Material Costs are Edging up, but Wages are Still Restrained

By | May 7, 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

World stocks were set for their biggest weekly loss since the middle of March, while the dollar hovered near highs on its recent rally as investors waited for jobs data from the United States. The MCSI All-Country World Index was up less than 0.1% for Friday, but was set for a 1.2% loss for the week. Investors were assessing trade talks between the U.S. and China, where officials said that there was progress on some issues but disagreed on others. The trade discussions have been “candid, efficient and constructive,” the official Chinese news organization said, but gave almost no details on what officials agreed on. A breakthrough deal to fundamentally change China’s economic policies was viewed as highly unlikely, though any signs of meaningful progress could delay any punitive action from the U.S.

The three major U.S. stock indexes rose more than 1% on Friday after weaker than expected U.S. wage growth helped calm investor fears about rising inflation and interest rates. For the week, the Dow Jones lost 0.2% and the S&P fell 0.24%, the second week of losses for both indexes. It was a busy week for economic data and reports came in mostly lukewarm. Payrolls came in at 164,000, just slightly below expectations and wages did not move much off of their 12-month average. An early reporting period and colder than normal weather likely played a role in dampening payroll growth. Personal income and spending came in stronger than expected in March, but not enough to save a soft first quarter for consumption. The solid March suggests decent momentum heading into the second quarter. The outlook for consumption and GDP is projected to gain momentum in Q2.

The Fed’s favorite measure of inflation hit 2% in March. This will keep the Fed on track to raise rates in June. Pending home sales came better than expected, rising 0.4%, but construction spending slowed as single-family construction slowed. Weather and lack of inventory are keeping construction soft. Rising rates are also a factor that housing will have to contend with in coming quarters. The factory sector is growing but signs of capacity shortages are testing production limits. The ISM manufacturing index slipped again in April, but still remains near its February high. Responses reiterated concerns about limited labor supply and supply chain disruptions restraining production. Delivery times are lengthening and backlogs are at a 14-year high. Tariffs and proposed tariffs are creating a great deal of uncertainty in the factory floor. Some businesses are re-thinking investment plans citing uncertain trade policy and rising material costs. Headline factory orders rose on the strength of aircraft orders, but underlying details were less supportive of growth. Core capital goods orders and shipments were down for the month. Non-manufacturing eased in April but remains elevated, pointing to continued growth in services.

The U.S. delegation asked China to decrease the trade deficit by at least $200 billion by the end of 2020. The U.S. also was expected to focus on concerns over China’s state owned economy, forced technology transfers, expanding two-way investment and protection of intellectual property. The U.S. has proposed tariffs on $50 billion of Chinese goods that go in effect in June after the completion of a 60-day consultations period. China has said that its own retaliatory tariffs, including soybeans and aircraft will go into effect if U.S. duties are imposed. A senior Chinese official said before the talks the government won’t accept U.S. preconditions for negotiations for abandoning its long-term manufacturing ambitions. Analysts are not optimistic about potential outcomes between the two countries beyond a delay on the threat of tit-for-tat tariffs. The official Chinese news organization, Xinhua said that the U.S. should show sincerity in talks instead of making unreasonable demands. It is unlikely that trade tensions between the U.S. and China will fade soon. However, as long as there is dialogue, the threat of a full blown trade war can be averted.

Next week, we will get a look at small business confidence, but the main focus will be on inflation. Both the PPI and CPI indexes will be released. We expect inflation to remain on trend, enough to keep the Fed on its scheduled track. Recent reports suggest the economy is in a sweet spot for the Fed, that is, inflation near target and unemployment low. Economic data this week largely reinforced the view that the economy is growing modestly. Material costs are edging up, but wages are still restrained. There are signs of slower economic growth in Europe and a more restrained China is expected. This is pushing up the value of the dollar. Slower global growth and a stronger dollar will limit input costs, including oil. This suggests a restrained inflationary environment. In all, the outlook for both the global and domestic economy looks fairly bright, barring trade disruptions.

