Market Insight Monthly | August 2018


ECONOMY: Economic Reports Solid In August Despite Trade Tensions

Economic Data
Overall, economic reports released in August—mostly reflecting economic activity in July—indicated solid U.S. economic growth without significant inflationary pressures, even though evidence grew of some cooling from trade concerns. The Conference Board’s Leading Economic Index (LEI), an aggregate of 10 leading indicators, increased 0.6% in July and 6.3% year over year, signaling low odds of recession in the coming year.
Jobs data showed a continually tightening labor market. Nonfarm payrolls rose 157,000 in July, below consensus estimates for a 193,000 increase. However, previously reported figures for both May and June were revised upward by a combined 59,000, to 268,000 and 248,000 respectively, making those the strongest two months for payroll growth since July 2016. The unemployment rate dropped to 3.9% after unexpectedly ticking up to 4.0% in June. Initial jobless claims continued to decline through August as the three-week average fell in the last week of the month to its lowest point since 1969.
While some inflation data eclipsed recent peaks, other reports showed pricing pressures remain relatively muted. The Producer Price Index (PPI) rose 3.3% year over year, while core PPI, which excludes volatile food and energy prices, jumped 2.7%, its highest growth of the cycle. Similarly, July’s Consumer Price Index (CPI) rose 2.9% year over year, while core CPI climbed 2.4% year over year, slightly above the 2.3% peak achieved three other times this cycle. However, core Personal Consumption Expenditures (PCE), the preferred inflation gauge of the Federal Reserve (Fed), rose 2.0% year over year in July, matching the Fed’s target (Figure 1). Average hourly earnings climbed 2.7% year over year in July, significantly below the 4% wage growth preceding each of the last five economic recessions. Based on core PCE and wages, inflationary pressures are unlikely to weigh on output for some time.

Signs of cooling amid trade uncertainty emerged in manufacturing reports. The Institute for Supply Management’s (ISM) and Markit’s Purchasing Managers’ Index (PMI) gauges both showed slowdowns in manufacturing in July as concern over recently implemented tariffs weighed on new orders. ISM’s nonmanufacturing (services) gauge also fell to an 11-month low as new orders and business activity slowed. However, NFIB’s gauge of small-business optimism climbed to its highest level since 1983, and the number of survey respondents expecting to increase capital spending rose. Some anxiety around trade is to be expected, but we have not observed any indications of tariffs weighing significantly on output, and fiscal stimulus is expected to help buoy business spending.
Consumer spending increased 5.2% year over year in July, the strongest pace since October 2014. The Conference Board’s Consumer Confidence Index also rose in July to its highest point of the expansion, showing that consumers expect better business and labor-market conditions to boost their spending even higher. Healthy consumer spending was evident in retail sales, which increased for a sixth straight month for the first time since 2014. Control group sales, which are used to calculate GDP, increased 0.5%, above consensus expectations for a 0.4% gain and signaling another strong quarter of economic growth.
August’s reports on the housing market were less encouraging. In June, housing prices, represented by the S&P CoreLogic Case-Shiller 20-City Composite, posted the smallest monthly increase since 2016. In July, existing home sales fell for the fourth straight month, while new home sales fell to the lowest point in nine months. Housing starts, or the number of new housing units that have started construction, rose 0.9% in July after a 12.9% plunge in June. The housing recovery has been inconsistent, in part reflecting rising interest rates, while housing construction has been challenged by a combination of factors, including rising material costs and shortages of buildable land and qualified labor.
Powell’s Pragmatism on Display as Fed Keeps Rates Steady
The Fed kept interest rates unchanged at its policy meeting that ended August 1. Minutes from that meeting reiterated policymakers’ optimism on U.S. economic growth, but focused more on the negative implications of trade tensions on global and domestic output. The more notable event last month was Fed Chair Jerome Powell’s speech at the Fed’s Economic Policy Symposium in Jackson Hole, Wyoming. In his speech, Powell emphasized a continued commitment to flexibility in assessing the economy, including looking for signs of excess beyond inflation and placing a greater emphasis on sensitivity to a wide variety of market and economic signals. Markets read his comments as pragmatic and dovish.
Overall, the August meeting minutes and Powell’s comments reinforced policymakers’ strong case for hiking rates in September, but fed funds futures’ implied probabilities show that increases beyond that are less certain (Figure 2).

Elsewhere, some central banks took summer breaks in August, as the European Central Bank and Bank of Japan did not hold policy meetings. On August 2, the Bank of England raised its official bank rate for the first time since November 2017 (to 0.75%). Central banks in emerging markets were heavily scrutinized last month amid the region’s ongoing currency crisis. Turkish President Recep Tayyip Erdogan publicly criticized the Turkish central bank’s approach to monetary policy, a sign that his government may intervene in the central bank’s future policy decisions. Argentina’s central bank also hiked short-term interest rates to 60%, the highest in the world, to combat surging inflation.
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