The Business Week In Review

Economic news has been strong for most of the last year, headlined by very solid GDP growth and very low unemployment. But the news in the latest week may show hints of slowing and are underscored by stubborn softness in manufacturing production and perhaps by an overly subdued assessment from the Beige Book. We'll start off with the industrial production report then turn to a couple of regional reports which will help hone our skills at small-sample analysis, something that may come in handy should the government in fact shut down and take the big economic reports with it.

The economy

Lack of manufacturing strength in the Federal Reserve's industrial production report, which has been posting low single digit annual growth, has been a consistent surprise over the last year, contrasting with mid-to-high single digit growth for factory orders and shipments and especially contrasting with the various private and regional surveys which have posted many of their best scores on record. The blue line of the graph tracks the very gradual upward slope of the manufacturing component over the last two years, a slope roughly similar to the yellow line for utilities and well below the gray line for mining which has been moving substantially higher since the 2016 Republican victory and promise of industry deregulation. But mining is comparatively small, making up only about a tenth of the industrial economy vs roughly 80 percent for manufacturing.

Moving to a month-on-month look, manufacturing inched only 0.1 percent higher in December and has been below the zero line on more than several occasions over the last year. Nevertheless the trendline, though very close to zero, is pointing higher. In contrast, the production index of the ISM report, which is a private report based on a comparatively small sample, has been posting an uninterrupted string of monthly increases that are far above breakeven which for this specific reading is measured at the 51 line. Both reports are monthly and both track volumes, so why the mismatch? One explanation is that enthusiasm may be inflating the ISM report, that repondents at stronger companies are volunteering their assessments more frequently than those at weaker companies. In any case, one thing the ISM definitely has right is the upslope of the trendline which is just about parallel with the Fed's trendline. Remember, when reading small-sample reports it's the direction of change, not magnitude of change, that's most important.

The Federal Reserve's Beige Book, like the manufacturing component, has been an anomaly over the last year. The report's assessments of overall economic growth have been little better than "moderate" despite 3 percent GDP rates in the second and third quarters and one possible for the fourth quarter as well. For manufacturing, the latest Beige Book actually downgraded the sector, striking moderate and moving to "modest" for the description of growth. Yet let's put the ISM aside and turn to some other small-sample reports where hints of slowing may be appearing. The graph tracks new orders in both the Empire State and Philly Fed reports, and though these readings have been well over zero to indicate monthly growth they have been showing less and less growth over the past few months. Less growth in new orders means less growth for future production and may even hint at negative readings ahead for the Fed's manufacturing measure.

Inflation pressures at the producer level, running soft at a roughly 2.5 percent rate, do in fact justify the Fed's modest assessment of activity. Yet looking at selling prices in the Empire State report does show improvement. The dark area of the graph tracks current selling prices which over the last year are posting their most solid gains since 2011 and 2012. Yet six-month expectations for selling prices, tracked in the light area, are not looking any better than the bulk of the expansion. Soft price expectations are a frustration for Fed policy makers and may be betraying what is actually soft demand in the factory sector.

Yet the Philly Fed shows significantly more price strength. Here current selling prices, the dark green area, are posting the strongest results since the last expansion, as is the light green area of price expectations. Something to remember, however, is that the Philly Fed has been noticeably stronger than other small-sample factory reports including those from the ISM, Markit Economics, and the other regional Feds including Dallas, Kansas City and Richmond. Philly was the first to turn higher in late 2016 and it hit the highest levels of any of these. Still, along with the ISM, it is very closely watched and its inflation signals could be a subject of comment for policy hawks at the month-end FOMC.

Inflation expectations, or lack thereof, have been in strong focus for the last year. The preliminary January report for consumer sentiment showed a 1 tenth rise in year-ahead expectations to 2.8 percent which matches the preliminary December report as the highest in two years. Still, 1 tenth is only 1 tenth and if pressures are building, they're not building very fast. A look at year-ahead inflation expectations for businesses also shows a recent uplift though the January reading fell back to the 2.0 percent line. The failure to get inflation moving is what Janet Yellen describes as the greatest disappointment of her term as chair.

Subdued news in the week also comes from the University of Michigan's consumer sentiment report where the current conditions component fell more than 4-1/2 points to 109.2 for a 15-month low. This hints at weakness for not only consumer spending in January but also perhaps for the January employment report. Yet expectations are holding up well which the report attributes to passage of the tax bill and hopes for lower taxes ahead. Still, the days of enormous strength for confidence reports and regional factory reports may be coming to an end.

But enormous strength has never been apparent in the consumer sentiment report where the composite index is actually below where it was three years ago. In contrast, the consumer confidence index, a separate series compiled by the Conference Board, began to accelerate sharply in late 2016 and at the last update for December was just off 17-year highs. The truth probably of course lies somewhere in between though the Beige Book's lukewarm description of consumer spending does suggest, at least from the Fed's perspective, that the sentiment index may be telling the more accurate of the two stories.

