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Economic strength that now includes core inflation
Simply Economics - January 12, 2018
By Mark Pender, Senior Editor



Fourth-quarter economic data are winding down and point to a solid finish to 2017 and a promising start for 2018. The consumer sector is pulling its weight and indications of housing strength continue to build. And even inflation, which has been long dormant, showed a rare bit of life in the week's data.


The economy

It was a very good holiday shopping season but perhaps not a great one. Retail sales rose 0.4 percent in December which is solid and follow November's very strong 0.9 percent gain. The columns of the graph track the monthly increases which, however, put December in perspective as really only a moderate month and far behind December 2017. But the trendline is favorable though it is distorted upward by September when replacement demand for vehicles drove retail sales 2.0 percent higher.


Yet there's no mistaking the improvement. Year-on-year rates have also been trending higher with December's 5.4 percent result only slightly below November's 6.0 percent peak. This is the best performance in six years. In actual dollars, consumers spent $564 billion at the nation's retailers during December. What's driving these results? A very strong labor market of course and one that looks to gain in muscle when wage hikes, like those just announced by Wal-Mart, begin to kick in. Growth rates in consumer spending could very well accelerate which is something policy makers at the Fed, especially those focused on inflation, would take careful note of.


The biggest winner of the holiday season was unquestionably the web. Though e-commerce isn't broken out in the initial retail sales numbers, it is lumped into nonstores where it makes up about 90 percent of the component. The dark line tracks the year-on-year rate of nonstore sales, at 12.7 percent in December and 12.9 percent in November. For all other retailers, sales were up only 4.6 and 5.2 percent in the two months. E-commerce is growing at least twice as fast as brick-and-mortar with its share now moving near 10 percent of all retail spending. But of course there are victims which are the nation's department stores where December sales fell a very steep 1.1 percent.


Other winners in December retail were anything related to housing including furniture and building materials. The housing sector has clearly been pivoting higher the last few months which is being reflected in costs and which are behind the week's other big news. The core CPI, which excludes food and energy prices, is a central measure for government policy and monthly percentage change is often broken out to two decimal places. December's rise at 0.28 percent is the strongest since last January and the second strongest in 7-1/2 years. This is a notable performance.


The dark columns of the accompanying graph track year-on-year change for housing  costs which make up more than 40 percent of the CPI. After holding at 2.8 percent for the prior three months, housing moved to 2.9 percent in December which doesn't look that substantial but is given its share in the index. Medical costs, which make up nearly 10 percent of the index, are another positive, rising a tenth to 1.8 percent and reflecting sharp and sudden acceleration in prescription prices. Further traction for housing and medical costs could begin to grab headlines and make the difference for inflation.


But there is still a long way to go. The core CPI is struggling below the 2 percent line and, as seen in the dark line of the graph, its trajectory is still unsure. The light line is the Fed's policy measure for inflation: the core PCE which tracks below the CPI though in the same direction. In parting comments at last month's press conference, Janet Yellen cited the lack of improvement in core inflation as a big disappointment of her 4-year leadership at the Fed. What will get inflation moving? Perhaps housing, perhaps medical costs, and perhaps those wage increases that major companies are beginning to announce.


Another factor that is likely to help inflation is the decline in the dollar. The trade-weighted dollar fell 6.0 percent last year and has been going down so far this year. This means that it costs more dollars to buy foreign goods including foreign consumer goods which are America's favorites. Getting less for more is the definition of inflation but this effect, perhaps due to discounting by foreign sellers, has yet to really take hold. The graph tracks the blue line of import prices for consumer goods against the green line of the dollar. They typically move inversely though gains for import prices over the last few months have yet to match the decline in the dollar. Still this may be only temporary. Dollar weakness is in fact a positive feature of the inflation outlook.


There was some bad news in the week or at least possibly bad. In what might be an early sign of loosening in the labor market, initial jobless claims rose 11,000 in the January 6 week to a higher-than-expected 261,000. The gain was widespread and not centered in Puerto Rico where claims, at 1,778, are now back to pre-hurricane levels. The 4-week average, at 250,750, rose a steep 9,000 and is 15,000 above the month-ago trend which hints at possible trouble for the January employment report. Initial claims data in the next report, for the January 13 week, will be very closely watched as it will track the monthly report's sample week.


