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Over heating and wage inflation
Simply Economics - October 6, 2017
By Mark Pender, Senior Editor



The laws of economics may not have to be repealed after all. September's employment report is an eye opener not because of nonfarm payrolls, where a 33,000 decline is no more than a clumsy head fake, but because of average hourly earnings which have risen from the dead. Slack in the labor market may have been fully absorbed all along, and with this possibility comes the immediate risk of a wage-push flash point. We now have to dust off an old word not used for 10 years -- and that's "overheating."


The economy

Average hourly earnings are a central measure of wage pressure and had been, to everyone's confusion, trending lower before September's report. But now wages are suddenly and clearly rising. September's 0.5 percent spike matches July (which in another shocker was revised 2 tenths higher) as the hottest wage month since the boom days of 2007. News reports have been filled with recruiters saying employers are squeezed and finally paying higher wages. Now we have confirmation.


Like the monthly surge, the year-on-year rate for average hourly earnings has also sprung to life. September's 2.9 percent matches December last year as the expansion high. Revisions are key here also as August was revised 2 tenths higher to 2.7 percent and now carries the upward run to 4 months in a row. What's happened? Why the sudden traction and the revisions? The Department of Labor didn't say but what they did say was Hurricanes Harvey and Irma had no discernible effect on wages.


Why are wages up? The theory, one that had been in doubt until September's report, is based on supply and demand: employers facing a shrinking supply of workers will have to bid up wages to fill posts. The pool of available workers, which tracks those who want to work but are not pounding the pavement, fell more than 1/2 million to 12.429 million. Down also is the number of unemployed which tracks those who are in fact pounding the pavement and which is used to compute the 4.2 percent unemployment rate.


The Labor Department also said hurricanes had no effect on the unemployment rate which apparently means that the dip, to the lowest seen since January 2001, is the real deal. Not a real deal, at least for policy makers, is a drop in September payrolls, one that likely reflects one-time hurricane effects which will be quickly reversed, assuming that is employers can find workers to put on their payrolls. Nonfarm payrolls fell 33,000 in September reflecting a 104,700 drop at restaurants.


Though the government wouldn't go out on a limb and attribute the payroll dip to Harvey and/or Irma, the drop at restaurants clearly hints at hurricane closures. Manufacturing also fell but only 1,000 and follows an upwardly revised 41,000 burst in August which is a 20-year high. The graph tracks manufacturing payrolls in yearly terms where growth is once again emerging. Strength in factory shipments, at 5.2 percent for the 2nd best reading in 5-1/2 years, helps explain the improvement.


It was surprise galore for the jobs data and another may be ahead for jobless claims once Puerto Rico, hit by Hurricane Maria, reports its own results. Initial claims for the Virgin Islands were estimated in mid-September, in this case due to Irma,  and when the territory reported its own data, they jumped more than 10 fold to 1,039. Puerto Rico's claims have been estimated the last 2 weeks at under 2,500. If the same effect hits again, it could be bigger. The Virgin Islands' population is 104,000; Puerto Rico, 3.6 million.


A very pleasant surprise comes from unit vehicle sales which shot up in September to an 18.6 million annualized rate for the strongest showing in 12 years. Yet the surge, no doubt tied to hurricane replacement demand, may be a one-time wonder, stealing sales from future months as motorists suddenly without wheels crowded into dealerships all at once. Unit sales don't always track with dollar sales yet the results are nearly certain to boost September consumer spending.


Turning back to manufacturing, what's going on with the ISM which is at 13-year highs? This is partly due to delivery delays which we'll get to in a minute but it's more than that: new orders are at a 4-year high, backlogs and hiring at 6-1/2 year highs. Yet the rival report from Markit is showing only moderate growth much more in line with actual hard data. Neither report specifes exact sample sizes but a mere 200 or so isn't a bad guess. And participation isn't mandatory, only for those who want to take part.


A clear hurricane effect is coming from slowing delivery times as tracked in ISM's manufacturing and non-manufacturing surveys. Times lengthened sharply to indicate some of the longest delays on record. This, like other hurricane effects, is likely to ease in future reports. Yet delays are raising input costs and may encourage shippers to expand their capacity and workforces even before the holidays. Delivery times are not measured by Washington and are a unique plus of private reports.


Turning to cross-border action, hurricane effects can't be found in August's trade data. Exports rose and imports dipped in results that are a plus for third-quarter GDP. One special detail is also favorable: narrowing between the nation's Achilles heel, consumer imports, and what is by far our greatest strength -- exports of capital goods. Consumer imports did edge higher to $48.9 billion but capital goods exports posted a gain of their own to $45.3 billion. There's still a gap here but at $3.6 billion, it's the smallest in a year.


