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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Fed Teeing Up Rate Hike
Posted Under: Government • Inflation • Monday Morning Outlook • Fed Reserve • Interest Rates

Just a couple of weeks ago the odds of the FederalReserve raising rates in June were slim to none. The federal funds futuresmarket put the odds of a rate hike around 4%.

Then, last week, we got the minutes from the Fed meeting back in April, whichshowed that as long as the economy continued to make progress the Fed was verycomfortable with a June rate hike. Now, the futures market is putting the oddsof a 0.625 percent interest rate on fed funds at about 30%.

We think those odds will move higher over the next few weeks and a rate hike inJune is more likely than not, say about 60%. Not definite, not 100%, just muchhigher than most investors now expect.

But none of this should concern equity investors. Monetary policy will still beloose and remain that way for an extended period of time. Consumer prices areup 1.1% in the past year while "core" consumer prices are up 2.1%.So, either way, the federal funds rate will remain well below inflation,meaning the "real" (inflation-adjusted) federal funds rate staysnegative.

Meanwhile, the banking system is still chock full of $2.3 trillion in excessreserves (reserves in excess of what banks are legally required to hold to meetreserve requirements). Raising rates is not going to change that. It will,however, mean the Fed pays banks more to hold these reserves, a plus forfinancial firms and, in turn, money growth. M2 has grown 9.4% at an annual ratein the past three months, while commercial and industrial loans have grown16.1%.

Raising rates should help the Fed get in a position where it can eventuallystart drawing down those excess reserves. But, until it does, the chance ofsharply accelerating money growth exists. This will bring more inflation.Normally, higher short-term rates tend to flatten the yield curve, withlong-term rates moving up, too, but not as much as short-term rates.

But this time really is completely and totally different. Raising rates makesmoney growth accelerate because of all the excess reserves out there.

One reason some analysts and investors still think the Fed won't raise rates inJune is that it hasn't clearly telegraphed that it wants to raise rates. But wethink the absence of a clear signal is because the Fed is rethinking itsposition on transparency.

Time and again over the last several years, the Fed has indicated a shift inpolicy was imminent only to reverse course when short-term gyrations infinancial markets scared the snot out of everyone. People still talk about thetaper tantrum. We always said this was an over-reaction on everyone's part.

In the end, the Fed eventually tapered, ended quantitative easing and thenraised rates as well, without negative economic consequences. So the Fed maynow think that if the economy deserves slightly higher rates, the best thing todo is
not make it clear it will raise rates beforehand (because marketsmight throw a fit), and just pull the trigger. Tapering, ending QE, and raisingrates in December didn't hurt growth, so why not raise rates again withoutgenerating any hysteria before the action takes place?

There is still time for the data to get worse before the Fed makes its decisionin mid-June. We just don't think that's going to happen. Instead, look forreports on durable goods, consumer spending, inflation, and the job market togive the Fed the confidence it needs to get back on track toward a more normalmonetary policy.

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Posted on Monday, May 23, 2016 @ 11:10 AM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted on Monday, May 23, 2016 @ 9:26 AM • Post Link Share: 
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  Existing home sales increased 1.7% in April to a 5.45 million annual rate


Implications:  Existing home sales moved higher in April, rising to a three-month high and beating consensus expectations.  Sales of previously owned homes rose 1.7% in April to a 5.45 million annual rate, and are up 6% from a year ago. This is encouraging, and we think the broader trend will continue to be upward, but there are still some headwinds. Tight supply and rising prices continue to be the main factors holding back sales. While inventories rose 9.2%, or 18,000 units in April they are still down 3.6% from a year ago.  The months' supply of existing homes – how long it would take to sell the current inventory at the most recent selling pace – is only 4.7 months.  According to the National Association of Realtors®, anything less than 5.0 months is considered tight supply.  The good news is that demand was so strong in April that properties typically only stayed on the market for 39 days, the shortest duration since June 2015.  In fact, 45% of properties in April sold in less than a month, pointing to further interest from buyers in the months ahead. The median price for an existing home is up 6.3% versus a year ago, marking the 50th consecutive month of year-over-year price gains. While this may be pricing some lower-end buyers out of the market, it should help alleviate some of the supply constraints as "on the fence" sellers take advantage of higher prices and trade-up to a new home, bringing more existing properties onto the market.  In other recent news, the Philadelphia Fed index, a measure of sentiment among East Coast manufacturers, came in at -1.8 in May versus -1.6 in April.  More broadly, new claims for unemployment benefits declined 16,000 last week to 278,000, marking 63 consecutive weeks below 300,000, the longest stretch in more than forty years.  Continuing claims declined 13,000 to 2.15 million.  These figures are consistent with a payroll increase of about 200,000 in May, which should help boost the odds of the Fed raising rates in June.

