Two advance reports on the nation's manufacturing
sector show sudden and significant weakness. They follow in the wake of
steel and aluminum tariffs that were put in place in March and are
being cited as a central factor behind what are rising costs and also
rising selling prices in the manufacturing sector. The week's data also
include housing updates but here the news is less urgent but still
significant for second-quarter GDP.
The economy
U.S.
manufacturing may be in secular decline but pivots in the sector may
still offer an advance signal of pivots for the economy as a whole. And
two advance readings for this forward-looking sector are both signaling
a pivot lower for June. The Philly Fed index, which is a centerpiece
of the economic calendar, is still showing a solid rate of growth but
the pace of growth, at 19.9 as tracked in the blue line of the graph,
is the suddenly the slowest over the last year-and-a-half, since
November 2016 when this index started to take off. The green columns of
the graph track the manufacturing PMI which is produced by Markit
Economics and where growth this month has slowed to a 7-month low.
Markit describes its result as a "clear loss of momentum." New orders
in both reports are down with exports in the Markit report, a reading
not tracked in the Philly report, at a 2-year low.
Another
common theme in the reports is a rise in price pressures -- pressures
which do appear to be getting passed through to customers. The outlook
for future selling prices in the Philly report surged dramatically to
56.6 for the highest reading in nearly 30 years, since December 1988.
Respondents in Markit's manufacturing report, as well as its services
report for June, are reporting steel-related price increases as other
respondents in other suveys have been since tariffs were imposed.
Prices are also up in the Empire State report where the graph's dark
blue of current selling prices is tracked against the light blue
background of future selling prices. Empire State, which was the first
to post its June results, is not showing slowing in orders or activity
but, as is visible in the graph, it is showing the greatest amont of
inflation pass through and expected pass through since the easy
comparisons early on in the expansion 8 years ago.
Jerome
Powell in his FOMC press conference earlier this month conceded that
reports such as these as well as the Fed's own business contacts have
been reporting building price pressures, yet he stressed that these
pressures have yet to appear in the government's data? Let's look back
at inflation data released in the prior week for clues. Producer prices
for May, tracked in the dark column at the far right of the graph,
rose 0.5 percent which is the highest monthly jump since January and is
in fact one of the very highest of the whole expansion. Oil was a big
factor in the PPI's rise but sharp gains for steel and aluminum at the
intermediate level were also evident and no doubt played their part in a
1.0 percent spike for final goods. The light blue columns are import
prices which have posted 0.6 percent gains the past 2 months with the
yearly rate over 4 percent which is another expansion high. If producer
prices and import prices move further higher in June, we can look back
at reports like Philly and Markit as offering fair warning.
Housing
indications, unlike those for manufacturing, are not showing any
changes; they continue to be mixed with saw-tooth patterns the norm. The
good news in May's housing starts report is centered in the present,
less so in the outlook. Starts jumped 5.0 percent in the month to a
1.350 million annualized rate that should give a boost to residential
investment in the second-quarter GDP report. The question of future
building is still positive but definitely did not improve in the May
report as building permits fell for a second straight month and very
steeply, down 4.6 percent to a 1.301 million rate. Permit weakness
includes single-family homes, down 2.2 percent to an 844,000 rate, and
once again multi-family units which fell 8.8 percent to a 457,000 rate.
Let's
magnify the time frame to the past year as seen in the graph. Starts
have been holding tightly around a 1.300 rate for the past half year and
based on permits are likely to continue to do so in the months ahead.
This points to limited acceleration if any at all for residential
construction spending which has been struggling at the $560 billion
annualized line. Residential investment, which is one of GDP's six
major components, likewise has a checkered record, pulling down the
nation's growth in three of the last four quarters including this
year's first quarter. The outlook for the second quarter's contribution
from residential investment is up for grabs, at least based on starts
and also anecdotal hints from the nation's home builders.
Home
builders have been reporting less and less optimism all year. And
their housing market index is not pointing to acceleration, edging back 2
points in June to a lower-than-expected 68. Tariff-related complaints
have been on the rise among builders who say steel-related items are
increasingly in short supply. Builders have also been having trouble
finding workers to do the construction. The red line of the graph
tracks a stubborn issue for builders and that's a lack of buyer
traffic. Theories on why traffic hasn't recovered center on the effects
from the subprime housing collapse 10 years ago: that it has locked in
home owners who, even this long after the collapse, may still owe more
on their house than its worth, and that for possible first-time buyers
it has tarnished the attraction of wanting to own a home in the first
place.
Yet
new home sales and home builders have been doing well this expansion.
One of the coming week's highlights will be May's update for new home
sales which, as seen in the blue line, have been climbing steadily
through the expansion, at just over 650,000 and approaching the 700,000
annualized rate. In sharp contrast, however, is the green line of the
resales which have not shown any lift at all and what does hint that at
least some homeowners can't get the price they need for their homes
and are patiently sitting underwater. The rate for single-family
resales has held at roughly 5.000 million annualized for nearly the
last three years.
Markets: Tariff resistant, at least so far
A
rise in tariffs as a discrete risk to the market outlook is hard to
pinpoint. Tariffs are likely of course to slow imports which would point
to replacement production in the domestic economy, but retaliatory
tariffs would point to an offsetting slowdown in exports. This
tit-for-tat balancing is perhaps being expressed in the stock market's
sideways movement. The Dow is only slightly lower than it was back in
March when steel and aluminum tariffs were first announced. Interest
rates have been showing much more movement but their climb, especially
on the short-end of the curve, has been tied to rising expectations for
Federal Reserve rate hikes. On the week, the Dow lost 2.0 percent to
24,580 and moved into the negative column for the year at minus 0.6
percent. But oil was the week's big mover, up 7.1 percent and back near
$70 at $69.23 on an OPEC supply cut. This is a reminder that compared
to the power punch oil is capable of, tariffs and low unemployment are
still theoretical threats to inflation stability.
Markets at a Glance | Year-End | Week Ended | Week Ended | Year-To-Date | Weekly |
2017 | 15-Jun-18 | 22-Jun-18 | Change | Change | |
DJIA | 24,719.22 | 25,090.48 | 24,580.89 | -0.6% | -2.0% |
S&P 500 | 2,673.61 | 2,779.42 | 2,754.88 | 3.0% | -0.9% |
Nasdaq Composite | 6,903.39 | 7,746.38 | 7,692.82 | 11.4% | -0.7% |
Crude Oil, WTI ($/barrel) | $60.15 | $64.66 | $69.23 | 15.1% | 7.1% |
Gold (COMEX) ($/ounce) | $1,305.50 | $1,282.70 | $1,272.10 | -2.6% | -0.8% |
Fed Funds Target | 1.25 to 1.50% | 1.75 to 2.00% | 1.75 to 2.00% | 50 bp | 0 bp |
2-Year Treasury Yield | 1.89% | 2.57% | 2.55% | 66 bp | −2 bp |
10-Year Treasury Yield | 2.41% | 2.92% | 2.89% | 48 bp | −3 bp |
Dollar Index | 92.29 | 94.79 | 94.55 | 2.4% | -0.3% |
The bottom line
Early indications of factory slowing in June are
beginning to appear. And what's specifically significant about the
signals of price pressures is that they're appearing in force in
selling prices, not just input costs. Some portion of this pressure is
tied to tariffs on steel and aluminum that have already been put in
place, and pointing to further pressure is the prospect of widening and
rising tariffs in the months ahead. Against the backdrop of a tight
labor market and high oil prices, tariffs could become an increasing
risk for inflation overshoot and a rising topic for Federal Reserve
policy makers.
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