Introduction

Federal Reserve policy makers generally describe the nation's economic growth as mostly solid, underpinned as it is by nearly full employment. But soft is really the only word to describe the price side of the Fed's mandate. Putting oil prices aside, softness in prices hints perhaps at less-than-solid economic demand. It's hard to find any great heroes in the week's heavy slate of economic news with inflation, housing, manufacturing and now even jobs not looking that great.

The Economy

Where's the heat?

This recovery is not the greatest which is one very important reason why prices aren't showing much life. The accompanying graph tracks the 3-month average of the national activity index, which is the composite headline from the Chicago Fed's monthly report that tracks 85 separate indicators. This index hasn't been showing much life this recovery, averaging minus 0.05 over the last 6-1/2 years to signal below average growth which makes it the only one of the seven recoveries tracked over 50 years of the data to land in the negative column. In contrast, the prior recovery, which lasted six years to January 2008, was right at historical trend, at plus 0.01. Recent readings for this index have been edging lower, held down in the latest report on December by weakness in three of four main components: production, consumption & housing, and sales/orders/inventories. The only main component showing any strength is, you guessed it of course, employment. But how long can this really last if general demand stays soft?

And if demand is soft, how will inflation ever get going? The consumer price index for December fell 0.1 percent, though the year-on-year rate is climbing with a 2 tenths gain to plus 0.7 percent. And the core rate is visibly climbing with the year-on-year rate up 1 tenth to 2.1 percent for the best showing since 2012 and finally over the Federal Reserve's 2 percent price line. The core excludes both energy, where gasoline is down nearly 20 percent from last year, and food where prices are down not quite 1 percent.

Service prices are what's helping to give the core rate a lift, though strength here unfortunately may be fading. Prices for services did rise in December but only 0.2 percent as seen in the column of the graph. The line is the year-on-year rate which had been steadily climbing but eased in December to fractionally below the 2.5 percent line, ending six months of steady improvement. Housing and medical-care prices, two main components of service prices, both showed gains in December but only at 0.1 percent each with the year-on-year rate for housing looking flat at plus 2.1 percent and medical care, where the slope had been rising slightly, falling back to plus 2.6 percent. These rates, which are at the top of the heap right now for consumer prices, are no more than moderate but still have to balance out weakness elsewhere.

Whatever strength there is in prices, consumer prices have been consistently showing the most of any inflation report. The Fed's policy target, however, is not centered on the CPI but on the more highly calibrated PCE core which, in contrast to the CPI, isn't showing any life at all, stuck at roughly  1.3 percent for the last entire year. These two lines are bound to come back together sooner or later, with perhaps the PCE finally accelerating (the favored outcome at the Fed) or the CPI slowing and moving back down (definitely not the favored outcome).

Mediocrity at its best

The housing sector has been up-and-down though, looking at the long slope, is probably climbing. What strength there is, is probably enough to make this sector a leading driver for the economy in what is another example of how soft general conditions are. The housing market report compiled by the nation's home builders has been pointing to confidence, especially for current and future sales, but the data did peak out in October and have since been easing. And the traffic component, the blue line in the graph, has yet move over the break-even level of 50 to indicate strength. A surprise here is the lack of a positive weather effect on traffic as less snow and ice, not to mention cheap gas, should be giving a boost to traffic which, however, continues to be depressed by lack of first-time buyers and lack of available homes for sales.

Housing starts and permits data were mixed in the latest report, also showing lack of punch despite the favorable weather. Starts fell 2.5 percent to an annualized rate of 1.149 million while permits fell 3.9 percent to a 1.232 million rate. But monthly data in this series are volatile and year-on-year rates look healthy, especially for permits which are up 14.4. percent. Starts, at plus 6.4 percent on the year, are still lagging but are bound to catch up. Favorable weather has been giving a sizable boost to construction spending and employment and is a plus in this report in housing completions, which jumped 5.6 percent in the month, and also in homes under construction, up 1.7 percent with this year-on-year rate at plus 18.5 percent.

