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.
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