Economy: Robust September Economic Data,
as Fed Hikes Rates

Economic Data

Overall, economic reports released in September— mostly reflecting economic activity in August— indicated solid U.S. economic growth without significant inflationary pressures, though wage gains bear monitoring. The Conference Board’s Leading Economic Index (LEI), an aggregate of 10 leading indicators, increased 0.4% in August and 6.4% year over year, signaling low odds of recession in the coming year.

August’s jobs report, released on September 7, reflected robust labor market growth. Nonfarm payrolls rose 201,000 in August, higher than consensus estimates of 190,000 and July’s reading of 157,000. While growth in nonfarm payrolls is tapering off, the slowdown is expected as the economic cycle matures. Meanwhile, the unemployment rate held steady at 3.9%, the lowest level since 2000. The percentage of workers quitting their jobs jumped to a 17-year high. Generally, a high quit rate is viewed positively as it signals employees are confident about finding better job opportunities.

Pricing and wage data showed inflationary pressures remain manageable. Data for the preferred gauge of the Federal Reserve (Fed)—core personal consumption expenditures (PCE) (excluding food and energy)—remained unchanged at 2% growth year over year. This annual reading is in line with the Fed’s implicit annual inflation target, but other headline inflation gauges show inflation remains well below levels reached in previous tightening cycles. The Consumer Price Index (CPI) rose 0.2% month over month, while core CPI rose 0.1% monthly and 2.2% year over year. Headline and core Producer Price Index (PPI) readings fell 0.1% month over month, but have grown 2.3% year over year. Average hourly earnings came in above consensus, rising 0.4% month over month, which tracked to 2.9% annual growth—the highest growth rate of the economic cycle. Labor is typically the largest cost component for companies, and wages can be a harbinger of building inflationary pressures. In spite of the high readings, the 2.9% annual earnings growth remains below the 4% level that has preceded recessions in the past.

Manufacturing reports showed strength, though the impacts of tariffs are becoming visible in the data. The Institute for Supply Management (ISM) Purchasing Managers’ Index (PMI), which has historically been a bellwether for economic growth, jumped to 61.3 in August, its highest level since May 2004 [Figure 1].

ISM’s New Orders gauge jumped 8.1%, its strongest monthly growth since August 2014. Domestic orders drove the multi-year high in ISM PMI, while international orders declined month over month. In our view, this shows that U.S. fiscal stimulus continues to outweigh any negative implications of tariffs on manufacturing.

The ISM’s Non-Manufacturing (Services) Index climbed to 58.5, recovering from disappointing July data. NFIB’s Small Business Optimism gauge rose to a record 108.8 last month. Perhaps most encouraging was that the percentage of surveyed firms expecting to increase capital expenditures rose to its highest level since 2007. Capital expenditures are associated with productivity gains per unit of labor, and when worker productivity increases, wage growth tends to follow.

Economic reports reflected a healthy U.S. consumer. The Conference Board’s consumer confidence survey hit an 18 year high, while personal spending rose 0.3% in August, in line with consensus expectations. Consumer spending accounts for about 70% of U.S. gross domestic product, so a healthy consumer is an important support of output.

Housing data continued to be a relative weak spot for the U.S. economy. Existing home sales, which account for 85 90% of home sales, were flat month over month at 5.34 million in August. Housing prices, represented by the S&P CoreLogic Case-Shiller 20- City Composite, rose 5.9%, lower than consensus estimates of 6.2% growth. Housing starts grew 9.2% in August, which was higher than expected, but building permits declined 5.7% month over month, the largest pullback since February 2017.

Fed Raises Key Rate, as Expected:

The Fed announced it would raise the fed funds rate to a range of 2-2.25% following the conclusion of its meeting on September 26, an outcome the markets widely anticipated. In our view, the Fed’s updated rate projections and an important change in its policy statement were the more interesting takeaways. The most recently released dot plot [Figure 2] implies that policymakers expect one more rate hike in 2018 and three more in 2019. The dots also show that members expect the fed funds rate to peak at 3.38% at the end of 2020 before declining into a “longerterm”
rate of 3%.

Moreover, the Fed removed the word “accommodative” from its description of its monetary policy in the September 26, 2018, statement, another signal that rates may be approaching a neutral level. According to Fed Chair Jerome Powell, this reflects that policy is moving in line with the Fed’s expectations.

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