Data are also mixed for existing homes, the other side of the housing market. Sales of existing homes surged a record 14.7 percent to a 5.46 million annualized rate but follow an unusual 10.5 percent plunge in November when administrative delays tied to new mortgage rules pushed sales into December. Averaging the two months together shows a respectable 5.11 million rate which, however, is below the 5.43 average of the prior six months and which hints at a slowing in momentum. Still, sales in 2015 totaled 5.26 million, well up from 4.94 million in 2014 for the best showing since the housing bubble of 2006. Low supply in the market has been a big negative for sales with total existing homes on the market at 1.79 million vs November's 2.04 million. Supply of existing homes is as low as it's been in nearly 11 years. But, looking at the other side of the coin,  low supply spells strength for prices. The median price of an existing home rose 1.9 percent in the month to $224,100 for a very respectable 7.6 percent year-on-year gain. Compared to other price measures, including average hourly wages which are at 2.5 percent, home prices look positively rich.

The worst may be over

The factory sector has been a drag on the nation's growth and is a key reason behind the economy's generally soft performance. The latest Empire State report points squarely at another month of trouble for the sector, with the January index at minus 19.37 for the lowest reading since April 2009. New orders, way under water at minus 23.54, contracted for an eighth straight month and at the sharpest pace in nearly seven years. And unfilled orders extended their even deeper string of contraction. Employment and the workweek fell for a sixth straight month with optimism in the outlook at its the lowest point since way back in March 2009.

But as an early indication on the factory sector, Empire State is not the most closely watched. This honor goes to the Philadelphia Fed index which is showing, not deepening contraction like Empire State, but easing contraction. The general business conditions index for January came in at minus 3.5 for the best reading since August. The new orders index likewise improved for the best reading since September. And shipments finally came in on the plus side, at a strong 9.6. But other readings did remain negative including employment and the workweek, while the outlook, like that in Empire State, is at a multi-year low. But the positives in the Philly report do stand out and were confirmed by strength in the flash index of Markit Economics' U.S. sample, moving 1.5 points higher to 52.7 and safely above 50. Respondents in this report cited strength in domestic demand which they say is helping to offset weakness on the foreign side.

But the best may have already passed

Strength in domestic side is central to the U.S. economy and it ultimately reflects strength in the jobs market. It's probably too soon to officially classify the December employment report, where non-farm payroll growth surged 292,000, as ancient history but the latest data on jobless claims point to a whole new set of numbers for January. Jobless claims may have already hit their lows, at least that's the emerging trend for initial claims which posted a sizable 10,000 rise in the January 16 week to 293,000 for the highest reading since July. This is the second straight gain and the third in four weeks and has driven the 4-week average to 285,000 which, against the month-ago comparison, is up a very noticeable 14,250. This comparison matches the sample weeks of the monthly employment reports and is setting up expectations for less employment strength in January.

Markets: Volatile but constructive

Watching the Shanghai composite is only recommended for those with iron stomachs. Up and down, up and down is what makes people sick. As goes Shanghai, so goes Wall Street but at the conclusion of the week, the news is good with the Dow posting a 0.7 percent gain and the Nasdaq up 2.3 percent. Oil likewise swung up and down, spending most of the week below $30 and even moving below $28 before rallying on Friday to $32. Belying all the volatility, however, are Treasuries and the dollar were day-to-day movements are narrowing. Stability here perhaps hints at easing demand for safety in what could be a positive indication (and a much needed one) for the stock market.

The Bottom Line

The latest economic numbers will not do much to boost confidence among some FOMC members, hawks included, who have been expressing doubts about inflation. Lack of inflation, the result of both falling energy and commodity prices and also general weakness in demand, is perhaps the greatest policy risk for the FOMC which next meets on the 26th and 27th of this month. The Fed's rate hikes this year could well be paced, less by the jobs market or economic strength, and more by the pace of inflation.

