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Your Bank > News

CNB Economic Comments September 29

October 13, 2017

To: Everyone
From: Gregory S. MacKay, Economist

Last month’s hopes for a strengthening economy have been struck a serious blow by a nasty gang including Harvey, Irma, Jose and Maria. Multi-billion dollar destruction and loss of lives has stretched from Puerto Rico and the Caribbean into Texas and Florida, and dropped large amounts of wind and rain along much of the east coast of the U.S. The short term effect has been dismal. However, like New Orleans and Katrina, the longer term outlook for the devastated areas is promising. Lessons learned with Katrina have set the stage for a quicker recovery that that in New Orleans.

However, the present situation indicates the economy will show slower recovery in this second half of 2017. While the first quarter of 2017’s anemic growth of 1.2% was countered nicely by second quarter growth of 3.1%, early hopes of a 3%+ third quarter have shrunk to a 2% or so estimate, with hopes for a full year GDP of around 2.2%, down from earlier hopes of 2.6% or higher.

Consumer spending has not advanced at a pace sufficient to reach that 2.6% GDP growth rate. Retail sales data for August were terrible, with total retail sales falling .2% from July levels. While August was partially blamed on Harvey, June and July retail sales figures were revised downward, dampening my belief that consumers were about to continue the spending gains of the early second quarter. Part of the blame can go to gasoline costs, where price increases boosted spending by 2.5% in August. There’s a connection between gasoline costs and other spending. With gasoline spending up 6.4% thus far in 2017, spending in health and personal care stores rose only .5%, clothing was up just .6%, department store spending fell .8%, and electronics and appliances dropped 3.5%. Stalwarts autos (+1.5% for the year) and internet sales (+8.4%, down from double digit growth) also disappointed. In fact, auto sales hit a seven month low in August, and increased a mediocre 1.5% thus far in 2017.

Housing data show the same consumer caution. Existing home sales in August were at a 5.35 million pace, down 1.7% from July and up only .2% from sales levels of August 2016. While inventories remain a big part of the problem, Harvey takes some of the blame, accounting for a 5.7% drop in sales in the South. The only bright spot here is that prices are holding, with the U.S. median price of $253,500 up 5.6% over year ago levels. So the 2.1% inventory shrinkage year-over-year has firmed prices for existing homes.

New home data were a bit of an enigma. They have been somewhat weak all year, and the Harvey affected August pace of 560,000 sales was down 3.4% from July, with weaknesses not only in the South, but also the Northeast and West. Unlike existing home prices, new home prices continued to sag. The median price of a new home was $300,200 in August, up a tiny .4% over August 2016 levels, yet inventories had grown almost 18% since August 2016. It’s hard to suggest the price differential between new and used is important, as the median sales price differential between the two has shrunk from 32% a couple of years ago to 18% today.

Inflation data got a Harvey spike in August as gasoline and other energy costs created a big wholesale bump in the Producer Price Index. The PPI for final demand rose a healthy .2% in August after a -.1% and +.1% performance in July and June. Energy costs rose 3.3% for the month, and final demand wholesale inflation would have been worse except for the fact that wholesale food costs fell 1.3%. Even so, the PPI for final demand rose 2.4% over the past twelve months, which certainly drew some attention from the Federal Open Market Committee (FOMC). Similarly, retail inflation as measured by the Consumer Price Index (CPI) saw a healthy jump in August of .4%, and a twelve month increase of 1.9%. Gasoline prices rose 6.3% for the month and were up 10.4% thus far in 2017, muting all those low price spring months. Still adding to inflation were most service items (shelter, transportation, medical commodities), while the lackluster demand for autos has dropped new car prices by 3.8%. Thus, “core” retail inflation rose only .2% for the month, and was up 1.7% for the year, still below the FOMC’s target range.

Business data has also been negatively impacted by the weather. Industrial production at our country’s plants, mines, and utilities was dramatically lower in August (-.9%). Mining and utility production were most affected, while manufacturing remained weak. However, durable goods orders are up 5% year-to-date over last year as capital goods orders (all types of machinery, aircraft, power and material handling equipment and similar) were up 6.9% year-to-date. There could be some strength developing from the business sector.

Finally, the most recent meeting of the Federal Open Market Committee (FOMC) had three primary takeaways: (1) the sale of its massive portfolio of government bonds (called “tapering”) will begin in October, but will take several years to shrink the portfolio. This tapering is not considered to be economically tightening, as banks are expected to use the provided funds to expand their lending and investment functions; (2) the 2% inflation goal expectation has been pushed back to 2019 as FOMC members continue to discuss the low inflation scenario; (3) while there was some discussion of the various hurricanes effects on the economy, the FOMC will probably raise rates again in December – as long as there are no unusually negative data received by then. So the FOMC continues to believe in the strength of the expansion over the intermediate term.

Equity prices continue to rise, even in the face of hurricanes, possible interest rate increases, ongoing geopolitical problems, and a fiscal scene that remains mired in self-interest. At the opening Friday, for the week and year:

Index 09/29/17 Weekly Change Year-to-Date Change
Dow Industrials 22381 +0.1% +13.2%
NASDAQ 6453 +0.4% +19.9%
S&P 500 2510 +0.3% +12.1%

Both Treasuries and munis have priced in the assumed .25% interest rate increase in December.

Return Period
U.S. Treasuries Municipal Bonds
09/29/17 09/08/17  09/29/17 09/08/17
2 year 1.45% 1.27% 1.01% 0.84%
5 year 1.88% 1.65% 1.36% 1.10%
10 year 2.30% 2.06% 2.00% 1.79%