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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  New Single-Family Home Sales Declined 12.8% in July
Posted Under: Data Watch • Home Sales • Housing


Implications:  Don't get bent out of shape over the headline decline in new home sales today, a large upward revision to June is distorting the picture.  In fact, June was revised up to a 728,000 annual sales pace, the fastest since 2007, and posted the largest monthly gain in percentage terms since 1992.  If it wasn't for the revision, July sales would've only been down 1.7% rather than 12.8%.   With that in mind, July looks like a return to a more normal pace of activity after a blowout month where sales were much higher than what should be expected based on the pace of home construction.  New home sales normally run around 70% of single-family housing starts.  June's sales pace brought that relationship up to 84%, but July's return to normal brought it down to a more sustainable 73%.  That said, sales have now exceeded that 70% threshold for each of the past six months, signaling plenty of appetite in the US for new homes.  This is part of the reason we think the US is nowhere close to recession.  In fact, this should be a tailwind for GDP growth in the year ahead, as opposed to the drag on growth residential construction has been for the past six quarters (through the second quarter of 2019).  Affordability has been playing a big role in the recent rebound in sales, with mortgage rates having fallen roughly 110 basis points after peaking in November.  On top of this, new home prices have moderated, with six of the seven months so far in 2019 posting declines on a year-over-year basis.  One caveat to this is that there looks to be a deficit of available new homes on the lower end of the price spectrum, with July being the first month on record where no properties worth $150,000 or less were sold.   Overall, the fundamentals signal growth in home sales over the medium to long term.  Relative to population, the number of new home sales remains well below where it should be.  That means much more home construction will be needed; it's simple math.  Bottom line, we expect sales and construction in 2019 to outpace 2018 and continue the upward trend.  In other recent news, initial jobless claims fell 12,000 last week to 209,000.  Continuing claims fell 54,000 to 1.674 million. Plugging these figures into our model suggests nonfarm payrolls will continue to grow at a healthy pace in August.  Finally, on the manufacturing front, the Kansas City Fed Index, a measure of factory sentiment in the region, declined to -6 in August from -1 in July, as trade uncertainty continued to hold down sentiment.

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Posted on Friday, August 23, 2019 @ 11:43 AM • Post Link Share: 
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  Existing Home Sales Increased 2.5% in July
Posted Under: Data Watch • Home Sales • Housing


Implications:  Existing home sales rebounded in July, continuing the upward trend that began in January.  Moreover, the recovery finally pushed sales into positive territory on a year-over-year basis for the first time in seventeen months.  That said, one piece of worrying news in today's report was that inventories have now fallen year-over-year (the best measure for inventories given the seasonality of the data) for two months in a row, following ten straight months of gains.  It's still too soon to tell if this means sellers are changing their behavior, but a reversal in the steady increase in listings we've seen recently could be a headwind for future sales.  Keep in mind, the primary culprit behind the weak existing home market in 2018 was lack of supply.  This is doubly true for properties worth $250k or less, which is the only market segment where sales are still down in the past year.  This deficit of lower end properties is also pushing up their prices at a much faster rate than homes at the higher end of the spectrum, according to the NAR.  What this means is that the "mix" of homes sold is more and more tilted towards the higher end, and those homes that are sold on the lower end are getting more expensive.  When you add in mortgage rates that have fallen roughly 110 basis points since their peak November 2018, it's no surprise that the year-over-year growth in median prices has begun to reaccelerate.  This measure had been slowing consistently since early 2017 but is now up 4.3% in the past year versus its low of just 3.3% in December.  It's also important to note that the months' supply of existing homes – how long it would take to sell the current inventory at the most recent sales pace – was only 4.2 months in July and has now stood below 5.0 (the level the National Association of Realtors considers tight) since late 2015.  With demand so strong that 51% of homes sold in July were on the market for less than a month, continued gains in inventories will remain crucial to sales activity going forward.    It won't be a straight line higher for sales in 2019 but fears the housing recovery have ended are overblown. 