Week of January 25 to January 29

The week is packed with news, centered in Wednesday's FOMC announcement where global risks and the outlook for inflation are likely to receive important updates. Key data begin on Tuesday with FHFA and Case-Shiller reports on home prices where growth rates, compared to price readings in general, have been solid. New home sales, which have been up-and-down, follow on Wednesday with durable orders, which have been mostly down, on Thursday. The first look at fourth-quarter GDP, where consensus growth is just 0.9 percent, starts a heavy Friday calendar where the highlight, however, may prove to be the employment cost index. The ECI is expected to show a second strong gain, one that could lift expectations for wage pressures and for inflation with it.

Monday

The Dallas Fed general activity index has been buried in deep contraction and, along with the Kansas City Fed report, have been suffering the greatest effects from the collapse in oil. The Econoday median is calling for a 13th straight month of contraction, at a steep minus 14.0 for January vs December's minus 20.1. Production has held in the plus column for this report but the outlook for continued strength is not supported by new orders which have been in contraction for 14 months.

Dallas Fed Manufacturing Index - Consensus Forecast for January: -14.0

Range: -17.0 to -10.0

Tuesday

Home-price appreciation may not be booming but has been respectable, up a monthly 0.5 percent for a year-on-year plus 6.1 percent in the prior FHFA house price report. Forecasters see the monthly rate coming in at another 0.5 percent gain for the November report. With commodity prices and import prices low and wage gains limited, home-price appreciation, however moderate, has been one of the few positives for the inflation outlook.

FHFA House Price Index - Consensus Forecast for November: +0.5%

Range: +0.3% to +0.6%

Lack of homes on the market has been helping prices of existing homes, up a year-on-year 5.5 percent in the prior Case-Shiller adjusted 20-city index. And the Econoday consensus is calling for a sizable increase in the November report, up 0.7 percent month-to-month and at 5.7 percent on the year. Home prices may not be booming but they are one of the few price areas showing visible pressure. Note that FHFA house price data will also be released Tuesday morning.

Case-Shiller, 20-City Adj. Index, M/M Chg - Consensus Forecast for November: +0.7%

Range: +0.4% to +1.1%

Case-Shiller, 20-City Unadj. Index, Y/Y Chg - Consensus Forecast for November: +5.7%

Range: +5.5% to +5.9%

The consumer confidence index rebounded sharply in December following an unusual dip in November. Earlier readings this month in other confidence measures have been surprisingly resilient despite the extreme volatility of the global markets. Forecasters are calling for little change in the January index, at 96.0. Assessments of the jobs market are always very closely watched in this report as a leading gauge for monthly employment data, and the Econoday consensus is hinting at another month of strength for January.

Consumer Confidence Index - Consensus Forecast for January: 96.0

Range: 91.0 to 99.2

Wednesday

Samples are small and monthly data often swing wildly as new home sales rose 4.3 percent in November to nearly reverse a 6.3 percent plunge in October. At a consensus 500,000 annualized rate, Econoday forecasters see a less volatile 2.0 percent gain for December sales. Supply of new homes has been tight but hasn't been helping prices much, at least for this report where the year-on-year gain was only 0.8 percent in November. Note that month-to-month revisions in this series can be extreme.

New Home Sales, Annualized Rate - Consensus Forecast for December: 500,000

Range: 483,000 to 520,000

The Federal funds rate target is expected to remain unchanged at a range between 0.25 to 0.50 percent, where it was lifted from zero to 0.25 percent at the December FOMC. Global events were not emphasized in the December statement but, given subsequent evidence of slowing in China and severe volatility in global markets, such risks are likely to be cited prominently in the January statement. On inflation, the December statement cited confidence among policy makers that inflation would begin to rise to their 2 percent target, but a change in wording is also possible here given global slowing and the continued collapse of oil prices. Four new voting members are rotating in from district banks and four have rotated out which will focus attention on the breakdown of the vote. Voting was a unanimous 10 to 0 for liftoff at the December meeting.

