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Core inflation crunch
Simply Economics - September 29, 2017
By Mark Pender, Senior Editor



It's all about your core. That's what they say at the gym and it also applies to monetary policy where decisions are keyed to improvement in core inflation which of course excludes food and energy and which, right now at least, isn't improving at all. Janet Yellen said at midweek that it would be "imprudent" to hold back rate hikes waiting for inflation to actually hit the FOMC's 2 percent target. But inflation should at least be moving toward the target, Right? Not away from it.


The economy

Looking first at monthly rates, core PCE prices managed only a 0.1 percent gain in August. FOMC members have been blaming "idiosyncratic" factors for the core's numbing run of weakness but the downward pull from these factors, most namely cell phone prices, has been easing. Maybe there's something fundamental going on? The graph compares the blue columns of the core with the green columns of hourly wages, another series at the very heart of inflation and which hasn't been showing any oomph at all.


Now let's turn to yearly inflation which is where the 2 percent target comes in. Core PCE prices, tracked in blue, are not going in the right direction. August's 1.3 percent is a 2-year low. Wages, in green, have been stuck at 2.5 percent since April in their worst run since early last year. FOMC members used to say that wages had to be over 3 percent to pull the core higher. Why are wages flat? Perhaps because costs are flat in a feedback loop that keeps workers, just happy to be working, from seeking better pay.


Consumer spending was solid, relatively speaking, in the second quarter making for the quarter's 3.1 percent GDP success. But that was spending after adjustment for inflation, inflation which pivoted lower during the quarter. When inflation sinks, small gains in adjusted spending are magnified relative to prior spending. Looking at unadjusted spending, that is the actual amount we pay out of our pockets as tracked in the green columns, recent results for consumer spending don't look that great.


Here the green columns are unadjusted spending on a yearly basis and again the trend is going the wrong way though the level, still holding at 4 percent growth, is respectable enough. Less great is total unadjusted income which broke below 3 percent early in the year and is at 2.7 percent in the August data. Yet the trend over the last 3 years, traced in the red line, is decidedly unfavorable. But I don't want to be a doomsdayer. Spending and income are still growing and inflation is low which makes our dollars go further.


Factory signals have also been mixed, some incredibly strong but others very weak. One that is turning positive is capital goods which speaks to rising business investment in line with strong business confidence. Core capital goods (nondefense ex-aircraft) are not one-time goods, rather they are used to produce future goods. Core orders have posted very big gains in 3 of the last 4 months and shipments are following suit. This hints at more productive output and a bit better economic growth ahead.


Yet yearly rates here aren't sky high. Core capital goods orders are the red line and they've been hitting 5 percent like it's a barrier. The columns are all other durable goods which, outside June's giant aircraft spike, have been struggling at the same line. Back in the meat of the prior expansion, in 2005 and 2006, core capital goods were posting 10 percent gains month after month with the rest of durables right behind. If our ongoing expansion is ever to come ailve, the red line really needs to move up a notch.


But new machinery is only part of the story. The big event of this expansion isn't what's going on now, it's what happened back in 2014 when the price of oil fell in half, from $100 to where it is still, at $50. This plunge, the result of Saudi Arabia's intentional burst of output, cut oil in half taking profits out of energy, cutting demand for energy equipment and stunting U.S. energy output as the Saudis intended. This made for a big dip in the factory sector as a whole which is just now returning to where it was 3 years ago.


Another big event for the factory sector, or at least one that looked big at first, was Hurricane Harvey's strike on Houston which is the center of the U.S. energy patch. Flooding hurt retail sales and construction but, unlike Saudi Arabia, it apparently hasn't made any big dent in manufacturing, at least that's the early indication. Manufacturers in both Dallas and Kansas are actually stepping up activity especially in hiring. But there are definitely temporary effects: higher input costs and delivery delays.


