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SIMPLY ECONOMICS

Monetary policy and fiscal policy collide; inflation subdued
Simply Economics - October 12, 2018
By Mark Pender, Senior Editor

  

Introduction

This very predictable collision has occurred: between the prudent caution of the Federal Reserve and the aggressive growth plans of the Trump administration. The Fed's plan is a path of rising interest rates that will work directly against the stimulative effects of increased government spending and this year's tax cuts. Monetary policy and fiscal policy are supposed to be on the same page working for the same goal, not in opposite directions. The theoretical point of conflict is whether the scarcity of labor is set to trigger a rise in inflation. Judging by this week's economic data, the Fed is on the defensive in this clash of titans.


 

The economy

Whatever inflation pressures that are forming from the scarcity of labor, they aren't showing up in consumer prices. The consumer price index edged only 0.06 percent higher in September which outside of an outright decline in March is the weakest showing since June last year. A 0.46 percent monthly decline in energy, reflecting drops for gasoline and electricity, held down the overall rate as did food which was virtually unchanged in the month. Prices of new vehicles posted a fractional decline with used vehicles a more substantial decline, both driving down the transportation component by a sharp 0.33 percent in the month. If consumer prices remain this subdued, don't expect President Trump to curb his criticism of the Federal Reserve any time soon.


 

But the real disinflationary force of the report comes from the housing component which makes up more than 40 percent of the total CPI. Housing costs, as tracked in the dark columns of the graph, edged only 0.08 percent higher in the month which, outside an outright decline in June, is the weakest showing since May 2015. The reading was pulled back by a 1.01 percent decline in motel and hotel rates though monthly increases for both rent, at 0.24 percent, and costs for homeowners, at 0.18 percent, are among the very lowest of the expansion. Another disinflationary force is the cost of medical care which, however much this is rising for the government, is not rising very much for the consumer. Medical care, which makes up nearly 10 percent of the CPI, edged only 0.16 percent higher as tracked in the graph's light column to the right. And, in a shocker, when throwing in declines of 0.23 percent in July and 0.18 in June, the latest 3-month run is the weakest on record for the CPI in data that go back to 1947. At play here have been cost declines for both hospital services and physician services.


 

Turning to year-on-year rates which are how price measures are popularly expressed, the Federal Reserve's goal is to keep inflation as closely at the 2 percent line as possible. The Fed's policy measure is the price index for personal consumption expenditures (PCE) which has a more complex methodology and which makes it run slightly lower than the CPI. The core rate for the PCE, the red line in the graph which excludes food and energy, has been skirting the 2 percent line all year which is right where the Fed wants to keep it. But keeping it here is the key and the risk that wages, the green line in the graph, may be tilting higher is really the Fed's fundamental justification for its projected rate-hike path. For President Trump, however, this explanation is simply "too cute".


 

One factor that will not be increasing inflationary pressures is the strength and stability in the dollar which, on the dollar index, has risen more than 3 percent this year. A firm dollar means more for your money and a lower cost for imports. Annual import costs, as tracked in the red columns, are up 3.5 percent this year but this reflects a 32 percent surge in petroleum. Excluding petroleum, import prices are up only 0.6 percent. And assuming the U.S. can continue to raise domestic oil production and reduce its dependence on foreign oil and also assuming that oil doesn't go much beyond $70, the effect of petroleum-related inflation should be limited. Very limited, actually almost non-existent, are price increases for imported finished goods which aren't rising at all. Prices of imported capital goods are unchanged year-on-year with vehicles up only 0.1 percent and consumer goods up just 0.6 percent. Tit-for-tat tariffs are a risk for this stability and may now be appearing in costs of imported foods which jumped a monthly 2.0 percent in September though the yearly rate, at minus 3.2 percent, remains well in the negative column, at least so far. Tariff effects are a wildcard not only for food prices but for imports in general though so far the effects, if any, are hard to detect.


