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CNB Economic Comments February 10

February 13, 2017

To: Everyone
From: Gregory S. MacKay, Economist

Coming on the heels of the first look at fourth quarter GDP, the statement after the FOMC (Committee) meeting of January 31 – February 1 offered a mostly unchanged view of economic progress, while giving us a couple of tidbits to contemplate. The Committee cited “solid” job gains, “moderate” economic expansion, unemployment “near recent lows”, “soft” business investment, and “moderate” increases in consumer spending – all about the same as the last several post-meeting statements. Then the picture got just a bit fuzzy. In the discussion on inflation, the Committee spoke of the recent increase in inflation in recent quarters, and left out any mention of energy prices and non-energy imports – the “transitory” items that had held inflation down through much of the last couple of years. However, the Committee went on to say that inflation is still below the 2% long term objective, and “market based measures of inflation compensation remain low” – Fed speak for no wage pressures out there. In a hint of better times coming, the Committee saw both consumer and business sentiment improving, suggesting a better first quarter of 2017. Probably most telling was the fact that no mention of a rate hike in March was made. Simply put… “moderate” growth begets slow, careful increases in the federal funds rate.

A quick side bar on inflation… some of you have reminded me that the Consumer Price Index for all items was 2.1% for calendar 2016, and the “core” CPI growth rate was 2.2% - add in the GDP deflator at 2.1% for the fourth quarter of 2016, and some wonder if inflation has reached its FOMC target. No… not really. The FOMC prefers to use the Personal Consumption Expenditure Index (PCE Index), which was up 1.6% in 2016 and the “core” PCE rose 1.7%. The PCE is thought to be more indicative of real spending habits of consumers, as it adjusts its “market basket” of goods more frequently than the CPI. The GDP deflator is a measure of inflation in the components of GDP - consumer spending, business investment, government spending, and imports/exports – and doesn’t really address a consumer market basket. If you’re interested in federal funds rate changes, keep your eyes on the PCE Index.

The payroll numbers for January were mildly encouraging, as there were 227,000 jobs added in the private sector. A nice sign was the 45,000 job gain in goods producing industries, of which construction jobs gained 36,000. Service industries dominated, as usual, with the retail, financial, professional and business, leisure, and health care and social assistance categories all adding more than 30,000 jobs each in January. The unemployment rate ticked up to 4.8%, the .1% rise attributed to a small rise in the number of unemployed for the second consecutive month. The average weekly earnings in January was $894.40, up a mere 1.9% from January 2016, attesting to the Fed’s call for stronger earnings growth.
At the heart of earnings growth is the productivity measure of the economy. As measured by the Department of Labor, American productivity advanced only .2% in 2016, after increasing an also poor .9% in 2015. The lingering effects of the strong dollar, energy glut, and weak global demand helped reduce annual output gains to 1.7% from 2015’s +3.1%. Hours worked also increased at a slower pace than 2015, and real compensation gains were a mere 1.5%, barely ahead of inflation as measured by these means. But as we’ve alluded to the recently, the business climate may be slowly gaining. Productivity in fourth quarter of 2016 rose 1.3%, with better output and a small gain in hours worked, bringing unit labor cost increases below 2% while averaging 2.6% in 2016.

A look at December 2016 factory orders confirmed the thesis that manufacturing may be showing a little improvement. Total factory orders were up 1.3% in December versus a decline of 2.3% in November. Excluding transportation and its volatile aircraft component gives a +2.1% reading for December, and without defense spending, factory orders increased 2.4% in December. However, the total gain in December came from the non-durables industries, suggesting that durables still have to find more firm footing.

We’re still looking for consumer spending to surge a bit. Fourth quarter consumer spending increased only 2.5% over the third quarter, a substantial departure from the prior 3 years of consumer data. Consumers shut down credit card spending in December, with a small 2.9% gain over November, although the November gain was a huge 14.4% better than October. Inflation adjusted personal income for December rose .1%, while personal expenses rose .3%. For the full year 2016, real personal disposable income and real personal consumption were the same, up 2.7%, just one more reason why the economy continues to expand moderately.

President Trump has issued executive orders sinking the Trans Pacific Partnership, putting a freeze on federal hiring (except for military and border protection), putting both energy pipelines back in play, looking to cut business regulation, and hinting at tax cuts to come. The equity markets have responded well. At Friday’s opening, for the week and year:

Index 02/10/17 Weekly Change Year-to-Date Change
Dow Industrials 20172 +0.5% +2.1%
NASDAQ 5715 +0.8% +6.2%
S&P 500 2308 +0.5% +3.1%

Bond yields are drifting lower in their trading ranges as inflation fears have been pushed into the background.

Return Period
U.S. Treasuries Municipal Bonds
02/10/17 01/27/17 02/10/17 01/27/17
2 year 1.19% 1.22% 1.08% 1.13%
5 year 1.88% 1.95% 1.60% 1.71%
10 year 2.41% 2.49% 2.28% 2.34%