The narrative around COVID-19 is constantly changing, so we thought we would put a one-pager out once a week with some of the charts and data that we think are important to keep an eye on to help gain some perspective.

Sources: First Trust Advisors, Department of Labor, Redbook Research, Box Office Mojo,  Association of American Railroads, American Iron and Steel Institute,  Hotel News Now, Opentable, Transportation Security Administration, Energy Information Administration

1 Data for level and year ago level are YOY % changes.

2 Data is provided daily instead of weekly.

3 Data shows year-over-year seated diners at restaurants on the OpenTable network across all channels: online reservations, phone reservations, and walk-ins. % change month over month is the current reading minus the month ago reading.

Implications: Following three months in a row of double-digit percentage gains, it looks like homebuilders took a breather in August, with housing starts posting a decline of 5.1%. However, the details of today's report were better than the headline number.  All of August's decline can be traced to the volatile multi-unit sector, which fell 22.7%. Meanwhile, single-family starts continued the recovery, rising 4.1% in August to post a fourth consecutive month of growth.  Moreover, new single-family construction is now only 1.3% below its February pre-pandemic high. This rebound is doubly important because growth in single-family construction has been the lone driver in the upward trend in overall starts since 2015 when the multi-unit sector plateaued, so continued gains remain crucial for the housing market going forward. The recent rebound in starts is even more impressive considering that builders are dealing with multiple headwinds to construction.  While home builders have been classified as "essential workers" in most areas of the country, regulations still require fewer people per crew, dragging out project times. The construction industry also seems to be suffering from an ongoing shortage of workers, with job openings above pre-pandemic levels while job openings in the broader economy have fallen.   In other words, there are still lots of unfilled construction jobs that, if filled, would promote a sharper rebound in new construction.  Finally, supply chains have been disrupted and are struggling to keep up with the pace of new construction.    Looking to the future, overall permits fell 0.9% in August.  However, just like with starts, this was entirely due to a decline in multi-unit permits which fell 14.2%; permits for single-family homes rose 6.0% in August, are now 4.2% above the February pre-pandemic high.   A continued rebound in construction is likely in the months ahead if the NAHB Index, a gauge of homebuilder sentiment, is anything to go by. That measure was released yesterday and rose to 83 in September, the highest reading on record going back to the mid-1980s.  In other news this morning, initial jobless claims fell 33,000 last week at 860,000.  Meanwhile, continuing claims for regular benefits fell 916,000 to 12.628 million. These figures suggest further payroll gains in September as well as another decline in the unemployment rate.  Finally, on the manufacturing front, the Philly Fed Index, a measure of East Coast factory sentiment, declined to a still robust +15.0 in September from +17.2 in August.  This number continues to show a healthy rebound in manufacturing activity versus the deeply negative readings early on in the pandemic.

Click here  for PDF version

The Federal Reserve was already holding short-term interest rates near zero.  What today's meeting made clear was how determined the Fed is to hold them there for at least the next few years and perhaps well into the current decade.

In previous statements the Fed had noted that its 2% inflation goal was "symmetric," which hinted that it would like to see inflation above 2% as much as below 2%.  That commitment is now explicit, with the Fed saying, it "will aim to achieve inflation moderately above 2% for some time, so that inflation averages 2% over time."

The Fed also made it clear that it will keep monetary policy loose for a prolonged period of time, saying it expects to maintain near zero short-term interest rates until (a) the employment situation is back to normal (with an unemployment rate around 4.0%) and (b) inflation is running at or above 2%.

In turn, the Fed's "dot plot" shows that the current consensus among policymakers is that there will be no rate hikes at all this year, or in 2021, 2022, or 2023.  None. Nada.  Zero. Zippo.  This is consistent with its new economic forecast, which, although it shows an upwardly revised pace of recovery in late 2020 as a well as a faster drop in the unemployment rate, shows the jobless rate at 4.0% at the end of 2023 and inflation not exceeding 2.0% until at least 2024.

