Economics News Week In Review

The Beige Book, an assessment of the nation's economy that the Federal Reserve publishes ahead of its policy meetings, proved subdued and lifeless as usual. Forget about reports that consumer spending is accelerating or that manufacturing is overheating because the Fed has a more sober view. But one view that shouldn't be surprising at all is their assessment of the labor market where strength and risk of related wage pressure will justify a rate hike at the month-end FOMC.

The economy

"Modest" is the Federal Reserve's assessment of consumer spending in what sounds off key following a second-quarter when a surge for the consumer made for a very strong 4.2 percent GDP rate. But modest is actually a generous description for August retail sales which managed a hard-to-see 0.1 percent monthly gain as tracked in the blue column at the right of the graph. But retail sales are only about 1/3 of total consumer spending which is dominated by services. Nevertheless, August's results are pointing squarely to slowing for total consumer spending as tracked in the green bars and which will be posted at month end. For third-quarter GDP, August's retail results are an offset to July's solid opening in the quarter.

A key weakness in the retail report is a third month of contraction at auto dealers where sales fell a steep 0.8 percent in August in what has been a very poor run for the auto industry. Autos make up about 1/5 of total retail sales and weakness here would be a red flag for discretionary demand if not, however, for the strength in restaurant sales which make up about 1/8 of retail sales. Sales here have simply been on fire. The graph tracks the red line of yearly restaurant sales on a 3-month average along with the 3-month average for vehicle sales. Restaurants and autos are going in opposite directions making conclusions on discretionary demand difficult, yet collapsing the two is reasonable enough and points to yearly growth in the mid-to-high single digits. And that's where total retail sales are, at 6.6 percent in August and showing very little change from July's 6.7 percent.

Another description from the Beige Book that can't be described as unreaslistically optimistic is a "moderate" verdict for the pace of the manufacturing sector. Anyone who has been tracking any of the regional manufacturing surveys let alone the ISM is of course completely shocked by this assessment. The ISM, for example, is posting its strongest run since the early  1970s and mid 1950s and the streak is still alive and apparently building steam. But the Fed's assessment turns out to be fair enough based on the manufacturing component of the industrial production report, the blue columns of the graph where growth has managed only 0.2 and 0.3 percent gains the past two months. In constrast, the green line tracks the ISM's production index which came in at 63.3 in August. Note that 51.5 for this index is consistent in theory with growth in production though the Bureau of Economic Analysis, which came up with this number, may have some refiguring to do. Over the course of the last two years, the ISM has never been below this magic level while actual monthly production has fallen a total of nine times? When it comes to using small sample reports for a better understanding of the actual economy, reader beware!

Another interesting verdict of the Beige Book, and one that contrasts perhaps with the perceived need to raise interest rates, is that inflation is rising at no more than a "modest-to-moderate" rate. The report even noted "signs" of deceleration. This is one assessment that definitely proved true in the week's data as the core consumer price index, which excludes both food and energy and which is tracked in the blue bars of the graph, rose only 0.08 percent in August. This is one of the very lowest readings of the ongoing 9-year expansion.

Food isn't part of the core but would be holding down the reading if it were. Food prices couldn't manage even a 1 tenth gain in August, up only 0.09 percent and, at a yearly rate of 1.4 percent, are not pointing to much stress for the consumer. Lack of stress is also the indication from medical costs which, as tracked in the dark columns of the graph, are on a rare 2-month decline, down 0.23 percent in August following July's 0.18 percent dip. This is the first back-to-back decline for this reading in five years and reflects a downturn in physician costs as well as prescription and over-the-counter drugs. Year-on-year medical costs are up only 1.5 percent vs 2.7 percent for total consumer prices.

Part of the softness in consumer prices reflects softness in prices of imported goods which fell 0.6 percent in August and were down 0.2 percent when excluding petroleum which is a third straight decline for this reading. Prices of imported consumer goods were unchanged in the month as were prices of imported vehicles. Year-on-year as tracked in the graph, vehicle prices are nearly unchanged, up only 0.2 percent, with consumer product prices up only 0.6 percent. Part of this weakness, and only part, reflects the strength of the dollar which gives U.S. buyers more purchasing power. Much of the weakness reflects a very subdued global price environment evident in export prices which have fallen 0.1 and 0.5 percent the last two months. The risk of imported inflation is not much justification for a month-end rate hike.

