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   Brian Wesbury
Chief Economist
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Deputy Chief Economist
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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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  The Producer Price Index Increased 0.2% in July
Posted Under: Data Watch • Inflation • PPI


Implications:  Inflation is under the microscope as the Fed plans its next move, and today's report did little to clarify the picture.  Energy prices - up 2.3% on rising gasoline costs - led the producer price index 0.2% higher in July.  As a result, producer prices are up 1.7% in the past year.  That's below the Fed's 2% inflation target, but not by much.  Those seeking further rate cuts will point to July's 0.1% decline in "core" inflation (which excludes the volatile food and energy sectors).  And while we agree that the core reading is a better measure of trend inflation, July represents the first monthly decline for that measure in more than two years.    More important is that, even with the July decline, core inflation is still up 2.1% in the past year and has run above 2% on a year-ago comparison basis for the past twenty-four months straight.  A 4.3% decline in prices for guestroom rentals was the key contributor to core prices moving lower in July.  Goods prices excluding food and energy rose 0.1% in July, while prices for services declined 0.1%.  It's notable that private capital equipment prices, a signal of demand for business investment, rose 0.4% in July and are up a healthy 2.3% in the past year.  Interestingly, these prices were falling in the late 1990s, when the Fed was mistakenly lifting rates.  What will this all mean for the Fed?  Not much.  The Flailing Fed  showed at the July meeting that it has moved away from being "data dependent," and is leaning toward another cut even if the economic data don't support it.  Political and bond market pressures have the Fed on its heels, and it will try to justify a cut however it can.  Case in point?  Go re-watch the last two Fed Chair press conferences and see if you can find a coherent rationale for the rate cut in July that Powell said wasn't warranted in June.  At the end of the day, do we think another rate cut is needed?  No, and we don't think they should have cut in July.  But the Fed is very likely to cut rates in September anyhow.  In recent employment news, initial jobless claims fell 8,000 last week to 209,000. Continuing claims declined 15,000 to 1.684 million. Plugging these figures into our model suggests nonfarm payrolls continue to grow at a healthy pace in August.

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Posted on Friday, August 9, 2019 @ 10:49 AM • Post Link Share: 
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  The ISM Non-Manufacturing Index Declined to 53.7 in July
Posted Under: Data Watch • ISM Non-Manufacturing


Implications:  The rate of growth in the service sector continued to decelerate in July, with the headline index falling to the lowest level in nearly three years.  However, it still showed growth and we anticipate a re-acceleration in the service side of the economy in the second half of the year.  It's important to recognize that thirteen of eighteen service sub-sectors reported growth in July, while only five reported contraction.  And, if survey respondent comments are any indication, direct impacts from the China tariff dispute remain minor, with only the construction and management/support services sectors claiming increased costs.   It looks like the bigger issue surrounding trade continues to be the uncertainty regarding a potential resolution, not impacts from what has/is happening.   And the negative sentiment that reflects this uncertainty in the headline numbers may get worse before it gets better, with the Trump Administration's latest tariff escalation set to take place September 1st if no deal is reached. The two most forward-looking indices – new orders and business activity – both fell to the lowest levels since August 2016, but remain in expansionary territory.  The new orders index declined to 54.1 from 55.8 in June, while business activity moved down to 53.1 from 58.2.  It's also worth pointing out that despite the recent slowdown in the pace of growth, as of this month both indices have now been in expansion for ten consecutive years.  Price pressures also eased in the service sector in July, led lower by bacon, fuel and steel.  Ending on a bright note, the one major category to show growth in July was employment which rose to 56.2 in July from 55.0 in June.  Both finding and paying up for qualified labor continues to be a dominant theme in survey responses as well, reflecting the ongoing tightness in the labor market.

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Posted on Monday, August 5, 2019 @ 11:24 AM • Post Link Share: 
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  The Flailing Fed
Posted Under: Europe • Government • Monday Morning Outlook • Trade • Fed Reserve • Interest Rates

The Fed is flailing.

For the past several years, under the leadership of both Jerome Powell and, before that, Janet Yellen, the Fed claimed it was "data dependent."  But the decision last week to reduce short-term rates by 25 basis points tore that narrative to shreds.

At the prior Federal Reserve meeting in mid-June, a slender majority of Fed policymakers projected no rate cuts this year.  After that, the data flow on the economy was generally better than expected, including solid reports on jobs, retail sales, manufacturing production, and real GDP.  These figures undermined the Fed's forecast that real GDP would grow only 2.1% this year.  In addition, both consumer and producer prices rose more than expected.  If the Fed were really data dependent then, if anything, these data should have moved it away from a rate cut.

The oddest part of the Fed's decision was Powell acknowledging how little its rate cut means.  "(W)e don't hear that from businesses.  They don't come in and say we're not investing because...the federal funds rate is too high.  I haven't heard that from a business.  What you hear is that demand is weak for their products."  And yet, the US consumer looks pretty strong.   Core retail sales, which exclude volatile items like autos, building materials, and gas, are up 4.4% from a year ago and up 10.6% annualized so far this year.       

Powell said at the press conference following the meeting that the Fed wants to "ensure against downside risks to the outlook from weak global growth and trade tensions."  Yes, Europe and China have experienced slower growth.  But some of the slower growth abroad, particularly in China, is a result of changes in trade policy so that the US no longer subsidizes China by turning a blind eye to that country's piracy of intellectual property.  And slower growth in Europe is largely a function of structural issues that US monetary policy can't solve: too much redistribution, too much regulation, too much socialism.  Moreover, it's not clear that slower growth overseas is a negative for the US; some of the slower growth abroad is because tax cuts and deregulation have made the US a better place to do business.

Another possibility is that the Fed is very concerned about the inverted yield curve, but is too scared to say it.  Maybe the Fed thinks very low long-term rates are, in part, a function of weak expectations of future growth (regardless of today's solid growth) and that if short-term rates stay above long-term rates, then eventually businesses and consumers will have an incentive to postpone economic activity because short-term rates will eventually move lower, as well.

But if that's what the Fed thinks then deciding to cut rates only 25 basis points might have been the worst decision it could have made.  If the Fed didn't cut rates at all and the Fed's statement and press conference focused on the bright side of the US economy, it could have spurred an increase in long-term interest rates that would help unwind the inversion of the yield curve.  Or, as an alternative, the Fed could have cut rates more drastically, in the 50-100 bp range, to make sure short-term rates go below long-term yields, and then make it clear in the statement that the Fed was simply reacting to the yield curve and that the prospects for the economy remain bright.  Instead, by reducing rates only 25 bp and letting the markets assume further rate hikes ahead, it did very little to end the inversion. 

Our view remains that last week's rate cut wasn't needed, nor are further rate cuts in the months ahead.  Nominal GDP is up 4.0% in the past year and up at a 5.0% annual rate in the past two years.  Gold is up 12.3% so far this year.  There are plenty of excess reserves in the banking system.  The Fed is not tight.  

At a deeper level, we think the Fed's recent flailing is an inevitable result of the experiment that began during the Panic of 2008 when it started paying banks interest on reserves.  The Fed then shifted to implementing monetary policy by directly targeting interest rates rather than managing the supply of money and deciding what short-term interest rate was appropriate given its target for the money supply.      

Either way, it looks like the flailing Fed is headed for another rate cut at the meeting in September.  The Fed is under enormous pressure to reduce rates, both political and from the bond market.  Maybe that's why it's having so much trouble articulating a rationale.  Eventually, inflation will rise as a result.  In the meantime, equities remain very cheap.

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

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Posted on Monday, August 5, 2019 @ 10:58 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 5, 2019 @ 10:45 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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