Some of the week's other economic news was also soft, at least the headline for housing starts which fell very sharply in December in what may however reflect unfavorable weather typical of winter months. And starts are only an intermediary, when ground is broken for construction. Two other readings in the report, permits and completions, are in fact very favorable. Permits for single-family homes held steady at a very strong 881,000 annualized rate while completions for single-family homes jumped 4.3 percent to an 818,000 rate. The gain in permits points to future supply of new homes while the increase in completions will provide immediate supply to a new home market where sales are already accelerating.

Such strength, however, is not the story for multi-family units. Demand here has been slowing for the past two years. Multi-family permits fell 3.9 percent in December to a 421,000 annualized rate with completions down 2.4 percent to a 359,000 rate. But, as seen in the graph, the weakness is isolated to permits which points to the risk of falling supply of multi-family units in the year ahead. Why the slowdown for multi-units? Plateauing rents may be a factor evidenced in the consumer price report where rents have been slipping since late 2016, from 4.0 percent annual growth to 3.7 percent for the last three reports. This is the first easing in rental prices since the housing bust 10 years ago. And some of this easing may also reflect movement from renting to buying, a possibility supported by rising traffic in the home builders survey and the uplift underway in both new home sales and existing home sales.

Turning to the labor market, data for initial jobless claims have been cloudy. Initial claims have been on a roller coaster the last six months, swelling briefly during the heavy hurricane season and then rising through December before falling off a cliff in the January 13 week, down 41,000 to 220,000 for the lowest showing in 45 years. Yet the decline may be revised away given that six states and two territories had to be estimated in the week. This includes California, where weekly claims rose 12,000, and once again Puerto Rico where claims rose more than 2,000 to 4,267 in a reminder that Hurricane Maria's impact is still disrupting the territory's labor department. In any case, even if January's employment report shows less strength than prior months, it would  probably still be consistent with a very strong labor market.

Markets: Foreigners not left out

We close the week's economic news with Treasury International Capital, a report that has been showing building foreign inflows into the U.S. stock market. Net foreign buying of U.S. equities, that is buying subtracted from selling, totaled $10.9 billion in November vs net inflows of $16.4 billion and $22.1 billion in the two prior months. As shown in the graph, recent inflows on the right side of the axis contrast with very heavy outflows on the left side through much of the expansion. Yet the current inflows are still no match for the 2005 heyday of the prior expansion nor the dotcom rush in the late 90s. Note that ongoing gains are not only tied to the stock market's unusual momentum but also to the yearlong decline in the dollar which gives foreign buyers more U.S. shares for their ever stronger foreign currencies. Note that the late 90s and especially 2005 were also soft times for the dollar.

The dollar's decline extended in the week, down 0.3 percent based on the dollar index and reflecting in large part ongoing strength in the euro (where the graph's values are in reverse order). Whatever the political questions in Europe right now, economic numbers out of the continent are showing accelerating strength which is one important factor for the euro's appreciation. Questions in the U.S. over a possible shutdown may not be hurting stocks, which once again moved to new highs in the week, but they aren't helping demand for U.S. Treasuries where yields are up. The 2-year yield is already up 17 basis points this year to 2.06 percent while the 10-year has gained 25 points to 2.66 percent. However much weakness in the dollar may help exports and foreign demand for U.S. securities, rising interest rates will work to slow demand in general and housing in particular.

Markets at a Glance	Year-End	Week Ended	Week Ended	Year-To-Date	Weekly
	2017	12-Jan-18	19-Jan-18	Change	Change
DJIA	24,719.22	25,803.19	26,071.72	5.5%	1.0%
S&P 500	2,673.61	2,786.24	2,810.30	5.1%	0.9%
Nasdaq Composite	6,903.39	7,261.06	7,336.38	6.3%	1.0%
Crude Oil, WTI ($/barrel)	$60.15	$64.40	$63.50	5.6%	-1.4%
Gold (COMEX) ($/ounce)	$1,305.50	$1,339.00	$1,334.40	2.2%	-0.3%
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%	2.01%	2.06%	17 bp	5 bp
10-Year Treasury Yield	2.41%	2.55%	2.66%	25 bp	11 bp
Dollar Index	92.29	90.94	90.64	-1.8%	-0.3%

The bottom line

The week had a bit of a rough edge, especially manufacturing production and the slowing in Empire State and Philly Fed orders. And the Beige Book didn't help. But housing news was once again positive as it may be in the coming week with updates on both new and existing home sales. But the big news coming up, and one that may make us forget all about the week just past, will be Friday's fourth-quarter GDP where a tantalizing 2.9 percent is Econoday's consensus.