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Posted on Wednesday, August 21, 2019 @ 12:17 PM • Post Link Share: 
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  This Is Not 2008
Posted Under: Government • Inflation • Monday Morning Outlook • Fed Reserve • Interest Rates

The threat of a recession is on the minds of investors.  Some traditional measures of the yield curve are inverted and, in the past, those have preceded recessions.  The link between an inverted yield curve and a recession has so dominated recent financial news that for some investors it's no longer a matter of whether we get a recession, but how long until it starts.  

What these investors are ignoring is how different recent circumstances are from the environment that preceded prior recessions.

Think about the Panic of 2008.  The bubble in home prices in the prior decade pushed national home values more than $6 trillion above "fair value" (based on the normal relationship between home prices and rents).  At the time, that over-valuation was the equivalent of about 50% of annual GDP.

The process of unwinding that massive over-valuation happened when bank capital ratios were significantly lower than they are today.  And, more importantly, the unwinding happened when banks had to use overly strict mark-to-market accounting standards that required them to value mortgage-related securities at "fire sale" prices regardless of how solid the actual cash flow was on many of these instruments.

Pretty much everyone agrees that housing isn't grossly overvalued like it was in the years before the Panic.  But some think we now have overvaluation in the stock market, so a downdraft in equities will play at least part of the role previously played by real estate, perhaps like back in the 2001 recession.            

The problem with this theory is the capitalized profits model we use to assess "fair value" on the stock market says stocks were substantially over-valued at the peak of the first internet boom before the 2001 recession but are still under-valued today. 

The price-to-earnings ratio on the S&P 500 peaked at 29.3 in June 1999 (end-of-month, based on trailing 12-month operating earnings).  At the end of July 2019, the same ratio was 19.3, more than one-third lower.  Meanwhile, the 10-year Treasury yield finished June 1999 at 5.81%.  Investors today would kill to get that kind of safe yield, versus the 1.55% we had at Friday's close.  In other words, the stock market is nowhere near the situation it was in about twenty years ago.             

Let's also think about the recessions of 1990-91 and 1981-82, both also preceded by inverted yield curves, but also preceded by a heck of a lot else.  Before the stock market crash of 1987, the Federal Reserve had been gradually raising rates.  But the October crash temporarily threw the Fed off course, getting it to cut rates, instead.  Once it was clear the crash wasn't the onset of another Great Depression, which some believed at the time, the Fed started raising rates again in early 1988.     

By early 1989, the Fed was targeting short-term rates near 10% and the yield curve was inverted all the way out through the 30-year Bond.  Unfortunately, the consumer price index was up 5.4% in May 1989 from the year prior.  Even "core" prices, which exclude food and energy, was up 4.6%.  The Fed was tight but justifiably so, because tight money was the only way to reduce higher inflation.  Remember, this was only a decade removed from bouts of double-digit inflation, and so, back then, it was tougher to wrestle higher inflation expectations out of the minds of investors, workers, and consumers.   

By contrast, the largest 12-month change in the core CPI since the expansion started is 2.4% and the Fed hasn't adopted policy tightness to squeeze this out; if anything, with overall CPI inflation now at 1.8%, the Fed has hinted they'd like to see higher inflation.

The same goes for the recession of 1981-82, but even more so.    CPI inflation peaked at 14.8% in 1980 and was still hovering above 10% early in President Reagan's first year in office.  So Fed Chairman Paul Volcker jacked up short-term rates to about 19% to smash inflation.  By contrast, the 30-year Treasury Bond was yielding about 13%.  You want to know what an inverted yield curve looks like?  That's an inverted yield curve.   

The bottom line is that yes, the yield curve inverted prior to each of the recessions we discussed, but there were a lot of other things going on, not just the inversion.  This time around we search in vain for a housing bubble, low capital ratios among US banks, mark-to-market rules that can turn a downturn into an inferno, a bursting stock market bubble, or a stubborn rise in inflation that the Fed has had to choke off with tight money.  Without any of those ingredients, we still believe those predicting a recession in the near term are way too pessimistic.

