Weekly Indicators for June 27 - July 1 at Seeking Alpha

 

 - by New Deal democrat

My Weekly Indicators post is up at Seeking Alpha.

There was yet more deterioration this week, focused on the long and short leading indicators.

But consumer spending still seems to be holding up.

As usual, clicking over and reading should bring you up to the virtual moment about the economy, and bring me a little pocket change to buy lunch.

Manufacturing and construction start out the second half of 2022 with more bad news

 

 - by New Deal democrat

Let’s take a look at the new month’s first data, on manufacturing and construction.

The ISM manufacturing index, and especially its new orders subindex, is an important short leading indicator for the production sector. In June, for the first time, the leading new orders index showed slight contraction, declining below 50 to 49.2 from 55.1. The overall index continued to show expansion, but also declined from 56.1 to 53.0:

This is important. The reason why is shown in this long term graph of the new orders index going all the way back to 1948:

Going back almost 75 years, the new orders index has always fallen below 50 within 6 months before a recession, and in three cases did not actually cross the line until the first month of the recession itself.

In other words, going by this metric alone it is *possible* that the US entered a recession in June, and increasingly likely that it will enter recession no later than Q1 of next year.

Meanwhile, construction spending declined - 0.1% in nominal terms in May, but April’s number was revised up from 0.2% to 0.8%. The more leading residential sector rose a mere 0.2%, although April was revised sharply higher, from 0.9% to 1.7%. Both thus again made new highs:

On a YoY basis, nominal residential construction spending is up 18.7%.

Adjusting for price changes in construction materials, which jumped 3.0% for the month, “real” construction spending declined -3.1% m/m, and residential spending fell -2.8% m/m. Thus in absolute terms, “real” construction spending has declined by about 20% since its peak in November 2020,  while “real” residential construction spending has declined about 10% since its post-recession peak in January of last year:

It remains the case that while the decline in residential construction spending, while substantial, is at roughly on par with its 2018-19 decline, and was nowhere near the -40.1% decline it suffered before the end of 2007. 

Last month I wrote that “it takes awhile for the downturn in mortgage applications, sales, and permits to filter through into actual construction, especially with record numbers of housing units permitted but not yet started.” This month may be just noise, or it may be the beginning of that turn.

Real personal income and spending decline in May, while the saving rate increases (not good!)

 

 - by New Deal democrat

In May nominal personal income rose 0.5%, and spending rose 0.2%. But since the personal consumption deflator, i.e., the relevant measure of inflation, rose 0.6%, real income fell -0.1%, and real personal spending fell -0.4%.

While both real income and spending are well above their pre-pandemic levels, I have stopped comparing them with that, but instead with their level after last winter’s round of stimulus. Accordingly, the below graph is normed to 100 as of May 2021:

Since then, real spending is up 2.1%, while real income has actually declined by -1.0%.

Comparing real personal consumption expenditures with real retail sales for May (essentially, both sides of the consumption coin) shows the decreases in both:

Finally, the personal saving rate turned slightly higher, up 0.2% to 5.4%:

This is not necessarily good news! Usually the savings rate has tended to decrease as expansions grow longer, leaving consumers more vulnerable to shocks (e.g., gas prices). 

The personal saving rate this year has been the lowest of any period in the past 60 years except the two months after 9/11, and the 2004-2008 period when home equity refinancing from the last housing bubble was all the rage. That means households have been making up shortfalls by digging into savings or tapping another source of credit. Households reversing that, and feeling the need to increase their saving is a signal that a recession is beginning. 

Given the poor retail sales report earlier this month, I was expecting a negative in the personal spending report. And the fact that April and May averaged together are still positive is encouraging. But this report is yet another in the drip, drip, drip of a deteriorating economy.

Initial claims continue weakening trend, but are not signaling recession this year

 

 - by New Deal democrat

Initial jobless claims declined -2,000 (from an upwardly revised 233,000), to 231,000 last week, vs. the 50+ year low of 166,000 set in March. The 4 week average rose further, by 7,250 to 231,750, compared with the all-time low of 170,500 twelve weeks ago.  Continuing claims declined 3,000 (from an upwardly revised 1,331,00) to 1,328,000, which is 22,000 above their 50 year low set on May 6:

Initial claims have been in an uptrend for nearly 3 months. If this continues one more week, they will no longer qualify as a “positive” in my array of short leading indicators, although they have not risen to levels that would change their rating to a negative.

Which brings up the issue, in this weak and deteriorating economy, just what would it take to flip this indicator to negative?

Four years ago in 2018, discussing a similar increase, I reviewed the entire 50+ year history of initial claims, concluding that “there are almost always one or two periods a year where the four week moving average of jobless claims rises between 5% and 10%. About once every other year for the past 50+ years, it rises over 10%. Typically (not always!) it has risen by 15% or more over its low before a recession has begun. And a longer term moving average of initial claims YoY has, with one exception, turned higher before a recession has begun.”

The first criterion can’t be graphed using FRED tools, but here’s what the second criterion looks like historically:

The current situation fulfills the first criterion, as claims are up about 35% from their *very* low starting point, but fails the second criterion. Claims are down roughly 45% from one year ago:

At the moment, claims have stabilized in the range of 230,000. At worst, the current uptrend in claims (so far!) is consistent with a potential 0.1% uptick in the unemployment rate going into autumn, which as I discussed last week, under the Sahm Rule it’s very unlikely that the unemployment rate will signal the onset of a recession during that time. Even if claims were to continue to rise from here on average about 4,000 a week (their average for the last 12 weeks), they would not turn negative YoY until November, which would be a short leading indicator for a recession thereafter.

