The Business News Week In Review

Last month's Beige Book raised the question whether tariffs could actually be giving a lift to the factory sector, at least a short-term one. The Fed's book warned that tariffs had sparked sometimes "dramatic" increases in metal prices that were being fed through to at least some degree. It also noted stockpiling and cited anecdotal reports that domestic metal manufacturers were reopening their facilities and calling back workers. This week we'll look at some of the very first hard evidence of tariff effects as well as turn our attention to a sector that continues to underperform, housing.

The economy

Tariff-related price inflation may be driving up dollar totals in manufacturing which, based on the April advance durable goods report, is off to a very strong start for the second quarter. Forget the 1.7 percent headline decline in April, one due entirely to an understandable swing lower for what have been very strong aircraft orders. Excluding aircraft and other transportation equipment, durable goods orders rose 0.9 percent to beat Econoday's consensus by 3 tenths. Other readings included a third straight strong rise for total unfilled orders, up 0.5 percent in April, and a useful 0.3 percent build for total inventories. The graph tracks the ex-transportation data in dollar totals, at $161.4 billion for April orders and $163.9 billion for shipments.

New orders for primary metals, where tariffs on steel and aluminum are in effect, came in at $21.7 billion in April for a 1.3 percent jump on top of March's 4.6 percent surge when tariffs were first imposed with inventories climbing 0.4 and 1.0 percent the last two months. And unfilled orders are also higher, up 1.6 and 2.1 percent in April and March. When throwing in fabricated metals, which are indirectly affected by tariffs, new orders rose 2.0 percent following March's 1.2 percent gain with both inventories and especially unfilled orders on the climb. Primary and fabricated metals together make up more than 20 percent of total durable orders and if these gains continue, the factory sector could quickly emerge as the economy's pivotal player.

Another area of strength in the April durable goods report is in capital goods in what is auspicious news for second-quarter business investment. Core orders, which exclude aircraft, rose a monthly 1.0 percent with core shipments, which are direct inputs into fixed nonresidential investment, up 0.8 percent. Strength has been centered in electrical equipment and also computers and communications equipment. Machinery, oddly, has not been showing much strength. Though inconsistent as seen in the graph, gains for the core have been tangible and speak to the strength of business confidence.

The momentum in the factory sector, however, is being offset by housing which is off to a slow start this year. The first indications on the second quarter and the Spring selling season are not pointing to any acceleration. Sales of existing homes fell 2.5 percent in April to an annualized rate of 5.460 million which came in below Econoday's low estimate. Sales of new homes came in 15,000 short of consensus, at a 662,000 annualized rate with revisions pulling down the prior two months by a total of 30,000. Housing data can be volatile making it important to look at 3-month averages. Here new homes, at a 664,000 average, are doing best in a curve that does continue to climb though existing home sales, at a sales average of 5.533 million, remain dead flat.

What may also be flattening are home prices. The FHFA house price index rose only 0.1 percent in data for March for the lowest result in more than three years. And after two months above 7 percent, the year-on-year rate fell 7 tenths to 6.7 percent as tracked in the graph's blue bars. Weakness is also appearing in the price data of the new and existing home sales reports. For new homes, price discounting may already be underway as April's median fell a very steep 6.9 percent to $312,400 for a year-on-year gain of only 0.4 percent. Relative to sales of new homes, which are up 11.6 percent year-on-year, prices look like very soft. For resales, the median did rise 3.2 percent in the month to $257,900 but the yearly rate, in contrast to FHFA or Case-Shiller data which are near 7 percent, fell 5 tenths to 5.3 percent for the lowest showing since September. Some of this downturn reflects less pressure out West where price gains, which are far and above anywhere else in the country, are now back under double digits.

Housing overall has not been contributing much to economic growth with first-quarter residential investment dead flat and the consumption & housing component of the national activity index still pulling down the total. Yet this index, at a 3-month average of 0.46 as tracked on the graph, is posting its best run of the 9-year expansion due to a large degree to manufacturing which gets us back to tariffs. Production, which includes manufacturing, contributed to roughly half of this index's growth in April and if tariff effects are indeed boosting the factory sector, further strength may be in store for May and June as well. Yet whether this risk is inflationary is still another question. The national activity index still has a way to go before it begins signaling inflation risk, at least based on its stated methodology which has 1.00 as the overheating red zone -- a reading, however, that was last posted way way back in 1984.

Like housing, consumer spending has been unexpectedly soft so far this year and a bit of sagging is now underway in consumer sentiment as well. The index ended May at 98.0 which was one full point under Econoday's consensus. Current conditions fell to 111.8 vs 113.3 at mid-month and down from 114.9 in April. The decline hints at weakness for May's jobs market and in turn also for May's consumer spending. Expectations also eased, to 89.1 from 89.5 at mid-month and 88.4 from April. This decline hints at less confidence in the jobs and income outlook. These results will hold down expectations for the upcoming May consumer confidence report which has also been showing less traction.

More important for Fed policy than consumer confidence are inflation expectations and these too are flat. Year-ahead inflation expectations in the consumer sentiment report, as tracked in the blue line, are only inching up at most, to 2.8 percent in May for a 1 tenth gain from April but no higher than it's been in recent years. Business expectations, the green line, are mixed with expectations spiking to a record high of 2.3 percent in April after tariffs were announced but then immediately falling back this month to 2.0 percent. These results, though uneven, will likely offer comfort to Federal Reserve officials as they now begin to guard the upside of their symmetric inflation target.

Markets: Ending the 3 percent alarm

Demand for bonds was reawakened in the week with the 2-year yield down 6 basis points to 2.48 percent and especially the 10-year which fell 14 basis points and is back under 3 percent in style, at 2.93 percent. These results were not due to rotation out of stocks where demand was steady during the week and they suggest that recent selling had lifted bonds to attractive yields. Lower yields pose less competition to gold which doesn't pay a yield and which rebounded 1.1 percent in the week and back over $1,300 at $1,305. The Dow, at 24,753, ended the week slightly higher with oil failing at $70, falling 5.1 percent in the week to $67.71.

Markets at a Glance	Year-End	Week Ended	Week Ended	Year-To-Date	Weekly
	2017	18-May-18	25-May-18	Change	Change
DJIA	24,719.22	24,715.09	24,753.09	0.1%	0.2%
S&P 500	2,673.61	2,712.97	2,721.33	1.8%	0.3%
Nasdaq Composite	6,903.39	7,354.34	7,433.85	7.7%	1.1%
Crude Oil, WTI ($/barrel)	$60.15	$71.35	$67.71	12.6%	-5.1%
Gold (COMEX) ($/ounce)	$1,305.50	$1,291.20	$1,305.70	0.0%	1.1%
Fed Funds Target	1.25 to 1.50%	1.50 to 1.75%	1.50 to 1.75%	25 bp	0 bp
2-Year Treasury Yield	1.89%	2.54%	2.48%	59 bp	–6 bp
10-Year Treasury Yield	2.41%	3.07%	2.93%	52 bp	–14 bp
Dollar Index	92.29	93.65	94.18	2.0%	0.6%

The bottom line

The factory sector is picking up steam and is showing no immediate negatives and possibly positives from tariffs, How long tariff effects can give a lift to the data is very uncertain and there's still plenty of suspicions that they could trigger foreign retaliation and slow manufacturing in the long run. But for the second quarter, manufacturing looks to be an increasing contributor to economic growth in contrast to housing and also perhaps in contrast to consumer spending as well.