Federal Funds Rate Target - Consensus Forecast for January 26 & 27 Meeting: 0.25 to 0.50%

Range: 0.25 to 0.50% to 0.25 to 0.50%

Thursday

Pulled down by weak exports and weak demand for energy equipment, the factory sector has been a weak link in the economy. More of the same is expected for December with the Econoday consensus calling for a only 0.2 gain for durable goods orders and no change for ex-transportation orders. Looking back, November orders were especially weak for core capital goods. Another decline here could lower estimates for fourth-quarter GDP.

Durable Goods Orders, M/M Chg - Consensus Forecast for December: +0.2%

Range: -3.0% to +1.5%

Durable Goods Orders, Ex-Transportation, M/M Chg - Consensus for December: 0.0%

Range: -0.4% to +0.5%

Initial jobless claims were expected to fall back to their favorable trend but instead burst to 293,000 for the highest reading since July. Claims again are expected to dip back, this time for the January 23 week where the Econoday consensus is 285,000. But even if claims do fall, the damage was done in the prior week which matched the sample week of the monthly employment report.

Initial Jobless Claims - Consensus Forecast for January 23 week: 285,000

Range: 281,000 to 290,000

Pending home sales are expected to rise 0.8 percent in December and point to rising strength for final sales of existing homes which, held down by lack of homes on the market, slowed going into year-end. However up-and-down the sector has been, housing has been a positive contributor to the nation's economy.

Pending Home Sales, M/M Chg. - Consensus for December: +0.8%

Range: -0.5% to +2.0%

Friday

Sharp slowing is the Econoday consensus for the first estimate of fourth-quarter GDP, to plus 0.9 percent from the third-quarter's plus 2.0 percent. A widening in the trade gap and slowing in inventory accumulation are expected to have held down growth. Personal spending, following the lackluster holiday shopping season, is also expected to have slowed. But residential investment, reflecting strength in housing, is expected to be a positive.

Real GDP, 4th Quarter, 1st Estimate, Annualized Rate - Consensus Forecast: +0.9%

Range: 0.0% to +2.3%

GDP Price Index, 4th Quarter, 1st Estimate - Consensus Forecast: +0.9%

Range: +0.2% to +1.3%

The international trade in goods is expected to narrow slightly in December to an advance reading of $60.1 billion. Declines in imports have been helping to narrow the gap though exports have been stubbornly weak, reflecting weak global demand made weaker for U.S. goods by the strength of the dollar.

International Trade In Goods, M/M Chg - Consensus Forecast for December: -$60.1 billion

Range: -$62.0 to -$58.0 billion

The impact of the employment cost index cannot be exaggerated with its results helping to shape inflation expectations among policy makers. Upward trends in this report are expected to be underscored by the fourth-quarter report where forecasters see a second straight outsized quarterly gain of 0.6 percent, one that would likely raise long-awaited talk of wage inflation.

Employment Cost Index, Q/Q Chg. - Consensus for 4th Quarter: +0.6%

Range: +0.4% to +0.8%

The Chicago PMI is expected to indicate a third month of contraction for the area's economy in January though, at an Econoday consensus of 45.5, less contraction than December's unusually low 42.9. Order readings have been especially weak in this report, one that tracks the whole scope of the Chicago area's economy. Note that volatility is not unusual for this report.

Chicago PMI - Consensus for December: 45.5

Range: 44.0 to 47.5

Consumer confidence measures have yet to pick up much concern over declines in stocks and volatility in the global markets. This includes the consumer sentiment index which came in at better-than-expected 93.3 in the January flash. The final reading for January isn't expected to show much change, at a consensus 93.0. Resiliency and patience in the consumer could be pointing to unexpected economic strength for the first quarter.

Consumer Sentiment, Final - Consensus for January: 93.0

Range: 90.0 to 93.5