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Thursday, March 21, 2019

What happened to the four rate increases and the federal funds interest rate rising to 3.5%? Well, it seems that the Federal Reserve was looking at the wrong indicator for signs of “overheating.” The Fed was scope-locked on watching real GDP growth surge to a 4% range instead of watching for signs of benign inflation, which by Fed Chair Powell’s own admission is now below expectations for both its core and headline gauges. The Fed was determined to get GDP growth to “trend,” but its 2.1% growth estimate for 2019 may be in error, especially after U.S. growth surged to 2.9% in full-year 2018.

What would Fed policies have been if the growth trend truly were 3%? GDP growth does not presently seem to be causing inflation pressure, so why not let it run? Here we are now with the 10-year U.S Treasury yield plummeting to 2.51%, the Atlanta Fed’s GDPNow 1Q19 forecast at an abysmal 0.4% and the International Monetary Fund having twice downgraded its 2019 global growth forecast — currently at 3.5% — driven by Europe and China, two of our “Big 3.” The good news is that the United States, the third of the Big 3, continues to get a boost from low tax rates and a pro-business regulatory backdrop; my expectation is for an improved second half of 2019. But for now, low bond yields are sending a dire message.

For an explanation of the Big 3, please see Global Perspectives 2019 forecast, “The Storm before the Calm.”

Tuesday, March 19, 2019

Special Guest Blogger: Tim Kearney

February saw disconcerting data from the manufacturing sector, which fell for the second consecutive month in the United States. Industrial production undershot, clocking in at 0.1% MoM (0.4% was expected), although January was revised upward to -0.4% from -0.6%. Manufacturing, which accounts for about three-fourths of industrial production, fell by 0.4% (0.1% was expected) although the big -0.9% MoM in January slimmed to -0.4%; the annual percent change dropped to 1%. Capacity utilization was basically flat at 78.2%. The nonfarm payroll (NFP) print of 20,000 jobs in March also pressured concerns over growth.

At this point, with many estimates at the lower end of their recent ranges, it seems a foregone conclusion that 1Q19 will be soft. The Atlanta Federal Reserve’s GDPNow forecast is currently a weak 0.4%, down from 2.8% earlier in the quarter. The New York Fed Nowcast is holding at 1.4%, down a point since early December 2018. There remain unresolved questions about the issue of 1Q19 seasonality, which may have been exacerbated by the severe winter weather. This is not to argue that we can explain away softer 1Q19 data, but simply that it may be difficult to separate signal from noise this quarter.

The fading inflation rate implies that the Federal Reserve is correct to be “patient”; I believe a useful notion for this pause is “data dependency.” I doubt that we are looking at a rise of inflation in the short run. It will be interesting to see how the Fed handles the next six months.

Please watch GDP on page 70 of the Global Perspectives book.

Thursday, March 14, 2019

According to the NAHB (National Association of Home Builders), housing contributes 12‒15% to U.S. GDP. The actual construction and remodeling of single and multifamily homes account for 3‒5% and the remainder is comprised of the associated consumption of housing services including rent and utilities. In addition, housing is usually a consumer’s biggest asset. Thus, any cracks in the housing market’s foundation are valid reasons for concern.

Limited inventory, high prices and rising interest rates contributed to an overall slowdown in housing sales in 2018. According to the S&P Case Shiller index, housing prices rose at a 4.7% annual pace in December, much higher than the pace of inflation. January new home sales dropped 7% from December and 4.1% from a year ago; not a very encouraging start to 2019. Still, housing starts which are considered a leading indicator, rebounded sharply – up 18.6% in January to an annual pace of 1.23 million. (To give this number some context, housing starts hovered around 2.3 million in 2006).

New construction leads to economic activity: jobs, loans and consumer spending. Mortgage rates recently fell to their lowest levels in a year, which may encourage sidelined buyers to jump in and boost sales. Housing is not as big a driver of the economy as it was pre-recession, but it certainly factors significantly into economic growth. Given limited inventory, increases in population and household formation, and a continued robust economic backdrop, housing prices should keep moving higher in 2019, but at a measured rate.

Please watch housing starts on page 67 of the Global Perspectives Book.