In other words, the Fed itself doesn't think the economy will meet its two-pronged test for rate hikes (employment and inflation) until at least 2024.  Furthermore, if the Fed wants to see inflation persistently exceeding 2.0% before it raises rates, it now thinks rate hikes won't happen until the second half of the 2020s.

We believe short-term rates are likely to stay near zero for at least the next couple of years, but the Fed will end up raising rates earlier than it now thinks.  The reason is that the M2 measure of the money supply has been growing at an extremely rapid pace, unlike in the aftermath of the Financial Crisis in 2008-09, and the federal government has taken measures (we think that will likely be extended) to support incomes in excess of the rebound in economic production.  This is a recipe for faster inflation.       

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

Click here for PDF version

Implications: Retail sales continued to move higher in August, growing 0.6%, although the gain was less than the consensus expected and there were small net downward revisions to prior months.  Some slowdown in the growth rate of spending should be expected as the $600 weekly unemployment checks from the federal government ran out at the end of July.  It's also important to keep in mind how much progress has been made.  Back in April, retail sales were down 19.9% from a year ago; now, in August, retail sales are up 2.6% from August 2019.  For some more perspective: from February (before the COVID shutdowns started) to the bottom in April, retail sales fell 17.7%.  Now, with the increase in August, we are 2.5% higher than the February mark, meaning retail sales have seen a full V-shaped recovery.  Nine of thirteen major categories of sales had gains in August, with the leaders continuing to be the sectors that were hit hardest during the shutdown. For example, restaurants & bars fell by 54.1% from February to April and led the way higher in August, up 4.7% from last month and have now recovered 70% of what was lost during the downswing.  Other categories that were large contributors this month were sales of building materials, up 2.0% in August, and sales at clothing and accessory stores which rose 2.9%. On the flip side, grocery store sales, which were one of the largest gainers over the first few months of the pandemic as people stocked up, declined 1.6% in August, but remain up 9.0% from a year ago.  "Core" sales, which exclude the most volatile categories of autos, building materials, and gas station sales, rose 0.6% in August, and are now up 3.1% from a year ago.  While the data are improving (virtually across the board), the second quarter for real GDP showed the steepest drop in real GDP for any quarter since the Great Depression.  What matters right now is the path forward, and we have started down that path at a healthy clip.  Third quarter real GDP looks set to grow at about a 25% annual rate, or more.

Click here for PDF version

Sources: First Trust Advisors, Department of Labor, Redbook Research, Box Office Mojo,  Association of American Railroads, American Iron and Steel Institute,  Hotel News Now, Opentable, Transportation Security Administration, Energy Information Administration

1 Data for level and year ago level are YOY % changes.

2 Data is provided daily instead of weekly.

3 Data shows year-over-year seated diners at restaurants on the OpenTable network across all channels: online reservations, phone reservations, and walk-ins. % change month over month is the current reading minus the month ago reading.

