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Consumer subdued but not manufacturing
Simply Economics - May 18, 2018
By Mark Pender, Senior Editor



There may be signs of capacity stress in the economy that will limit business expansion and turn up pressure on inflation, but they aren't coming from the consumer sector, at least not lately. Retail sales have been subdued so far this year in contrast to manufacturing where indications continue to accelerate.


The economy

A flat line is the week's most telling graph. Retail sales managed only a 0.3 percent rise in an April report where the headline tells the story of the details, mostly all modest to moderate. The trendline over the past year is pointing to a roughly 0.4 percent average monthly rate but it's the lack of acceleration that is key. If sales growth stalls then the Federal Reserve will have little reason to upgrade its assessment of consumer spending which it described as "moderating" in both the May and March FOMC statements. Yet 0.4 percent monthly growth does make for a nearly 5 percent annual growth rate which is nothing to sneeze at.


Turning to yearly comparisons, retail sales rose 4.7 percent in April which was 2 tenths slower than March and well down from November's expansion peak at 5.9 percent. Consumer spending began to slow noticeably at the beginning of the year for reasons that aren't clear especially given the benefits of this year's tax cuts not to mention the enormous strength of the labor market. It's worth noting that seasonal adjustments, which add or subtract from original totals to make each month comparable with one another, could be distorting the results. This is an especially big risk for retail sales where dollar totals are very heavy in November and December but then fall off a cliff in January and February.


But there are some positive movements in the retail data, illustrated here with 3-month averages. Rates of growth for two major discretionary components, though still modest, are on the upswing: autos moving from a 2.1 percent year-on-year low in February to 3.7 percent in April and restaurants rising to 3.6 percent in April for the best rate over the last year. If autos and restuarants can continue to pick up, they could have a major impact and could start pulling total sales higher. These two components are very sizable making up 1/3 of total retail spending with autos at 21 percent and restuarants at 12 percent.


The lack of punch in the consumer sector is being offset by acceleration in the factory sector. One of the week's biggest headlines comes from the manufacturing component of the Federal Reserve's industrial production report, posting a 0.5 percent rise in April that follows closely on the heels of February's 1.5 percent surge. These gains are tracked in the blue columns of the graph while the green line tracks the production index of ISM manufacturing, easily the most closely watched of all the small-sample reports. Both series track month-to-month change in volumes and though the ISM has been far stronger than the Fed's measure, the trendlines are running parallel. This is a reminder that small-sample surveys are best used not as advanced signals for the magnitude of change but as advanced signals for directional change. Note that the monthly breakeven line for ISM production is 51, a level never even approached in what is quite a contrast to the seven monthly declines in the Fed's measure over the last year.


There are other highlights in the industrial production report especially mining output which jumped 1.1 percent to a 119.3 index level to extend what is a very convincing sweep higher. On a year-on-year percentage basis, mining output is up 10.8 percent in what is one of the strongest rates of growth anywhere in the economy. Energy extraction is a major piece of the mining sector and $70 oil looks to drive this curve even higher. Utility output is also on the rise, up 6.0 percent over the last year with manufacturing improving though still at only a 1.8 percent yearly rate.


However subdued the manufacturing trend is in the industrial production report, small-sample surveys continue to signal nothing less than a vast breakout for the sector. The Philly Fed report, which is another closely watched small-sample survey, is literally exploding higher. The report for May is studded with near records whether for new orders at a 45-year high or the second best reading ever for employment or some of the slowest delivery times on the books. And a very delicate reading, one that will test the vigilance of inflation hawks everywhere, is selling prices, tracked in the dark green area of the graph and which jumped nearly 7 points to 36.4 for the strongest reading in 39 years. Some of the rise in prices is bound to be the pass-through of metal tariffs but the trend has in fact been accelerating for the past two years. And future selling prices, the light green area which offers a measure of inflation expectations at the factory level, are near their strongest levels of the 9-year expansion despite having eased sharply from February's 50-year peak at 51.3.


