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Understated strength of a rising economy
Simply Economics - January 26, 2018
By Mark Pender, Senior Editor



"Modest-to-moderate" was the Federal Reserve's unvarying verdict of the economy all through last year and even in the last Beige Book posted earlier this month. But don't be too surprised if FOMC policy makers begin to upgrade their assessment given the building strength of incoming data centered in the consumer. In this week's report we'll breakdown fourth-quarter GDP, take a look at the housing sector, and even offer updates on the dollar and the lift underway for oil.


The economy

GDP came in at 2.6 percent annualized growth in the fourth quarter which is solidly above the FOMC's long-range median of 1.8 percent and also well above the long-range 2.2 percent high estimate. GDP has been gradually trending upward over the course of the expansion including the last 3 years and especially during 2017, a year that included the 3.1 percent and 3.2 percent results of the second and third quarters.


But the hidden highlight of 2017 may very well be the fourth quarter's results. Consumer spending, which makes up more than 2/3 of GDP, rose at a very strong 3.8 percent rate. This is among the very strongest results of the expansion and, importantly, is centered in durable goods which surged at a 14.2 percent rate. Buying a new car or a new appliance speaks to the confidence and strength of the consumer and stands in contrast perhaps to less discretionary spending on essential services like medical care or electric bills or spending on nondurable goods such as groceries or household supplies. The 14.2 percent showing for durables is the strongest in more than 9 years, a time when results were being lifted by easy comparisons coming out of the Great Recession.


What really limited the fourth quarter were net exports, at an annualized deficit of $652.6 billion. This comes out to more than 54 billion inflation-adjusted dollars leaving this country each month! Imports of oil are always an issue for the deficit but less so in recent years given increases in the output of domestic oil. What is a persistent sore point is the import of consumer goods, and looking at the details (here in nominal dollars) shows an average monthly deficit of nearly $53 billion. Imports of capital goods are even slightly higher but these goods help improve business output and worker productivity. Consumer goods, whether discretionary or non-discretionary, don't provide the same benefits. These increasing levels of consumer imports are masking what is in fact a healthy rate of export growth led especially by foreign demand for capital goods which is one of this nation's greatest strengths, such as aircraft and machinery. Cross-border trade is in fact very active though the U.S. consumer's preference for foreign consumer products continues to inflate the deficit and in turn hold down U.S. GDP.


Inventories also held down fourth-quarter GDP, rising $9.2 billion in the quarter vs the prior quarter's $38.5 billion increase which is a negative in the GDP calculation. But here, like the rising totals for exports which are being masked by the greater totals for imports, the slowing inventory build is coming at a time of strengthening demand which is actually very positive for the economy. The lack of fourth-quarter build points to the need for a greater first-quarter build and that means rising production and rising employment. When excluding the effects of net exports and inventories, GDP actually rose 4.3 percent in the fourth quarter which is the best showing in 3-1/2 years and the second best in nearly 9 years.


A major plus for the economy over the past year has been solid rates of business expansion which is measured in the GDP report by nonresidential fixed investment. This rose at a 6.8 percent rate in the fourth quarter and follows similar rates in the prior 3 quarters. Strength here is no surprise given the exceptional rise in business confidence and flow of investment funds into the stock market. But there is a note of caution in the week's data and that comes from the core capital goods component of the durable goods report. This reading, which excludes defense products and also aircraft, shows a 0.3 percent December decline in orders. The monthly weakness in core orders, which includes a second straight sharp decline for communications equipment, points to a future slump in capital goods shipments and poses an obstacle to first-quarter growth in business investment.


We close fourth-quarter GDP with a look at residential investment, which is another consumer-related component and which rose at a very impressive 11.6 percent rate. This is the best showing in nearly 2 years and reflects the rising strength of the new home market and rising demand for home improvements. And similar to the strength in nonresidential investment, it reflects the general strength of confidence in the economy and especially the fundamental strength of the labor market.