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Posted on Friday, May 20, 2016 @ 2:00 PM • Post Link Share: 
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  Housing Regulation Hurdles
Posted Under: Home Sales • Housing

Housing, the economic sector that started its crash in late 2005, and which is often cited as the driver of the financial market collapse that followed, has seen a steady if unspectacular recovery. The pace of housing starts, as well as sales of new and existing homes, continue to climb higher. It's had to, because the US needs new homes, and employment growth and income gains have continued while household financial obligations (recurring monthly payments as a percent of after-tax income) remain near multi-decade lows. However, tight lending markets have held back the pace of recovery. So have low inventories of houses available for sale. But there is another, often overlooked factor – rising regulatory costs.   

According to the National Association of Home Builders (NAHB), the average cost of regulatory compliance to home builders for new construction has increased a staggering 30% since 2011. This closely mirrors an increase of 34% over the same time period in the average cost of a new home. In fact, the cost of regulation per home now stands at roughly $85,000 or about 24% of the final sticker price of an average new single-family home. Examples of typical regulations include local impact fees, environmental mitigation, storm-water discharge permits and ever changing construction codes that, on average, builders say add 6.6 months to the development process. This squeezes builders at the margin, and is a driving factor in the movement away from the construction of cheaper starter homes in favor of premium models.

This lack of supply to the lower end of the market has hit first-time buyers the hardest, effectively pricing many people out of the opportunity to own a home. In a recent blog post, Trulia.com's Chief Economist reported that the inventory of "starter" homes (defined as homes with values in the lower third nationally) has fallen 44% since 2012, and median prices in that segment of the market have risen by 32%.  The result is that the share of first-time buyers in the market dropped to a nearly three decade low in 2015, according to the National Association of Realtors®. This has been part of the reason the housing market has been held back post-recovery, people aren't able to get their foot in the door. Once someone owns a home, even at the lower end of the market, they begin to build equity and are able to eventually trade up. Not only does this stimulate sales for more expensive homes, it puts an existing home on the market and helps alleviate the inventory issue as well.

This is an example of the kind of damage over-the-top regulations can cause to an economy. However, don't expect the government to address these problems at the source. More likely they will continue to raise regulatory costs through micromanagement and respond with government programs that make loans easier to obtain. After all, what could go wrong?    

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

Posted on Thursday, May 19, 2016 @ 11:08 AM • Post Link Share: 
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  Industrial Production Increased 0.7% in April
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  After two consecutive months of ugly reports, industrial production surged 0.7% in April, easily beating consensus expectations, and posting its strongest advance since November 2014.  The biggest increase in today's report came from utilities, where output spiked 5.8% higher, the largest monthly gain since 2007.  This comes on the heels of an unusually warm winter, which had been a consistent drag on utilities over the past several months.  More important, manufacturing was another bright spot in today's report, increasing 0.3% in April to 0.5% above its year ago level.  This was primarily due to a jump in auto production, which rose 1.3% in April, and is up 4.3% from a year.  Although the production of business equipment is still down 0.4% from a year ago, it rose 0.9% in April and is up 4.4% annualized in the past three months, showing healthy recent demand for U.S. produced capital goods.  Meanwhile, mining output continued its slide in April, falling 2.3%, reflecting a more pronounced 6.8% drop in oil and gas extraction.  While mining (and energy in general) has been a drag on production over the past year, we expect activity in that sector to stabilize in the months ahead as energy prices have started rising again.  Based on other commodity prices, oil prices should average at higher levels over the next several years.  Although we don't expect overall production to boom any time soon – weak overseas economies will continue to be a headwind – we do expect a gradual pick-up in activity in 2016.  One sign of these headwinds is that in other news yesterday, the Empire State index, a measure of manufacturing sentiment in New York, fell unexpectedly to -9.0 in May from +9.6 in April.