Implications:  Industrial production increased for a fourth consecutive month in August, continuing the ongoing recovery in the factory sector, though at a slower pace than the consensus expected.  However, if you include upward revisions to prior months, August's gain was 1.2% rather than the more tepid headline gain of 0.4%. Industrial production has now made up roughly 57% of the decline in activity seen during the height of COVID-19 lockdowns back in March and April. Meanwhile, the major source of strength in today's report came from the manufacturing sector, and while downward revisions to activity in prior months sapped away most of August's gain, the underlying details showed continued progress in the sector in most need of a further rebound.  Auto production, which is volatile, fell 3.8% in August.  However, some slowdown in this series was expected as it has already posted a full recovery from its April low.  Meanwhile, non-auto manufacturing rose 1.5% in July, continuing a rapid pace of growth.  That said, non-auto manufacturing is still lagging the overall recovery in industrial production, having only gained back roughly 54% of the decline in March and April, so we still have a ways to go until a full recovery.  The biggest drag on industrial production came from outside the factory sector in August, with mining activity falling 2.5%. It looks like this was mostly the result of a sharp temporary decline in oil and gas extraction and drilling activity due to Tropical Storm Marco and Hurricane Laura, so look for a rebound in the months ahead.  The good news for the beaten down oil and gas sector is that mining activity seems to have hit a bottom in May, and the number of drilling rigs in the US has leveled off after falling roughly 65% since the pandemic began, so it looks like most of the damage is behind us.  As economic activity continues to rebound, demand for energy grows, and the surviving firms consolidate, mining eventually will be a tailwind for industrial production.  In other factory-related news this morning, the Empire State Index, which measures factory sentiment in the New York region, rose to +17.0 in September from +3.7 in August.  Also, this morning on the inflation front, import prices increased 0.9% in August, as fuel led the way rising 3.3%, while nonfuel imports rose 0.7%.  Meanwhile, export prices increased 0.5%, led by nonagricultural exports, which rose 0.8%.  In the past year, import prices are down 1.4%, though notably excluding petroleum these prices are now up 1.1%. Meanwhile, export prices are down 2.8%.

Click here for PDF version

As we near the end of the third quarter, key economic reports will be released that will influence our forecast for third quarter real Gross Domestic Product.  It will be a very strong quarter.  We expect a 25% "annualized" growth rate in Q3.  Using just the data that have already come in so far, the Atlanta Federal Reserve Bank's GDP Now Model says 30%.  Either would be a record quarter for the US economy, but still an incomplete rebound from the shutdown collapse in the first half of the year.  This week industrial production, retail sales, housing starts, and a weekly report on unemployment insurance are on tap.

Also this week, the Federal Reserve will hold a two-day meeting, which ends on Wednesday.  The Open Market Committee will revise its economic forecasts, reveal its expected path of short-term interest rates, and Chairman Powell will hold a post-meeting press conference.

We anticipate a focus on the Fed's willingness to let inflation run higher than its 2.0% target to make up for periods when it has run below 2.0%.  For the record, this is not a new policy.  The Fed has talked about it for years.  But what does it really mean?  The Fed's favorite measure of inflation, the PCE deflator, has grown at a 1.5% annual rate in the past ten years.  So, in theory, the Fed could let it grow at an annual rate of 2.5% for the next ten years and claim consistency.  And because the Consumer Price Index typically grows faster than the PCE deflator, that could mean the CPI increases at about a 2.75% annual rate.    

Back in June, the median forecast among Fed policymakers was that PCE prices would rise 0.8% in 2020 (Q4/Q4), which already appears too low.  We're estimating an increase of 1.4%, which is only a hair below the 1.5% increase in 2019.

The Fed's June forecasts for inflation in 2021 and 2022 also look too low, at 1.6% and 1.7%, respectively.  The M2 measure of the money supply is up 23% in the past year, the fastest rate on record, and much above its growth rate after the first use of Quantitative Easing between 2008 and 2015.

Meanwhile, consumer spending has revived much faster than production, with retail sales up 2.7% versus a year ago in July, while industrial production is down 8.2%.  The reason for the gap is unprecedentedly generous government transfer payments, which, in the four months ending in July, were up 77% versus a year ago.  You show us a country where people can spend more without producing more, and we'll show you a country that is heading for faster inflation.              

But with the Fed willing to let inflation rise, we don't think it's going to lift short-term interest rates anytime soon.  This, in turn, will hold the entire yield curve down.  At least for the near- to medium-term.

But what happens if, as we expect, inflation has clearly and persistently outstripped the Fed's long run 2.0% target?  Will the Fed act to bring it back down?  Will it let it run?  The Fed has embarked on a dangerous game.  Let's hope it has not forgotten the hard lessons learned from the late 1960s through the early 1980s.  For now, rates will stay low.  But no country can print its way to prosperity, nothing is free.  The stakes are very high.

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

Click here for PDF version

Source: St. Louis Federal Reserve FRED Database