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   Brian Wesbury
Chief Economist
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Deputy Chief Economist
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  Fed Policy Not in Tune With Data
Posted Under: CPI • Data Watch • Employment • Government • Home Sales • Monday Morning Outlook • Retail Sales • Fed Reserve • Interest Rates

If the Fed were completely honest and transparent, its statement on monetary policy on Wednesday would be only two words:  "We goofed."

Back in June, the self-identified "data dependent" Fed walked back expectations of rate hikes with a dovish policy statement and lower projections of future rate hikes, which was odd because these changes happened despite very little change in the tone of economic data.

In reality, the Fed simply over-reacted to one bad employment report – the kind we get from time to time even when the labor market is improving at a healthy pace.  Brexit fears probably played a role, too.         

Since then, the dire Brexit fears have proved silly and economic data have clearly turned for the better.  The ISM Manufacturing index rose to 53.2 in June from 51.3 in May while the ISM Service index rose to 56.5 from 52.9.  Payroll growth surged in June, growing 287,000.  And in the past three weeks, new claims for unemployment insurance have remained below 255,000, a new consistent low reached while claims have remained below 300,000 for 72 consecutive weeks.

Worker pay is accelerating.  Average hourly earnings are up 2.6% from a year ago, which is a 30% acceleration in the growth rate from the 2.0% growth during the year ending in June 2015.  "Core" retail sales, which exclude volatile components like autos, building materials, and gas, are up 4.3% from a year ago and have risen in 15 of the last 16 months.  Tell us again about the freaked out consumer?  

Home building continues to recover.  Single-family housing starts are up 13.4% from a year ago on top of a 14.3% gain in the year ending in June 2015.  Meanwhile, price gains and low inventories of both new and existing homes signal plenty of room in the year ahead for a continued increase in home building.    

In other words, the Fed ought to be upgrading its view of the economy and the speed of rate hikes.  Especially with equities at new record highs, after mindless fear over Brexit knocked them down.  Add in the fact that "core" consumer prices (which exclude food and energy) are up 2.3% from a year ago, it's clear the Fed is actually falling behind the curve.       

Putting all this together, and given the natural inclination for government officials to save face, we're not holding our breath that the Fed will admit they could (and should) have hiked in June.  Instead, look for a statement with no great changes from last time.  The Fed will recognize the economy is better than it thought, but the language won't change much.

However, when the Fed releases the more detailed minutes from this week's meeting (on August 17th) we expect some financial fireworks.  Those minutes will show that the Fed is more confident about the economy and more willing to raise rates than is now baked into the federal funds futures market.  Right now, that market thinks the most likely outcome is zero rate hikes in 2016.  By contrast, we think the Fed is highly likely to raise rates at least once, and that the odds of two rate hikes is higher than the odds of none at all. 

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

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Posted on Monday, July 25, 2016 @ 9:36 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, July 25, 2016 @ 8:00 AM • Post Link Share: 
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  Stocks Will Beat Bonds
Posted Under: Markets • Video • Bonds • Stocks • Wesbury 101
Posted on Friday, July 22, 2016 @ 12:28 PM • Post Link Share: 
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  Existing Home Sales Increased 1.1% in June
Posted Under: Data Watch • Home Sales • Housing


Implications:  Existing home sales continued to show strength in June, posting the fourth consecutive monthly gain and hitting the fastest pace since 2007.  Sales of previously owned homes rose 1.1% in June to a 5.57 million annual rate and are up 3% from a year ago.  Moreover, in a sign of a mild loosening of lending standards (finally!), the share of first-time buyers reached its highest level since 2012 in June, helping boost sales.  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 hold back sales.  Inventories fell 0.9% in June and are now down 5.8% 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 4.6 months.  According to the National Association of Realtors® (NAR), anything less than 5.0 months is considered tight supply.  The good news is that demand was so strong that 48% of properties in June sold in less than a month, pointing to further interest from buyers in the months ahead.  However, higher demand from the summer selling season also helped push the median price for an existing home to a new all-time high, up 4.8% versus a year ago.  While this may temporarily price 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 as well.   In other housing news this morning, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.2% in May and is up 5.6% from a year ago.  Another sign that supply remains limited and home builders have room to keep ramping up construction.  On the manufacturing front, the Philadelphia Fed index, a measure of sentiment among East Coast manufacturers, came in at -2.9 in July versus +4.7 in June.  However, more broadly, new claims for unemployment benefits declined 1,000 last week to 253,000, defying the consensus, and marking the 72nd consecutive week below 300,000. Continuing claims declined 25,000 to 2.13 million.  These figures are consistent with the kinds of job gains that should get the Fed back on track toward higher rates, possibly as early as September.