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Posted on Tuesday, May 17, 2016 @ 12:36 PM • Post Link Share: 
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  The Consumer Price Index Increased 0.4% in April
Posted Under: CPI • Data Watch • Inflation


Implications:  If the Fed is truly "data dependent," a June rate hike is on the table.  The consumer price index rose 0.4% in April, led by rising energy costs.  However, the increase in prices was broad-based, not just confined to energy. "Core" consumer prices, which exclude the volatile food and energy components, rose 0.2% in April and show annualized readings above 2% over the past three, six, and twelve-month periods.  This consistent pace of "core" inflation above 2% – paired with continued employment gains – means a rate hike would certainly be justified in June.  The increase in the core CPI in April was led by housing rents and medical care.  Owners' equivalent rent, which makes up about ¼ of the CPI, rose 0.3% in April, is up 3.1% in the past year, and will be a key source of higher inflation in the year ahead.  Energy prices rose 3.4% in April, as prices for gasoline and fuel oil more than offset declining electricity costs.  And given the continued rise in oil prices through the first half of May, the trend in higher energy costs looks likely to continue into next month's report.  This is a big change from recent years, where energy prices are down. Excluding energy, consumer prices are up 2.0% in the past year.  In other words, as energy prices rise, the headline index will follow at a faster pace than many are expecting.  Food prices rose 0.2% in April as dairy prices rebounded from March.  One negative piece of news in today's report is that the big CPI jump pushed "real" (inflation-adjusted) average hourly earnings down 0.1%.  But this is the first decline in nine months and we still think wages will rise faster than prices in the months ahead as employment keeps growing at a healthy clip. Taken as a whole, and paired with the continued health in the labor market, today's report is a green light for the Fed. The only issue is whether the Fed will have the guts to move forward.

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Posted on Tuesday, May 17, 2016 @ 11:59 AM • Post Link Share: 
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  Housing Starts Increased 6.6% in April
Posted Under: Data Watch • Home Starts • Housing


Implications:  After a large decline in March, housing starts shot back up in April, easily beating consensus expectations.  Although starts in April were down 1.7% from a year ago, this is not something to worry about.  Bad weather held down starts at the beginning of 2015, followed by a 23.7% surge in April 2015, so the year-ago comparison for this particular month is unusually tough.  If starts are unchanged in May, they'll be up 10.3% from a year ago, which is a more accurate picture of the underlying trend.  Within that upward trend, we're seeing a better "mix" of home building.  When the housing recovery started, multi-family construction generally led the way.  The number of multi-family units currently under construction is the highest since the early 1970s.  But the share of all housing starts that are multi-family appears to have peaked last year and single-family building is starting to climb more quickly.  Single-family starts are up 4.3% from a year ago while multi-family starts are down 11.7%.  Meanwhile, single-family building permits are up 8.4% from a year ago while multi-family permits are down 23.8%.  The shift in the mix of homes toward single-family units is a positive because, on average, each single-family home contributes to GDP about twice the amount of a multi-family unit.  Based on population growth and "scrappage," housing starts should rise to about 1.5 million units per year, 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, remained unchanged at 58 in May.  Readings greater than 50 mean more respondents report good market conditions.  One year ago, the overall index was at 54.  It won't be a straight line higher, but expect the housing sector to keep adding to real GDP growth in 2016. 

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Posted on Tuesday, May 17, 2016 @ 11:50 AM • Post Link Share: 
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  Forget About Macy's
Posted Under: Autos • GDP • Monday Morning Outlook • Retail Sales

Two simple questions: How many times have you bought something at Macy's in the past month?  How many times have you bought something through Amazon over the same timeframe?  We're guessing the answer to the first questions is once...maybe, while the answer to the second question is so many times you can't keep track.   

We're not picking on Macy's, in particular, which is a perfectly fine department store.  It's just the chain that grabbed the biggest headlines among all the department stores recently reporting relatively weak sales and profits.