Latest Data

The U.S. Economy:

Personal income increased 0.3% in March, following increases of 0.3% in February and 0.4% in January. Personal spending increased 0.4% in March, but that followed a 0.2% decline in February and a 0.1% drop in January. Spending on goods advanced 0.6% in March. Motor vehicles and parts saw a 1.1% rise. Spending started out the year on a weak note, but bounced back strongly in March. While too late for first quarter spending, it does suggest the second quarter will be much brighter. Income growth so far this year has been strong. The weather impacts are gone. The labor markets are tightening. This suggests that spending will rebound in the second quarter and remain firm throughout the year.

The PCE deflator was unchanged in March, following a 0.2% rise in February. Goods prices fell 0.5%, Gasoline and other energy goods prices declined 4.5% for the month. Despite being unchanged in March, the PCE deflator was up 2% y/y, compared to 1.7% the last four months. This suggests the Fed will stay on track on its schedule to raise rates. Now that inflation hit the Fed target of 2%, the Open Market Committee won’t change its planned schedule. The Fed likely will let inflation run above the 2% target for a bit, rather than make sudden moves because inflation has been below target for such a long time. The Fed has spent 9 years trying to create inflation in the economy. Overshooting the target slightly won’t change the current trajectory of rate tightening.

Pending home sales advanced 0.4% to 107.6 in March. Potential sales were mixed across Census regions as the South and Midwest registered gains, while the Northeast and West suffered losses. The index remains down 3% from a year earlier. Higher mortgage rates are likely deterring some buyers. The 30-year fixed mortgage rate is up about a half a percent over the last three months. The lack of inventory has also been a stumbling block for higher sales. The months-of-supply is very tight at 3.6 months. Labor market drivers will remain supportive of decent sales volumes. The market will likely remain positive, but modest the next two years.

Construction spending declined 1.7% in March, following a 1.0% increase in February and a 1.8% advance in January. Total private residential construction was the main drag on the headline number, falling 3.5%. Residential private construction spending excluding home improvement fell a more modest 0.8%. Nonresidential construction spending declined 0.4% in March, following a 1.2% advance in February. Public construction was unchanged in March. We expect construction to remain healthy this year, but higher mortgage rates will dampen activity somewhat. The metrics suggest the softness in first quarter residential construction will not carry over into the second quarter. The budget agreement suggests a positive public sector for this year. This data series is subject to large revisions. February’s 0.1% gain was revised in March to a 1.0% rise.

The ISM manufacturing index came in weaker than expected, but fundamentals remain supportive and factory activity should remain busy. The index retreated to 57.3 in April, down from 59.3 in March. The decline places the index at the lowest point since July 2017. Details also weakened in April. New orders fell from 61.9 to 61.2. 16 out of 18 industries reported increases in new orders. Production backtracked from 61.0 to 57.2. Inventories fell from 55.5 to 52.9. Supplier deliveries rose from 60.6 to 61.1, the 19th consecutive month of slowing deliveries. Employment fell from 57.3 to 54.5. Imports fell from 59.7 to 57.8. Exports fell from 58.7 to 57.7. Prices paid rose from 78.1 to 79.3. Among the commodities up in price were aluminum, caustic soda, copper, corrugate, diesel, freight, steel and wool. The only commodity down in price was soybean oil.

U.S. vehicle sales retreated on April to an annualized pace of 17.2 million units, down from 17.5 million in March. Although April had two less selling days than in April 2017, sales did manage to eke out a small year-over-year increase. Passenger cars sales retreated from 6.48 million a year ago to 5.42 million. Light truck sales were higher in April rising from 10.56 million to 11.72 million. Light truck sales again surpassed the two-thirds of sales for a second consecutive month. Fleet sales picked up in March, outpacing last year’s totals. April was the first month in which the largest domestic automaker, General Motors, is no longer reporting monthly sales and instead is switching to quarterly volumes. Evidence of higher interest rates are showing up. The average monthly payment on a new vehicle was $535 last month, compared to $509 in April 2017 and just $463 five years ago. Higher rates and tightening credit will dampen sales going forward. However, income gains and a sturdy job market will keep sales at a decent volume near 17 million over the next couple of years.