Tuesday, March 12, 2019

Special Guest Blogger: Tim Kearney

The nonfarm payroll (NFP) print of 20,000 jobs raised some concerns about the economy, but the balance of key recent data points to a continued low inflation/good growth situation in the United States. February CPI was up 1.5% YoY while Core CPI rose 2.1%. Each was 0.1% lower than expected. Headline inflation had hit 2.9% YoY as recently as July 2018. As a result, real average weekly earnings continue to grind higher, reaching 1.6% YoY in February, up from -0.7% in January 2017. Importantly, the four-quarter moving average of nonfarm productivity rose by 1.8% in 4Q18 from zero in mid-2016.

As for NFPs, Stanford economist Edward Lazear’s research shows that the initial print is the single most revised data point published in any given month. In fact, the data are so volatile that the most useful cut is the 12-month moving average (where seasonal factors are smoothed). The fading inflation rate implies that the Federal Reserve is correct to be “patient”; I believe a useful notion for this pause is “data dependency.” I doubt that we are looking at a rise of inflation in the short run, but the economy can surprise the Fed to the upside. It will be interesting to see how the Fed handles the next six months.

Please watch inflation on page 60 of the Global Perspectives book.

Thursday, March 7, 2019

Increased productivity allows firms to produce more output with the same level of input. This, in turn, allows for higher profits and the ability to pay higher wages without eroding profit margins or stoking inflation. U.S. productivity advanced 1.9% in 4Q18, a move up from 3Q18 and affirmation of an encouraging trend higher. Annually, the 1.4% increase was the best reading since 2010. Below trend productivity began to turn around in 2017, and it wasn’t caused by a surge in sales of energy drinks.

The means of improving productivity are straightforward — new technologies, investment in human capital with education and training and physical investment in machines and infrastructure. The 2017 tax reform offered incentives to businesses to invest in new technologies and equipment to increase output. The deregulation overhaul made it easier for competition to jump into the market with greater efficiency. Hence, better productivity and improved economic growth allowed the Federal Reserve to raise rates eight times in the last two years.

Europe has failed to receive the memo. European economic growth for 2019 has been slashed from 1.7% to 1.1%. Although 4Q18 GDP growth picked up slightly, the European Central Bank isn’t taking any chances. ECB President Mario Draghi unveiled a new round of “sugary” central bank stimulus in the form of cheap bank loans (TLTRO – Targeted Longer Term Refinancing Operations), its third round since 2016. In addition, the ECB’s guidance revealed that rates will remain on hold for the remainder of 2019.

Please watch U.S. productivity on page 65 of the Global Perspectives book.

Tuesday, March 5, 2019

Special Guest Blogger: Tim Kearney

There are important developments in the running of the Federal Reserve’s monetary policy, centered on the meaning of the inflation target and the disposition of the Fed’s balance sheet expansion. Regarding the target, discussions are beginning to hone in on something akin to nominal GDP targeting or price level targeting. This is a longer-term project, as positions must be worked out and communicated.

By contrast, the discussion over the balance sheet is well underway and in fact, “normalization” seems to be happening. Although the balance sheet has increased by five times since the global financial crisis, there has been no significant inflation — the PCE deflator has averaged 1.8% during this period, the same as the 25-year average ending December 2018.

The flattened yield curve, low level of long-term interest rates, anchored inflation expectations and the fall of commodity prices imply that there is no need for the Fed to reduce the balance sheet further. Nevertheless, recent comments indicate that the reduction process will continue. Be aware that the risks for markets seem to skew more heavily to the downside.

Thursday, February 28, 2019

U.S. economic growth in the fourth quarter surprised on the upside with a GDP reading of 2.6% QoQ (2.9% YoY). Consumer spending pulled back a little from the third quarter, but still made a solid showing with a 2.8% increase for 4Q18. Consumer expenditures are the biggest contributor to economic growth. The snap-back in the consumer confidence index in February (post government shutdown), and the continuing vigorous employment outlook, temper the dismal December retail sales report and bode well for continued economic expansion.

