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Inflation now at target, consumer unexpectedly softens
Simply Economics - June 29, 2018
By Mark Pender, Senior Editor



The pace of developments in the economy has been picking up sharply over the last several weeks. The Fed is no longer trying to lift inflation but, given easy comparisons and rising oil prices, may instead be scrambling to get out in front of it very soon. The week's news also includes an unexpectedly weak performance for the consumer that belies the Fed's assurance spending was picking up. We'll also take a look at exports, which are the likely target of tariff reprisals, and also home prices which appear to be slowing.


The economy

Inflation may be accelerating a little faster than scheduled this year. The core PCE index jumped to a year-on-year 2.0 percent in May, up from 1.8 percent in April and March and up from a very subdued 5-month run at 1.5 percent. To be fair, the Fed has been warning us about this all along saying in January that the 2 percent target would be hit sometime "this year" then in March saying inflation would "move up" in the medium term. Then in rising anticipation, the Fed in May highlighted the upside area of risk stressing the "symmetry" of its target and its commitment to protect against an overshoot. The 2.0 percent result already hits the FOMC's median for the year, a forecast that was upgraded just a couple of weeks ago, and is 1 tenth away from the FOMC's high range for the year. Data comparisons with this time last year look easy which should limit the shock if the core goes right through what the FOMC was expecting.


And the overall PCE price index (which is more volatile than the core) is already beyond target, jumping from 2.0 percent to 2.3 percent in June vs the FOMC median estimate for 2.1 percent this year and a high estimate for 2.2 percent. Year-ago comparisons for this reading also look easy and the rising price of oil, now well over $70 and approaching $75, should make an increasing overshoot this summer no surprise either. But there is one piece that isn't pointing to an inflation overshoot, and that's the green line in the graph: Average hourly earnings remain contained despite a very low unemployment rate and a very high number of job openings. Should average hourly earnings in next week's employment report, however, show sudden acceleration, talk will certainly increase that the Fed will raise rates, not twice more, but three times more this year.


An even bigger surprise in the personal income & outlays report comes from consumer spending which managed only a 0.2 percent gain to fall below Econoday's consensus range. The subdued result is not at all consistent with the FOMC's verdict back at mid-month that consumer spending was "picking up." And given what was standout strength in retail sales data posted at mid-month, the result came in from the blue. Nondurables did their share in the month, rising 0.6 percent on high energy prices, but durables came in at only a 0.1 percent gain as did services which make up the bulk of consumer spending. May's consumer results point to a knock down for second-quarter GDP estimates, making outside calls for a 5 percent quarter history.


If consumer spending isn't "picking up" after all, what should we expect for the summer months? Employment is very strong which is the most important factor of all and consumer confidence readings, with strength centered in the assessment of current conditions, remain very favorable. High energy prices may hold down non-energy spending but, in an offset, spending for utilities and at gas stations looks to show strength. But there's a wildcard. Questions over tariffs are beginning to surface at the consumer level and appear to be holding down expectations with this reading showing a June dip in both the consumer sentiment and consumer confidence reports. As tracked in the accompanying graph, the blue line from the sentiment report is down nearly 3 points to 86.3 while the green line of confidence is down 4 points to 103.2. In a special question in the sentiment report, one quarter of the sample cited the potential impact of tariffs as an issue in what is a direct echo of the Chicago PMI sample for June where one quarter of this sample, which here are Chicago-area businesses, said tariffs are already affecting purchasing decisions.


Let's now consider what the actual effects of tariffs have been so far. The initial shot across the bow in what may become a tariff war was the 25 percent duties on imported steel and 10 percent on imported aluminum that were imposed in March. These led initially to big jumps for domestic orders of primary metals and also fabrications which are indirectly affected. But tariff-driven demand for the domestic factory sector totals no more than $1 billion at most based on gains that were centered in March and April but faded in May. Import tarrifs may have helped total orders (the blue columns of the graph) peak at $253 billion in March and hold at $250 billion in April. But with May edging back to $249 billion, the question whether steel and aluminum tariffs will continue to stimulate domestic orders is still unanswered.


Whether tariffs will stem metal imports is also still playing out. Imports for primary metals jumped very sharply in March, up a monthly 20 percent to $9.1 billion but then fell back to $8.9 billion in April with this breakdown for May not yet available. But some advance data for May are available and help focus our attention on what's at risk in a trade war for the U.S. economy. Exports of goods surged 2.1 percent in May to $143.6 billion led by a 12.8 percent monthly jump in foods & feeds and a 3.7 percent gain for capital goods which are the nation's strongest exports. And consumer goods also rose, up 3.2 percent. Including exports of services, which is another major U.S. strength, the nation's export total rises to $211 billion in full trade data for April. Over the 12 months from May last year to April this year, the nation's exports totaled $2.395 trillion for a year-on-year gain of 10.9 percent. This is one of the outstanding rates of growth in the entire economy and this, as highlighted by Harley Davidson's decision to move production to Europe, is what's at stake in a trade war.


