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Pressure evident but not all inflation data higher
Simply Economics - February 16, 2018
By Mark Pender, Senior Editor


Simply Economics will be taking the February 19th week off. Next posting will be March 2.



The ultimate source of the market scare is the approaching risk that available capacity will hit its limit, resulting in higher prices and especially higher wages. The week's headlines include another run of expansion highs yet not all the data are pointing to overheating. We'll go through the week's very heavy inflation slate looking for initial signs of pressure and then turn to supply-side updates out of manufacturing, retail and housing.


The economy

Tangible increases in many basics led a strong 0.5 percent jump in consumer prices for January, actually a 0.54 percent increase when going out two decimals which is common for the CPI given its importance. This is the highest result since early in the economic expansion, nearly 5 years ago. The core CPI, which excludes food and energy, is even more closely watched and its January increase came to 0.35 percent. This is the highest since the peak of the prior expansion, 12-1/2 years ago. Transportation costs led January with sharp hikes for parking, vehicle leasing, body work, insurance and vehicle fees. Medical care costs, which had been flat, also rose noticeably including sharp gains for health insurance and especially hospital services. Apparel, which had been sinking sharply, popped up with a surge in prices for women's apparel.


But the year-on-year rates, which are the common language for inflation, show less pressure, holding just above the Fed's 2 percent inflation goal at 2.1 percent with the curve for the core slightly more favorable but the rate still no better than 1.8 percent. The Fed's expectations, outlined in their January FOMC statement which marked the opening move in the inflation scare, call for inflation to move up and "stabilize" around 2 percent. And though their particular guage is the PCE index which is running several tenths below the CPI, the slight upward drift for the CPI core would appear to be on target and right where the Fed expects inflation to be.


A primary source of price influence on the consumer sector is the wholesale sector and here the year-on-year readings are even less than striking. The blue line for the core and the gray line overall have been coming back down in recent months, to 2.2 and 2.7 percent respectively for January, yet the prior trend is favorable and a reminder that current rates are still near their best readings since early in the expansion when yearly comparisons, against depressed prices, were easy. Many of the details in the January producer price report do in fact point to pressure including construction and government components as well as a bounceback for service prices.


And there is one very important factor that has yet to kick in, and that's higher prices for consumer imports. Imports of consumer products dominate the nation's trade deficit and prices for these goods have not been moving in the direction suggested by the fall in the dollar, a fall that means it takes more dollars to buy foreign goods. The green line of the trade-weighted dollar index ended January with an 8.0 percent year-on-year decline yet import prices, instead of rising, had yet to show any pressure at all, hovering around the zero line. This suggests the possibility that foreign sellers are marking down prices to keep their share of the U.S. consumer market, a move however that may not have long legs. Prices of imported vehicles and capital goods, two smaller components, are already rising and noticeably, at a 5-year high for vehicles and a 6-year high for capital goods. The dollar has continued its move lower so far in February and sooner or later prices for imported consumer goods look like they are bound to go up.


But consumers apparently aren't scared, based on year-ahead inflation expectations in the consumer sentiment report. This reading has been stuck at a very subdued 2.7 percent for the last three months, a result that doesn't point to much hope for wage gains. Business expectations are no better with the Atlanta Fed's reading stuck at 2.0 percent for three of the last four months. The pink line in the graph is the CPI which may not be moving much higher or lower at least based on how expectations are moving.


But there is a report, one that has been signaling outsized strength for the last year, where inflation expectations are at a new high. The dark green area tracks the Philly Fed's current selling price index against the light area of future selling prices, that is what respondents in Philly's sample expect their products to sell for six months from now. Expectations for selling prices are at an expansion high of 49.5 in strength that is tied directly to increases in current selling prices, which are at 23.9 for the second strongest reading of the expansion. The Philly Fed is a very closely watched report and we can view its over-the-top strength the last year to the emphatic accuracy of its indication: simply, that manufacturing is expanding. And here this sample is clearly reporting an environment of price traction for finished goods.


The Philly Fed has been posting some of its strongest readings in the 50 years of its data in sharp contrast to the industrial production report which posted yet another flat result in January. Capacity utilization fell sharply to 77.5 percent as tracked in the blue line. Yet utilization is still solidly higher than the 76 percent readings of September and August. If utilization does manage to resume its climb it will, like consumer imports, add another important factor to the inflation outlook.


Not a factor raising inflation pressure, however, is the largest single force of demand and by far. Consumer spending not only sank back at retailers in January but, after revisions, posted no increase at all in December in a disappointment to be felt in the second estimate for fourth-quarter GDP. A key weakness in the retail report was supposed to be a great strength, that is acceleration in e-commerce sales. Based on the nonstore component, which is dominated by e-commerce, sales have not been that great lately, coming in dead flat in January with December's initial monthly surge of 1.2 percent revised down to a more moderate looking gain of 0.5 percent. But stepping back and looking at the year-on-year rates of the graph, nonstores are indeed doing very well, in the double digits vs a 3 percent growth pace for all other retailers. The disappointment for e-commerce is evident in its share of the retail sector, unchanged in just released data for the fourth-quarter at 9.1 percent. The ongoing pause aside, e-commerce's share has been rising steadily from the 3 percent level 10 years ago.