The South is by far the largest region for housing, whether for new homes or for resales and the latter is what we'll turn to now. However much the economy may be up, resales are not part of the success story. The blue columns of existing home sales, pulled down in August by Harvey's effects in the South, posted their 4th dip in 5 months while the red line of pending sales, which track initial contracts, posted their 5th dip in 6 months. The pending sales drop points at weakness for final sales in the months ahead.


But Harvey may not be totally to blame as housing trends have been softening all along. Housing got off to a good start this year before stumbling during the spring push, not regaining any balance since. Resales, in red, have been bumping against the annual zero line since March while sales of new homes, in blue, have taken the cold plunge below. Lack of affordability, at a median price of $253,500 for resales and $300,200 for new homes, isn't helping and neither are weak wages nor this year's hurricanes.


If you like the unknown then you're going to love September's employment report. Hurricane effects may or may not completely scramble the results. Judging strictly by jobless claims data, September payrolls are likely to slow at least slightly from 156,000 in an August report, sampled at mid-month, when Harvey played no part. Claims in Texas spiked early in September then eased off while claims in Florida began to rise right at mid-month And Puerto Rico? Washington has been estimating their claims.


What hurricane effects will prove to be on third-quarter GDP is another question though we do know that it slowed consumer spending and housing, at least in August. The week's other data includes cross-border goods trade where exports posted a small August gain and imports another decline. Wholesale and retail inventories were also released with both showing unusually big builds. Did the hurricanes shut out imports and keep inventories sealed in? Maybe so, but in any case both are pluses for GDP.


Markets: Trading Friday's employment report  

Forecasters see only a 95,000 rise for September nonfarm payrolls which would probably be no big deal for the markets. But there is a risk, the size of which is unknown, that Harvey and Irma could sweep the results even lower. Given this possibility, even a disappointing payroll gain, say 30,000 which is Econoday's low estimate, could trigger a move into risk on relief that the results weren't even worse. Who knows? For the past week, most trading was narrow with Dow posting a 0.2 percent gain to 22,405.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2016 22-Sep-17 29-Sep-17 Change Change
DJIA 19,762.60 22,349.59 22,405.09 13.4% 0.2%
S&P 500 2,238.83 2,502.22 2,519.36 12.5% 0.7%
Nasdaq Composite 5,383.12 6,426.83 6,495.96 20.7% 1.1%
Crude Oil, WTI ($/barrel) $53.71 $50.64 $51.56 -4.0% 1.8%
Gold (COMEX) ($/ounce) $1,152.50 $1,300.40 $1,283.20 11.3% -1.3%
Fed Funds Target 0.50 to 0.75% 1.00 to 1.25% 1.00 to 1.25% 50 bp 0 bp
2-Year Treasury Yield 1.21% 1.44% 1.49% 28 bp 5 bp
10-Year Treasury Yield 2.45% 2.26% 2.33% –12 bp 7 bp
Dollar Index 102.26 92.15 93.08 -9.0% 1.0%


The bottom line

The markets may not have shown much reaction to the week's news but the weakness in core PCE prices stands in contrast to the core CPI which, remembering back to mid-month, rose 0.2 percent and was almost strong enough to be rounded up to 0.3 percent. That was the best result in 6 months and it tripped a run out of the bond market and expectations for a December FOMC rate hike that have yet to be unwound. Sourced differently than the CPI, the PCE index also has an amped up adjustment system and is the FOMC's personal price gauge. Since the core PCE disappointment didn't move the markets, the pressure is now on average hourly earnings which will be the second biggest headline out of the September employment report. And the Econoday consensus for this reading is one of solid strength, at 0.3 percent.


Week of October 2 to October 6

Expanding indications on Hurricane Harvey and initial indications on Irma's effects will fill a very busy week that starts off with ISM manufacturing on Monday and winds up with the September employment report on Friday. Only slightly easing strength is the call for September's ISM which has been unusually strong while construction spending in August, despite Hurricane Harvey, is expected to move into positive ground. Vehicle sales are Tuesday's key data and are, despite Hurricane Irma, expected to show some bounce from August's unusual weakness. Attention turns to the service sector on Wednesday where both PMI services and ISM non-manufacturing are expected to hold at solid levels with Thursday's attention turning to international trade where hurricane effects, due perhaps to port closures, may narrow the deficit, and also to jobless claims where Irma will make another early appearance. Factory orders are also released Thursday with a solid headline the call in line with the prior week's durable goods report. Econoday's consensus for September nonfarm payrolls is 95,000 in what would be a major hurricane-related move lower. Yet there is improvement expected for average hourly earnings which are expected to bounce higher.