But just because old-line brick-and-mortar department stores are having weak sales doesn't mean consumers are weak overall or the Plow Horse economy is about to keel over.  The problem with some department stores is their business model, not fatigue on the part of consumers.

Retail sales surged 1.3% in April, led by autos and non-store retailers (internet and mail-order).  "Core" sales, which exclude volatile components like autos, building materials, and gas station sales, rose 0.8% in April, the largest gain in the past year and the 13th increase in the past 14 months.

Automakers have reported US sales of 17.6 million cars and light trucks in the past year, very close to the record high set at the peak of the dot-com boom back in 1999-2000.

These robust spending figures are consistent with the improving financial situation of households.  During the past few years, the financial obligations ratio, the share of after-tax income that consumers need to meet monthly obligations (mortgages, rent, car loans and leases, student loans and credit card debt) has hovered at the lowest level since the early 1980s.

Although some analysts have bemoaned a $5 billion rise in seriously delinquent auto debt over the past few years, all seriously delinquent debts (mortgages, home equity loans, autos, credit cards, and student loans, combined) are down about $600 billion since 2010.    

Meanwhile, payrolls are up about 2.7 million in the past year, while wages have been growing and are starting to accelerate.  This is not an environment in which consumer spending is going to get weaker. 

Instead, Friday's report on retail sales, as well as other recent data, suggests a modest upward revision to first quarter real GDP growth, closer to 1% annualized.  The Atlanta Fed's tracking model for real GDP growth says 2.8% for Q2.  We think that's probably too high because of a temporary correction in inventories.  But real (inflation-adjusted) final sales, which is real GDP excluding inventories, should be up at about a 3% annual rate in the second quarter. 

In other words, no recession.         

Nothing in the big picture has changed.  Monetary policy remains loose, tax rates should be lower but are not particularly high, and new free trade deals may be on hold, but the old ones haven't gone away (at least not yet).  We do worry about big spending politicians and over-regulation, but we haven't seen anything yet that means a recession.  Slower economic growth over the long run, yes; recession, no.

What we are witnessing in the retail sector isn't a sign of weakness.  Instead, they're the gales of creative destruction at the heart of free-market capitalism. 

Out with the old, in with the new.  Unlike stale economies run by politicians, free market economies show their dynamism and strength by letting the former establishment take a fall.  If we weren't free, that couldn't happen.  That it can happen is something to be celebrated, not feared.    

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

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Posted on Monday, May 16, 2016 @ 11:22 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, May 16, 2016 @ 7:42 AM • Post Link Share: 
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  Retail Sales Increased 1.3% in April
Posted Under: Data Watch • Retail Sales


Implications:  Forget about Macy's!  The economy is doing just fine, thank you. Government statistics show that retail sales rose 1.3% in April, the biggest gain in more than a year, with eleven of the thirteen major retail categories up.  Autos led the way, but even ex-autos retail sales rose up 0.8%. Adding in upward revisions to prior months, they rose 1.1%. These sales are accelerating, up 5.6% annualized over the past three months versus 3.0% from a year ago.  The second largest gain in April was for non-store retailers.  So, when you hear about old-line brick-and-mortar department stores doing poorly, this explains why.  Meanwhile, gas station sales, after subtracting from retail sales for eight consecutive months, have added to retail sales over the past two as oil prices have been trending higher. Still even with the 2.2% gain in April, sales at gas stations are down 9.4% from a year ago.   "Core" sales, which exclude autos, building materials, and gas, rose 0.8% in April and were up 1.1% including revisions to prior months.  Core sales are up a very respectable 3.9% from a year ago, which is a healthy pace considering consumer prices are up only about 1%.  Look for better growth in consumer spending in the months ahead.  Employment continues to expand, while wage growth is starting to accelerate.  In other news yesterday, new claims for unemployment benefits increased 20,000 last week to 294,000. This was mostly caused by a 14,000 increase in claims in New York, most likely from a strike at Verizon.  The four-week moving average is still 268,000 and claims have remained below 300,000 for 62 straight weeks, the longest stretch in more than forty years.  Continuing claims increased 37,000 to 2.16 million.  Plugging these figures into our models suggests May payrolls will rise about 200,000.

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Posted on Friday, May 13, 2016 @ 12:09 PM • 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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