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Posted on Thursday, July 21, 2016 @ 12:32 PM • Post Link Share: 
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  Will the Yield Curve Invert?
Posted Under: Government • Video • Fed Reserve • Interest Rates • Wesbury 101
Posted on Wednesday, July 20, 2016 @ 3:12 PM • Post Link Share: 
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  Housing Starts Rose 4.8% in June
Posted Under: Data Watch • Home Starts • Housing


Implications:  Home building continues to be a bright spot for the US economy.  Housing starts rose 4.8% in June, beating consensus expectations. In fact, the pace of starts in the second quarter as a whole was the fastest since 2007.  While starts are 2% below a year ago, that's due to a surge in multi-family home building in June of last year, which made it the strongest month for overall home building in all of 2015.  Starts in June this year were a solid 7.3% higher than the average for all of 2015.  Moreover, the "mix" of homes being built is improving.  When the housing recovery started, multi-family construction generally led the way.  The number of multi-family units now under construction is the highest since the early 1970s.  But the share of all housing starts that are multi-family appears to have peaked in 2014-15 and single-family building is starting to climb more quickly.  This trend should continue.  Single-family building permits are up 5.1% from a year ago while multi-family permits are down 34.3%.  The shift in the mix of homes toward single-family units is a positive one 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.   It won't be a straight line higher, but expect the housing sector to keep adding to real GDP growth in 2016-17.  In other recent housing news, the NAHB index, which measures sentiment among home builders, slipped to 59 in July from 60 in June.  However, 59 is still well above 50, showing that the index remains in healthy expansion territory.  More jobs and faster wage growth are making it easier to buy a home and builders are responding.

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Posted on Tuesday, July 19, 2016 @ 10:29 AM • Post Link Share: 
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  Real GDP Accelerating
Posted Under: GDP • Government • Monday Morning Outlook • Fed Reserve

Forecasting economic growth from quarter to quarter is a humbling experience. Even when you get the trend right – and it's hard to beat our forecast of Plow Horse growth – there's always a quarter here and there that will throw you for a loop. 

Trying to estimate growth in the second quarter is even tougher than others because that's the time of year when the government goes back and revises the GDP reports for the past few years.  Moreover, the government has had persistent problems seasonally adjusting GDP, tending to underestimate growth in the first quarter each year while overestimating growth in the middle two quarters.  Government statisticians say they're trying to fix that problem, but who knows how much they'll do this time.
With all this in mind, we're forecasting that the economy grew at a 2.2% annual rate in Q2, maintaining a Plow Horse pace.  However, there are important signs of improvement.  For example, it looks like "real" (inflation-adjusted) personal spending rose at the fastest pace in a decade.  And the key reason holding down overall growth in Q2 is an inventory correction that may end up overshooting, helping boost growth in the quarters ahead.
Meanwhile, the M2 measure of the money supply has grown at an 8.2% annual rate in the first six months of 2016, the fastest pace since 2012.  This is consistent with our forecast that both real GDP growth and inflation should be accelerating more than most investors expect in the next year or so, which, in turn, should be good for equities and bad for most bonds.        

Below is our "add-em-up" forecast for Q2 real GDP.

Consumption:  Auto sales declined slightly in Q2, but retail sales outside the auto sector rose at a 7.1% annual pace in Q2, and services, grew at about a 2.5% rate.  Overall, it looks like real personal consumption of goods and services, combined, grew at a 4.4% annual rate in Q2, contributing 3.0 points to the real GDP growth rate (4.4 times the consumption share of GDP, which is 69%, equals 3.0).

Business Investment:  Business equipment investment looks like it declined at a 1% annual rate in Q2 while commercial construction fell at a 10% rate. R&D probably grew around its trend of 5%.  Combined, we estimate business investment slipped at a 1% rate, which should subtract 0.2 points from the real GDP growth rate (-1.0 times the 13% business investment share of GDP equals -0.1).

Home Building:  Residential construction looks like it took a breather in Q2, dropping at an 8% annual rate.  Don't get worried, though.  This a temporary breather; builders still need to ramp up production to fill a shortage of homes.  In the meantime, the temporary drop in Q2 will trim 0.3 points off of the real GDP growth rate.  (-8.0 times the home building share of GDP, which is 4%, equals -0.3).