The only bubble we see right now is in the bond market, with yields way too low given solid economic fundamentals.  But, with the Fed unlikely to raise rates, that bubble's not bursting anytime soon.  More likely is a gradual deflating as investors get better returns elsewhere and yields eventually move higher.       

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

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Posted on Monday, August 19, 2019 @ 11:28 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, August 19, 2019 @ 10:57 AM • Post Link Share: 
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  Housing Starts Declined 4.0% in July to a 1.191 Million Annual Rate
Posted Under: Data Watch • Home Starts

Implications:  While the headline looks bleak from today's housing starts release, the details of the report tell a different story.  Let's start with the bad news.  Housing starts declined for a third consecutive month in July and fell well short of the consensus expected pace of 1.256 million units at an annual rate.  And starts declined in three of the four regions, with only the West eking out a gain.  The pouting pundits will likely stop there in raising their banner of fear, but a deeper dive shows housing activity is not as weak as the starts number alone suggests. First, all of the weakness in July came from the typically volatile multi-family sector, while single-family starts rose 1.3%.  On average, each single-family home contributes to GDP about twice the amount of a multi-family unit, so a sustained shift back towards single-family construction would be a boon for economic growth.  Second, building permits rose a strong 8.4% in July, and easily outpaced consensus expectations.  Third, homes under construction has been trending lower of late (on the flip side, housing completions have moved higher), which means labor is being freed up to start new projects in the months ahead.  Remember, when the National Association of Home Builders released their survey of top challenges for builders in 2019 at the beginning of the year, concerns related to the cost and availability of labor were the most prevalent, with 82% of developers surveyed citing them as their biggest challenge in the year ahead.  In other words, labor has been a primary headwind for starts, and that looks like it is starting to ease.  On the demand side, fundamentals for potential buyers have improved markedly over the past several months.  Mortgage rates have dropped more than 100 basis points since the peak late last year, and wages are now growing near the fastest pace in a decade, boosting affordability.  Our outlook on housing hasn't changed: we anticipate a rising trend in home building in the next few years.  Based on fundamentals – population growth and scrappage – the US needs about 1.5 million new housing units per year but hasn't built at that pace since 2006.  Don't get caught up in the doom and gloom that has enraptured the markets this week, the fundamentals continue to point to growth.   

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Posted on Friday, August 16, 2019 @ 11:57 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 Thursday, August 15, 2019 @ 1:04 PM • Post Link Share: 
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  Industrial Production Declined 0.2% in July
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  No doubt about it, industrial production was weak in July.  The one positive contribution for the month came from utilities, the result of temperatures returning to normal and boosting demand for air conditioning following the coolest June since 2009.  Aside from that series, declines were broad-based.  Auto manufacturing fell 0.2% in July following two months of strong gains.  Meanwhile, manufacturing outside the auto sector (which represents the majority of activity) declined 0.4%.  Putting the two series together shows overall manufacturing fell 0.4% in July and is now down 0.5% from a year ago.  This represents a considerable slowdown in the twelve-month growth rate since the end of 2018, and the same pattern can be seen in overall industrial production as the chart above shows.  However, it's important to remember that we saw a similar slowdown in 2015-16 during the oil price crash, and no recession materialized.  Keep in mind that manufacturing is only responsible for about 11% of GDP and is much more sensitive to global demand than other sectors of the economy.  Even though non-auto manufacturing is now down 0.9% in the past year, the various capital goods production indices continue to outperform the broader index.  For example, over the past twelve months business equipment is up 1.0%, high-tech equipment is up 5.3%, and durable goods more generally are up 1.1%.  By contrast non-durable goods production is down 2.1%, demonstrating that the ongoing weakness in non-auto manufacturing growth isn't being led by the death of business investment   Finally, mining activity fell 1.8% in July, its largest monthly drop in over three years. However, according to the Fed this was just the result of a sharp temporary decline in oil extraction due to hurricane Barry.  In the past year mining is still up 5.5%, showing the fastest year-over-year growth of any major category.  In other recent news from the manufacturing sector, the Philly Fed Index, a measure of East Coast factory sentiment, dropped to +16.8 in August from +21.8 in July.  Meanwhile, the Empire State Index, which measures factory sentiment in the New York region, continued its rebound, rising to +4.8 in August from +4.3 in July.  Notably, both of these readings beat consensus expectations and signal continued optimism.  On the housing front, the NAHB index, which measures homebuilder sentiment, rose to 66 in August from 65 in July, matching its 2019 high. The increase was driven by expectations of stronger sales activity and buyer foot traffic. 

