a row, but these orders were down five months in a row in mid-2012 even as the economy was expanding at a 2% annual rate. What we’re probably seeing is some reaction to lower oil prices, which is reducing orders for equipment used to explore for oil. Next week’s report on factory orders will provide more details. The worst news in today’s report was that “core” shipments,” which exclude defense and aircraft, declined 0.2% in December and were down at a 3.3% annual rate in Q4 versus the Q3 average. As a result, it now looks like business investment in equipment shrank at a 3.5% annual rate in Q4. In turn, we’re marking down our forecast for Q4 real GDP growth to a still healthy 3.1% annual rate from a prior estimate of 3.3%. Keep in mind, though, that the drop in orders is not consistent with ongoing gains in manufacturing production. Signaling future gains in output, unfilled orders for “core” capital goods rose 0.2% in December, hit a new record high, and are up 8.6% from a year ago. Expect more of the same, as lower oil prices mean higher production outside the oil sector. Orders and shipments for durables should accelerate 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 breaching long-term norms, leaving more room (and need) for business investment. In other news this morning, the Richmond Fed index, which measures mid-Atlantic manufacturing sentiment, came in at +6 in January versus +7 in December, signaling continued growth.

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Posted on Tuesday, January 27, 2015 @ 11:43 AM • Post Link Share: 
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  New Single-Family Home Sales Boomed 11.6% in December
Posted Under: Data Watch • Home Sales • Housing

Implications: Sales of new homes ended 2014 on a high note soaring 11.6% in December and coming in at the highest level since June 2008. Sales are up 8.8% from a year ago and look to be picking up some steam. It’s about time! New home sales had been depressed for a few reasons. First, the homeownership rate is low as 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. But that is starting to change. Recently, single-family housing starts have started growing faster than multi-family starts, which is an early sign of a larger appetite for homeownership and single-family purchases. Builders have already started to react and have much further to go. The inventory of new homes rose 5,000 in December, but still remains very low, as the chart to the right shows. As a result, homebuilders still have plenty of room to increase both construction and inventories. The median sales price in December increased 2.2% and is up 8.2% from a year ago. The increase in December was due to the “mix” of home sales in that particular month. Sales of homes over $750,000 made up 8% of sales in December, compared to 4% in November, while homes priced under $200,000 accounted for 18% of sales in December, down from 25% in November. In other news this morning, the Case-Shiller home price index increased 0.8% in November (seasonally-adjusted) and was up 4.7% from a year ago. Although still a solid gain, it’s much smaller than the 10.7% increase in the 12 months ending in November 2013. Expect more of the same in the year ahead, with price gains continuing, but at a slightly slower pace. In the past year, price gains have been led by San Francisco, Miami, Las Vegas, Dallas, and Denver. The smallest gain, of only 0.6%, was in Cleveland (sorry, Lebron).

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Posted on Tuesday, January 27, 2015 @ 10:52 AM • Post Link Share: 
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  GDP, Strong Again
Posted Under: Europe • GDP • Monday Morning Outlook
With all the focus on Europe in general and Greece in particular, it’s important to keep in mind that the US economy continues to move forward. After real GDP dropped in the first quarter of last year, some analysts were predicting another recession. By contrast, we said the drop was due to unusually harsh winter weather and the economy would rebound quickly.

And rebound it did. Real GDP grew at a 4.6% annual rate in the second quarter and a 5% rate in the third. On Friday, the government will report its initial estimate for real GDP growth in Q4 and we think the economy grew at a 3.3% annual rate. If we’re right, real GDP was up a Plow Horse 2.6% in 2014, slightly faster than the 2.3% pace the economy has averaged since the recovery started in 2009.

For 2015, we’re forecasting 2.7%. Some analysts are lifting their forecasts based on plummeting oil prices and Europe’s quantitative easing, while some might mark them down due to Greece. But these are all sideshows.

Lower oil prices may push up non-oil spending, but oil production will now expand more slowly. QE in Europe is not going to help boost growth; it’ll just stuff European banks with as many useless excess reserves as US banks hold already. And our exports to Greece are less than 0.01% of US GDP.

Instead, investors need to focus on the fundamentals that drive the economy, which haven’t changed. Monetary policy remains loose, tax rates are not going up (regardless of what President Obama said in his State of the Union address), and entrepreneurs are still innovating.

