Economic data on consumer spending, labor markets, consumer and business sentiment, and manufacturing production have been strong in early 2017, setting the stage for a major economic policy regime shift in 2017. The post-election surge in confidence and diminishing headwinds, including the powerful rally in equity markets, seems to be lifting economic activity that had stagnated for such a long time. In addition to establishing a firm basis for the fiscal and regulatory reforms that are now under consideration, these strong data make it exceedingly difficult for the Fed to explain its way out of a March rate hike.
Retail sales advanced by a solid 0.4 percent (month over month) in January despite a drop in sales of motor vehicles and parts. Excluding autos, sales rose a strong 0.8 percent. Control retail sales (excludes autos, food services and drinking places, gasoline, and building materials), which matters most for GDP, advanced 0.4 percent and was revised up by two tenths of a percentage point in December to a 0.4 percent gain. With these increases, the control retail sales in January is already 1 percent higher than its 2016 fourth quarter average (4 percent annualized), pointing to strong growth in Q1.
The strong sales data suggest that consumers are more willing to open up their pockets to spend on discretionary items. Indeed, discretionary categories such as electronics (+1.6 percent), clothing (+1.0 percent), sporting goods (+1.8 percent), and food services and drinking places (+1.4 percent) recorded strong increases in January. Even sales at department stores, which have been on a long-run downward trend, rose by an outsized 1.2 percent (strongest since December 2015). Solid job gains, rising wages and the stronger stock market provide fundamental support for consumer spending. Consumer sentiment measures have remained optimistic, leading households to reduce their saving rate and expand credit. The rapid growth of consumer credit and lower rate of personal saving reflect a heightened sense of comfort with consumer finances.
The surge in business sentiment seems to be feeding through to the “hard” data. The Empire State manufacturing survey headline index jumped over 12 points to a 2.5 year high in February, providing more evidence that the post-election jump in sentiment was more than ephemeral. All the subindexes on current conditions increased, but most notable were the gains in unfilled orders, new orders and shipments that point to both strong current factory activity and likely robust future demand. This follows the sustained high level of confidence in the latest survey of the National Federation of Businesses (NFIB) – a small business association. A growing share of NFIB members believes that now is a good time to expand and is planning to increase employment.
The industrial production data headline for January disappointed, falling 0.3 percent, but the underlying details were encouraging for the current state of demand. Motor vehicle production declined due to (reported) shutdowns to reduce vehicle inventories while utilities production fell due to warmer-than-usual weather lowering heating demand. Both of these sectoral declines are transitory. Other industrial sectors advanced.
Manufacturing production excluding motor vehicles and parts, which provides a reliable gauge of underlying demand, increased by 0.5 percent in January – the fastest growth since November 2014 – in line with the optimistic manufacturing sentiment. Mining production posted a strong 2.8 percent increase as the increase in oil prices is allowing the sector to work through the malaise of the last couple of years – the U.S. oil and gas rig count is currently 741 after bottoming at 404 in the middle of last year.
Besides the pickup in oil prices there are signs that price pressures may be building. The headline consumer price index (CPI) advanced by a strong 0.6 percent month over month (+2.5 percent from the same time the previous year) in January as a result of the surge in energy prices, and the core CPI (excludes food and energy) also rose by 0.3 percent month over month, the largest monthly gain since March 2006, lifting the year over year rise to 2.3 percent. Core commodity prices (excluding energy) rose. Strong increases in apparel (+1.4 percent) and new vehicles prices (+0.9 percent) may be unsustainable, but the risks on inflation are to the upside.
Surveys show that the prices manufacturers are paying and receiving for goods have been elevated. While some of this is due to the increases in oil prices, it likely reflects business feeling more comfortable raising prices as product demand accelerates.
The NFIB small business survey showed that the net share of firms raising worker compensation over the last three months has increased markedly. Given that small businesses account for a larger share of U.S. employment than medium and large sized businesses, there is some upside risk to wage numbers in the near term.
These increases of 0.6 percent in the CPI and 0.3 percent in its core will be reflected in the January PCE deflator, lifting the Fed’s inflation measure of choice. Along with clear strengthening in economic conditions and heightened confidence, this puts more pressure on the Fed to hike rates in March.
Mickey Levy is the chief economist of Berenberg Capital markets, LLC for the Americas and Asia and member, Shadow Open Market Committee. The views expressed in this column are the author’s own and do not reflect those of Berenberg Capital Markets, LLC.
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