Government:  Military spending rose in Q2 while public construction projects declined.  On net, we're estimating that real government purchases rose at a 1% rate in Q2, which would add 0.2 percentage points to real GDP growth (1.0 times the government purchase share of GDP, which is 18%, equals 0.2).

Trade:  At this point, the government only has trade data through May, 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 0.3 points on the real GDP growth rate.

Inventories:  At present, we have even less information on inventories than we do on trade, but what we have suggests companies were surprised by the acceleration in consumer spending, resulting in a sharp slowdown in the pace of inventory accumulation during Q2.  We're forecasting inventories subtracted 0.9 points from real GDP growth in Q2.

Put it all together, and we get a forecast of 2.2% for Q2, another Plow Horse quarter.  However, the sharp inventory slowdown suggests production and, therefore, real GDP is likely to pick up in the third and fourth quarters.  Corporate profits and stock prices are likely to keep rising as well.  We expect this to affect the Fed and Fed speakers to become more hawkish, letting investors know a rate hike is a serious possibility by September.

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

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Posted on Monday, July 18, 2016 @ 9:51 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, July 18, 2016 @ 9:48 AM • Post Link Share: 
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  Industrial Production Increased 0.6% in June
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  Industrial production surged at the fastest pace since 2014, erasing May's decline, and demonstrating strength in an industrial sector that that has begun to find its footing. While the headline number is still down 0.8% from a year ago, it is up 0.2% in the past six months and up at a 2.7% annual rate in the past three months, a recent acceleration that signals the sector may be leaving behind the headwinds related to the drop in oil prices in the past couple of years.  However, industrial output is not going to grow every month and some of the brightest spots in June are also the most volatile categories.  The single biggest factor affecting today's report came from motor vehicle manufacturing, which surged 5.9% and is now up 7.8% versus last year. This helped push manufacturing up at its fastest pace since January and points to strong auto sales numbers in the months ahead.  Meanwhile, utility output jumped 2.4% in June, reflecting unusually warm June weather in the lower 48 states.  On a surprising note, mining production posted its first consecutive gain since last year, up 0.2% in June after a 0.3% gain in May.  This month's gain was driven primarily by coal mining, as well as small uptick in oil and gas well drilling. 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 are well off the lows from earlier this year.  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.  In other news this morning, the Empire State index, a measure of manufacturing sentiment in New York, fell to a still positive +0.6 in July from +6.0 in June, the fourth positive reading in five months. In other words, factory activity should remain in a growth mode for the foreseeable future.

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Posted on Friday, July 15, 2016 @ 11:54 AM • Post Link Share: 
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  The Consumer Price Index Increased 0.2% in June
Posted Under: CPI • Data Watch • Inflation


Implications:  Fed officials, take note, inflation is on the rise.  The consumer price index rose 0.2% in June, but more importantly the pace of inflation has been steadily on the rise. While up a modest 1.0% in the past year, consumer prices have risen at a 1.6% annualized in the past six months and at a 3.4% annual rate in the past three months.  Energy prices rose 1.3%, as rising prices for gasoline and fuel oil more than offset declining electricity costs.  Excluding energy, consumer prices are up 2.0% in the past year, which means that as energy prices rise, the headline index will follow at a faster pace than many are expecting.  Food prices fell 0.1% in June, led lower by declining costs for meats and dairy products, but "core" consumer prices, which exclude the volatile food and energy components, rose 0.2% in June and show annualized readings above 2% over the past three-, six-, and twelve-month periods.  While the Fed continues to kick the can down the road, this consistent pace of "core" inflation around 2% – paired with continued employment gains and a clear acceleration in the headline consumer price index – shows the economy is ready for the next rate hike.  The increase in the core CPI in June was led by housing rents, medical care and education.  Owners' equivalent rent, which makes up about ¼ of the CPI, rose 0.3% in June, is up 3.2% in the past year, and will be a key source of higher inflation in the year ahead.  One negative piece of news in today's report is that "real" (inflation-adjusted) average hourly earnings declined 0.2% in June.  However real wages are up 1.5% in the past year and we think wages will rise faster than prices in the year ahead as employment continues to grow at a healthy clip.  Consumers are ready, the economy is ready, and the data shows that a "data dependent" Fed should be ready to make monetary policy a little less loose.

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Posted on Friday, July 15, 2016 @ 11:46 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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