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  Powell Takes Charge
Posted Under: Employment • GDP • Government • Inflation • Research Reports • Fed Reserve • Interest Rates


In his first meeting as Chair of the Federal Reserve, Jerome Powell and company delivered what almost everyone had been expecting, a 25 basis point hike in the federal funds rate, and raised expectations for economic activity in the months and years ahead.  While the hike (which we expect is the first of four in 2018) needs little more than passing mention given its essentially shoe-in status heading in to today's meeting, the Fed Statement and projection materials warrant closer inspection.  

Start with the statement, where the Fed upgraded the outlook on jobs growth to "strong" from "solid", while continuing to note that the unemployment rate remains low. And while they made a point to note a moderation in growth in household spending and business fixed investment from their fourth-quarter readings, they added new language noting that the economic outlook has strengthened in recent months.  This pickup in activity is likely due in large part to the passage of tax reform in late December that the FOMC has now had time to digest and work into their outlook.
On the inflation front, the Fed took a more hawkish tone, changing their expectations for inflation to move to the Fed's 2% objective "in coming months", up from "this year" as was used in the January statement.  With inflation closing in on the Fed's target and unemployment already low, the summary of economic projections released today provide more guidance on how the Fed expects both economic growth and monetary policy to develop in the years ahead.
The Fed raised the outlook for GDP growth to 2.7% in 2018 and 2.4% in 2019, up from 2.5% and 2.1%, respectively, in their December projections. At the same time, they lowered the projected year-end level for the unemployment rate in the comings years and moderately raised their inflation outlook.   
What is most notable from the projections is that the Fed expects both inflation and the Federal Funds rate to overshoot the long-term targets in 2020, with inflation forecast to exceed the 2% objective at 2.1%, while the federal funds rate is forecast at 3.4%, a full 50 basis points above the 2.9% that the Fed believes appropriate over the long term.
For 2018, the Federal Funds rate is still projected to end the year in the 2.0-2.25% target range (representing three rate hikes), but a look at the "dot plot" shows a notable change in the distribution of forecasts in-line with what we noted in this week's Monday Morning Outlook. Back in December, twelve of sixteen participants forecast a year-end rate at or below 2.25% for 2018, while today's projections show a near even split with eight participants expecting three or fewer hikes and seven expecting four or more. In other words, if economic data points continue to show a pickup in the pace of growth – and we expect they will – a shift towards a Fed consensus of four hikes in 2018 looks likely.
In addition to the Fed statement and projection materials, Chair Powell also made a few comments of note during his first press conference. When asked about concerns regarding trade policy and the trade tariffs recently announced by President Trump, the Chair noted that the FOMC does not expect these policies to impact the Fed's economic outlook. At the same time, he expressed expectations that the tax cuts signed into law last December should provide a positive tailwind to the economy for at least the next few years.
These were not groundbreaking statements by any means, but they reinforced the hawkish outlook from the Fed and provide some insight into the thinking of an FOMC that voted unanimously on today's rate hike and changes to the Fed statement.  Chair Powell appears to have a "coalition of the willing" behind him as the Fed seeks to avoid falling behind the curve in an economy that's heating up.   

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

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Posted on Wednesday, March 21, 2018 @ 3:57 PM • Post Link Share: 
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  Existing Home Sales Increased 3.0% in February


Implications:  Following two straight months of declines, existing home sales bounced back in February, though buyers continue to grapple with a lack of options.  Sales of previously-owned homes rose 3% in February to a 5.54 million annual rate and are now up 1.1% versus a year ago.  Notably, sales in February were driven by the South and West regions while the Northeast and Midwest continued to lag.  Unseasonably cold weather in the latter regions has muted sales activity, and should continue to weigh on data in March according to the NAR.  However, once those weather effects filter out of the data we should see an added tailwind to sales in Q2.  That said, the major headwind for existing homes has been inventories, now lower on a year-over-year basis for 33 consecutive months, and down 8.1% from a year ago.  The months' supply of existing homes – how long it would take to sell the current inventory at the most recent sales pace – remained unchanged at a still extremely low reading of 3.4 months in February.  According to the NAR, anything less than 5.0 months (a level we haven't breached since 2015) is considered tight supply.  Despite the lack of choices, demand for existing homes has remained remarkably strong, with 46% of homes sold in February remaining on the market for less than a month.  Higher demand and a shift in the "mix" of homes sold toward more expensive properties has also driven up median prices, which are up 5.9% from a year ago.  The strongest growth in sales over the past year is heavily skewed towards the most expensive homes, signaling that supply constraints may be disproportionately hitting the lower end of the market.  Tough regulations on land use raise the fixed costs of housing, tilting development toward higher-end homes.  Although some analysts may be concerned about the impact of tax reform on home sales, few homeowners exceed the new thresholds for deductibility.  Finally, though mortgage rates may be heading higher, it's important to recognize that rates are still low by historical standards, incomes are growing, and the appetite for homeownership is starting to move higher again.