Residential investment makes up a deceptively small percentage of GDP, less than 5 percent, yet the effect of housing on the economy as a whole can be very significant. Home sales were another feature of the week's news and the results were mostly solid. Month-to-month sales data can be extremely volatile which makes 3-month averages a necessity. Sales of new single-family homes (blue line of graph) have been very strong, up 12 percent for the 3-month average over the past year and up 9 percent during the fourth quarter to a 638,000 annualized rate. But sales of existing single-family homes (green line) are another story, up only 1 percent during 2017 though they did show life at year-end with a 4 percent quarterly gain to a 4.973 million rate. Yet with employment as strong as it is and with the stock market taking off, why haven't more Americans been moving up to better homes?


The Federal Reserve's explanation is lack of housing inventory which limits buyer choices. On the new home side, completions have been rising with 6 percent more homes, at 295,000 in December, on the market than in September. But existing homes are going the other way, at only 1.480 million for a quarterly decline of 20 percent. Why aren't more homeowners putting their homes on the market? It's not because prices are low. They've been rising at an annual 6 percent pace by the various measures which, outside the stock market right now, is a strong rate of return in a low interest rate economy. Perhaps part of the answer lies in the labor market, specifically the JOLTS report where the monthly separation rate has been subdued at just under 4 percent. With people staying put, that is employers holding onto their employees very closely and vice versa, there may be less relocation going on and with this less need to swap homes. Whatever the factors, lack of supply in the resale market looks to be one of the few early obstacles for the 2018 economy.


Markets: The dollar and worn out jawbones

The dollar fell sharply at midweek after Treasury Secretary Mnuchin cited the positive effects of its decline on "trade and opportunities", comments that ECB President Draghi the next day warned are the language of a currency war. The dollar index fell 1-1/2 percent in reaction to Mnuchin to hit a 3-year low below 89 before President Trump voiced his support for a strong dollar which sent the greenback higher. This is a back-and-forth replay of the dollar-yen strategy early in the Clinton administration when some advisors, seeking to reduce the nation's trade imbalance with Japan, were calling for a stronger yen while others were warning against it, most memorably Larry Summers who, as then Treasury Undersecretary, spoke his famous line "you cannot devalue yourself into prosperity." But devaluation was definitely the outcome back then as the dollar fell 1/3 against the yen during the first 3 years of Clinton's first term. And what did this mean for the deficit? Devaluation certainly didn't reduce it as the goods deficit with Japan widened from $49.6 billion in 1992 to $59.1 billion in 1995. Note that the dollar index is down 3.4 percent so far this year following last year's very sizable decline of 9.7 percent.


One effect of a weaker currency, if not improvement in the deficit, is a higher cost for imported foreign goods and services. This means getting less for more which is the definition of inflation and which actually would be welcome by Fed policy makers who have been trying hard to reflate the economy. Another source of inflation is also now coming from oil. Here supply is the key as OPEC is talking about sustained production cuts at the same time that U.S. inventories, as tracked in the columns of the graph, continue to fall. Dollar weakness and oil strength, not to mention a very low 4.1 percent unemployment rate and the risk of wage inflation, could fire up inflation quickly -- and, in what would be an irony, perhaps more quickly than the Fed could contain.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 19-Jan-18 26-Jan-18 Change Change
DJIA 24,719.22 26,071.72 26,616.71 7.7% 2.1%
S&P 500 2,673.61 2,810.30 2,872.87 7.5% 2.2%
Nasdaq Composite 6,903.39 7,336.38 7,505.77 8.7% 2.3%
Crude Oil, WTI ($/barrel) $60.15 $63.50 $66.14 10.0% 4.2%
Gold (COMEX) ($/ounce) $1,305.50 $1,334.40 $1,354.20 3.7% 1.5%
Fed Funds Target 1.25 to 1.50% 1.25 to 1.50% 1.25 to 1.50% 0 bp 0 bp
2-Year Treasury Yield 1.89% 2.06% 2.11% 22 bp 5 bp
10-Year Treasury Yield 2.41% 2.66% 2.66% 25 bp 0 bp
Dollar Index 92.29 90.64 89.12 -3.4% -1.7%


The bottom line

There's a lot of activity in the U.S. economy right now and FOMC policy makers may not have the luxury of downplaying the strength. Yes, inflation has been very limited but there are many advanced indications of greater pressure ahead: strong consumer demand, strong business demand, a falling dollar, rising oil prices -- not to mention a tax cut and full employment.