 

Not hard to detect at all, however, have been the soaring cost increases posted all year in anecdotal surveys such as the Philly Fed and those from the Institute for Supply Management. These are based on small samples but do track monthly assessments of the nation's purchasers and business leaders. But what they've been reporting isn't really what we've being seen in the government's exhaustive data on producer prices which, though trending higher, haven't been going through the roof. The overall producer price index has been skirting the 3 percent line for the past year with the core rate showing a bit more upward direction but also under 3 percent. Yet transport costs have in fact been surging as trucks and truckers are growing increasingly scarce which is behind this year's jump in delivery times and which are in fact an inflationary red signal.


 

Jerome Powell's special emphasis is on inflationary expectations where ongoing stability reflects strong confidence, he argues, that the Fed will act, that is raise rates, to limit any excessive pressures. And there may be just a hint of upward pressure in inflation expectations. These expectations at the business level, as tracked in the green line, are up 1 tenth this month to 2.3 percent. This rate is still subdued but does match April this year as the high for the expansion. Inflation at the consumer level, as tracked by the blue line and measured by the Conference Board, is just off multi-year highs at 3.0 percent which were hit in both August and June this year. These increases may not be enough to convince the administration that inflation is at the risk of shooting higher, but they may give Powell something to hang on to at his next appearance. Powell's last set of appearances, and it was an exhaustive number of them, followed the rate hike of the September FOMC meeting but preceded the recent run of criticism from the president. The chairman's speech calendar is empty right now with his next public appearance not scheduled until the December FOMC when another rate hike, President Trump notwithstanding, is still the expectation.


 

The Fed's assessment of inflation risk is tied to the law of supply and demand that dictates when the former is scarce and the latter is strong, prices are supposed to go up. This idea has been bundled in long generations of empiricism from the non-accelerating inflation rate of unemployment (NAIRU) to the Phillips curve to R* (r-star) and U* (u-star). And given how few people are searching for jobs right now and how many job openings keep opening up, the price of labor should be increasing – but it hasn't. Despite all the empiricism, the Fed doesn't have an answer with Powell just recently conceding it's "a mystery" why wages aren't accelerating. The week's data also include weekly jobless claims which remain at long-term lows, I mean very long term. The green columns track the 4-week average for continuing claims which are now at 1.656 million. This is the lowest reading since 1973 when the nation's workforce was nearly half the size it is now. Downsizings and layoffs are at their minimums as employers, desperate for dependable labor, are holding onto their workforces like never before. Still there may be some noise appearing in the claims series in the coming weeks as disruptions from Hurricane Michael make their appearance which risk distorting the October employment report. Hurricane Florence, which hit the Carolinas in September, turned out to have only minimal impact on claims and no discernable impact at all on the September employment report. Econoday's consensus for the coming claims report do not show any expectations of trouble, at 215,000 for initial claims versus 214,000 in the prior week.


 

Markets: Fear is contagious

It's no accident that Halloween is in October, often a bad month for the stock market including frightening losses during October 2008, October 1987 not to mention of course October 1929. These were months when the stock market collapsed in on itself like a hollowed-out tree. And this October has been shaky to say the least,  trimming the year-to-date gains for the Dow from 7.0 percent at the end to September to only 2.5 percent right now. Gains for the S&P 500 have sunk from 9.0 percent to 3.5 percent with the Nasdaq moving from 16.6 percent to 8.6 percent. Jerome Powell's recent assessment of asset values in general, which include the stock market, is that levels are in the high normal range but not beyond. Let's hope he's right.


 

Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 5-Oct-18 12-Oct-18 Change Change
DJIA 24,719.22 26,447.05 25,339.99 2.5% -4.2%
S&P 500 2,673.61 2,885.57 2,767.13 3.5% -4.1%
Nasdaq Composite 6,903.39 7,788.45 7,496.89 8.6% -3.7%
     
Crude Oil, WTI ($/barrel) $60.15 $74.31 $71.53 18.9% -3.7%
Gold (COMEX) ($/ounce) $1,305.50 $1,207.10 $1,221.60 -6.4% 1.2%
Fed Funds Target 1.25 to 1.50% 2.00 to 2.25% 2.00 to 2.25% 75 bp 0 bp
2-Year Treasury Yield 1.89% 2.88% 2.85% 96 bp −3 bp
10-Year Treasury Yield 2.41% 3.24% 3.16% 75 bp −8 bp
Dollar Index 92.29 95.62 95.28 3.2% -0.4%

