The Weekly Economic News Wrap-Up

					GDP came in very strong in the second quarter which raises the unwanted question whether the Federal Reserve may have to increase the pace of rate hikes. And it's more than just GDP's growth rate. Price pressures surged while inventories fell, the former pointing to the risk that the Fed may have already fallen behind the inflation curve and the latter, given the strength of demand and the need to restock inventories, hinting at perhaps stronger GDP growth in the quarters ahead. The Trump administration has already cracked what was once a closed door and jawboned the Fed, and that door could be swinging wide open sooner than later. The economy Three percent GDP growth is more or less already here. GDP jumped to a real 4.1 percent annualized rate in the second quarter for the strongest showing in nearly four years and the second strongest since the easy comparisons coming out of the recession. The average over the past five quarters is 2.9 percent. Overheating would appear to be a danger for the economy right now, consistent with the array of regional and private economic data where delivery delays, input costs and even price pass through are at or near record highs. And these pressures are evident in the GDP price index which shot far beyond expectations, from 2.0 percent in the first quarter to 3.0 percent in the second quarter. This is the strongest price reading of the entire expansion, since shortly before the recession in 2007. Much of this pressure is coming from construction where shortages of labor and high prices of materials have been reported for the past year. High energy prices are also a key factor. And the core, which excludes food and energy prices which have also been high, shows similar pressure, at 2.7 percent vs the first quarter's 2.4 percent. The severity of these headline rates can't be easily ignored by the Federal Reserve especially with oil holding near $70. The central force driving GDP is the economy's very heart. Consumer spending rose at a very strong 4.0 percent rate and, as tracked in the graph, contributed 2.69 percentage points to the quarter's overall 4.1 percent result. The strength in services shows gains in household consumption spending, health care, as well as food services and accomodations which are both discretionary. Spending is also on the rise for durable goods including vehicles and furniture, again both discretionary, with nondurable goods showing gains for apparel and food as well as fuel. Net exports, which had been weak, also contributed strongly to the quarter, adding 1.12 points to headline GDP with gains centered in goods. Some of this may be inflation pass through but the jump speaks to the strength of foreign demand. Exports of services have been slowing but still were a positive contributor in the quarter. Further adding to net exports was a slowing in import growth. Note that this calculation is tied to quarterly improvement, not to total net exports which came in at a massive annualized deficit of $849.9 billion but still much better than $902.4 billion in the first quarter. And the good news continues with another strong showing for business spending as nonresidential fixed business investment added 0.98 points to GDP. Structures are the highilght here, posting back-to-back quarters of 13.3 and 13.9 percent real annualized growth for a 0.39 point contribution to GDP. The gain here further speaks to demand for construction labor and materials. Intellectual property grew at an 8.2 percent rate and added 0.35 points. Equipment rose a comparatively subdued 3.9 percent for a still valuable 0.23 point contribution. Business investment is no doubt getting a boost from this year's corporate tax cut as well as the very high levels of business confidence and expectations for demand growth ahead. As the tax cut helped business investment, rising levels of government spending are also lifting GDP. Government purchases contributed 0.37 points to the second-quarter's total though the annualized rate is relatively subdued, at 2.1 percent but up from 1.5 percent in in the frist quarter. Natoinal defense is the main factor here, adding 0.21 points to GDP with nondefense offering only a fractional contribution. The breakdown between federal spending and state & local spending shows the former adding 0.22 and the latter adding 0.15. But the sleeper among the components -- where bad news is good -- is inventories. They fell $27.9 billion for a 1.0 point subtraction from GDP. But this pull lower is actually a very strong positive for the economy, as inventories are too low right now and need to be built up which should be a positive for third-quarter GDP not to mention employment levels as well. When looking at final sales, a key measure of demand that excludes inventories, GDP came in at 5.1 percent rate! The one weakness in the report comes from residential investment which, however, pulled down GDP only fractionally in the quarter, by minus 0.04 points. The annual rate of growth proved negative for a second straight quarter, at 1.1 percent after a 3.4 percent decline in the first quarter. This is proof positive that the housing sector is not having a good year and that the Spring sales push came up short. As far as the week's other economic numbers go, they pretty much all got wrapped up somewhere in the GDP report. But there is a rush of housing data to look at and, like the residential investment component, they proved weak. The accompanying graph tracks the blue line of single-family new home sales against the green line of single-family existing sales. Three-month averages are used here to help smooth what are often volatile month-to-month performances. And the graph is clear: new home sales, at a 646,000 annualized 3-month rate, have flattened out while resales, at 4.797 million, have long been flat and may now be edging lower. The weakness is a disappointment of course for Realtors and home sellers both and can in part be explained by low supply of both new and existing homes on the market and also perhaps by a lack of fundamental interest for home owners to swap houses. Is this the lingering hangover from the subprime mortgage collapse of the last recession? Or is it a reflection of the strong jobs market and lack of the need to relocate? One developing result of the sales weakness is a downturn in home-price appreciation. FHFA's house price index managed only a small monthly gain with the yearly rate, as tracked in the blue columns of the graph, slipping 2 tenths to 6.4 percent for the lowest reading since Januay last year. Regional data show cooling conditions in the West where double-digit price bubbles were a concern early in the year but less so now with the Mountain states at 9.1 percent and the Pacific states at 7.6 percent. Weakness in home prices is a negative for household wealth which, however, in an economy that appears to be taking off, is perhaps one less source of excessive growth. Markets: The Facebook fiasco The strength of the GDP report and the pressure in prices certainly point to more not less rate hikes ahead which can't be great news for the stock market. And clearly bad news came with Facebook's earnings miss and disappointing outlook, taking shares of the social media bellwether down 20 percent in one single move and making for a weekly decline of 1.1 percent for the Nasdaq. Will we look back at this week as the cyclical peak of the stock market? Another sign of trouble comes from rising interest rates, up 6 basis points for the 2-year Treasury to 2.66 percent and up 7 basis points for the 10-year to 2.96 percent. Even if the Fed doesn't accelerate its rate hike program, the market rise in rates will have a slowing effect of its own. Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly 2017 20-Jul-18 20-Jul-18 Change Change DJIA 24,719.22 25,058.12 25,451.06 3.0% 1.6% S&P 500 2,673.61 2,801.83 2,818.82 5.4% 0.6% Nasdaq Composite 6,903.39 7,820.20 7,737.42 12.1% -1.1%       Crude Oil, WTI ($/barrel) $60.15 $70.21 $68.89 14.5% -1.9% Gold (COMEX) ($/ounce) $1,305.50 $1,231.20 $1,232.20 -5.6% 0.1% 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% 2.60% 2.66% 77 bp 6 bp 10-Year Treasury Yield 2.41% 2.89% 2.96% 55 bp 7 bp Dollar Index 92.29 94.44 94.66 2.6% 0.2% The bottom line A rate hike at next week's FOMC could have been justified as a retaliatory assertion of the central bank's independence. But now it could be justified by what looks to be a broad-based pivot higher for the economy, one led by the consumer and fed by tax cuts and higher government spending. The Fed after all does have an institutional ethos, a long tradition of anticipating risks and safeguarding the economy, even when its actions may not be popular. And even if the Fed refrains from action at the upcoming meeting, it will be interesting to see if the unanimous voting block shows any cracks.