The Economics News Week In Review

The week's data include surprising weakness in the services sector and continued weakness out of housing which is clearly proving to be 2018's biggest disappointment. But indications on manufacturing, this year's strong suit, remain very solid and news is especially positive for the labor market. Inflation indications were heavy in the week but were both up and down. Yet there definitely appears to be one development we can all count on and that's a scheduled rate hike by a Federal Reserve which is focused on one key issue – the increasing scarcity of labor.

The economy

A big surprise in the week was the PMI flash for September, a report that showed a sharp slowing in the service sector against a general backdrop of rising inflation pressures. Services, the dark green columns in the accompanying graph, fell to 52.9 which was sharply below expectations for 55.0 and which overshadowed a solid showing for manufacturing where the index, as tracked in the light green columns, rose to 55.6. This month's weakness in services is centered in the year-ahead outlook which fell to its lowest level of the year reflecting concerns over cost pressures as input prices rose sharply and selling prices surged to a record high in survey data going back 10 years. Companies in the services sample cited the need to pass through higher labor costs as well as higher input costs sourced from overseas. The cost concerns overshadow a rise in new orders, a build in backlogs, and a jump in hiring to a 3-1/2 year high that hints at another month of standout strength for the September employment report. The year-ahead outlook also weakened on the manufacturing side as this sample cited higher costs tied to metal tariffs and the related need for forward purchasing. Some of these respondents said strong order levels are allowing them to push up selling prices. Yet other details, much like the service side of the report, are positive including rising orders and production.

Though a fraction of the size of services, manufacturing is considered a leading barometer for overall future change in the economy and here the results in the PMI are echoed by both Empire State and especially the Philly Fed survey. But in contrast to the PMI, both of these reports are showing easing price pressures. The Philly Fed index surged 11.0 points to a 22.9 level that topped Econoday's forecast range. New orders highlight the data, jumping very sharply with unfilled orders rising strongly and with growth in shipments and employment both up. But the sample's available capacity may be getting tested as delivery times extended further and the workweek climbed. Inventories contracted very sharply in a draw, judging by the strength of orders and shipments, that's unwanted and may reflect delays in deliveries and also production limitations. Yet despite capacity issues, prices in the Philly sample are actually moderating this month with input costs down though still elevated and with selling prices losing traction. Growth in the Empire State survey slowed in the September report, down 6.6 points to a still very solid 19.0. New orders and unfilled orders are both moderating and inventories in this sample are on the rise. Both input costs and selling prices are steady to lower. For Fed policy makers, the conflicting inflation indications between the PMIs and the Philly Fed and Empire State reports, given the generally strong levels of growth, probably won't ease concerns that the risk for prices is more likely up than down.

But more down than up is the indication for the housing sector. Housing data are always volatile and the accompanying graphs use 3-month averages to help smooth out the numbers and make trends more visible. Also helping to smooth the results is our focus on single-family homes, excluding multi-units which are much fewer in number and where monthly change is often extreme. The 3-month average for single-family starts, the blue line in the graph, fell a sharp 1.9 percent in August to an annualized rate of 876,000. And not pointing to any acceleration ahead are single-family permits, the green line in the graph where the 3-month average fell 0.8 percent to an 849,000 rate. The decline in permits is a prominent negative that underscores this year's downtrend for housing which is tied, not only to soft demand, but also to capacity constraints in construction where lack of available labor and high material costs are blunting the ambitions of home builders.

Sales data for housing, that is for existing homes, were also out in the week and they missed Econoday's consensus for a fifth month in a row. The 3-month average, tracked in the red line, fell 0.3 percent to a 4.753 million rate in August. Compared with August last year, the 3-month average is down 1.5 percent. Resales have been unusually flat the last several years and reflect, to a degree, lack of traction in new homes where sales strength, if it should begin to pick up speed, would increase the need for buyers to sell their existing homes. Sellers were offering discounts in the month with the median price for a resale down 1.7 percent to $264,000. However strong the economy and stock market are, the nation's housing sector is not participating which is a major negative for household wealth. New home sales for August, to be released Wednesday, will be a highlight of the coming week's calendar.