 

The bottom line

The Fed has been sticking to its empiricism, that high levels of employment mean a high level of risk that inflation could take off. And if, against the backdrop of strong fiscal stimulus, the Fed sits back and does nothing it runs the risk that inflation expectations, as well as public confidence in the Federal Reserve as an institution, could become unanchored. To offset an actual runaway jump in inflation (however distant that risk may be) would require a steep run higher in interest rates and with that a very strong risk that the economy would sink into recession. Yet from the Trump administration's perspective, even the prospect of incremental rate increases, the kind the Fed has already penciled in, could be enough to blunt their expansionary efforts. Interest rates have a way of penetrating into everything and if the Fed does continue to raise rates, the administration will have a hard time offsetting the effects given the ever limiting scope to raise government spending or cut taxes. An unprecedented and openly public confrontation at the heart of national economic policy may be unfolding.


 

Week of October 15 to October 19

A busy week that will cover broad areas of the economy opens Monday with a headliner indicator: retail sales which are expected to post a strong auto-related surge in what would be good news for third-quarter GDP. Also helping GDP are likely to be business inventories which, in another Monday report, are expected to show a solid build. Industrial production follows on Tuesday and, amid very soft expectations, will offer the first definitive data on September's manufacturing sector. For manufacturing during October, the first anecdotal indications come on Monday with Empire State and Thursday with Philly Fed which, in contrast to the industrial production report, are both expected to show strength. The labor market will be in focus with Tuesday's JOLTS report that will update job openings which have been soaring, while Thursday's jobless claims data will offer an initial measure of the effects on Hurricane Michael and how much it may or may not impact the October employment report. FOMC minutes on Wednesday afternoon will certainly be a focus for the Trump administration as it searches for clues on the Fed's plans for further rate hikes. Housing is another of the week's topics and Wednesday's housing starts and permits report is expected to show an easing for the former but a badly needed rebound for the latter. But no rebound at all is seen for Friday's existing home sales report which has been among this year's most disappointing indicators. And a wildcard for the week is the likely release of the Treasury's closing budget report for fiscal 2018, one that has been delayed because of fiscal-year-end reporting requirements and that will sum up the unsustainably vast quantity of the government's red ink.

 

Monday


 

Retail Sales for September

Consensus Forecast: 0.6%

Consensus Range: 0.3% to 0.8%


 

Retail Sales Ex-Autos

Consensus Forecast: 0.4%

Consensus Range: 0.2% to 0.7%


 

Retail Sales Ex-Autos Ex-Gas

Consensus Forecast: 0.4%

Consensus Range: 0.2% to 0.5%


 

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

Consensus Forecast: 0.4%

Consensus Range: 0.2% to 0.5%


 

A bounce-back 0.6 percent increase is the forecast for September retail sales which in August proved unexpectedly soft at only a 0.1 percent gain. Driven by possible replacement demand from Hurricane Florence, unit vehicle sales were very strong in September. Ex-autos may be the reading that best tracks underlying demand and a more moderate gain of 0.4 percent is the call vs August's 0.3 percent rise . Ex-autos ex-gas is at a consensus 0.4 percent gain in September as is control group sales.


 

Empire State Index for October

Consensus Forecast: 19.3

Consensus Range: 17.0 to 21.4


 

At a consensus 19.3 vs 19.0 in September, steady and strong growth are the expectations for the October Empire State index. The September report, though strong, did see moderate cooling in backlog orders and an easing in 6-month confidence.


 

Business Inventories for August

Consensus Forecast,  Month-to-Month Change: 0.5%

Consensus Range: 0.3% to 0.7%


 

A solid 0.5 percent increase is the consensus for August business inventories, a constructive build that would contribute solidly to third-quarter GDP and could help narrow the gap with underlying sales which have been very strong.


