The Business News Week In Review

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.