Turning back to the home front, housing prices seem to be cooling in what is probably good news for the sustainability of overall economic growth but nevertheless is a surprise given how few homes there are on the market. The FHFA house price index, the blue columns in the graph, barely edged higher on a monthly basis while the year-on-year, which peaked at 7.4 percent early in the year, is down to 6.4 percent in the latest data. Case-Shiller's 20-city adjusted index, the green area of the graph, likewise managed only a small monthly increase with this yearly rate slipping to 6.6 percent. Similar indications of price slowing have been coming from both the new home and existing home reports. The results, appearing at the beginning of the Spring sales push, suggest that housing may be in a buyer's market right now.


Slowing appreciation in home prices would not be a positive for household wealth which, however, is on solid ground based on the most important factor of all in the economy -- the labor market. Payroll growth has been very solid and the unemployment rate, down 1 tenth in May to 3.8 percent, is only 2 tenths above where the FOMC sees it going this year. And based on weekly unemployment claims, another notch to 3.7 percent in the June employment report would not be a major surprise. Initial jobless claims did rise slightly in the June 23 week but the 4-week average, at 222,000, compares favorably with levels in May. Continuing claims, where data lag by a week, posted a sizable decline with this 4-week average at 1.720 million and a new 45-year low. And talking about unemployment rates, the rate for insured workers is only 1.2 percent.


Markets: The unbearable heaviness of oil

Jerome Powell already warned us at the mid-month FOMC press conference that high oil prices may very well push inflation above the 2 percent target, at least temporarily he said. Whether his outlook anticipated the current acceleration toward $75 is unknown as is whether his outlook included the political controversy surrounding Iran. Tariffs are the weapon that President Trump is showing in his efforts to isolate Iran, warning that the U.S. may impose tariffs on countries trading with the giant oil producer. Forget about capacity stress, or tariffs on metals, or the unavailability of labor because when it comes to impacting inflation, oil is in its own league. A further run higher, whether based on politics or OPEC production or market speculation, could upend expectations for gradual rate hikes, forcing the Fed to protect the upside of its inflation target with urgency.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 22-Jun-18 29-Jun-18 Change Change
DJIA 24,719.22 24,580.89 24,271.41 -1.8% -1.3%
S&P 500 2,673.61 2,754.88 2,718.37 1.7% -1.3%
Nasdaq Composite 6,903.39 7,692.82 7,510.30 8.8% -2.4%
Crude Oil, WTI ($/barrel) $60.15 $69.23 $74.35 23.6% 7.4%
Gold (COMEX) ($/ounce) $1,305.50 $1,272.10 $1,252.90 -4.0% -1.5%
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% 2.55% 2.52% 63 bp −3 bp
10-Year Treasury Yield 2.41% 2.89% 2.85% 44 bp −4 bp
Dollar Index 92.29 94.55 94.64 2.5% 0.1%


The bottom line

Consumer spending makes up more than two thirds of GDP and the unexpected weakness for May points to less second-quarter acceleration than expected. This though is eclipsed in importance by the increase in core inflation coupled with the ongoing risk that significant pressure from oil prices may kick in as well. These are big results that are big surprises. The economy, stable and predictable for so long, may be entering a summer of uncertainty.


Week of July 2 to July 6

It will be a week split in two by Wednesday's Fourth of July holiday. The first half will be concentrated on the factory sector with ISM manufacturing out on Monday and offering an advance look at June and with factory orders on Tuesday offering a definitive and final look at May. Construction spending will be posted on Monday and strength in this report would support second-quarter GDP expectations. The sleeper in the first half of the week will be Tuesday's unit vehicle sales where the total will offer the very first hints whether consumer spending rebounded or not in June. Coming back from the holiday, services will be Thursday's theme highlighted by ISM non-manufacturing whose sample has been voicing concern over tariff risk. FOMC minutes will be released Thursday afternoon for a meeting that produced a rate hike and raised expectations for more. June's employment report on Friday will top the week and another month of very solid strength, including an uptick in year-on-year wage growth, is the expectation. Also released Friday morning will be international trade data which, based on a substantial rise in exports in advance data on the goods side of the report, is expected to show a sharp decline in the deficit.




PMI Manufacturing for June, Final

Consensus Forecast: 54.6

Consensus Range: 54.6 to 56.2


The PMI manufacturing index is expected to come in at a final of 54.6 in June, unchanged from the mid-month flash. Amid warnings of tariff effects, the flash report cited a "clear loss of momentum" with new orders slipping and with export sales at a 2-year low.


ISM Manufacturing Index for June

Consensus Forecast: 58.3

Consensus Range: 57.0 to 60.0


Econoday's consensus is calling for slight slowing at a still elevated level for the ISM manufacturing index, to 58.3 in June vs 58.7 in a May. But the top-end forecast is calling for acceleration to 60.0 in a reminder that both new orders and, in a rarity, backlog orders were both well over 60 in the last report.


