A week of noisy data

The economic news this week was confusing at best. Small-business confidence fell in the most recent month, but hiring intentions in the very same report surged. Initial unemployment claims fell decisively to fewer than 300,000 people in the most recent week, but that was likely due to new computer systems in two states. Retail sales for August were a disappointment, but previous months were revised nicely higher.

On the surface, Federal deficit numbers didn't look so hot, but that was largely due to the Labour Day holiday, which forced normal September payments back into August. In addition, while the news out of Europe had been consistently better (including McDonald's MCD reporting better European sales), industrial production in Europe inexplicably went over a cliff in July, falling 1.5%, with even Germany falling 2.3%. I suspected Europe was not out of the woods, but no one really saw this decline coming. Hopefully, it is a statistical or summer vacation issue.

Sentiment and real-world data pointed in opposite directions

As confusing as the news was, I still think the data is consistent with a 2.0%-2.25% GDP growth rate for the U.S. in 2013. Looking at this week's data on a year-over-year basis showed little change in trend for more than a year. Retail sales, employment data, and consumption all still point to lethargic growth. The one odd phenomenon is that a lot of sentiment-based indicators have looked markedly better for some time, but the subsequent real-world data have to yet to validate everyone's optimism. Consumer sentiment, purchasing manager surveys, small business, and even homebuilder sentiment had all been rising for a number of months—at least until this week's disappointing sentiment data). However, retail/consumption data, industrial production, and employment have all levelled out despite surging sentiment data. I am hoping the differences get resolved by improving real-world conditions, but I would not count on it.

Fed news due next week

The biggest news next week is a Fed announcement expected Wednesday, regarding what it will do relative to its two major bond-buying programs. As I have said many times, I really don't care when it stops its purchases. Markets are already clearly anticipating an end to the programs, as rates on the 10-year Treasury bonds have surged from 1.6% earlier this year to 2.9% by the end of the week. On a 10-year bond, whether bond purchases begin tapering in September or December hardly makes a difference.

With the effectiveness of the bond program openly in question, and the sheer size of what the Fed already owns, the interest in tapering is huge. However, the economy is not nearly as strong as the Fed hoped when it first began discussing tapering. In addition, the immediate impact on emerging-markets economies, because of the mere threat of tapering, could give the Fed some pause, too. On the other hand, Bernanke has frequently mentioned that the recovery from the Great Depression was delayed two or three years because both fiscal and monetary policy became too tight in the mid-1930s after a partial recovery had begun. Current fiscal policy has become incredibly tight and may even get worse in the months ahead, as I discuss later in this piece. My gut feeling is that the Fed will make some tapering move to maintain its creditability, but the move is likely to be a small one.

Retail slump even as earlier months are revised higher

The government's overall retail sales figure for August came in at a relatively soft growth rate of 0.2% versus expectations for growth of 0.5%. However, the blow was softened by a revision in July's increase from just 0.2% growth to 0.4%, largely due to a massive revision of the building materials figures, which went from a substantial decline to a meaningful increase. Putting the two months together, retail sales were just a little below where most economists had expected, although the short-term trend in sales growth is down again.

Problematic category sales trends continue in August

By category, the report showed the categories that did poorly in July did better in August, and July's good performers did worse in August.

One worrisome trend noted when the original data came out was that the major housing market-related categories (building materials, electronics, and furniture) were all down in July. With the revised data, only two of the three were down in July. In addition, like the general data, the poor performers--electronics and furniture--turned in stellar performances in August. Meanwhile, building materials declined in August. In other words, it's hard to tell exactly how the real estate market is performing based on the data, but it is clearly neither booming nor falling apart.

I have also talked a lot about the boom in restaurant hiring. It certainly has not been matched by gains in restaurant sales. In fact, comparing the three months ending in August to the three months ending in May, restaurant sales were down 0.3%. The mismatch between sales growth and employment growth cannot go on forever. Restaurant sales are often a great indicator of very short-term consumer confidence, so the lackluster restaurant sales trend is disappointing from that standpoint as well.

Non-store retailer sales such as Amazon AMZN, while still up 0.5% in August, are well below longer-term growth rates that are closer to 1%. I don't know if conventional retailers are learning how to beat the likes of Amazon, if it might be due to a weather-related phenomenon, or something else altogether.

Broad-based, longer-term retail sales growth is slow, but intact

I prefer to look at retail data on a year-over-year basis, excluding autos and gasoline; I analyze autos when automakers release their data and with gasoline demand is relatively flat but price changes cause huge swings in the reported numbers, which are not inflation-adjusted. I also like to use three-month averages because they remove some of the seasonal issues in looking at month-to-month data, and decrease the impact of the most recent month, which is subject to substantial revisions.