Softness in housing definitely does not speak to the need for a rate hike but one area of the economy that definitely points to one is the labor market. In a milestone report, all four key readings in the jobless claims hit historic lows. Initial claims fell 3,000 in the September 15 week to 201,000 with the 4-week average down 2,250 to 205,750. Both of these readings are at new 50-year lows. Continuing claims in lagging data for the September 8 week fell a very sharp 55,000 to 1.645 million with this 4-week average down 20,000 to 1.692 million. Both of these readings are at new 46-year lows. Turning back to initial claims, the September 15 reporting week was also the reporting week for the September employment report. Comparisons with the reporting week for the August employment report show a 9,000 decline at the headline level and an 8,000 decline for the 4-week average. These results will build expectations for strong payroll growth and downward pressure on the unemployment rate for September. No states were estimated in the report which is rare, not even North Carolina which was hit late in the week by Hurricane Florence. Whether North Carolina will be able to issue its own data in the next report is in question.

Turning back to the previous week, let's take a look at a major force that's working against the Fed's efforts to slow the economy -- the sharp rise underway in government spending. With only one month left in fiscal year 2018, the government's deficit is running 33.3 percent deeper than fiscal year 2017. August's deeper-than-expected monthly deficit of $214.1 billion pulled the year-to-date shortfall to an awful looking $898.1 billion vs $673.7 billion in the prior fiscal year. The spending side shows an 8.3 percent increase in Medicare to a year-to-date $562.3 billion with defense up 6.8 percent to $610.3 billion. Net interest is also a factor in the spending rise, up 21.0 percent to $332.1 billion which reflects the rise underway in the nation's debt. Total spending, in contrast to only a small increase for receipts, is up 6.7 percent. Some of the strength of the 2018 economy can be attributed to old fashioned Keynesianism -- a deepening in deficit spending.

But the deepening deficit isn't due to individual tax receipts which, thanks to strong growth in the labor market and despite this year's tax cut, are up 7.0 percent from the prior fiscal year to a year-to-date $1.522 trillion. This gain helps to offset a striking 30.4 percent decline in corporate income taxes to only $162.6 billion, a drop that reflects this year's big tax cut on the corporate side. Total receipts, which include a 17.1 percent jump in custom duties to a year-to-date $36.7 billion, are up but not very much, only 0.6 percent higher from fiscal 2017.

Markets: Stocks show no fear of Fed

The week's rally in the stock market, that saw the Dow gain 2.3 percent, may seem out of place given not only the imposition of tariffs on $200 billion of Chinese goods and the risk of further actions by year end but also given the apparently certain prospect that the Fed is going to raise rates at the pending FOMC. But a look at the Fed's prior three rate hikes, all coming in 3-month intervals, shows little effect on the market. The Dow actually rallied 400 points going into the final sessions before December's hike, slipped a bit before March's move, and rallied another 400 points ahead of June's action. There's no reason to believe that stocks will be showing much hesitation in the coming week. This lack of apprehension speaks to the success of the Fed's transparency, that its moves are all carefully telegraphed with no misunderstandings.

Other data in the week come from the Treasury International Capital report which tracks cross-border investment flows in financial securities. However much the stock market has been rallying in recent months, foreign interest can't be cited as a plus. Foreign accounts sold a net $14.1 billion of U.S. equities in July in what was the third straight month of outflow and the fifth decline in six months. U.S. accounts were light sellers of foreign equities in July, at a net $1.3 billion, much of which may have been reallocated to domestic shares. This report also tracks Chinese holdings of U.S. Treasuries which have shown no break lower at all despite this year's breakdown in trade talks. Chinese accounts held $1.171 trillion in U.S. Treasuries in July, down only $7.7 billion in the month. The Chinese total in this report will be of increasing interest as a new round of trade deadlines approach at year end.

Markets at a Glance	Year-End	Week Ended	Week Ended	Year-To-Date	Weekly
	2017	14-Sep-18	21-Sep-18	Change	Change
DJIA	24,719.22	26,154.67	26,743.50	8.2%	2.3%
S&P 500	2,673.61	2,904.98	2,929.67	9.6%	0.8%
Nasdaq Composite	6,903.39	8,010.04	7,986.96	15.7%	-0.3%
Crude Oil, WTI ($/barrel)	$60.15	$68.95	$70.77	17.7%	2.6%
Gold (COMEX) ($/ounce)	$1,305.50	$1,198.70	$1,203.30	-7.8%	0.4%
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%	2.79%	2.81%	92 bp	2 bp
10-Year Treasury Yield	2.41%	2.99%	3.07%	66 bp	8 bp
Dollar Index	92.29	94.98	94.28	2.2%	-0.7%

The bottom line

The lead up to Wednesday's FOMC announcement isn't likely to derail the markets though it may raise objections from President Trump and his administration. But of all the issues facing the markets, whether trade or government deficits or housing or manufacturng, the single greatest point of concern for Fed policy makers is the enormous demand for labor and the risk that labor will become increasingly scarce.