NAM: Monday Economic Report

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As expected, the Federal Open Market Committee (FOMC) voted to raise short-term interest rates at the conclusion of its June 13–14 meeting for only the third time since the financial crisis. After hiking the federal funds rate in December and March, the Federal Reserve increased rates by another 25 basis points, with a new target range of 1 to 1.25 percent. In making this decision, participants noted recent strengthening in the overall macroeconomy, including better data for consumer spending, business investment and hiring. Beyond this latest action, it is widely anticipated that the FOMC will increase rates one more time in 2017, perhaps as soon as its September 19–20 meeting. Participants also provided an update to the Federal Reserve’s economic projections. The outlook improved marginally from what was released in March. Members now see the U.S. economy expanding 2.2 percent in 2017, up slightly from 2.1 percent three months ago. It forecasts 2.1 percent real GDP growth in 2018.

In addition to raising short-term rates, the FOMC also seeks to normalize the size of its balance sheet, which has ballooned to well over $4 trillion. Prior to the Great Recession, it never exceeded $1 trillion. The Federal Reserve set new policy guidelines for reducing its balance sheet, as outlined in an addendum that the committee passed unanimously. Starting later this year, the Federal Reserve will allow $10 billion per month in Treasury securities, agency debt and mortgage-backed securities to not be reinvested. It would then increase that amount by $10 billion each quarter until it reaches $50 billion per month. In doing so, the FOMC’s actions would likely put further upward pressure on interest rates. Hence, its moves will be gradual in nature.

The inflationary picture has been positive for the Federal Reserve. While we had seen accelerations in both consumer and producer prices over much of the past few months, costs appear to have started to slow more recently. The consumer price index increased 1.9 percent year-over-year in May, its first reading below 2 percent since November, and producer prices for final demand goods and services have increased 2.4 percent since May 2016, easing a bit from April’s 2.5 percent year-over-year pace, which was the fastest pace since February 2012. In terms of core inflation, which excludes food and energy costs, consumer prices have risen 1.7 percent over the past 12 months, with producer prices up 2.1 percent year-over-year. Both represent some deceleration from earlier in the year. For manufacturers, many of whom had been concerned about the pickup in pricing pressures in recent months, this should be a welcome development.

Despite the optimism in the Federal Reserve’s moves, many of the economic data points released last week were disappointing. For instance, manufacturing production fell for the second time in the past three months, down 0.4 percent in May. Motor vehicles and parts production led the decline in May, down 2.0 percent for the month and off 1.5 percent year to date, as automotive demand has continued to be weaker than desired so far in 2017. Despite the easing in this latest release and some lingering challenges, the underlying data remain consistent with a manufacturing sector that has turned a corner and has moved in the right direction, especially relative to where it stood at this point last year. Manufacturing production has risen 1.4 percent over the past 12 months, expanding for the seventh consecutive month. In addition, manufacturers in the New York and Philadelphia Federal Reserve Bank surveys continued to be upbeat in their outlook, with activity strengthening in both June reports.

Consumer confidence was also weaker. The Index of Consumer Sentiment from the University of Michigan and Thomson Reuters declined in June to its lowest point since November, according to preliminary data. Political uncertainties played into this waning in assessments, with continuing wide disparities in opinions based on partisan affiliation. Along those lines, retail sales fell 0.3 percent in May, signaling a more cautious consumer than we would expect or prefer. Retail spending has increased 3.8 percent since May 2016, a modest pace that reflects some progress from what was seen at this point last year. Yet, the year-over-year growth rate was 5.6 percent in January, its fastest rate since March 2012, but it has eased since then.

Similarly, the housing market has also been softer than desired of late. New housing starts weakened again in May, dropping for the third straight month. Since reaching 1,288,000 units in February, housing starts have pulled back considerably. In May, single-family and multifamily starts slipped for the month, both eight-month lows. On a year-over-year basis, housing starts decreased 2.4 percent from May 2016’s pace of 1,119,000. Yet, that mainly reflects a huge drop in multifamily activity, down 23.0 percent. In contrast, single-family starts have risen 8.5 percent, suggesting a better longer-term trend than the headline figures might seem to indicate. Along those lines, perhaps we will see a rebound during the summer. Homebuilder optimism remains strong, with respondents to that survey predicting healthy gains in activity over the next six months. I am also predicting a bounce-back, which is for 1.25 million starts by year’s end.

There will only be a handful of economic releases out this week, with data focusing mainly on manufacturing and housing. IHS Markit will release new surveys on U.S. and Eurozone manufacturing activity for June, with Europe building on May’s 73-month high in confidence as its economy continues to trend mostly in the right direction. Other highlights this week include the latest figures for existing and new home sales, the Kansas City Federal Reserve Bank’s monthly survey and leading economic indicators.

Chad Moutray, Ph.D., CBE
Chief Economist
National Association of Manufacturers