Another plus for third-quarter GDP (and perhaps another hint of over-heating) comes from wholesale trade. Inventories in the sector jumped 0.9 percent in August to $608 billion following back-to-back surges of 0.6 percent in June and July. Sales in the sector are even stronger, up 1.7 percent in August which, despite the jump in inventories, pulls the stock-to-sales ratio down one notch to an even leaner 1.28. Inventory data for retailers and manufacturers aren't showing the same kind of acceleration, at least yet.


Markets: Tax reform, are we sure?

Republicans are making moves in the House to push through tax reform by year's end, changes that would sharply cut corporate taxes as well as lower individual taxes. Stocks got a major boost from the moves all week despite slim voting margins and this year's lack of policy follow through. Will Senate Republicans get on board? And if not, will there be payback in the market? Risk is risk after all. The Dow, at 22,773, rose 1.6 percent on the week while bonds showed little Friday reaction to the wage jump.


Harvey, Irma and Maria did their worst and now it may be Nate's turn as the tropical storm is headed for the Gulf as a possible hurricane. Oil hasn't responded to the threat but gasoline did a bit, rising from $1.55 per wholesale gallon on Monday to $1.62 on Thursday before sliding back on Friday. Inventories of gasoline haven't yet recovered from Harvey, at 218.9 million barrels in the Sept. 29 week from a 2-year low of 216.2 million at mid-month and still well down from 229.9 million in mid-August.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2016 29-Sep-17 6-Oct-17 Change Change
DJIA 19,762.60 22,405.09 22,773.67 15.2% 1.6%
S&P 500 2,238.83 2,519.36 2,549.33 13.9% 1.2%
Nasdaq Composite 5,383.12 6,495.96 6,590.18 22.4% 1.5%
Crude Oil, WTI ($/barrel) $53.71 $51.56 $49.32 -8.2% -4.3%
Gold (COMEX) ($/ounce) $1,152.50 $1,283.20 $1,277.40 10.8% -0.5%
Fed Funds Target 0.50 to 0.75% 1.00 to 1.25% 1.00 to 1.25% 50 bp 0 bp
2-Year Treasury Yield 1.21% 1.49% 1.53% 32 bp 4 bp
10-Year Treasury Yield 2.45% 2.33% 2.37% –8 bp 4 bp
Dollar Index 102.26 93.08 93.81 -8.3% 0.8%


The bottom line

We all knew that the September employment report would be a gem for those who like surprises. But can one single report change the view of the world? Maybe, given not only the strength of average hourly earnings in the latest month but the upward revisions to prior months. The sudden appearance of the pressure, against a labor market where the unemployment rate is at a 16-1/2 year low, points to lack of slack in the labor market and risk of accelerating wage pressure ahead. The results also confirm the strength seen in this year's employment cost index, a quarterly report that FOMC policy makers focus on closely for wage-pressure indications. Forget about the December FOMC, it's now too far in the future. September's wage results raise the chances, if not for a rate hike at this month's FOMC, then at least for a much more lively debate. Yes the meeting, which begins on October 31 and ends on November 1, won't have quarterly forecasts nor Janet Yellen's press conference but these bells and whistles, given the new risk to inflation, may not be necessary.


Week of October 9 to October 13

The week starts off slowly putting the focus on Fedspeak following the prior week's striking pressure in average hourly earnings. Two doves speak on Tuesday, Neal Kashkari of the Minneapolis Fed and Rob Kaplan from Dallas. Speakers who follow are Charles Evans of Chicago on Wednesday, another dove, with Governor Jerome Powell, Eric Rosengren of Boston and Raphael Bostic later in the week. Minutes from last month's historic FOMC meeting will be Wednesday's highlight though JOLTS data in the morning may offer a strong reminder of tightness in the labor market. Jobless claims, skewed or not by hurricanes, are the highlight on Thursday which will also offer producer prices and the final Treasury budget report for fiscal year 2017. The big news comes out on Friday with consumer prices, where limited but constructive pressure for the core is the call, and retail sales where a giant spike in the headline may mask only moderate trends below.




Small Business Optimism Index for September

Consensus Forecast: 105.4

Consensus Range: 105.0 to 106.5


At 105.3 in August, the small business optimism index is at its best level in 12 years. Sales expectations are strong as are capital investment plans. Econoday's call for September is for steady and exceptional strength, at a consensus 105.4.




JOLTS: Job Openings for August

Consensus Forecast: 6.160 million

Consensus Range: 6.000 to 6.200 million


Tight conditions in the labor market are the signals from the labor market's 4.2 percent unemployment rate and are consistent with the JOLTS report. Job openings in the report rose to 6.170 million in July and were far ahead of hirings at 5.501 million. This separation indicates that employers are having a hard time filling slots. Econoday's consensus for August job openings is a steady reading at 6.160 million.


FOMC Minutes

Covering the September 19 & 20 Meeting


September's FOMC meeting was one for history, marking the decision to begin balance-sheet unwinding. Special details on the unwinding, especially its possible duration and how much policy makers plan to reduce their $4.5 trillion balance sheet, will be closely watched in the minutes. Lack of inflation was a serious topic at the meeting but market interest here may be limited by the September employment report that has since shown a major uptick for wages.