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Posted on Thursday, August 15, 2019 @ 11:40 AM • Post Link Share: 
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  Retail Sales Increased 0.7% in July
Posted Under: Data Watch • Productivity • Retail Sales


Implications: Tell us again why the Fed should be cutting rates?  Add today's retail sales report to the litany of other positive news coming out of the US economy over the past few months.  A truly "data dependent" Fed should not have cut rates in late July and would not be heading for another rate cut in September, like it has signaled and as the financial markets fully anticipate.  Today's retail sales report shows the consumer is doing very well.  Sales increased 0.7% in July, rising for the fifth consecutive month and beating even the most optimistic forecast on Bloomberg.  Ten of the thirteen major categories had higher sales, led by non-store retailers (think internet & mail order), gas stations, and restaurants & bars. Powered by "Prime Day," non-store sales were up 16.0% from a year ago, sit at record highs, and now make up 12.8% of overall retail sales, also a record.  The only significant decline in today's report was for autos.  "Core" sales, which exclude autos, building materials, and gas stations (the most volatile sectors) were up 1.0% in July, up 1.1% including revisions to prior months, and are up 4.8% from a year ago.  Jobs and wages are moving up, companies and consumers continue to benefit from tax cuts, consumer balance sheets look healthy, and serious (90+ day) debt delinquencies are down substantially from post-recession highs.  For these reasons, expect continued solid gains in retail sales in the year ahead.  In other news today, nonfarm productivity (output per hour) rose at a 2.3% annual rate in the second quarter, coming in well above the consensus expected increase of 1.4%.  The rise in nonfarm productivity came as output rose while hours worked declined, pushing output per hour higher.  Nonfarm productivity is up 1.8% in the past year and up 1.7% at an annualized rate over the past two years.  This is the fastest two-year increase since 2011, which was early in the recovery, when it's normal for productivity growth to surge as firms increase output while still reluctant to add hours.  The recent gain, however, comes deep in an economic recovery, which suggests tax cuts and deregulation are the key drivers. We expect productivity will remain elevated in 2019, as the investments in machinery and R&D continue to come online. Meanwhile, the tight labor market will encourage firms to keep looking for more efficient ways to produce. Also today, initial jobless claims rose 9,000 last week to 220,000. Continuing claims rose 39,000 to 1.726 million. Plugging these figures into our model suggests nonfarm payrolls continue to grow at a healthy pace in August. In other news yesterday, on the inflation front, both import and export prices rose 0.2% July.  In the past year, import prices are down 1.8%, while export prices are down 0.9%.  We expect these inflation figures to continue to head north in the coming months.   

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Posted on Thursday, August 15, 2019 @ 10:51 AM • Post Link Share: 
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  The Consumer Price Index Rose 0.3% in July
Posted Under: CPI • Data Watch • Inflation