In the 10 years since the recession, consumer spending has been mostly steady. Business spending, however, has been spotty. Companies have been reluctant to invest in nonresidential structures, equipment or intellectual property. As a result, worker productivity growth has been weak. Thus, the increase in nonresidential investment of 6.2% in the fourth quarter, even amidst uncertainty and market turmoil, is a welcome component of GDP and foreshadows an improving productivity outlook.

Productivity is the key to higher trend economic growth. We believe the tax cuts, regulation overhaul and strong corporate profits should provide some muscle to business spending in 2019. In another indication of a bustling economy, the February Chicago Purchasing Managers’ index (PMI) surged to levels not seen in more than a year and included a sharp pick-up in new orders. As February comes to a close, strong U.S. economic data, a patient Federal Reserve and progress in the U.S.-China trade talks generally have produced another positive month of market returns.

Please watch U.S. GDP on page 70 of the Global Perspectives Book.

Tuesday, February 26, 2019

Special Guest Blogger: Tim Kearney

One swallow may not make a spring, but one tweet sure can prompt a rally. President Trump prompted one by tweeting that he will push the trade deadline past March 1, noting “substantial” progress in trade talks with China. This positive news comes at a good time, as the Dutch Bureau for Economic Policy Analysis recently reported that global trade volumes fell by 1.4% YoY — breaking a three-year run of positive readings. More importantly, it appears to be the largest drop in a decade. There are two takeaways: there is a big appetite for resolution of these trade tensions and this is a major known-unknown, an unpredictable issue that will require market participants to remain careful.

It helps that recent U.S. data have rebounded a bit. The February National Association of Home Builders Housing Market index unexpectedly moved up to 62 in January from 58 in December, a bit of ventilation following a yearlong decline. The index is about on its five-year average value. The February Dallas Fed Manufacturing index rebounded as well and outperformed expectations. Unemployment claims are dialing down and remain at 50-year lows. Markit Composite PMI hit 56 versus 54, which was expected.

This all is important to the global economy, as PMIs in Germany, Japan and the Eurozone aggregate all have slumped below 50, i.e., into contraction territory. Germany is now at 47.6; last winter, it was printing near 60. The United States has some heavy lifting ahead but the momentum remains positive.

Tuesday, February 19, 2019

We’ve seen some “sloppy” U.S. data in recent months, starting with December retail sales and heading on to January industrial and manufacturing production. There are reasonable excuses for the downbeat retail report, including the government shutdown, an increase in part-time employment and the now infamous polar vortex. One sparrow does not make a spring, but then there were the industrial production data, where the 0.6% drop in the headline reading was driven by a 0.9% drop in the manufacturing sector. While some blamed the drop on the auto sector, ex-auto manufacturing was down 0.2%.

The combination of these data seemingly supports the Federal Reserve’s current stance, which is essentially, “Do no harm.” With German GDP at zero in Q4 and China stumbling, is the U.S. following suit or the victim of unusual circumstances? The good news on that front is that the February Empire State Manufacturing Survey, the University of Michigan (UM) Index of Consumer Sentiment and Index of Consumer Expectations all exceeded analyst projections. In fact, UM Expectations hit 86.2 in February versus 79.9 in January. A key to come will be the February PMI data, which could provide a clearer indication of the economy’s direction.

Friday, February 15, 2019

According to the National Retail Federation, Valentine’s Day will add $20.7 billion of consumer spending to the U.S. economy in 2019. It looks like the economy is going to need it. Consumer spending drives 2/3 of the U.S. economy represented monthly by retail sales which has been a bright spot and with expectations for a positive December its drop of 1.2% was heartbreaking. To put in context, this -1.2% decline was the worst decline since September 2009, renewing economic worries. Although the reporting period was pre-government shutdown, it was amid a month of violent market swings which may have contributed to the consumers’ reluctance to spend. Fourth quarter U.S. GDP will not be released until February 28. It is expected to confirm a fourth quarter slowdown but is estimated to exhibit solid growth of about 2.7%. Meanwhile, the Eurozone’s GDP continued to disappoint, expanding only a mere .2% in Q4 and although China’s January trade data was much better than expected, it is not yet indicative of a sustained economic pick-up. As Q4 2018 earnings season winds down, economic data and the possibility of a U.S./China trade deal will remain front and center for investors.

Please review retail sales on page 12 of the Global Perspectives book.

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