Two long leading indicators - real money supply and credit conditions - worsen

 

 - by New Deal democrat

M1 and M2 money supply for May was reported yesterday by the Fed. The former was unchanged for the month, and the latter was up a tiny 0.1%:

That is significant. Why? Because real money supply is a long leading indicator. Real M2 fell out of favor after failing to actually decline YoY prior to the 2001 and 2008 recessions, but a YoY% decline in real M1 and a real YoY% gain of M2 of less than 2.5% is nevertheless an excellent leading indicator for recession:

Here is a close-up on the past year:

Both real M1 and real M2 are outright negative as of May.

There have been several false positives for this indicator: 1967, 1987, and 1994. But otherwise, every time this has happened, a recession has followed within 9 months to 2 years.

Additionally, the Chicago Fed updated its financial conditions indexes this morning. The Adjusted National Conditions Index rose to +.15, and the Leverage Index rose to +.53. With the exceptions of 1987 and 2011, both of these are at levels typically associated with oncoming recessions:

In sum, the long leading indicators continue to worsen. The only unambiguously positive such indicator at the moment is the Treasury yield curve (and even there, the 10 year minus 2 year spread is *almost* - but not quite - inverted).

House prices continued to surge through April; expect no meaningful moderation in the CPI anytime soon

 

 - by New Deal democrat

House prices increases continued to go through the roof as of April, as reported this morning in both the Case Shiller and FHFA house price indexes. The Case Shiller national index rose another 2.1% for the month and 20.4% YoY, just 0.1% below last month’s biggest YoY% gain ever, while the FHFA purchase only index rose 1.6% for the month, and 18.8% YoY, below its peaks of 19.3% in February, and 19.4% last July. The YoY% changes for both for the past 5 years are shown below:

Here is a longer term view, demonstrating that the current surge in house prices is the biggest in the past 30 years, surpassing even the housing bubble:

Owners’ Equivalent Rent (x2 for scale, black) is also shown above. As I have pointed out many times, OER follows house price indexes with roughly a 12-18 month lag. OER has also risen to a 30 year record YoY high, and can be expected to accelerate further. 

For further context, here is the YoY% change in median new home sales price from the Census Bureau in the past 5 years:

While I can’t show you graphically the YoY% change in prices in existing homes from the NAR, since they only allow FRED to show one year, below are the YoY% changes for every month in median existing home sales prices for the past 13 months:

Apr 2021 +19.1%

May +23.6% [peak]

Jun +23%

Jul +20%

Aug +15%

Sep +13%

Oct +13.1%

Nov +13.9%

Dec 2021 +15.8%

Jan 2022+15.4%

Feb 2022 +15%

Mar 2022 +15%

Apr 2022 +10.4% [lowest]

May 2022 +14.8%

Since the NAR data is not seasonally adjusted, the YoY% change is the only valid way to measure.

Last month the existing home sales increase gave some hope that house price gains were moderating. That still apppears to be the case with regard to new homes. But there is very little evidence of moderation in either house price index.

And since OER plus rents contribute a full 1/3rd of the entire value of the CPI, and can be expected to accelerate further, I see very little reason to believe that, absent the Fed creating a recession, consumer inflation is going to abate meaningfully anytime soon.

A comment on housing, inflation, and Fed policy (and a side comment on spending)

 

 - by New Deal democrat

No big economic news today, and as usual little State reporting on COVID over the weekend, so let me make a couple of points.

As an initial note, the big report I will be paying attention to this week is personal spending and income, which will be reported on Thursday.

As I’ve noted several times recently, the goods-producing side of the economy has been fading somewhat. And earlier this month, we got an awful retail sales report (which we average about once every year).

Personal spending is the flip side of retail sales. And what’s been happening there is a bifurcation between spending on goods vs. spending on services. Here’s a graph of each, normed to 100 as of right before the pandemic:

There was a huge increase in spending on goods, especially in last spring’s stimulus spending spree. But that was while a lot of people were avoiding social events and were ordering stuff from home. While that has faded in the past year, spending on services has motored right ahead, and is presently still up about 6% YoY - which in the long term is a *very* healthy rate.

Which means that the signal from a fading goods-producing sector - normally a reliable leading indicator - may be overstated this time around.

We’ll get a further read on that Thursday.

Now, on to my main topic: inflation.

Prof. Paul Krugman continues to tweet that inflation may be taking care of itself, and the Fed shouldn’t hit the brakes too hard, e.g., in this long thread:

https://mobile.twitter.com/paulkrugman/status/1541039031525457923

I would be very cautious about this. That’s because, to recapitulate, 1/3rd of the entire CPI reading is housing, and housing prices have been on a tear. That gets reflected, with a 12 to 18 month lag, in “owner’s equivalent rent” (OER), which is currently at a 30 year high (gold in the graph below, vs. overall CPI, red):

Inflation normally declines before OER peaks, but precisely *because* the Fed slams on the brakes (black in the graph above). 

Well, house prices are still up (awaiting tomorrow’s updates) about 16% YoY. That is going to continue to feed into OER for the next 12 months at least.

In other words, the only reason inflation declines in the next 12 months is if the non-housing 2/3’s of the number slows down drastically. I’m skeptical of that happening if the Fed retreats towards the sidelines.

That being said, the Fed should as a matter of discipline differentiate between supply-driven inflation, especially of durable goods, vs. demand-driven inflation. That’s because, if there is a supply bottleneck, that bottleneck isn’t going to magically disappear by cutting down demand. All it is going to do is create more pent-up demand, and unleash more inflation in that good once interest rates are lowered. 

This is particularly true of housing. To the extent housing inflation is driven by a shortage of construction materials, building even less housing to keep a lid on prices just means even more of a shortage of housing, and more demand once the Fed releases the brakes.  In other words, if there’s a shortage of supply of a durable good, the Fed ought to accept higher inflation rather than bring on a needless recession which won’t cure that shortage anyway.