Week of January 29 to February 2

Friday's January employment report will highlight an extraordinarily busy week for economic news. Personal income and outlays on Monday will break out December's consumer share of fourth-quarter GDP followed on Tuesday by Case-Shiller home prices, which are expected to be strong, and consumer confidence where unusual strength is the usual result. The employment cost index comes out only once a quarter and Wednesday's data on the fourth quarter will offer an important clue whether wage inflation is beginning to take hold. Wednesday will also see pending home sales and the latest on the supply-depleted resale market. But the big news on Wednesday will be the FOMC announcement which could offer clues whether policy makers, perhaps raising their assessment of the economy and concerned about the high level of employment, are beginning to think about a fourth rate hike this year. Thursday's highlights start off with the always strong ISM manufacturing report along with construction spending which has been showing solid strength followed late in the day by motor vehicle sales which will offer the first indication on consumer spending in January. This will be followed on Friday by the employment report where solid payroll growth, low unemployment, and moderate wage pressures are the calls.




Personal Income for December

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

Consensus Range: 0.2% to 0.5%


Consumer Spending

Consensus Forecast, Month-to-Month Change: 0.5%

Consensus Range: 0.3% to 0.8%


PCE Price Index

Consensus Forecast, Month-to-Month Change: 0.1%

Consensus Range: 0.1% to 0.3%


PCE Price Index

Consensus Forecast, Year-on-Year Change: 1.7%

Consensus Range: 1.7% to 2.0%


Core PCE Price Index

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.3%


Core PCE Price Index

Consensus Forecast, Year-on-Year Change: 1.6%

Consensus Range: 1.5% to 1.7%


The monthly personal income and outlays report will unbundle December's data from last week's fourth-quarter GDP report. Personal income is seen rising 0.3 percent which would match November's gain while consumer spending is expected to slow only slightly to 0.5 percent vs November's very solid 0.6 percent gain. The PCE price index is expected to inch only 0.1 percent higher for a year-on-year rate of 1.7 percent with the core PCE price index, which excludes both food and energy, seen up 0.2 percent for a yearly 1.6 percent.


Dallas Fed General Activity Index for January

Consensus Forecast: 25.4

Consensus Range: 22.0 to 29.0 


January's consensus for the Dallas Fed general activity index is 25.4 which would compare with December's very robust  29.7. Unsustainable strength is the risk with this sample as new orders keep pouring in, unfilled orders continue to build, and manufacturers in the region, facing long delivery delays and rising work hours as well as elevated prices, may be having trouble keeping up with demand.




Case-Shiller, 20-City Adjusted Index for November

Consensus Forecast, Month-to-Month Change: 0.6%

Consensus Range: 0.4% to 0.7%


Case-Shiller, 20-City Unadjusted Index

Consensus Forecast, Year-on-Year Change: 6.4%

Consensus Range: 6.3% to 6.7%


November's Case-Shiller report is expected to show a solid 0.6 percent gain for the adjusted 20-city index in what would underscore the strength of home-price appreciation which was one of the strongest aspects of the 2017 economy. The consensus for the unadjusted year-on-year rate is 6.4 percent.


Consumer Confidence Index for January

Consensus Forecast: 123.4

Consensus Range: 120.0 to 125.1


Consumer confidence in January is expected to come in at 123.4 and up from December's dip to 122.1 which, however, did not reflect any slowing at all in current conditions or the assessment of the current labor market. This report rose steadily last year to 17-year highs in sharp contrast to the consumer sentiment report which has been flattening out.