Turning to the rest of the retail report, signs of weakness are coming from the two key discretionary components of vehicles and restaurants. Both of these are converging at the 3 percent annual growth line as tracked by 3-month averages. The drop for the dark green line of vehicles is tied to a drying up of demand following the heavy replacement sales of the hurricane season. The resumption of slowing for restaurants offers a counter indication against the strength of confidence surveys and is also a reminder that consumer demand may, in fact, not be that inflationary.


The last indicator of the week is housing permits where outstanding strength does focus attention on a key area of economic strength -- home prices. Permits surged in January to a 1.396 million rate from December's already strong 1.300 million for the best showing of the expansion. The jump points to future supply relief for a depleted housing market as does a similar rise in housing starts that points to more immediate help. The graph tracks the blue line of permits against the brown line of residential construction spending, a factor that was a leading contributor to fourth-quarter GDP.


Markets: Will foreign demand keep helping the market?

Foreign demand for equities was very pronounced going into year-end, at $35.0 billion in December which is one of the highest net inflows on record. What is a record is the amount of foreign inflows over the last four reports which include $12.6 billion, $12.3 billion and $26.2 billion in the three prior months. Foreign accounts are usually strong buyers of U.S. Treasuries but not for the last several reports with December showing net foreign selling of $16.0 billion. It will be interesting to see how foreign investors are responding to the market gyrations and whether they're cutting their holdings in U.S. equities in favor of, once again, the security of Treasuries. But Treasures were for sale in the latest week, especially the 2-year note where the yield, after several weeks of relative stability, jumped 12 basis points to 2.19 percent. The spread between the 2- and 10-year note narrowed sharply in the week but at 68 basis points is still wider, and by common definition less recessionary, than the 52 basis points at the beginning of the year.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 9-Feb-18 16-Feb-18 Change Change
DJIA 24,719.22 24,190.90 25,219.38 2.0% 4.3%
S&P 500 2,673.61 2,619.55 2,732.22 2.2% 4.3%
Nasdaq Composite 6,903.39 6,874.49 7,239.47 4.9% 5.3%
Crude Oil, WTI ($/barrel) $60.15 $59.23 $61.66 2.5% 4.1%
Gold (COMEX) ($/ounce) $1,305.50 $1,317.50 $1,351.20 3.5% 2.6%
Fed Funds Target 1.25 to 1.50% 1.25 to 1.50% 1.25 to 1.50% 0 bp 0 bp
2-Year Treasury Yield 1.89% 2.07% 2.19% 30 bp 12 bp
10-Year Treasury Yield 2.41% 2.86% 2.87% 46 bp 1 bp
Dollar Index 92.29 90.4 89.13 -3.4% -1.4%


The bottom line

Home price appreciation has been moving gradually above the 6 percent line and may very well, based on housing demand, move toward 7 percent this year. And though data on manufacturing are mixed, there are at least hints of emerging price traction. More immediately for policy makers, the core CPI is moving, however slowly, to the 2 percent line.


Week of February 19 to February 23

A light holiday week is concentrated entirely on Wednesday and Thursday. Existing home sales will be posted Wednesday morning and are expected to extend their uneven climb, but it will be Wednesday afternoon and the release of FOMC minutes that will be the week's highlight. The minutes cover the meeting in January when the Fed raised their assessment of inflation in a move that was soon followed by the upending of the stock market. Thursday will include jobless claims and also the index of leading economic indicators which may ironically get a lift from the stock market that, despite the sell-off, still ended last month with a strong gain.




PMI Composite for February, Flash

Consensus Forecast: 54.0

Consensus Range: 51.9 to 54.1


PMI Manufacturing

Consensus Forecast: 55.0

Consensus Range: 53.6 to 55.7


PMI Services

Consensus Forecast: 53.5

Consensus Range: 51.4 to 53.7


Services were behind January's slowing in the PMI composite but even here production was still solid. The consensus for February's composite is 54.0 vs 53.8 in January with February services seen at 53.5 and manufacturing at 55.0.


Existing Home Sales for January

Consensus Forecast, Annualized Rate: 5.650 million

Consensus Range: 5.530 to 5.730 million


Existing home sales have been choppy but did finish 2017 on the uptrend. But the number of homes for sale are at a19-year low which should limit January's sales results. Against December's 5.570 million annualized rate, a 5.650 million rate is January's consensus.


FOMC Minutes

Covering the January 30-31 Meeting


FOMC members turned the inflation screw one notch in their January statement, saying plainly they expect inflation to move up and stabilize around 2 percent this year. Closely watched in the minutes will be the debate on inflation and especially wage pressures and also any hints whether members, having already set expectations for three rate hikes this year, were discussing the possibility of a fourth.




Initial Jobless Claims for February 17 week

Consensus Forecast: 230,000

Consensus Range: 227,000 to 235,000


Initial claims are expected to come in at 230,000 in the February 17 week which would be unchanged from the prior week. Claims have been low and consistent with minimal layoffs and strong demand for labor.


Index of Leading Economic Indicators for January

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

Consensus Range: 0.3% to 0.9%


Despite all the turbulence, January was still a positive for the stock market which looks to contribute solidly to the month's index of leading economic indicators. Extraordinary strength in ISM new orders will be a key positive as will the month's decline in jobless claims. January's call for the LEI is a very strong 0.6 percent gain.


Kansas City Manufacturing Index for February

Consensus Forecast: 16.5

Consensus Range: 14.0 to 18.0


The Kansas City manufacturing report, like other regional reports, has held steady and strong, at a composite score of 16 in January with February's consensus at 16.5. New orders and backlogs were both very strong in January.


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