On this basis, retail sales growth is stuck in neutral, with little variance over the last year on either a nominal or an inflation-adjusted basis. August's data is just about on its 12-month average of 4.2%, and adjusted for inflation it is dead on the 2.5% average. It is great news that sales are holding up, but they certainly aren't booming or even accelerating. That's too bad because retail sales of goods account for one third of the overall consumption report—the rest is the service sector, which is usually even less volatile.

Moderate producer prices bode well for next week's CPI results

Producer prices increased just 0.3% in August after showing no change in July. Combining those two months together suggests a very small increase in the more important Consumer Price Index, which is released next week. Of the small 0.3% increase in producer prices, energy-related items accounted for two thirds of the increase. In the short run, energy prices will be driven by the outcome in Syria. On a year-over-year single-month basis, prices were up just 1.4%, their lowest showing since April. The less-volatile three-month moving average is still running slightly higher, at 2% as shown below.

The report also contained clues about future inflation. The PPI reading that most people reference is for finished goods. The government also calculates the rates for intermediate goods and for raw materials. The intermediate goods index was unchanged, while raw materials were down 2.7% and should eventually influence the more closely watched finished goods index.

Budget deficit shrinkage for 2013 coming down to the wire

The Federal budget deficit for the first 11 months, through August, of fiscal 2013 came in at $755 billion versus $1,164 billion for the same period in 2012. The full-year deficit should be meaningfully lower than the $755 billion 11-month deficit figure. The deficit should shrink substantially from August to September, as September is a big month for tax collections and because a substantial portion of September's expenses were paid in August because Sept. 1 was not a business day. It looks like the deficit is going to get close to 4% of GDP for fiscal 2013, down from close to 10% at the peak.

The good news and the bad news is that spending was down from a year ago in nominal dollars. This is great news for the budget and not so great for GDP growth. As the sequester stands now, there will be more spending cuts in 2014 before government spending begins growing at 2% again in 2015 and beyond. For those who think the worst of the sequester is over, it is not. The spending authority has been cut for some time, but only more recently have actual cash payments by the government declined; that is why the pain has seemed relatively minimal lately despite some pretty nasty cuts. On the defense side of the equation the budget authority was cut by $37 billion in 2013 and is slated for a $52 billion cut in 2014. However, current spending for defense was only cut by $20 billion in 2013; that jumps 50% to $30 billion in 2014.

Housing, manufacturing, and consumer pricing data all due next week

The industrial production report for August is scheduled for Monday; analysts are expecting a 0.4% increase, versus no growth the prior month. The optimism is based on consistently better reports from the purchasing managers as well as hours worked and employment data for the manufacturing sector from the Labor Department. Manufacturing employment was down in every month between April and July, but was up in August. The auto industry is ramping up, as many manufacturers note that sales could have been even better if they only had enough cars to sell. However, lower utility demand in August will slow some of those anticipated gains. In addition, a slowing housing market will not help manufacturers, either. Finally, without stronger consumer demand, it will be difficult for manufacturing growth to accelerate much.

Inflation likely to remain muted

Consumer prices are expected to increase by 0.2% in August, about the same amount that they did in July. I think that might prove a little high given the recent producer price results as well as falling gasoline prices. At the 0.2% monthly level, the year-over-year averaged index is likely to move from 1.7% to 1.8%. For all of 2013, consumer prices look likely to rise by 1.6% to 1.8%, slightly below Fed targets.

Housing data should help gauge the effect of higher interest rates

Next week brings a trifecta of housing data, including builder sentiment, housing starts, and existing home sales. Recently, builder sentiment has been much stronger than actual housing starts or new home sales. The consensus is expecting builder sentiment to be flat at a recovery high of 59, but I think at least some slippage is more likely due to higher rates and anecdotal evidence of less customer interest.

Housing stars could move modestly higher

Housing starts were lackluster in July and are expected to be only slightly better in August based on mediocre permits data frin the previous month. Starts in July were just 896,000, and that is expected to improve to 913,000 in August; starts have been depressed since this spring, and some people think a bounce is likely. Unfortunately, my estimate of one million home starts for the full year appears to be in jeopardy without a quick pickup, which is why I will be taking a close look at permits, too. Unfortunately, housing data does not appear strong enough to drive GDP growth a lot higher.

After huge jump in July, August existing home sales likely to fall

Existing home sales surged to 5.4 million units in July as buyers rushed to close sales quickly to avoid higher interest rates—previously it had been trending in the range of 5.0 million homes annually. The consensus forecast expects things to settle back to 5.3 million units in August. I think an even greater fall-off is a possibility as recent pending home sales data has been weak.