ADP, Private Payrolls for January

Consensus Forecast: 195,000

Consensus Range: 160,000 to 234,000


ADP is always hit and miss and December's call unfortunately was definitely a miss, at an accelerating gain of 250,000 for private payroll growth vs an actual 146,000 and a sharply decelerating gain. The consensus for ADP's private payroll call for January is 195,000.


Employment Cost Index for 4th Quarter

Consensus Forecast, Quarter-to-Quarter Change: 0.6%

Consensus Range: 0.4% to 0.9%


Another quarter of emerging wage pressures is the expectation for the fourth-quarter employment cost index where forecasters are calling for a 0.6 percent rise. The ECI jumped 0.7 percent in the third quarter for a year-on-year 2.5 percent, both near the highest rates of the expansion. Pressures in the third-quarter report were evenly split between wages and benefits.


Chicago PMI for January

Consensus Forecast: 64.0

Consensus Range: 60.0 to 68.0 


Enormously strong growth, well in excess of the national economy, was last year's results for the Chicago PMI which surged to end 2017 at a December score of 67.8 (revised 2 tenths higher from the initial reading). This index doesn't have much headroom left as forecasters are calling for easing in January to what is still a very robust 64.0. Readings from this sample, which track both manufacturing and non-manufacturing firms in the Chicago economy, are at or near historic highs in data that go back more than 50 years.


Pending Home Sales Index for December

Consensus Forecast, Month-to-Month Change: 0.4%

Consensus Range: -0.3% to 0.6%


Pending home sales have been doing a good job of tracking final sales of existing homes, jumping in October and then leveling off in November vs what proved to be an actual surge in November and slight dip back in December. The Econoday consensus for December's pending sales index is a useful gain of 0.4 percent.


Federal Funds Target for January 30 & 31 Meeting

Consensus Forecast, Midpoint: 1.375%

Consensus Range: 1.25% to 1.50%


No rate hike is the universal expectation for the January FOMC, the last to be chaired by Janet Yellen. What to watch will be any indications whether strong economic growth and full employment are pushing policy makers toward four rate hikes this year vs the three that are already penciled in. The federal funds target is expected to hold at a midpoint of 1.375 percent inside a range of 1.25 and 1.50 percent.




Initial Jobless Claims for January 27 week

Consensus Forecast: 235,000

Consensus Range: 234,000 to 240,000


Initial claims are expected to come in at 235,000 in the January 27 week compared to 233,000 in the January 20 week. Jobless claims have been showing recent volatility yet have been firmly consistent with a low level of layoffs and unusually strong demand for labor.


Nonfarm Productivity, 1st Estimate, 4th Quarter

Consensus Forecast, Annualized Rate: 1.1%

Consensus Range: -0.5% to 2.6%


Unit Labor Costs

Consensus Forecast, Annualized Rate: 0.9%

Consensus Range: -0.1% to 2.2%


Fourth-quarter GDP came in at 2.6 percent which points to a respectable fourth-quarter productivity rate and no more than moderate pressure for labor costs. Forecasters see nonfarm productivity rising 1.1 percent in the fourth quarter vs 3.0 percent in the third quarter with unit labor costs seen up 0.9 percent vs a 0.2 percent third-quarter decline.


PMI Manufacturing for January, Final

Consensus Forecast: 55.5

Consensus Range: 54.2 to 55.5


PMI manufacturing posted a solid 5 tenths increase in the January flash to 55.5 for the best reading in nearly three years. Export sales were a highlight of the flash report as was production, employment and overall orders. The report's sample was trying to build inventories while traction for selling prices was the strongest in more than four years, both tangible signs of strength. The consensus for January's final PMI manufacturing is unchanged from the flash, at 55.5.


