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SIMPLY ECONOMICS

Importing deflation
Econoday Simply Economics 10/9/15
By Mark Pender, Senior Editor

  

Introduction

Minutes from the September FOMC were a highlight of the week and, on net, give us a mixed message on what to expect for the December FOMC. Policy makers are determined and focused on raising their policy rate but they held back in September, the result of uncertainty tied to China and also lack of progress on the inflation front. The minutes show concern among the doves that inflation may not be building to the Fed's 2 percent target, a central policy risk underscored by the week's data.


 

The Economy

Imports rose strongly in August, boosted by a surge in new iPhones from China and despite declining dollar levels of oil imports. The strength in imports — though counted as a subtraction in the national accounts — is actually a sign of strength in domestic demand and domestic confidence, which is a very good thing especially heading into the holiday shopping season. A key factor that has raised demand for imports, as it has lowered demand on the export side, is strength in the dollar. A stronger dollar makes imports less expensive, allowing U.S. buyers to get higher quantities and/or higher quality for their money. But in dollar terms as opposed to volume terms, the effect hasn't had much pull at all as seen in the graph which compares the shaded area of imports with the trade weighted dollar.


 

On the export side, however, there is a visible effect. The rise in the trade weighted dollar through the second half of last year corresponds with a subsequent fall off in exports. Exports would have been soft in any case given weakness in foreign demand, but foreign demand for U.S. goods is taking a special hit from the strong dollar which makes foreign buyers get less for their money. And the drop in exports has definitely made an unfortunate difference in the domestic factory sector where total orders have been in contraction for the last year.


 

More for your dollar

Though not having a major impact on dollar totals for imports, the strong dollar is having a significant impact on price inflation. As seen in the graph, the index for import prices (dark line) has been falling sharply for more than a year which is good for U.S. buyers but a problem for FOMC policy makers who are trying to lift inflation. The graph also tracks export prices (light line) which also have been falling, meaning U.S. businesses are getting fewer dollars for their exports which is yet another source of deflationary pressure.


 

Turning to year-on-year terms which is the measurement standard for policy makers, import prices were down 10.7 percent in September and have been treading the 10 percent decline line all year. Lower prices for imports in turn, as seen in the graph, are pulling down consumer prices, which again is two-sided, that is good for the consumer but bad for the general price environment. The year-on-year rate for the consumer price index, pulled lower by import prices, has been skirting the zero line all year.


 

The Fed has been counting on the prospect that a leveling if not a bounce higher for oil prices will begin to give inflation readings a boost. And this effect is evident in September's import price data where a bounce back for petroleum prices helped to limit the overall decline. But apart from oil, deflationary trends are nevertheless apparent. The graph compares the import prices of finished goods where the up-and-down effects of oil prices are muted. All three readings — capital goods, motor vehicles, consumer goods — have been in year-on-year contraction since the beginning of the year.


 

Price declines for finished goods, which by the way are also evident on the export side as well, don't typically appear during periods of economic growth. The challenge doesn't look easy for policy makers who are trying to get inflation moving toward their 2 percent target. The graph tracks two widely watched year-on-year readings, the core rate for the CPI, which excludes energy and is under 2 percent but inching higher, and also the PCE core, which also excludes energy and which, however, has not really been inching higher. The PCE core, where readings are finely tuned, is the Fed's preferred inflation reading. Note also that these two core rates also exclude food where price pressures this year have been soft and are yet another factor behind the general weakness in prices.


 

Let's just stay home!

A general rise in the tide of domestic demand, separate and apart from all the global weakness, would no doubt do wonders for the Fed's inflation efforts. But there are concerns that slowing overseas will soon begin to creep into the domestic economy — fortunately there's no evidence yet of such an effect. Two diffusion readings in the week, though slowing, remain very strong and well above the 50 mark which separates growth from contraction. Actually, contraction is just about the last thing either of these reports, the services PMI and the ISM non-manufacturing report, are pointing to. The non-manufacturing report, which unlike the services PMI also tracks construction and mining, has been posting some of its best numbers in the 18-year history of the series. Orders have been strong as has employment in these reports. But there is price weakness. In an echo of the import price data, finished prices in the services PMI posted their first back-to-back decline in the six-year history of the series.


 

Markets: Has the bond sell-off already started?

It's been very volatile for the bond market where rates backed up sharply this past week following, however, the prior week when rates plunged even more sharply on the friendly FOMC outlook. The 2-year Treasury yield jumped 7 basis points in the week to what is a still very low 0.65 percent. The 10-year rose 12 basis points to 2.10 percent. Despite the rise, rates are still lower than at the beginning of the year when there was no risk of a Fed rate hike! If and when it looks like the FOMC will make its rate move, the outlook for higher interest rates would appear certain to lower demand for Treasuries. It was a good week for the stock market where the indexes rose from 3.7 percent for the Dow to 2.6 percent for the Nasdaq. The gain for the Nasdaq puts it into the plus column year-to-date.


 


 

The Bottom Line

Weak prices stand in the way of a December rate hike. Job growth could swing higher in November but even a very strong employment report would not necessarily spell a December liftoff, not if inflation keeps lying still. Perhaps no less important than the November employment report will be the third-quarter employment cost index to be posted at the end of this month. This is the Fed's favorite reading on wage inflation which, in the last report for the second quarter, absolutely tanked.