Less than great news on the labor market also comes from JOLTS where job openings slipped 0.8 percent to 5.879 million in data for November. Hires also fell, down 1.9 percent in the month to 5.488 million. Openings have been moving lower after peaking at 6.140 million in July which does hint at cooling. Hires, despite November's dip, have been showing more strength and are still near the expansion high set in October at 5.592 million. Workers and employers appear in fact to be very cautious, holding onto one another as evidenced by the layoffs & discharge rate, little changed at only 1.1 percent, and the quits rate which was unchanged at a low 2.2 percent.


We end the week on a very strong note, that is inventory building which can't seem to keep pace with sales growth. Business inventories rose 0.4 percent in November after no change in October. This compares with the months' gains of 1.2 percent and 0.8 percent in business sales. The mismatch points to the immediate need for restocking which in turn points to the need for production increases and hiring. This is a very positive setup going into 2018. Wholesalers were the most active in November, building inventories by 0.8 percent to $611 billion. Retail inventories were little changed at $619 billion while inventories rose 0.4 percent in November to $665 billion.


Markets: The giants of U.S. Treasuries

Treasuries got whipsawed during the week on international chatter, first that the Bank of Japan has or has not eased back on its open-market bond purchases and second that China may or may not officially begin to step back from U.S. Treasuries. But accounts from these two giants have already been cutting back their Treasury exposure. In data last updated in October, Chinese holdings of Treasuries totaled $1.189 trillion which is down roughly $75 billion from two years ago. Chinese holdings in fact fell sharply immediately following the 2016 election, cratering to $1.149 trillion in November that year. Japanese holdings totaled $1.094 trillion in October which is down roughly $50 billion from two years ago. These numbers are part of the Treasury International Capital report which will be updated on Wednesday of the coming week. Turning to the market, there has in fact been heavy selling of Treasuries so far this year with the 2-year yield, at 2.01 percent, up 12 basis points and the 10-year, at 2.55 percent, up 14 basis points.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 5-Jan-18 12-Jan-18 Change Change
DJIA 24,719.22 25,295.87 25,803.19 4.4% 2.0%
S&P 500 2,673.61 2,743.15 2,786.24 4.2% 1.6%
Nasdaq Composite 6,903.39 7,136.56 7,261.06 5.2% 1.7%
Crude Oil, WTI ($/barrel) $60.15 $61.61 $64.40 7.1% 4.5%
Gold (COMEX) ($/ounce) $1,305.50 $1,320.80 $1,339.00 2.6% 1.4%
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% 1.96% 2.01% 12 bp 5 bp
10-Year Treasury Yield 2.41% 2.47% 2.55% 14 bp 8 bp
Dollar Index 92.29 91.98 90.94 -1.5% -1.1%


The bottom line

The economic numbers are looking good going into 2018. Consumer spending is solid and is complemented by acceleration in housing as well as manufacturing. Employment may be easing back though gains in overall demand, together with the need to build inventories, point to greater hiring ahead. Inflation is still a little soft but new factors, whether housing costs or higher import prices, are pointing to improvement. For the Federal Reserve, the week's results may hint at a less than gradual process for this year's rate hikes.


Week of January 15 to January 19

A week shortened by Monday's Martin Luther King holiday opens on Tuesday with Empire State and the year's first indication on the 2018 factory sector. Definitive data on December's factory sector come on Wednesday morning with industrial production where the outlook is surprisingly soft. The Beige Book was surprisingly soft all last year and the first reading on this year comes Wednesday afternoon, setting the stage for the month-end FOMC. Housing was the big strength of the year-end economy and solid performances are expected for December housing starts and permits on Thursday. Also on Thursday will be jobless claims where another sharp rise would raise questions over the strength of the January employment report. Consumer sentiment winds up the week on Friday and a bounce higher is the call.




