The Economy Could Overheat and Inflationary Pressures are Likely to Intensify

By | February 26, 2018

Welcome to FTR’s “Monday Morning Coffee “ blog. The following article is designed to keep busy executives up to date with the latest economic data releases. Released every Monday, this blog promises to keep our clientele updated with the latest weekly economic news and developments, highlighting its impact on the transportation, freight, and equipment markets. Hopefully, this will be an informative addition to the fine body of work associated with FTR.

Overview

Coffee and Economic Review

A stronger dollar and slightly higher borrowing costs kept world shares subdued on Friday and left gold limping toward the worst week since December. The Stoxx Europe 600 edged lower on Friday as declines in car makers offset gain in telecom shares. Broader global cross-asset issues have remained much the same as they have during a choppy few weeks. How far and fast U.S. interest rates can rise and what is it going to do to global borrowing costs, risk appetite and business confidence. The caution is reverberating in the bond markets with U.S. yields rising by more than 50 basis points since early December, more than the 38 points for German government debt. The Fed is now likely to raise rates four times this year, but only takes rates to 2.5% by the end of the year. The big question is, would the increases continue at that pace in 2019?

It was a very light week for economic data, but the continued upward movement in Treasury yields has continued to dominate the market’s attention. On the economic front, existing home sales fell 3.2% in January to a 5.38 million pace with sales falling in all four Census regions. Existing home prices continue to increase, up 5.8% y/y in January. The sluggish pace is due to the fact that supply is historically low. Even with tight supply and rising prices, we still expect some progress this year.

Treasuries have taken the spotlight. In part, the story of higher yields has been driven by news of supply. Supply is expected to pick up just as global demand is starting to wane. The main driver is the added Federal government debt coming from the tax cuts and spending increases. Higher rates are likely to continue through the year and now inflation is beginning to be a factor.

The minutes of the Federal Open Market Committee reiterated that there isn’t any urgency to tighten monetary policy more than policymakers anticipate. That is not surprising, it has been their mantra over the past few years. A number of participants indicated that they marked up their forecasts for growth in the near term because of accommodative financial conditions, solid growth abroad and recent tax changes. Inflation was heavily debated. There was no consensus on where the federal funds rate is heading. Some argued that the improving U.S and global economies could push the neutral rate higher. Other believed that in the absence of fundamental shifts in productivity growth and demographics, that the rate should be lower. There was discussion on the tax legislation, including the expectation that it would boost growth. However, the magnitude was unclear. Some participants thought it would boost inflation, but others thought that the recent corporate tax cuts might lead firms to cut prices and gain market share. The Fed was sticking to its plan to raise rates three times this year. However, the Fed is data dependent. If inflation continues to show vigor, they will try and squeeze in a fourth.

Next week will be busy in the economic calendar. Data will be released on new home sales, advanced durable goods orders, advanced international trade in goods, fourth quarter GDP, pending home sales, personal income and spending, construction spending, vehicle sales and the ISM manufacturing index. The economy is strong and growing. With the addition of the big tax cuts and the extra federal spending, growth will accelerate in 2018-19. However, 2020-21 are likely to look much different after the stimulus fades. The economy could overheat and inflationary pressures are likely to intensify. Landing an economy after an overheated period will take deft policymaking. In this kind of conditions a recession is possible. The next two years, however, look very strong.

Latest Data

The U.S. Economy:

Existing home sales tumbled in January, falling 3.2% compared with December and down 4.8% from a year earlier. The decline was regionally constant, with declines in all four census regions. Sales equaled an annual pace of 5.38 million in January, down from 5.56 million in December. The fall in sales did not weaken prices. The median price for an existing home increased 5.8% y/y. Existing single-family home sales totaled 4.76 million in January, down 3.8% from December and down 4.8% from January 2017. Condo, and co-op sales totaled 620,000 in January, up 1.6% from December, but down 4.6% from January 2017.Average time on the market for existing homes was 42 days in January, up from 40 days in December, but down from 50 days in January 2017. Sales of existing homes, which sold within one month of being on the market, accounted for 43% of sales in January.

Expectations for the U.S. economy are only getting better. The Conference Board’s index of leading economic indicators rose 1% in January, following a 0.6% rise in December. Building permits, ISM new orders and stock prices made the biggest contribution to the January increase. No indicator was negative last month. Existing claims made a 0.1% contribution last month. The average workweek or production workers made no contribution, suggesting the labor market’s impact was mildly positive. Financial markets were once again positive. Stock prices increased 0.18%, while the interest rate spread-the 10-year Treasury minus the federal funds rate-increased 0.13%. The economy will continue to keep motoring along, according to the newest data from the Conference Board. For the first tme in several months, no indicators were in negative territory. The new orders of the ISM was again one of the biggest contributors in January. U.S. manufacturers have built momentum in recent months. Despite a few soft spots, U.S, factories are doing well. Orders rose 1.7% in December, the fifth monthly consecutive gain. Shipments are also on a rising tide.

International:

The flash composite PMI for the 19-nation euro zone fell to 57.5 from 58.8 in January, still hovering at a decent rate. The rate of the PMI corresponds with quarterly rate of 0.9%, the fastest in eight years. The  economy likely expanded 2.4% in 2017, the most in a decade. While order growth slowed in February to a five-month low, companies are still boosting staffing at the fastest pace since 2011. Services slowed the rate at which they raised prices. The factory PMI dropped to 58.5 from 59.6. The index measuring output sank to a four-month low of 59.5 from 61.1.

Important Data Releases This Week

December international trade will be released on Tuesday, February 27 at 8:30 AM EDT. The U.S. trade deficit widened more than expected in December, increasing to $53.1 billion from a revised $50.4 billion. Exports increased 1.8% to $203.4 billion. Goods exports added $3.4 billion, up 2.5%. Total imports rose for a fourth consecutive month to $256.5 billion. Goods imports increased 2.9%. The weaker dollar, down 9.5% since the beginning of 2017, is a big support for exports. Imports are being supported by the healthy advance of the U.S. economy.

January ISM manufacturing index will be released on Thursday, March 1 at 10:00 AM EDT. The ISM manufacturing index remains elevated but the index fell from 59.3 in December to 59.1 in January. New orders are over 65, a strong reading. The outlook for manufacturing is solid, boosted by yhe strong U.S. and the accelerating global economy.

January construction spending will be released on Thursday, March 1 at 10:00 AM EDT. Construction spending has increased for five consecutive months and there could be another positive month coming up. Private construction is driving the expansion, but the public sector is also contributing.

January vehicle sales will be released on Thursday, March 1 at 4:00 PM EDT. December vehicle sales fell to a better than expected annual rate of 17.2 million units. We expect sales to track near 17 million for the remainder of the year.


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Category: Monday Morning Coffee

About Steve Graham

Steve is one of the premier analysts in the transportation equipment industry. On a monthly basis Steve tracks and analyzes in detail the trailer and heavy-duty truck industry. Aside from following these two sectors he is also instrumental in helping our customers analyze the economy and its impact on transportation and transportation equipment.