The economy looks to be finishing off 2017 in very
strong fashion, led by a consumer who is spending more but not,
however, earning more. Lack of wage growth is one of the week's themes,
evoked by another soft consumer price report and underscored by Janet
Yellen herself who cited it as one of enigmas of her tenure as Federal
Reserve chair. But it's definitely optimism and consumer-led
acceleration that are the week's most immediate takeaways.
The economy
The
consumer is in gear for the holidays as a very strong retail sales
report points to a solid fourth-quarter contribution from consumer
spending. Retail sales rose a sharp 0.8 percent in November which was
well beyond the consensus and 3 tenths over Econoday's high estimate.
The data included upward revisions to October which now stands at a 0.5
percent gain and also September where the month's 2.0 percent gain is
the strongest since March 2010. November's standout is a 2.5 percent
jump in nonstore sales, pointing to unusual strength for e-commerce
which makes up about 90 percent of the nonstore component. Electronics
& appliances are high ticket items and they appear to be early
holiday favorites with these stores reporting a 2.1 percent jump on top
of a 1.2 percent rise in October. Price discounting for apparel hasn't
been holding down totals for clothing stores where sales rose 0.7
percent for a second straight month. Restaurants had been soft in prior
months but also rose 0.7 percent in confirmation of discretionary
confidence. November points convincingly to a rebound for consumer
spending which rose at only a 2.3 percent inflation-adjusted annualized
rate in the third quarter and, despite September's retail jump, was
the third weakest showing in four years.
What
is driving this spending? Certainly confidence in the economic outlook
is an important factor as are high levels of employment. Hiring as
tracked in the Labor Department's JOLTS report and the red line of the
graph jumped to 5.552 million in October for a 4.4 percent monthly
surge and a new expansion high. And, in what offers strong
justification for the economic confidence, there are still plenty of
jobs to be filled, at 5.996 million as tracked in the blue columns of
the graph. For comparison, there were 6.520 million Americans actively
looking for work back in October meaning that there is nearly 1 job
available for every single person out of work. Yet openings have been
ahead of hires for the last two years as employers have had a difficult
time filling positions in what underscores recent warnings out of the
Federal Reserve's Beige Book: skilled workers are in short supply which
is holding down business expansion.
This
lack of skilled workers is very likely a key factor behind the
expansion's central anomaly, that high levels of employment have not led
to meaningful wage improvement. Real average hourly earnings, data
that are adjusted for inflation and were released with the week's
consumer price report, have been very weak, falling to negligible
year-on-year growth of only 0.2 percent in both October and November.
And this lack of inflation-adjusted growth comes surprisingly at a time
when inflation is weak. Should inflation for goods and services
finally begin to pick up at the same time that wages stay flat, real
average hourly earnings could easily turn negative in an unwanted
outcome that was last seen coming out of the Great Recession. However
much holiday spending is getting a lift from total employment and low
prices, it's not getting a lift from higher pay.
Janet
Yellen said her chief regret as chair is the stubborn weakness of
inflation which has been unable to make a meaningful run at the Fed's 2
percent policy goal. November's consumer price report was just another
disappointment with the core reading, as tracked in the dark blue line,
slipping 1 tenth to 1.7 percent. Apparel and once again medical care
and housing all dragged on inflation in November. The core in fact has
been going in the wrong direction all year and has been under 1.8
percent for six out of the last seven months. Yes, prices for cell
phone services were very weak early in the year but they have since
been on an extended rebound and, in any case, they make up only a tiny
fraction of total prices, at only 1.5 percent. The core results point
squarely at a November reversal for the Fed's central inflation measure,
the core PCE price index which, as tracked in light blue, hasn't been
able to hold even the 1.5 percent line.