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Posted on Wednesday, March 21, 2018 @ 11:06 AM • Post Link Share: 
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  The Powell Fed: A New Era
Posted Under: Employment • Government • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates

In the history of the NCAA Basketball Tournament, a 16th seed has never, ever, beaten a one seed...until this year.  But, on Friday, the University of Maryland, Baltimore County (UMBC) beat the University of Virginia – not just a number one seed, but the top ranked team in the USA.

We don't expect the unexpected, however, when the Federal Reserve finishes its regularly scheduled meeting on Wednesday.  Based on the federal funds futures market, there is a 100% chance that the Fed will boost the federal funds rate by 25 basis points, to a new range of 1.5% to 1.75%.

The markets are even giving a roughly 20% chance that the Fed raises rates 50 basis points.  That's better odds than UMBC had, but we suspect it's highly unlikely given that this is Jerome Powell's first meeting as Fed chief.

The rate hike itself is not worrisome.  It's expected and, at 1.75%, the federal funds rate is still below inflation and the growth rate for nominal GDP.  There are also still more than $2 trillion in excess bank reserves in the system.  The Fed is a very long way from being tight.

Instead, investors should focus on how the Fed changes its forecast of what's in store for the economy and the likely path of short-term interest rates over the next few years.

Back in December, the last time the Fed released projections on interest rates and the economy, only some of the policymakers at the Fed had incorporated the tax cuts into their forecasts.  Prior to the tax cut, the median forecast from Fed officials expected real GDP growth of 2.5% in 2018 and 2.1% in 2019.  Now that the tax cut is law, we expect Fed forecasters to move those estimates noticeably higher, to near 3% growth for 2018 and 2019, which should lower unemployment forecasts. 

In December, the median Fed forecast was that the jobless rate would reach 3.9% in the last quarter of 2018 and remain there in 2019 before heading back to 4.6% in following years.

We're forecasting the unemployment rate should get to 3.3% by the end of 2019, which would be the lowest since the early 1950s.  Beyond 2019, it's even plausible the jobless rate goes below 3.0%, as long as we don't lurch into a trade war or back off tax cuts or deregulation.

We doubt the new Fed forecast gets that aggressive, but with the jobless rate already at 4.1%, faster economic growth should push Fed forecasts well below 3.9% in spite of faster labor force growth.

For the Fed, lower unemployment rates mean faster wage growth and higher inflation.  This may force a change in the Fed's "dot plot," which puts a dot on each member's expected path of short-term interest rates.

Back in December, the dot plot showed a median forecast of 75 basis points in rate hikes this year – basically, three rate hikes of 25 bps each.  Four Fed officials expected four or more rate hikes in 2018, while twelve expected three or fewer.  This time, we expect the dots to show a much more even split between "three or fewer" and "four or more." 

At present, the futures market is pricing in three rate hikes as the most likely path this year, with a 36% chance of a fourth rate hike (or more).  Look for the market's odds of that fourth rate hike to go up by Wednesday afternoon, which means longer-term interest rates will also likely move higher.

In addition, the markets will be paying close attention to Jerome Powell's performance at his first Fed press conference.  With journalists planning "gotcha" questions, some negative headlines could result.  If so, and if equities drop, the smartest investors should treat it as yet another opportunity to buy.

Since 2008, the Fed has embarked on unprecedented monetary ease.  Rather than boosting the actual money circulating in the economy, however, quantitative easing instead boosted excess bank reserves, which represent potential money growth and inflation in the years ahead.

The Fed has decided that it can pay banks to hold those reserves, and not push them into the economy.  Four rate hikes in 2018 mean the Fed will be paying banks 2.5% per year to hold reserves.  Never in history has the Fed tried this.  The jury is out.  The Fed thinks it will work, we're not so sure.  The odds of rising inflation in the next few years, because of those excess reserves, are greater than the chance of a number 16 seed beating a number one seed.  Granted, that's not high odds, but we suggest investors, especially in longer-dated fixed income securities, should be worried.  Stay tuned.