 

Tuesday


 

Industrial Production for September

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

Consensus Range: 0.0% to 0.4%         


 

Manufacturing Production

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

Consensus Range: 0.0% to 0.3%


 

Capacity Utilization Rate

Consensus Forecast: 78.2%

Consensus Range: 77.9% to 78.3%


 

Utilities and especially mining have been holding up industrial production which otherwise would be flat given softness in manufacturing. But the consensus for September industrial production is only a 0.2 percent gain vs 0.4 percent in August with manufacturing also seen rising a modest 0.2 percent. Pressures on capacity utilization are expected to tighten 1 tenth to 78.2 percent.


 

Housing Market Index for October

Consensus Forecast: 67

Consensus Range: 66 to 67 


 

Weakness in traffic, the result of high home prices and general lack of interest in home buying, has held down the housing market index which isn't expected to show any acceleration in October. Econoday's consensus is 67 vs 67 in both September and August which were the lowest readings since September last year.


 

JOLTS: Job Openings for August

Consensus Forecast: 6.900 million

Consensus Range: 6.800 to 7.000 million


 

Forecasters see job openings in August, at 6.900 million, holding steady near July's record 6.939 million which easily topped Econoday's consensus range. This report has been signaling very strong demand for labor.


 

Wednesday


 

Housing Starts for September

Consensus Forecast, Annualized Rate: 1.216 million

Consensus Range: 1.179 to 1.251 million


 

Building Permits

Consensus Forecast: 1.272 million

Consensus Range: 1.230 to 1.287 million


 

A slowing in starts and reacceleration for permits are September's expectations, at a consensus 1.216 million for the former, vs 1.282 million in August, and 1.272 million for the latter vs 1.249 million (revised from an initial August reading of 1.229 million). Starts for multi-family units had been weak before surging in August's report though permits for multi-family units fell. Permits for single-family homes also fell in what proved to be a widely mixed August report.


 

FOMC Minutes

Released for the September 25 & 26 meeting


 

Given President Trump's strong criticism of the Federal Reserve, clues on the justification for the necessity of future rate hikes will be a key focus of the FOMC minutes from the September meeting. The meeting produced its own rate hike with FOMC forecasts calling for one more 25-basis-point rate increase this year and three more next year.


 

Thursday


 

Initial Jobless Claims for October 13 week

Consensus Forecast: 215,000

Consensus Range: 210,000 to 217,000


 

Initial jobless claims are expected to come in at 215,000 in the October 13 week and little changed from 214,000 in the prior week. The effects of Hurricane Michael which struck the Florida panhandle will be the wildcard but are not expected to inflate the week's claims. Hurricane Florence and related flooding in the Carolinas during September turned out to have only a modest impact.


 

Philadelphia Fed Manufacturing Index for October

Consensus Forecast: 20.3

Consensus Range: 16.2 to 22.9 


 

Slightly easing strength to 20.3 is the call for October's Philly Fed manufacturing index which surged in September to 22.9. September's report was strong throughout, led by acceleration in both new orders and backlogs and including a noticeable draw in inventories that likely reflected delivery and production limitations. 


 

Index of Leading Economic Indicators for September

Consensus Forecast, Month-to-Month Change: 0.5%

Consensus Range: 0.3% to 0.5%


 

September's increase for the stock market, now since faded, looks to boost the index of leading economic indicators which is also likely to benefit from predictable gains in the report's credit and yield-spread measures. Econoday's consensus is a 0.5 percent increase vs August's solid 0.4 percent rise.


 

Friday


 

Existing Home Sales for September

Consensus Forecast, Annualized Rate: 5.300 million

Consensus Range: 5.230 to 5.380 million


 

Existing home sales have missed Econoday's consensus for five straight reports with September's consensus at a modest 5.300 million annualized rate vs August's 5.340 million. Resales of both single-family homes and condos have been showing similar weakness in this report.


 

Wildcard


 

Individual tax receipts are up, corporate tax receipts are down and spending on Medicare and defense is on the rise. Eleven months into the government's fiscal year, the year-to-date deficit to August, at $898.1 billion, was 33 percent deeper than the prior year. Econoday's consensus for the September Treasury statement is a monthly surplus of $77.5 billion. Note that the monthly statement is usually released on the eighth business day of the month but the September statement has been delayed due to end-of-fiscal-year reporting requirements. No new posting date has been set.


 

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