Below is our “add-em-up” forecast for Q4 real GDP.

Consumption: Auto sales increased at a 0.5% annual rate in Q4 while “real” (inflation-adjusted) retail sales outside the auto sector were up at a tepid 1.8% rate. But services make up about 2/3 of personal consumption and those were up at about a 4.5% rate. So it looks like real personal consumption of goods and services combined, grew at a 3.8% annual rate in Q4, contributing 2.6 points to the real GDP growth rate (3.8 times the consumption share of GDP, which is 68%, equals 2.6).

Business Investment: Business equipment investment and commercial construction were both unchanged in Q4. Factoring in R&D suggests overall business investment grew at a 0.8% rate, which should add 0.1 point to the real GDP growth rate (0.8 times the 13% business investment share of GDP equals 0.1).

Home Building: A 9% annualized gain in home building in Q4 will add about 0.3 points to real GDP (9 times the home building share of GDP, which is 3%, equals 0.3).

Government: Public construction projects continued to increase in Q4 while military spending picked up as well. As a result, it looks like real government purchases grew at a 1.1% annual rate in Q4, which should add 0.2 percentage points to real GDP growth (1.1 times the government purchase share of GDP, which is 18%, equals 0.2).

Trade: At this point, the government only has trade data through November, but the data so far suggest the “real” trade deficit in goods has gotten a little smaller. As a result, we’re forecasting that net exports add 0.1 point to the real GDP growth rate.

Inventories: After a weather-related lull in Q1, companies built inventories at a very rapid pace in Q2. Since, then that pace has neither slowed nor sped up further, meaning inventories are a net zero for GDP, neither adding nor subtracting.

The US government has expanded way too much in the past decade or so, which is why we have a Plow Horse economy rather than a Race Horse economy. But, even in this environment, the private sector still has room to grow. Not just in Q4, but in 2015 and likely beyond.

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Posted on Monday, January 26, 2015 @ 10:05 AM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve

Posted on Monday, January 26, 2015 @ 8:14 AM • Post Link Share: 
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  Existing Home Sales Rose 2.4% in December
Posted Under: Data Watch • Home Sales • Housing

Implications: Sales of existing homes are trending up, but nowhere close to booming. Sales rose 2.4% in December and are up only a modest 3.5% from a year ago. However, the underlying fundamentals are improving. Distressed homes (foreclosures and short sales) now account for only 11% of sales, down from over 30% in the recent past, while all-cash buyers are down to 26% of sales from a high of 35% in February 2014. As a result, non-cash sales (where the buyer uses a mortgage loan) have jumped to 74% of the total and have been rising. In other words, 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. Those predicting a housing crash from tapering were completely wrong. Probably the biggest reason 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 at the lowest level in almost two years. 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. Also, on the housing front, the FHFA index, which measures prices for homes financed with conforming mortgages, was up 0.8% in November, the largest increase in 18 months. In the past year, the FHFA index is up 5.3% versus a gain of 7.4% in the year ending in November 2013. We expect further gains in home prices in 2015, although at a slower pace than in recent years. In other recent news, new claims for unemployment benefits declined 10,000 last week to 307,000. Continuing claims increased 19,000 to 2.44 million. Plugging these figures into our models suggests nonfarm payrolls will be up 231,000 in January. That would bring the total gain for the past twelve months to more than 3 million, the first time that’s happened for any 12-month period since 1999.

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Posted on Friday, January 23, 2015 @ 11:10 AM • Post Link Share: 
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  Housing Starts Rose 4.4% in December
Posted Under: Data Watch • Home Starts

Implications: Home building continues to pick up steam and the recovery still has much further to go. Housing starts rose 4.4% in December, easily beating what the consensus expected, and has shown annualized growth exceeding one million units for a fourth straight month. Overall, more homes were started in 2014 than any year since 2007. The best news in the report was that the gain in December was all due to single-family units, which generate more real GDP per unit than multi-family homes, like apartments. Even the negative news in the report had a silver lining. Building permits fell 1.9% in December, but all of the drop was due to multi-family units, which are very volatile from month to month; permits to build single-family homes hit the highest level since 2008. Until recently, the recovery in home building had been dominated by multi-family units. As a result, the number of multi-family units still under construction is now the highest since 1987, when the last wave of baby Boomers had recently graduated college and filled up apartment buildings. But today’s data adds to the evidence that the recovery in single-family housing is starting to catch up. Over the past two years, multi-family starts have been roughly unchanged while single-family starts are up 18.4%. Multi-family permits are down 9.9% from a year ago, while single-family permits are up 8.1%. The underlying trend in housing clearly remains upward and we expect that to continue. No wonder residential construction jobs are up 132,100 in the past year. Based on population growth and “scrappage,” housing starts should rise to about 1.5 million units per year over the next couple of years. In other recent housing news, yesterday, the NAHB index, which measures confidence among home builders, declined to 57 in January from 58 in December. Readings greater than 50 mean more respondents said conditions were good rather than poor. Given the pick-up in construction, look for sales numbers to pick up as well in the year ahead.