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

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Posted on Monday, March 19, 2018 @ 9:40 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, March 19, 2018 @ 8:47 AM • Post Link Share: 
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  Brian Wesbury on Fox Business: Tariffs Need to be Eliminated Entirely
Posted Under: Trade • Video • TV • Fox Business
Posted on Friday, March 16, 2018 @ 11:30 AM • Post Link Share: 
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  Industrial Production Rose 1.1% in February
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  Industrial production picked up pace in February following January's breather.  The headline series rose 1.1% in February, the fastest monthly pace of growth in four months, as most major categories showed gains.  More importantly, industrial production has increased 4.3% in the past year, the largest 12-month increase since early 2011.  And the gains in February would have been even larger but for warmer than usual weather that pushed down utilities production 4.7%.  Meanwhile, mining jumped 4.3% in February – the largest monthly increase since late 2008 - on the back of strong gains in oil and gas extractions.  In the past year, mining production is up 9.7%.  Drilling slowed in the second half of 2017, most likely associated with hurricanes Harvey and Irma, but remains up 27.2% from a year ago.  In addition, the rig count has continued to rise in recent weeks, suggesting gains in mining production in the months ahead.  In other recent factory news this morning, the Empire State index, a measure of manufacturing sentiment in New York, rose to a very healthy 22.5 in March from 13.1 in February.  Meanwhile, the Philly Fed index, its counterpart among East Coast manufacturers, declined modestly to a still strong 22.3 in March from 25.8 in February, signaling optimism in the region.  On the inflation front, import prices rose 0.4% in February while export prices increased 0.2%.  In the past year, import prices are up 3.5% while export prices have increased 3.3%, reinforcing other recent data showing a rising trend in inflation.

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Posted on Friday, March 16, 2018 @ 10:57 AM • Post Link Share: 
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  Housing Starts Declined 7.0% in February
Posted Under: Data Watch • Home Starts • Housing


Implications:  After starting 2018 with a bang, housing starts took a breather in February.  Starts fell 7% in February to a 1.236 million annual rate, and are now down 4% from a year ago.  However, the weakness in today's headline number came exclusively from the very volatile multi-unit sector, where starts fell 26.1% after rising 25.6% in January.  Meanwhile, single family starts rose 2.9% in February, and continue to be the main driver of trend growth, as the chart to the right shows.  The transition to more growth in single-family construction than multi-family is good news for the overall economy.  On average, each single-family home contributes to GDP about twice the amount of a multi-family unit.  Even though permits for new construction fell 5.7% in February, driven primarily by authorizations for multi-unit buildings, the horizon continues to look bright for future activity.  Permits are up from a year ago for both single-family and multi-family units.  Meanwhile, the number of units currently under construction and the rate at which developers finished building homes, which frees them up to take on new projects, are both at their fastest post-recession pace.  Notably, this has all happened despite a significant uptick in mortgage rates in the past year, which some analysts claimed would derail the housing recovery.  Based on population growth and "scrappage," housing starts should eventually rise to about 1.5 million units per year.  And the longer this process takes, the more room the housing market will have to eventually overshoot the 1.5 million mark.  Although tax reform trimmed the principal limit against which borrowers can take a mortgage interest deduction to $750,000 versus the prior amount of $1 million, the law only affects new mortgages.  Large reductions to marginal tax rates in the early 1980s, which reduced the value of the mortgage interest deduction, coincided with a rebound in housing.  In other words, we don't expect the changes in the deduction to cause problems for the housing industry at the national level, although we do expect some shift in building toward regions with lower taxes and land prices.  In other recent housing news, the NAHB index, which measures homebuilder sentiment, fell slightly to 70 in March from 71 in February, remaining at a historically elevated level signaling strong optimism from developers.  On the employment front, new claims for jobless benefits fell 4,000 last week to 226,000, while continuing claims fell 4,000 to 1.88 million.  These figures are consistent with continued healthy job growth in March, although at a pace that's likely to be slower than the rapid gains in February.

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Posted on Friday, March 16, 2018 @ 10:47 AM • Post Link Share: 
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  Retail Sales Declined 0.1% in February
Posted Under: Data Watch • Retail Sales