Factory orders increased 1.6% in March after rising the same amount in February. Durable goods orders rose 2.6%, while nondurable goods posted a more modest 0.5% rise. The March increase was largely driven by transportation orders, which rose 7.6% on the strength of the civilian aircraft industry, where orders jumped 44.5%. Orders for autos were down 1%. Core capital goods orders fell 0.4%. Total shipments rose 0.4%, but core capital goods shipments fell 0.8%. Fundamentals remain solid for manufacturers. Core capital goods orders and shipments came in soft, but we expect this to be a temporary phenomenon. Declining capacity calls for expansion and more investment spending. Manufacturing capacity utilization is now at a cycle high and is trending higher. Evidence is accumulating that companies are using lower taxes to buy stock back, rather than invest in machinery. Still, companies can expense their outlays on equipment, which does make it more enticing.

Payrolls rebounded in April, adding 164,000. In addition, gains for March were revised up by 33,000 to 136,000. Looking through the volatility, gains have averaged 200,000 so far this year. The private sector accounted for all the gains, as government payrolls fell slightly. However, the breadth of industries that added jobs narrowed to 58% from 64% in March and 70% in February. The unemployment rate fell to 3.9% for the first time since 2000. However, the result was mostly caused by a decline of 236,000 in the labor force. Participation declined to 62.8%, in line with the average of the last twelve months. Average hourly earnings increased by 4 cents, to a year-over-year pace of 2.56%. In 2000, the last time the unemployment rate fell below 4%, there were strong gains in both the labor force and employment growth and wages were growing better than 4%. The tax cuts and deficit-fueled federal stimulus will tighten the labor market further. The unemployment rate could fall to 3.5%, but earnings will likely top out at 3%.

International:

Manufacturing activity remained solid in major Asian economies, but exports showed signs of weakness, a worrying development given heightened Sino-U.S. trade tensions. The momentum in global trade, which has been responsible for much of the world’s growth over the past year or two, may already e weakening, as firms that are part of supply chains that could be hit by tariffs may be ordering fewer components for products they sell overseas. China’s Caixin/Markit PMI climbed to 51.1 in April from a four-month low in March. However, a subcomponent on export orders shrank for the first time since November 2016. The official PMI also showed external orders slowed last month. Japan saw a similar trend. The manufacturing PMI rose to 53.8 in April, up from 53.1 in March. But growth in export orders slowed sharply to marginal levels, in part due to a stronger yen. Manufacturing activity contracted in South Korea for a second month in April, with both domestic and export orders falling. Exports from South Korea declined in April for the first time in 18 months. In Taiwan, factory growth slowed to a six-month low. Business growth in the United States and Europe while still strong, slowed to a more modest level with U.S. manufacturers complaining about rising commodity prices in anticipation of trade tariffs. On the positive side, domestic orders remain strong and the long spell of sharply higher input prices appears to be leveling off. For Asia, this means central banks can leave interest rates low in order to continue to support their economies.

Important Data Releases This Week

April NFIB will be released on Tuesday, May 8 at 6:00 AM EDT. The survey decreased to 104.7 in March, but we expect a small rise to 105.2 in April. The survey is tracking at a fairly elevated level, but equity markets and trade tensions likely slowed the index in March. Stronger employment intentions and rising compensation intentions should pull the index up.

April PPI index will be released on Wednesday, May 9 at 8:30 AM EDT. The PPI rose 0.3% in March, as service prices accelerated. We expect the recent trend to continue, with both goods and services rising 0.3%.

April CPI index will be released on Thursday, May 10 at 8:30 AM EDT. Inflation was weak in March, falling 0.1%. Rising energy and food prices should drive the index up 0.3% in April.


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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.