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Posted on Wednesday, January 21, 2015 @ 10:02 AM • Post Link Share: 
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  Davos - And the Euro
Posted Under: Europe • Government • Monday Morning Outlook • Trade
Perfect! Last week, the Swiss National Bank in reaction to market pressure, ended its crawling peg against the euro. The Swiss Franc surged 40% versus the euro, before settling around 20% higher, and roughly 17% against the already strong dollar. So, guess what? Attendees at The World Economic Forum – an annual gaggle of the global financial elite held in Davos, Switzerland, which starts today – just saw their trip get a lot more expensive.

Most people who attend (or who aspire to attend) just call the meeting “Davos.” It’s been described as a meeting of the 1% - wealthy business CEO’s, high-ranking government officials, heads of international organizations, and, occasionally a famous economist, artist, professor, or author. And, don’t forget the press – they are everywhere.

For the most part, the meeting is made up of people who believe the “elite,” in business and government – the ones often called the “smartest people in the room” – can “fix” just about any problem that exists in the economy or society.

Last year’s theme was “Resilient Dynamism.” No joking; to the people at Davos that actually means something, or at least they all pretend that it does. This year, it’s “The Reshaping of the World: Consequences for Society, Politics and Business.” Some attendees actually think a central authority can Reshape the World and still have Resilient Dynamism.

Reading the agenda items, it sounds like an interesting conference. The panels will fret about financial market risk, inequality, global warming and talk about designing the perfect regulatory environment for fixing all these things.

While they may not say it exactly like this, they believe a “partnership between government, business and academia will produce a ‘better’ world.” And why shouldn’t they; many of them would be the central planners in that supposedly better world. But what these government, business, and academic officials just found out is that markets ultimately control prices, not central planners.

The Swiss National Bank, the central bank of Switzerland, had previously tied the local Swiss Franc to the

value of the euro. It did this to prevent the Swiss Franc from rising too much against the euro, which would, in theory, have made Swiss exports less competitive.

But, Switzerland has an excellent long-term monetary track record. The Swiss Franc has generally gained strength versus other currencies (even the US dollar) in the past 45 years. As a result, investors from around the world still prized investing in Switzerland. Moreover, with the European Central Bank threatening more quantitative easing, these two forces (one long-term and one short-term) put upward pressure on the Swiss Franc. To offset that upward pressure the central bank had been intervening in the foreign exchange market by buying Euros, issuing more Swiss Francs and racking up losses.

Continuing the peg would have swelled its balance sheet even further. In the end the “smartest Swiss in the room” were forced to cave to market forces. The world was aghast. Journalists, politicians, central bankers, and all forms of central planners were stymied. Their best laid plans of more QE to solve Eurozone problems took a massive hit. This is a lesson we doubt will be learned.

In the end, markets always win. You can only fight them for so long. The foreign exchange markets wanted the Swiss Franc higher because it represented the collective wisdom of people protecting their own assets, not just the Mandarins at the central bank who had temporarily decided it’d be better if the Swiss Franc didn’t move higher.

Keep that in mind when you hear breathless interviews and reporting from Davos in the week ahead, on what the smart set, the elite, thinks about world problems and how to solve them. Because in the end, what they often say is that they know better than markets. But, the Invisible Hand, which most of them refuse to believe in, and many try to control, is simply more powerful.

If they really want to “Reshape the World,” Davos attendees will agree that getting out of the way and trusting that Invisible Hand is a much better solution than the ones they will likely dream up.

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Posted on Tuesday, January 20, 2015 @ 9:29 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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M2 and C&I Loan Growth
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