Implications:  This is why the Fed shouldn't be cutting rates.  Consumer prices rose 0.3% in July while "core" prices – a gauge of inflation that strips out the typically volatile food and energy components – also rose 0.3%, tied for the largest monthly increase since 2005.  Overall consumer prices are up 1.8% in the past year, but core prices are up 2.2%.  Given the Fed's 2% inflation target, that should be a signal that everything is looking A-OK. Not too fast, not too slow, just right.  But the Fed showed at its last meeting that it has moved away from a "data dependent" stance, so don't expect this pickup in inflation to change its plans for an additional rate cut at the next meeting in September.  A look at the details of today's report should, at the least, make things interesting when the Fed releases its survey of economic projections (the "dot plots") at its next meeting.  Although core inflation is up 2.2% in the past year, it's up at a 2.8% annualized rate over the past three months.  The Fed needs to keep this in mind in the months ahead as it deliberates about rate cuts.  In addition, the Cleveland Fed's median CPI series, which adjusts for both upside and downside outliers, shows inflation up 2.9% in the past year.  With employment data continuing to run strong, the Fed would clearly be putting their dual mandate on the back burner in an attempt to use monetary policy to "solve" issues that have developed overseas.  It would be better served realizing that the woes in Europe, Japan, and China are issues with fiscal and regulatory policy , things monetary policy can't fix.  Housing, gasoline, and medical care led the index higher in July, but prices rose virtually across the board.  We believe these data, as well as strength in trend inflation (which is far more important than single-month readings) don't support the case for rate cuts.  The worst news in today's report was that real average hourly earnings declined 0.1% in July but are up 1.3% in the past year.  With the strength in the labor market noted above, we believe the trend will move higher in the months ahead.  Healthy consumer balance sheets, a strong job market, inflation in-line with Fed targets but pushing upwards, and the continued tail winds from improved tax and regulatory policy, all reinforce our belief that the economy is on solid footing. 

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Posted on Tuesday, August 13, 2019 @ 11:27 AM • Post Link Share: 
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  Those Crazy Negative Interest Rates
Posted Under: Europe • Government • Monday Morning Outlook • Fed Reserve • Interest Rates

More than five years ago the European Central Bank adopted negative interest rates as a policy tool to address economic weakness in the Eurozone.  Starting at -0.1%, eventually the target short-term rate fell to -0.4%.

In Europe, as in every country or region that has tried Quantitative Easing, banks have not increased loans by the amount that QE suggested.  As a result, central banks (like the ECB) have attempted to force banks to lend by "charging" banks (with negative rates) to hold these excess reserves.  Negative interest rates are "man-made"," not something that has happened organically.  More importantly, they prove QE didn't work.  If QE worked, then negative interest rates wouldn't be necessary.

Now policymakers are nearly in a panic because some key Eurozone economies are sputtering.  Germany's industrial production was down 5.2% in June versus a year ago, the largest drop since 2009.   Meanwhile, many now expect that German real  GDP contracted in Q2.  Italy's economy hasn't grown in the past year and France's economy is up only 1.3% from a year ago.  Some economies in Europe are doing well, particularly Poland and Hungary, but these aren't large enough by themselves to power the whole Eurozone higher. 

It's time for Europe to recognize that neither negative interest rates nor quantitative easing have saved their economies.  By using negative rates, the ECB has been trying to punish banks into lending, and it hasn't worked.  Worse, negative rates are, in effect, a tax on the financial system.  As a result, they undermine bank profitability and weaken the financial system. 

Instead of looking toward monetary policymakers to rescue their economies, they needed to point their fingers at the real culprits all along, bad fiscal and regulatory policies.  Germany, for example, is still running budget surpluses even though investors buying their debt are willing to accept negative rates. This is absurd.

This isn't to say the German government should spend more, spending is already too high.  But Germany has room for deep tax cuts oriented toward boosting incentives for investment and economic growth.  Increasing the incentive to produce would, in turn, generate the growth in lending that negative interest rates were supposed to encourage.  

On top of tax cuts, we'd recommend cutting government transfers to non-workers (yes, that includes limiting the generosity of future government retirement benefits) and regulations that have stifled entrepreneurship.

Hopefully the US learns the right lessons from Europe's crazy negative rate approach, which is an admission of failure by government officials.  In the 1980s, the US saw real GDP growth of 4% - not because of low (or negative) interest rates – but because of better fiscal policies.  Paul Volcker actually held interest rates high while President Reagan pushed through tax rate and regulatory reductions and spending restraint.  Those policies strengthened the dollar and the economy.  That's what works.

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

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Posted on Monday, August 12, 2019 @ 11:26 AM • Post Link Share: 
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