Empire State Index for January

Consensus Forecast: 18.6

Consensus Range: 15.0 to 20.0


Forecasters are looking for continued strength in the January's Empire State index, at a consensus 18.6 vs December's 18.0. But there was a slight hint of weakness in the December report as unfilled orders contracted for a second month and hiring slowed noticeably. Six-month expectations for new orders were also down. Yet in general this report has been very strong for the last year and, as the first regional report to be released each month, has consistently and accurately telegraphed strength in subsequent reports including the Philly Fed and the Dallas Fed.




Industrial Production for December

Consensus Forecast, Month-to-Month Change: 0.4%

Consensus Range: 0.3% to 0.8%


Manufacturing Production

Consensus Forecast,  Month-to-Month Change: 0.3%

Consensus Range: 0.0% to 0.5%


Capacity Utilization Rate

Consensus Forecast: 77.3%

Consensus Range: 77.2% to 77.8%


Econoday's consensus gain for December industrial production is 0.4 percent which would follow November's 0.2 percent rise. Mining rose in December but utilities dipped and it was in fact a 0.2 percent gain for the manufacturing component that set the modest pace of November's report. Vehicle and hi-tech production eased in November while the production of consumer goods fell noticeably. Based on factory hours in December's employment report, forecasters see the manufacturing component rising a moderate 0.3 percent to extend what has been a stubbornly soft trend for this series. Total capacity utilization in December is seen rising 2 tenths to 77.3 percent.


Housing Market Index for January

Consensus Forecast: 73

Consensus Range: 70 to 75


Confidence among the nation's home builders has been unusually strong. The traffic component was the highlight of the last housing market report, jumping to a long-term high and pointing to a buyer surge in the new home market. Current sales and future sales likewise hit long-term highs. Econoday's January consensus calls for only the slightest slowing in the housing market index to 73 from December's 74.


Beige Book

Prepared for the January 30 & 31 FOMC Meeting


"Modest-to-moderate" was once again the economic assessment of the last Beige Book released in late November. Consumer spending was said to be flat while growth in the factory sector was described as wide but still no more than moderate. And there was a hint of an imbalance in the last report which warned that a scarcity of skilled labor was constraining business growth.




Housing Starts for December

Consensus Forecast, Annualized Rate: 1.280 million

Consensus Range: 1.230 to 1.320 million


Building Permits

Consensus Forecast: 1.300 million

Consensus Range: 1.270 to 1.330 million


A little give back is the call for December's housing starts and permits data which posted significant gains in November and October. Single-family homes, the dominant component in this report, have been the center of recent strength and have more than offset extending weakness for multi-family units. The consensus for December housing starts is a 1.280 million annualized rate vs 1.297 million in November with housing permits seen at a 1.300 million rate vs November's revised 1.303 million (1.298 million initially reported).


Initial Jobless Claims for January 13 week

Consensus Forecast: 250,000

Consensus Range: 239,000 to 265,000


Initial claims are expected to come in at 250,000 in the January 13 week compared to 261,000 in the January 6 week which was unusually high and which hinted at a possible rise in layoffs. The January 13 week is also the sample week for the January employment report which, together with the weakness in the January 6 week, will focus strong attention on this report.


Philadelphia Fed Manufacturing Index for January

Consensus Forecast: 25.0

Consensus Range: 21.0 to 31.8


New acceleration from an already enormously strong rate of growth was December's result for the Philadelphia Fed manufacturing index which is expected to slow a modest 1.2 points in January to 25.0. New orders poured in back in December with backlogs building and shipments moving out the door. Selling prices also showed traction in the last report.




Consumer Sentiment Index, Preliminary January

Consensus Forecast: 97.0

Consensus Range: 95.3 to 99.0


Though the consensus is up for January, consumer sentiment did slow noticeably in December especially toward the end of the month. Expectations were December's weakness offset only in part by a positive assessment of current conditions and much welcome improvement in inflation expectations. Econoday's consensus for the preliminary January consumer sentiment index is 97.0 which would compare with 95.9 in December and 98.5 in November.


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