ISM Manufacturing Index for January

Consensus Forecast: 58.7

Consensus Range: 57.7 to 60.0


January's consensus for the ISM manufacturing index is 58.7 vs a revised 59.3 in December (59.7 initially reported) when unusual strength across readings -- in stark contrast to the Federal Reserve's "modest" assessment of overall factory activity -- was once again the outcome. New orders, at 69.4, hit a 14-year high in December in results that included unusual strength for export orders, production, backlog orders, and employment.


Construction Spending for December

Consensus Forecast, Month-to-Month Change: 0.5% 

Consensus Range: -0.3% to 0.8%


Construction spending rose a strong and broad-based 0.8 percent in November with December's call at a gain of 0.5 percent. November spending on residential construction rose 1.0 percent led by a 1.9 percent rise for single-family homes in what promises to provide badly needed supply to a depleted market. Home improvements also showed strength, up 0.7 percent in the month, with private nonresidential spending up 0.9 percent.


Total Unit Vehicle Sales for January

Consensus Forecast, Annualized Rate: 17.3 million

Consensus Range: 16.7 to 17.6 million


Domestic-made Unit Vehicle Sales

Consensus Forecast, Annualized Rate: 13.1 million

Consensus Range: 12.9 to 13.7 million


Vehicle sales accelerated in December to a solid 17.8 million annualized rate (17.9 million initially reported) which, outside of hurricane-related spikes in October and September, was among the best results of the last 2 years. January's consensus is for easing strength at a median 17.3 million overall with sales of domestic-made vehicles expected to come in at 13.1 million vs December's 14.0 million.




Nonfarm Payrolls for January

Consensus Forecast: 176,000

Consensus Range: 150,000 to 205,000


Unemployment Rate

Consensus Forecast: 4.1%

Consensus Range: 4.0% to 4.2%


Private Payrolls 

Consensus Forecast: 172,000

Consensus Range: 142,000 to 200,000


Manufacturing Payrolls 

Consensus Forecast: 18,000

Consensus Range: 5,000 to 22,000


Participation Rate

Consensus Forecast: 62.7%

Consensus Range: 62.6% to 62.7%


Average Hourly Earnings

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

Consensus Range: 0.2% to 0.3%


Average Hourly Earnings

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

Consensus Range: 2.5% to 2.7%


Average Workweek

Consensus Forecast: 34.5 hours

Consensus Range: 34.4 to 34.5 hours


Econoday's consensus for January growth in nonfarm payrolls is 176,000 in what would compare with a moderate but still favorable 148,000 in December. The unemployment rate is expected to hold unchanged at a 17-year low of 4.1 percent which would continue to point to full employment and the risk of wage inflation which did show some December pressure as average hourly earnings rose 0.3 percent with January's expectations also at a 0.3 percent gain. Year-on-year average hourly earnings increased 1 tenth in December to a still modest 2.5 percent against the January consensus for 2.6 percent. Private payrolls are expected to rise 172,000 with manufacturing payrolls expected to climb 18,000. The workweek is seen unchanged at 34.5 hours and the labor participation rate also seen unchanged at 62.7 percent.


Consumer Sentiment Index, Final January

Consensus Forecast: 95.0

Consensus Range: 94.4 to 96.0


Consumer sentiment continued to edge back in the preliminary January index, to 94.4 in what was the softest showing in six months. Weakness was in the current conditions component which fell more than 4-1/2 points to 109.2 for a 15-month low and what hints at weakness for January consumer spending. Econoday's consensus for the final January consumer sentiment index is 95.0.


Factory Orders for December

Consensus Forecast, Month-to-Month Change: 1.5%

Consensus Range: 0.3% to 2.5%


A 2.9 percent rise in the durable goods report for December makes for a 1.5 percent consensus call for total factory orders which include nondurable goods. Strength in the durables report included vehicles and once again aircraft with weakness centered in a monthly decline for core capital goods orders (nondefense ex-aircraft).


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