And justification is hard to come by when looking at inflation expectations, an area that Jerome Powell highlighted last month at Jackson Hole when he described stability in expectations as a central precondition for monetary policy. Inflation expectations at the business level, tracked by the green line, are up 1 tenth to 2.2 percent this month which, however, is below a 2.3 percent rate back in April. But inflation expectations among consumers, tracked in the blue line, are not going up at all this month, down 2 tenths to 2.8 percent. Still trends for both, as well as the underlying trend for the core CPI as traced in the pink line, are moving higher -- not much higher, not dangerously higher, but higher.

The real reason why the Fed is going to raise rates isn't tied to inflation expectations or to imports or to consumer prices, but to employment. Here the Beige Book is noticeably less moderate, describing labor markets as "tight throughout the country" with "widespread" shortages of labor both for highly skilled workers and, in a new development, low skilled workers as well. It's the risk that these shortages will begin to push up general wage pressures that will be the central message of the upcoming FOMC. And this was all underlined by the prior week's first reading on August inflation when average hourly earnings, part of the monthly employment report, posted a rare 0.4 percent monthly jump and a 2.9 percent year-on-year rate. This rate is tracked in the red line of the graph and is the strongest since 2009.

And the week's data offer new evidence on how unusually tight the labor market is. Job openings in the JOLTS report are absolutely surging at the same time that hiring is falling further behind. Openings jumped 1.7 percent in July to 6.939 million with hires unchanged at 5.679 million. Year-on-year, openings are up 11.9 percent with hires up only 3.3 percent with the latter now having fallen for three months in a row. The widening gap between openings and hires strongly suggests that employers are having a hard time finding employees with the right qualifications at the right pay points. Comparing openings to the number of Americans actively looking for work further illustrates the lack of slack and lack of choice for Federal Reserve policy makers. The graph tracks the blue line of openings against the green line of the unemployed. For the first time on record, the number of openings moved past the number of unemployed in March this year. This gap keeps widening and stood at 659,000 in July in a mismatch that raises the risk of coming wage pressures.

Markets: Treasury yields on rise as Fed prepares hike

Treasury yields moved noticeably higher in the week. For shorter maturities, this reflects expectations for a rate hike at the coming FOMC while for longer maturities, the rise perhaps reflects rising demand for riskier investments and with it easing demand for safety. The spread between the 2-year and 10-year yields is narrowing fast, now at only 20 basis points in a coming together that preceded the onset of the last two recessions, as traced in the pink bars of the graph. But whether this coming together points to a recession is uncertain. The onset of recession may most reflect the effects of a rising Fed funds target which pulls the 2-year along in lockstep. This target is tracked by the red line of the graph and its immediate and overpowering impact on the blue line of the 2-year Treasury yield is clearly visible. So recession may have less or perhaps nothing to do with the 10-year and may reflect nothing more than the impact that a rising policy rate has on the economy. Based on Fedspeak and the FOMC's own forecasts, the funds rate looks to move 25 basis points higher at month end to 2.125 percent with still another rate hike penciled in to 2.375 percent before the year is out. What direction does this point for the 2-year yield? Upward is a safe answer.

Markets at a Glance	Year-End	Week Ended	Week Ended	Year-To-Date	Weekly
	2017	7-Sep-18	14-Sep-18	Change	Change
DJIA	24,719.22	25,916.54	26,154.67	5.8%	0.9%
S&P 500	2,673.61	2,871.68	2,904.98	8.7%	1.2%
Nasdaq Composite	6,903.39	7,902.54	8,010.04	16.0%	1.4%
Crude Oil, WTI ($/barrel)	$60.15	$67.84	$68.95	14.6%	1.6%
Gold (COMEX) ($/ounce)	$1,305.50	$1,201.90	$1,198.70	-8.2%	-0.3%
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%	2.70%	2.79%	90 bp	9 bp
10-Year Treasury Yield	2.41%	2.94%	2.99%	58 bp	5 bp
Dollar Index	92.29	95.38	94.98	2.9%	-0.4%

The bottom line

The week's inflation data were surprising in how benign they proved. Retail spending and manufacturing production also proved subdued but probably not as subdued as the Beige Book would lead one to believe. But what the Beige Book didn't hedge on was the labor market where its assessment of building strength sets up the justification for the coming rate hike.