Construction Spending for May

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

Consensus Range: 0.4% to 1.2%


A rebound in multi-family units helped drive construction spending 1.8 percent higher in April to fully reverse the prior month's 1.7 percent decline. Construction spending, often volatile month to month, is expected to rise a very constructive 0.6 percent in May in what would be a positive for second-quarter GDP.




Unit Vehicle Sales for June

Consensus Forecast, Annualized Rate: 17.0 million

Consensus Range: 16.9 to 17.1 million


A 17.0 million annualized rate is the consensus for unit vehicle sales in June, a moderate-to-solid outcome that would compare with 16.9 million in May and hint at another constructive month for the auto component of the retail sales report.


Factory Orders for May

Consensus Forecast, Month-to-Month Change: -0.1%

Consensus Range: -2.2% to 0.2%


Durable goods orders for May slipped back both at the headline level and when excluding transportation equipment, yet the report nevertheless showed fundamental strength highlighted by another strong build in unfilled orders. Forecasters see factory orders in May, a report that will include data on non-durable goods, slipping 0.1 percent.




ADP, Private Payrolls for June

Consensus Forecast: 188,000

Consensus Range: 162,000 to 205,000


Econoday's consensus for ADP's private payroll estimate in June is 188,000 which would compare with 178,000 in ADP's May estimate and against 218,000 in the government's data for May. ADP is always hit and miss and underestimated the strength of the May employment report.


Initial Jobless Claims for June 30 week

Consensus Forecast: 223,000

Consensus Range: 220,000 to 225,000


Initial claims are expected to come in at 223,000 in the June 30 week vs 227,000 in the prior week. All readings in this report are at or near historic lows and consistent with strong demand for labor.


PMI Services for June, Final

Consensus Forecast: 56.5

Consensus Range: 56.5 to 56.5


PMI services moved higher in the flash report for June on strength in both new orders and employment as well, however, as a 5-year high for input costs. The index is expected to hold at the 56.5 flash reading.


ISM Non-Manufacturing Index for June

Consensus Forecast: 58.3

Consensus Range: 56.0 to 59.0


A steady pace is the call for the ISM non-manufacturing index which has been signaling strong activity underscored by sharp slowing in delivery times. Higher costs tied to tariffs and a shifting outlook for trade have been central concerns of the sample. Forecasters see the index easing very slightly to 58.3 in June.


FOMC Minutes

Covering the June 12-13 Meeting


The June meeting produced an incremental 25-basis-point rate hike as expected but also included an increase in the number of rate hikes FOMC forecasters are expecting for the remainder of the year, from one to two. The quarterly FOMC forecasts also pointed to increasing strength for both employment and inflation. A rebound for the consumer was a highlight of the FOMC statement, though this may seem outdated following the subsequent slowing in consumer spending data for May.




Nonfarm Payrolls for June

Consensus Forecast: 190,000

Consensus Range: 144,000 to 210,000


Unemployment Rate

Consensus Forecast: 3.8%

Consensus Range: 3.7% to 3.8%


Private Payrolls 

Consensus Forecast: 183,000

Consensus Range: 142,000 to 205,000


Manufacturing Payrolls 

Consensus Forecast: 15,000

Consensus Range: 10,000 to 18,000


Participation Rate

Consensus Forecast: 62.7%

Consensus Range: 62.7% to 62.8%


Average Hourly Earnings

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

Consensus Range: 0.2% to 0.3%


Average Hourly Earnings

Consensus Forecast, Year-on-Year Change: 2.8%

Consensus Range: 2.7% to 2.9%


Average Workweek

Consensus Forecast: 34.5 hours

Consensus Range: 34.5 to 34.5 hours


Following a very strong May, nonfarm payrolls are expected to extend their strength to June where Econoday's consensus is calling for a 190,000 rise. The unemployment rate, down 1 tenth to 3.8 percent, was the highlight of the May report with June's rate seen holding unchanged. Wages showed some pressure in May and mixed results are expected for June with the monthly gain for average hourly earnings modest at a 0.2 percent consensus, enough however to lift the year-on-year rate by an expected 1 tenth to 2.8 percent. Private payrolls are seen rising 183,000 with manufacturing payrolls, at 15,000, expected to show another solid increase at 15,000. The workweek is seen unchanged at 34.5 hours with the labor participation rate also unchanged at 62.9 percent.


International Trade Balance for May

Consensus Forecast: -$43.5 billion

Consensus Range: -$50.5 to -$42.7 billion


The international trade deficit for goods and services is expected to narrow sharply in May to $43.5 billion in line with major improvement in advance data on the goods side of the report. The advance data showed a very strong 2.1 percent rise for exports against only a 0.2 percent gain for imports. Tariff effects have so far been limited in this report.


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