PMI Manufacturing for September, Final

Consensus Forecast: 53.0

Consensus Range: 52.5 to 53.0


PMI manufacturing has been running at much more moderate rates of growth than any other private or regional survey, more in line with the actual pace of the nation's factory sector. New orders posted their slowest rate of growth of the year in September's flash with export orders stagnate. There were few indications of specific trouble tied to Hurricanes Harvey or Irma though input costs did hit a 5-year high. Forecasters see no change from September's 53.0 flash.


ISM Manufacturing Index for September

Consensus Forecast: 58.0

Consensus Range: 57.0 to 59.0


The ISM manufacturing index has been surging this year, beating the consensus the last 4 months in a row and often by very large margins. Production has been unusually strong, over 60 in 3 straight reports in sharp contrast to actual manufacturing production as tracked by the Federal Reserve which posted outright declines in 2 of those months. Other ISM readings are likewise exceptionally strong including new orders, backlog orders and employment. The Econoday consensus for September's headline is 58.0 vs August's 58.8.


Construction Spending for August

Consensus Forecast, Month-to-Month Change: 0.3% 

Consensus Range: -0.1% to 0.5%


Housing starts and completions were held down by the South and the impact from Hurricane Harvey. But forecasters don't see the same for construction spending where the consensus call for August is a 0.3 percent rise which would be the first in 3 months for this series. Residential spending in this report has been the leading component with nonresidential spending holding down results.




Total Unit Vehicle Sales for September

Consensus Forecast, Annualized Rate: 16.7 million

Consensus Range: 15.0 to 17.4 million


Domestic-made Unit Vehicle Sales

Consensus Forecast, Annualized Rate: 12.6 million

Consensus Range: 12.5 to 13.6 million


Motor vehicle sales are coming off their worst showing in 3-1/2 years due to initial disruptions from Hurricane Harvey. The weakness in unit sales translated into weakness for dollar sales as tracked in the retail sales report where the vehicle component dropped sharply during August. Though Hurricane Irma's Florida hit is in play for September's numbers, forecasters see much better strength with the consensus for total unit vehicle sales at a 16.7 million annualized rate vs August's 16.1 million. Yet the low call for this reading, at 15.0 million, does reflect expectations for a major hurricane hit. Sales of domestic-made models are expected to come in at 12.6 million vs the prior month's 12.7 million.




ADP, Private Payrolls for September

Consensus Forecast: 150,000

Consensus Range: 45,000 to 175,000


ADP has been very wild in recent months, calling for exceptional acceleration in September private payrolls which actually slowed sharply. In July and June, ADP fell well short of actual growth. The ADP consensus for September is 150,000 vs ADP's 237,000 August call when actual private payrolls rose only 165,000.


PMI Services for September, Final

Consensus Forecast: 55.1

Consensus Range: 55.1 to 56.3


Though there was little indication of hurricane effects, PMI services did slow noticeably in the September flash to what was still a very solid 54.6 score but down from August's 56.0. Service providers reported increases in both consumer and business spending in the flash report though optimism on future sales slowed to the lowest level since September last year. Inflation readings were mixed with input costs, despite the hurricanes, slowing while selling prices showed the most traction in three years. The consensus for final September, at 55.1, points to expectations for month-end strength.


ISM Non-Manufacturing Index for September

Consensus Forecast: 55.4

Consensus Range: 54.0 to 56.2


ISM non-manufacturing had been surging earlier in the year but began to moderate through most of the summer. Yet readings were still very strong with new orders, business activity and employment all in the upper 50s. Econoday's call for the September headline is 55.4 vs August's 55.3.