Implications: Retail sales disappointed in February, falling for the third straight month and coming in below consensus expectations.  Despite the negative headline number, the recent weakness in spending looks to be moderating; including upward revisions to prior months, sales would have been unchanged in February.  Further, retail sales are still up a healthy 4% from a year ago. That being said, plugging in today's report into our GDP models suggests real consumer spending will be up at a roughly 1.0% annual rate in Q1, the slowest pace for any quarter in almost five years.  As a result, it now looks like real GDP is only growing at about a 2.0 – 2.5% annual rate in Q1.  However, this has more to do with the timing of economic growth than the trend.  We remain very optimistic about an acceleration of growth in 2018.  At present we estimate that real GDP will grow 3.0%+ this year, which would be the best year since 2005.  It is not unusual for retail sales to fall three or four months in a year, even during periods of robust growth.  February was one of those months.  Hurricanes in the second half of last year pulled some sales forward. It makes sense that autos represented the largest decline in February, as hurricane victims were buying new cars at a rapid clip to replace those destroyed in the storms late last year.  Removing autos, sales were up 0.2% in February and 4.4% in the past year, showing the consumer isn't dead. As we get back to normal, expect overall retail sales to resume their trend higher in the months to come.  Why are we optimistic about retail sales growth in the months ahead?  Jobs and wages are moving up, tax cuts are taking effect, consumers' financial obligations are less than average relative to incomes, and serious (90+ day) debt delinquencies are down substantially from post-recession highs.

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Posted on Wednesday, March 14, 2018 @ 11:01 AM • Post Link Share: 
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  The Producer Price Index Increased 0.2% in February
Posted Under: Data Watch • Inflation • PPI


Implications:  Producer prices moved higher in February, rising 0.2% in the final key inflation reading before next week's Fed meetings.  And, with producer prices up 2.8% in the past year, there is little question the Fed has the green light to raise rates while also signaling intentions for four rate hikes in 2018.  The pouting pundits of pessimism may cry fears of rising rates slowing economic activity, but the Federal Reserve is still running a loose monetary policy.  Yes, the federal funds rate is slowly and steadily on the rise, but there are still more than two trillion dollars of excess reserves in the banking system, and monetary policy won't be tight until that excess slack is removed.  This is especially true because anti-bank attitudes and regulation have been reversed, which reduces the headwinds to monetary growth.  Taking a look at the details of today's PPI report shows rising costs for services less trade, transportation, and warehousing (think areas like health care, lodging, and banking) led the way in February.  Energy prices fell 0.5% in February as fuel prices declined for the month, but remain up 9.1% in the past year.  Meanwhile food prices declined 0.4%, led by a sharp drop in costs for vegetables.  Strip out these typically volatile food and energy groupings, and "core" producer prices rose 0.2% in February and are up 2.5% in the past year (the largest twelve-month increase going back to early 2012).  For comparison, "core" prices rose 1.3% in the twelve months ending both February 2017, and February 2016.  And a look further down the pipeline shows the trend higher should continue in the year to come.  Intermediate processed goods rose 0.7% in February and are up 4.8% from a year ago, while unprocessed goods increased 2.8% in February and are up 5.6% in the past year.  Both categories have seen a pickup in the pace of price increases over recent months.  Given these figures, and with employment growth remaining strong, the greater risk now is that the Fed flinches and falls behind the curve.   

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Posted on Wednesday, March 14, 2018 @ 10:28 AM • Post Link Share: 
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  The Consumer Price Index Rose 0.2% in February
Posted Under: CPI • Data Watch • Inflation


Implications:  Consumer prices marched higher in February, continuing an acceleration in the pace of inflation. The persistent and consistent rise in prices gives the Fed plenty to think about when they meet next week.  The consumer price index rose 0.2% in February and is up 2.2% in the past year, marking a sixth consecutive month of year-to-year inflation above 2%.  But, in both the past three  and six months, the CPI is up at a 3.6% annual rate, showing clear acceleration.  Energy prices increased 0.1% in February, while food prices were unchanged. Remove these, and "core" prices rose 0.2% in February following January's 0.3% increase.  Core prices are up 1.8% in the past year, but are showing acceleration in recent months, up at a 2.5% annual rate over the past six-months and a 3.1% rate in the past three months.  In other words, both headline and core inflation stand above the Fed's 2% target, and both have been accelerating.  Housing costs led the increase in "core" prices in February,  rising 0.3%, and are up 2.8% in the past year. Meanwhile prices for services rose 0.2% in February and are up 2.6% over the past twelve months.  Both remain key components pushing "core" prices higher and should maintain that role in the year ahead.  One piece of disappointing news in today's report is that real average hourly earnings were unchanged in February.  Inflation-adjusted hourly earnings have been on the decline in recent months, down at a 0.7% annualized rate over the past six months. However, these earnings data do not include irregular bonuses – like the ones just paid by companies after the tax cut.  In addition, earnings are still up a modest 0.4% in the past year, while job growth is accelerating. We expect a visible pickup in wage pressures in the months ahead. A strong February jobs report, combined with today's inflation data suggests the Fed is on track to raise rates four time in 2018.

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Posted on Tuesday, March 13, 2018 @ 10:03 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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