Philly's sample is not alone in reporting price pressures. Current input prices in Empire State, a regional manufacturing report compiled by the New York Fed, are at 54.0 and a 7-year high. Yet it's not only inflation that's the news in the May report but also a very welcome recovery in the 6-month outlook which, at 31.1, rebounded nearly 13 points in the month. This reading is still 13 points below where it was in  March, but the recovery suggests that the sample is beginning to adjust to tariff disruptions.


Perhaps the most immediately important news in the week, at least on what to expect for the May employment report, is another set of very favorable unemployment claims. Initial claims in the May 12 week, which was also the sample week of the monthly employment report, came in at 222,000 which is 11,000 lower than the sample week of the April employment report. And the 213,250 level of the 4-week average, as seen in the blue line of the graph, is down a very sizable 18,250 from April's sample week. And some more superlatives are coming as the current 4-week average is the lowest since 1969. Continuing claims, where data lag by a week, fell a sizable 87,000 to 1.707 million in data for the May 5 week with this 4-week average, as tracked in the green columns, down 40,000 to 1.774 million. Both of these readings are the lowest since 1973. Employers are holding onto their employees like never before which shouldn't make a strong employment report for May any surprise.


Markets: Foreigners selling stocks

The stock market's explosive gains late last year and at the beginning of this year appear to be only a memory. The Dow is dead flat so far this year, a big contrast to last year's 25 percent gain. Some of that gain was due to buying by foreigners who posted 5 straight monthly gains at record levels before fizzling in February and then turning to a $21.8 billion pull out in March. Some of this flight no doubt reflects volatility concerns over the market and some may also reflect the value of the dollar which has been turning higher in recent months and reducing the purchasing power of foreign investors.


The benchmark that's in special focus right now is the 10-year Treasury yield which, reflecting weakening demand for govenment bonds, has been testing the 3 percent line the last couple of weeks. The list of negatives for Treasuries is convincing and includes: a widening government deficit, the prospect of continued rate hikes by the Fed, and less direct buying by the Fed as it unwinds its balance sheet. On the other hand, outcomes that could raise demand for Treasuries would be a slowing in economic growth and especially a sudden step backward for inflation. And a silver lining for Treasuries so far this year is that the shape of the yield curve has held firm, that the 2-year yield has gone up no more than the 10-year, both 66 basis points so far this year. It would be the risk of inversion, when short rates exceed long rates, that could trigger recession worries and policy uncertainties at the Fed.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 11-May-18 18-May-18 Change Change
DJIA 24,719.22 24,831.17 24,715.09 0.0% -0.5%
S&P 500 2,673.61 2,727.72 2,712.97 1.5% -0.5%
Nasdaq Composite 6,903.39 7,402.88 7,354.34 6.5% -0.7%
Crude Oil, WTI ($/barrel) $60.15 $70.56 $71.35 18.6% 1.1%
Gold (COMEX) ($/ounce) $1,305.50 $1,319.40 $1,291.20 -1.1% -2.1%
Fed Funds Target 1.25 to 1.50% 1.50 to 1.75% 1.50 to 1.75% 25 bp 25 bp
2-Year Treasury Yield 1.89% 2.55% 2.54% 66 bp –1 bp
10-Year Treasury Yield 2.41% 2.97% 3.07% 66 bp 10 bp
Dollar Index 92.29 92.54 93.65 1.5% 1.2%


The bottom line

There are many superlatives in the week but none of them come from retail sales. This odd quiet could be a time when pent-up demand builds, the release of which could pull consumer spending sharply and suddenly higher. And sharply and suddenly higher is what may be in store, based on the advance signals, for the factory sector not to mention the labor market as well.


Week of May 21 to May 25

The coming week will be centered on the housing sector but starts on Monday with the national activity index and an overall assessment of April's economy followed on Wednesday by an advance assessment of May's economy with a flash set of PMI data. New home sales will be Wednesday's highlight and respectable strength is the call with similarly upbeat results the expectations for FHFA house prices and existing home sales, both of which will be posted on Thursday. Capping the week on Friday will be the durable goods report where core rates, in contrast to the headline, are expected to prove very solid.