International Trade Balance for August

Consensus Forecast: -$42.5 billion

Consensus Range: -$45.2 to -$41.4 billion


The international trade deficit held steady in July and forecasters, in what be a plus for third-quarter GDP, are calling for a sharp narrowing in August to $42.5 vs July's $43.7. This would be in line with advance data on the goods part of the report which narrowed in August, to $62.9 billion from $63.9 billion. Note that hurricane effects are in play as Irma may have shut in imports and kept out exports during the month.


Initial Jobless Claims for September 30 week

Consensus Forecast: 265,000

Consensus Range: 260,000 to 300,000


Hurricane volatility has made initial jobless claims very difficult to forecast but the consensus for the September 30 week is 265,000 vs 272,000 in the prior week. Claims in Texas following Hurricane Harvey have eased back but claims in Florida after Hurricane Irma have been on the rise. Claims in Puerto Rico, where unemployment offices have been closed following Hurricane Maria, are likely to estimated once again.


Factory Orders for August

Consensus Forecast, Month-to-Month Change: 0.9%

Consensus Range:  0.4% to 2.2%


Factory orders are expected to rise 0.9 percent in August in what would be an aircraft-related bounce following July's 3.3 percent decline. Aircraft swings aside, underlying data have been mostly solid especially orders and shipments for core capital goods which point to strength in business investment.




Nonfarm Payrolls for September

Consensus Forecast: 95,000

Consensus Range: 30,000 to 140,000


Unemployment Rate

Consensus Forecast: 4.4%

Consensus Range: 4.3% to 4.5%


Private Payrolls 

Consensus Forecast: 117,000

Consensus Range: 20,000 to 150,000


Manufacturing Payrolls 

Consensus Forecast: 11,000

Consensus Range: 10,000 to 15,000


Labor Force Participation Rate

Consensus Forecast: 62.8%

Consensus Range: 62.7% to 62.9%


Average Hourly Earnings

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.2% to 0.4%


Average Hourly Earnings

Consensus Forecast, Year-on-Year Change: 2.6%

Consensus Range: 2.5% to 2.6%


Average Workweek

Consensus Forecast: 34.4 hours

Consensus Range: 34.4 to 34.5 hours


September will be the first employment report to register effects from Hurricane Harvey which hit too late in August to affect the data, and also the first to pick up the effects of Hurricane Irma. Going into September's report, nonfarm payroll growth slowed sharply to 156,000 after plus 200,000 showings in both July and June. Econoday's September consensus for nonfarm payrolls is 95,000 though the consensus range is extremely wide, at 30,000 to 140,000. The unemployment rate is seen unchanged at 4.4 percent. Average hourly earnings were very weak in August, at only a 0.1 percent gain, but improvement is seen for September at a consensus 0.3 percent.  Year-on-year hourly earnings are expected to come in at 2.6 percent vs August's 2.5 percent. Other calls are for a 117,000 rise in private payrolls vs August's 165,000 in what would reflect a rise in government hiring, an 11,000 gain for manufacturing payrolls following August's big 36,000 surge, a 1 tenth downtick in the labor force participation rate to 62.8 percent, and 34.4 hours for the workweek which would be unchanged.


Wholesale Inventories for August

Consensus Forecast, Month-to-Month Change: 0.7%

Consensus Range: 0.3% to 1.0%


Wholesale trade inventories are expected to rise 0.7 percent in what would be a downward revision from August's advance data that showed a gain 1.0 percent jump. Wholesalers have been building their inventories aggressively the last several months though an outsized build for August could also reflect transportation snags tied to hurricane effects.


Consumer Credit for August

Consensus Forecast: $16.0 billion

Consensus Range: $12.5 to $16.2 billion


Consumer credit has been on the rise this year though revolving credit, which is where credit cards are tracked, did slow in July. Nonrevolving credit, reflecting growth in vehicle financing and student loans, has been very strong. Forecasters are calling for a $16.0 billion rise in August vs $18.5 billion in July.


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