The Business Week In Review

Fourth-quarter economic data are winding down and point to a solid finish to 2017 and a promising start for 2018. The consumer sector is pulling its weight and indications of housing strength continue to build. And even inflation, which has been long dormant, showed a rare bit of life in the week's data.

The economy

It was a very good holiday shopping season but perhaps not a great one. Retail sales rose 0.4 percent in December which is solid and follow November's very strong 0.9 percent gain. The columns of the graph track the monthly increases which, however, put December in perspective as really only a moderate month and far behind December 2017. But the trendline is favorable though it is distorted upward by September when replacement demand for vehicles drove retail sales 2.0 percent higher.

Yet there's no mistaking the improvement. Year-on-year rates have also been trending higher with December's 5.4 percent result only slightly below November's 6.0 percent peak. This is the best performance in six years. In actual dollars, consumers spent $564 billion at the nation's retailers during December. What's driving these results? A very strong labor market of course and one that looks to gain in muscle when wage hikes, like those just announced by Wal-Mart, begin to kick in. Growth rates in consumer spending could very well accelerate which is something policy makers at the Fed, especially those focused on inflation, would take careful note of.

The biggest winner of the holiday season was unquestionably the web. Though e-commerce isn't broken out in the initial retail sales numbers, it is lumped into nonstores where it makes up about 90 percent of the component. The dark line tracks the year-on-year rate of nonstore sales, at 12.7 percent in December and 12.9 percent in November. For all other retailers, sales were up only 4.6 and 5.2 percent in the two months. E-commerce is growing at least twice as fast as brick-and-mortar with its share now moving near 10 percent of all retail spending. But of course there are victims which are the nation's department stores where December sales fell a very steep 1.1 percent.

Other winners in December retail were anything related to housing including furniture and building materials. The housing sector has clearly been pivoting higher the last few months which is being reflected in costs and which are behind the week's other big news. The core CPI, which excludes food and energy prices, is a central measure for government policy and monthly percentage change is often broken out to two decimal places. December's rise at 0.28 percent is the strongest since last January and the second strongest in 7-1/2 years. This is a notable performance.

The dark columns of the accompanying graph track year-on-year change for housing  costs which make up more than 40 percent of the CPI. After holding at 2.8 percent for the prior three months, housing moved to 2.9 percent in December which doesn't look that substantial but is given its share in the index. Medical costs, which make up nearly 10 percent of the index, are another positive, rising a tenth to 1.8 percent and reflecting sharp and sudden acceleration in prescription prices. Further traction for housing and medical costs could begin to grab headlines and make the difference for inflation.

But there is still a long way to go. The core CPI is struggling below the 2 percent line and, as seen in the dark line of the graph, its trajectory is still unsure. The light line is the Fed's policy measure for inflation: the core PCE which tracks below the CPI though in the same direction. In parting comments at last month's press conference, Janet Yellen cited the lack of improvement in core inflation as a big disappointment of her 4-year leadership at the Fed. What will get inflation moving? Perhaps housing, perhaps medical costs, and perhaps those wage increases that major companies are beginning to announce.

Another factor that is likely to help inflation is the decline in the dollar. The trade-weighted dollar fell 6.0 percent last year and has been going down so far this year. This means that it costs more dollars to buy foreign goods including foreign consumer goods which are America's favorites. Getting less for more is the definition of inflation but this effect, perhaps due to discounting by foreign sellers, has yet to really take hold. The graph tracks the blue line of import prices for consumer goods against the green line of the dollar. They typically move inversely though gains for import prices over the last few months have yet to match the decline in the dollar. Still this may be only temporary. Dollar weakness is in fact a positive feature of the inflation outlook.

There was some bad news in the week or at least possibly bad. In what might be an early sign of loosening in the labor market, initial jobless claims rose 11,000 in the January 6 week to a higher-than-expected 261,000. The gain was widespread and not centered in Puerto Rico where claims, at 1,778, are now back to pre-hurricane levels. The 4-week average, at 250,750, rose a steep 9,000 and is 15,000 above the month-ago trend which hints at possible trouble for the January employment report. Initial claims data in the next report, for the January 13 week, will be very closely watched as it will track the monthly report's sample week.

Less than great news on the labor market also comes from JOLTS where job openings slipped 0.8 percent to 5.879 million in data for November. Hires also fell, down 1.9 percent in the month to 5.488 million. Openings have been moving lower after peaking at 6.140 million in July which does hint at cooling. Hires, despite November's dip, have been showing more strength and are still near the expansion high set in October at 5.592 million. Workers and employers appear in fact to be very cautious, holding onto one another as evidenced by the layoffs & discharge rate, little changed at only 1.1 percent, and the quits rate which was unchanged at a low 2.2 percent.

We end the week on a very strong note, that is inventory building which can't seem to keep pace with sales growth. Business inventories rose 0.4 percent in November after no change in October. This compares with the months' gains of 1.2 percent and 0.8 percent in business sales. The mismatch points to the immediate need for restocking which in turn points to the need for production increases and hiring. This is a very positive setup going into 2018. Wholesalers were the most active in November, building inventories by 0.8 percent to $611 billion. Retail inventories were little changed at $619 billion while inventories rose 0.4 percent in November to $665 billion.

Markets: The giants of U.S. Treasuries

Treasuries got whipsawed during the week on international chatter, first that the Bank of Japan has or has not eased back on its open-market bond purchases and second that China may or may not officially begin to step back from U.S. Treasuries. But accounts from these two giants have already been cutting back their Treasury exposure. In data last updated in October, Chinese holdings of Treasuries totaled $1.189 trillion which is down roughly $75 billion from two years ago. Chinese holdings in fact fell sharply immediately following the 2016 election, cratering to $1.149 trillion in November that year. Japanese holdings totaled $1.094 trillion in October which is down roughly $50 billion from two years ago. These numbers are part of the Treasury International Capital report which will be updated on Wednesday of the coming week. Turning to the market, there has in fact been heavy selling of Treasuries so far this year with the 2-year yield, at 2.01 percent, up 12 basis points and the 10-year, at 2.55 percent, up 14 basis points.

Markets at a Glance	Year-End	Week Ended	Week Ended	Year-To-Date	Weekly
	2017	5-Jan-18	12-Jan-18	Change	Change
DJIA	24,719.22	25,295.87	25,803.19	4.4%	2.0%
S&P 500	2,673.61	2,743.15	2,786.24	4.2%	1.6%
Nasdaq Composite	6,903.39	7,136.56	7,261.06	5.2%	1.7%
Crude Oil, WTI ($/barrel)	$60.15	$61.61	$64.40	7.1%	4.5%
Gold (COMEX) ($/ounce)	$1,305.50	$1,320.80	$1,339.00	2.6%	1.4%
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%	1.96%	2.01%	12 bp	5 bp
10-Year Treasury Yield	2.41%	2.47%	2.55%	14 bp	8 bp
Dollar Index	92.29	91.98	90.94	-1.5%	-1.1%

The bottom line

The economic numbers are looking good going into 2018. Consumer spending is solid and is complemented by acceleration in housing as well as manufacturing. Employment may be easing back though gains in overall demand, together with the need to build inventories, point to greater hiring ahead. Inflation is still a little soft but new factors, whether housing costs or higher import prices, are pointing to improvement. For the Federal Reserve, the week's results may hint at a less than gradual process for this year's rate hikes.