Initial Jobless Claims for October 7 week

Consensus Forecast: 252,000

Consensus Range: 250,000 to 275,000


Pressures from Hurricane Harvey's hit on Texas and Hurricane Irma's strike on Florida have been easing in recent jobless claims reports though the effects of Hurricane Maria on Puerto Rico, which so far have been estimated, pose a risk for an over-sized increase. But forecasters are calling for further improvement in initial jobless claims during the October 7 week, at a consensus 252,000 vs 260,000 in the prior week.


PPI-FD for September

Consensus Forecast, Month-to-Month Change: 0.4%

Consensus Range: 0.3% to 0.5%


PPI-FD Less Food & Energy

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.4%


PPI-FD Less Food, Energy, & Trade Services

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.2% to 0.3%


Producer prices have been unusually soft at only a 0.2 percent gain in August despite a jump for energy prices. Excluding energy and also food, the core rate was even weaker, up only 0.1 percent in August to miss Econoday's consensus for the 4th month in a row. Weakness here has been tied to lack of price pressures in trade services. Excluding food, energy and also trade services, producer prices managed only a 0.2 percent August gain. September's consensus forecasts are as follows: plus 0.4 percent for the PPI-FD overall, plus 0.2 percent less and energy, plus 0.2 percent less food, energy and trade services.


Treasury Budget for September

Consensus Forecast: $0.0 billion

Consensus Range: -$3.0 to $48.0 billion


September's Treasury budget will wind up the government's fiscal year 2017 which, in August, was tracking 8.8 percent wider than fiscal 2016. The Econoday consensus for September is no change which would compare with a $33.4 billion surplus in September last year.




Consumer Price Index for September

Consensus Forecast, Month-to-Month Change: 0.6%

Consensus Range: 0.3% to 0.7%


Consumer Price Index

Consensus Forecast, Year-on-Year Change: 2.3%

Consensus Range: 2.0% to 2.4%


CPI Core, Less Food & Energy

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.3%


CPI Core, Less Food & Energy

Consensus Forecast, Year-on-Year Change: 1.8%

Consensus Range: 1.7% to 1.8%


The 0.2 percent gain for core consumer prices was perhaps the most important economic data coming out of the month of August. Though it didn't translate into strength for the Federal Reserve's preferred inflation reading, core PCE prices, it did foreshadow an outsized September gain and upward revisions for wages (average hourly earnings). Forecasters don't see a major gain for September's core CPI, at a consensus 0.2 percent repeat, but they do see energy-related strength for the overall CPI where the consensus is 0.6 percent in what would follow a 0.4 percent gain in August that also was boosted by higher fuel costs. Year-on-year rates are expected to rise, to 2.3 percent overall in what would be a 4 tenths increase and 1.8 percent for the core in what would be a 1 tenth improvement.


Retail Sales for September

Consensus Forecast: 1.9%

Consensus Range: 0.7% to 2.6%


Retail Sales Ex-Autos

Consensus Forecast: 0.8%

Consensus Range: 0.1% to 1.9%


Retail Sales Ex-Autos Ex-Gas

Consensus Forecast: 0.4%

Consensus Range: 0.2% to 0.6%


Retail Sales Control Group (Ex-Food Services, Ex-Autos, Ex-Gas, Ex-Building Materials)

Consensus Forecast: 0.2%

Consensus Range: 0.2% to 0.4%


Replacement demand made for one-time strength in unit auto sales during September and together with a major lift from higher gasoline prices are expected to drive a rare 1.9 percent gain for total retail sales. When excluding autos, the expected gain remains formidable at 0.8 percent though when excluding autos and gas, expectations fall to 0.4 percent. Control group sales offer a more steady reading on underlying trends and here the consensus is very modest, at 0.2 percent. Note that sales in August were unusually weak and will make for easy monthly comparisons: down 0.2 percent overall, up 0.2 percent ex-auto, down 0.1 percent ex-autos ex-gas, down 0.2 percent for the control group.


Business Inventories for August

Consensus Forecast,  Month-to-Month Change: 0.6%

Consensus Range: 0.3% to 0.7%


Business inventories climbed in advance data as companies tried to keep up with rising sales during August. After a modest 0.2 percent July build, business inventories are expected to rise by 0.6 percent in August led by unusual strength at the wholesale level.


Consumer Sentiment Index, Preliminary October

Consensus Forecast: 95.5

Consensus Range: 93.5 to 95.8


The consumer sentiment index showed only modest impact from Hurricanes Harvey and Irma in September when the index fell 1.7 points to what is a still very strong 95.1. Expectations are calling for a resumption of gains, to a consensus 95.5 for the preliminary October index. However inflation expectations, which are watched closely by FOMC policy makers, have been a key negative, unchanged at 2.7 percent in September despite gains in wages and hurricane pressures in gasoline prices.


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