National Activity Index for April

Consensus Forecast: 0.25

Consensus Range: 0.12 to 0.40


The consumer may have been quiet but April was a good month for the industrial sector and especially for employment as the unemployment rate fell 2 tenths to 3.9 percent. Forecasters see the national activity index coming in at 0.25 vs a modest 0.10 gain in March.




Richmond Fed Manufacturing Index for May

Consensus Forecast: 10

Consensus Range: 6 to 16


Rebound into the plus column is the consensus for the Richmond Fed manufacturing index, at 10 for May vs a rare minus 3 in April. This will be the third advance indication on May's factory sector following strong reports from both Empire State and the Philly Fed.




PMI Composite for May, Flash

Consensus Forecast: 54.8

Consensus Range: 54.5 to 55.2


PMI Manufacturing

Consensus Forecast: 56.4

Consensus Range: 55.0 to 56.8


PMI Services

Consensus Forecast: 54.6

Consensus Range: 54.1 to 55.4


Moderate growth has been the steady signal from the PMIs with manufacturing showing increasing strength. The flash May consensus for the PMI composite is 54.8 with PMI manufacturing seen at 56.4 and PMI services at 54.6.


New Home Sales for April

Consensus Forecast, Annualized Rate: 677,000

Consensus Range:  650,000 to 692,000


New home sales surged higher in March and are understandably expected to slow slightly in April, to a consensus 677,000 annualized rate vs April's 694,000. Before the April report, new home sales had been hesitant and slow but following that report, which also included steep upward revisions, the pace turned solid.




Initial Jobless Claims for May 19 week

Consensus Forecast: 220,000

Consensus Range: 217,000 to 220,000


Initial claims are expected to come in at 220,000 in the May 19 week in what would be a small increase from 222,000 in the prior week. The 4-week average in the prior week, at 213,250, marked a 49-year low. Low readings in this report are consistent with strong demand for labor.


FHFA House Price Index for March

Consensus Forecast, Month-to-Month Change: 0.7%

Consensus Range: 0.6% to 0.7%


The FHFA house price index is expected to rise 0.7 percent in March, extending its run of strength this year. At a consensus annualized rate of 5.600 million, The year-on-year rate, at 7.2 percent in February, was just off January's 4-year high at 7.4 percent.


Existing Home Sales for April

Consensus Forecast, Annualized Rate: 5.600 million

Consensus Range: 5.500 to 5.640 million


At a consensus annualized rate of 5.600 million, existing home sales in April are expected to hold onto the strong gains in March and February. Recent gains aside, resale trends have been flat with year-on-year readings still in the negative column.


Kansas City Manufacturing Index for May

Consensus Forecast: 22

Consensus Range: 20 to 25


A modest fall back to 22 is the May consensus for the Kansas City manufacturing index which jumped 9 points in April to 26. Both new orders and backlog orders were unusually strong in April which points to gains for production and employment in the May report.




Durable Goods Orders for April

Consensus Forecast, Month-to-Month Change: -1.3%

Consensus Range: -2.5% to 1.7%


Durable Goods Orders, Ex-Transportation

Consensus Forecast: 0.6%

Consensus Range: -0.2% to 0.8%


Durable Goods Orders, Core Capital Goods (Nondefense Ex-Aircraft)

Consensus Forecast: 0.5%

Consensus Range: 0.1% to 1.4%


Underlying strength is the call for durable goods orders which, however, is not expected to be evident at the headline level where a 1.3 percent decline is Econoday's consensus, one reflecting expectations that aircraft orders, which have been very strong, will finally pull back. Ex-transportation orders, which exclude aircraft, were flat in March and solid improvement is the call for April, at a consensus gain of 0.6 percent. A decline in core capital goods was a disappointment in the March report and a 0.5 percent rebound is the April consensus.


Consumer Sentiment Index, Final May

Consensus Forecast: 99.0

Consensus Range: 98.8 to 99.3


The consumer sentiment is expected to hold steady at a solid 99.0 in the final reading for May, in what would be little changed from April's 98.8. Year-ahead inflation expectations in this report have been edging higher.


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