There
was another down note in the week and this came from the sector where
anecdotal reports have been making headlines all year. Manufacturing in
the Federal Reserve's industrial production report rose a very modest
0.2 percent in November which was 1 tenth below Econoday's already
subdued consensus. Vehicle production eased in November to only a 0.1
percent increase with selected hi-tech also slowing but to a still
useful 0.3 percent gain. Production of business equipment was solid at
0.5 percent with construction supplies at 0.6 percent. Weakness was
once again centered in consumer goods where volumes fell 0.4 percent to
underscore the nation's lack of competitiveness in this very
significant and very large category. One notable positive in the report
was an upward revision to total manufacturing in October which now
stands at a very outsized 1.4 percent, an isolated gain however that
reflects hurricane effects. The graph compares the blue columns of the
Fed's measure, which is comprehensive in scope, with the green line of
ISM's manufacturing report which is based on small samples measuring in
the low hundreds. Both measure month-to-month change in volume terms
with 51, according to the Bureau of Economic Analysis, ISM's breakeven
number for production. What's most important on how to read the ISM
isn't that it has been at a much higher rate of change but that it has
accurately predicted the path of change in the very simplest terms,
that is higher.
A
run down of the week's news wouldn't be complete without turning to the
FOMC's 7 to 2 vote to lift its federal funds target by 25 basis
points, to a 1.25 to 1.50 percent range centered at 1.375 percent. The
FOMC continues to expect that the labor market will remain strong and
that the economy will continue to rise. Growth in household spending
(and this was before the release of the retail sales report) was once
again described as moderate and most of the 16 FOMC members still
expect inflation to move higher and stabilize around 2 percent. But the
two votes against the hike do underscore skepticism that high levels
of employment will actually lead to wage-push inflation. Yellen, in
what was her last Fed press conference, cited the softness in wages and
conceded that inflation is on a frustratingly low path. She said it
could take a "longer period of a very strong labor market" before
inflation finally does gain traction. Though the nation's 4.1 percent
unemployment rate is already 1/2 point below the Fed's own long-term
projections, she would not describe the economy as being at full
employment, rather only in the "vicinity" of full employment. Asked
whether the Fed may have to rethink its assumptions on employment and
inflation, she said it is "conceivable" that unemployment will have to
come down even more before full employment is reached. She also
repeatedly noted that one factor behind the lack of wage gains and lack
of inflation in general is the workforce's low rate of productivity
growth. Fed Governor Jerome Powell has been designated to succeed
Yellen.
Markets: Santa Claus coming at full speed
Year-end
rallies are always the expectation and 2017's version, driven
especially by rising expectations for a big corporate tax cut, is very
strong. The Dow has been posting a series of record closes and ended
the week with a 1.3 percent gain to 24,651. But there's been another
pattern in the market and that's the flattening of the yield curve
which got even flatter in the week as the 2-year yield, reflecting
falling demand, rose 4 basis points to 1.84 percent and the 10-year,
reflecting rising demand, fell 3 points to 2.35 percent. The closer
these two yields approach each other, the more talk will rise that
recession may be in store. Yellen in her press conference noted that
there is much discussion underway in the Fed about the slope of the
yield curve and that comparatively low long rates reflect a low
term-premium for future inflation risk. This suggests that investors,
despite the strength of the labor market, don't see wages gaining
traction anytime soon.
Markets at a Glance | Year-End | Week Ended | Week Ended | Year-To-Date | Weekly |
2016 | 8-Dec-17 | 15-Dec-17 | Change | Change | |
DJIA | 19,762.60 | 24,329.16 | 24,651.74 | 24.7% | 1.3% |
S&P 500 | 2,238.83 | 2,651.50 | 2,675.81 | 19.5% | 0.9% |
Nasdaq Composite | 5,383.12 | 6,840.08 | 6,936.58 | 28.9% | 1.4% |
Crude Oil, WTI ($/barrel) | $53.71 | $57.35 | $57.28 | 6.6% | -0.1% |
Gold (COMEX) ($/ounce) | $1,152.50 | $1,250.40 | $1,259.10 | 9.2% | 0.7% |
Fed Funds Target | 0.50 to 0.75% | 1.00 to 1.25% | 1.25 to 1.50% | 75 bp | 25 bp |
2-Year Treasury Yield | 1.21% | 1.80% | 1.84% | 63 bp | 4 bp |
10-Year Treasury Yield | 2.45% | 2.38% | 2.35% | –10 bp | –3 bp |
Dollar Index | 102.26 | 93.9 | 93.93 | -8.1% | 0.0% |
The bottom line
For GDP to ramp higher two things will be
paramount: exports have to begin rising faster than imports and
consumer spending will have to prove consistently strong. The first of
these two isn't yet taking shape but the latter is, at least it appears
to be for the holidays.
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