 

Looking Ahead: Week of October 12 to October 16

Following Monday's Columbus Day holiday, the week gets underway on Tuesday with the small business optimism index where job readings could spark early talk about the October employment report. Weak gasoline prices are expected to hold down Wednesday's retail sales headline but not the core where a respectable gain is expected. No pressure is expected for consumer prices which are out on Thursday. And Thursday will also see the Empire State and Philadelphia Fed reports and the first indications on October manufacturing. Industrial production will follow on Friday with the first definitive data on September's manufacturing sector, and another decline is expected.


 

Tuesday


 

The small business optimism index is expected to hold steady at a moderate 95.8 in September. Job openings were up solidly in August and another gain for this component could lift the outlook for the October employment report.

 

Small Business Optimism Index - Consensus Forecast for September: 95.8

Range: 94.8 to 96.5


 

The Treasury budget report for September will close out the government's fiscal year. Forecasters see a surplus of $95.0 billion in the month which would be down from $105.8 billion last September but more than enough to end a positive year for the budget which, as of August, was running 10 percent below fiscal 2014.

 

Treasury Budget - Consensus Forecast for September: $95.0 billion

Range: $90.0 to $95.0 billion


 

Wednesday


 

Forecasters don't see much strength for retail sales, at a consensus gain of only 0.1 percent for September. Auto sales, based on strong unit sales, are expected to be a positive, excluding which the consensus is minus 0.1 percent which reflects price weakness at gas stations. Excluding both autos and gas, the outlook is more upbeat with another respectable gain expected, at plus 0.3 percent. Consensus outcomes in this report would not turn up the heat for a Fed rate hike, but there is uncertainty in the sample with a wide spread for the headline and ex-auto readings.

 

Retail Sales, M/M Chg - Consensus Forecast for September: +0.1%

Range: -0.1% to +0.8%

 

Retail Sales Less Autos, M/M Chg - Consensus Forecast for September: -0.1%

Range: -0.3% to +0.4%

 

Retail Sales Less Autos & Gasoline, M/M Chg - Consensus Forecast for September: +0.3%

Range: +0.2% to +0.6%


 

Producer prices in September are expected to show even less pressure than the prior month, down a consensus 0.2 percent for the headline vs no change in August. The ex-food and ex-energy core reading is also soft,  seen up 0.1 percent vs August's plus 0.3 percent.

 

PPI-FD - Consensus Forecast for September: -0.2%

Range: -0.4% to +0.2%

 

PPI-FD Less Food & Energy - Consensus Forecast for September: +0.1%

Range: 0.0% to +0.2%

 

PPI-FD Less Food, Energy & Trade Services - Consensus Forecast for September: +0.2%

Range: +0.1% to +0.2%


 

Business inventories are expected to remain unchanged in August following a small 0.1 percent gain in July. Inventories ended the second quarter on the heavy side and, given moderate sales conditions, look to be flat in the third quarter.

 

Business Inventories, M/M Chg - Consensus Forecast for August: 0.0%

Range: -0.2% to +0.3%


 

Thursday


 

Pulled down by energy prices, the consumer price index is forecast to contract 0.2 percent in September following August's 0.1 percent decline. The core, which excludes both food & energy, is expected to rise but only fractionally, by plus 0.1 percent. Consensus outcomes would not raise talk of a Fed rate hike.

 

Consumer Price Index, M/M Chg - Consensus Forecast for September: -0.2%

Range: -0.4% to +0.2%

 

CPI Less Food & Energy, M/M Chg - Consensus Forecast for September: +0.1%

Range: +0.1% to +0.2%


 

Jobless claims are expected to rise slightly to 270,000 in the October 10 week, up from the prior week's unusual low of 263,000. For the past six months, claims have been signaling very tight conditions in the labor market.

 

Initial Jobless Claims - Consensus Forecast for October 3 Week: 270,000

Range: 252,000 to 275,000


 

Back in August, the Empire State report was the first to signal what proved to be sudden weakness in manufacturing. The report's reading for September was also very weak and another contractionary reading is expected for October, at minus 7.00. This report will offer the first look at this month's manufacturing sector.

 

Empire State Index, M/M Chg - Consensus Forecast for October: -7.00

Range: -10.00 to -5.00


 

The Philadelphia Fed report fell sharply in September but the decline was not confirmed by sub indexes which came in mostly solid. But erosion for such readings as new orders or employment could raise new talk of manufacturing weakness.

 

Philadelphia Fed General Business Conditions Index - Consensus for October: -1.0

Range: -4.0 to +3.0


 

Friday


 

Industrial production is once again expected to prove weak, at minus 0.3 percent following September's decline of 0.4 percent. These readings would just about reverse July's 0.9 percent auto-related jump and point to limited contribution from the industrial sector for third-quarter GDP. The manufacturing component, based on hours in the employment report, is expected to fall 0.2 percent. Weakness in exports is behind much of the weakness in this report, though exports are not broken out in the data.

 

Industrial Production, M/M Chg - Consensus for September: -0.3%

Range: -0.6% to +0.3%

 

Capacity Utilization Rate - Consensus for September: 77.4%

Range: 77.2% to 77.9%

 

Manufacturing Production, M/M Chg - Consensus for September: -0.2%

Range: -0.4% to +0.5%


 

Consumer sentiment showed the most reaction to market and global troubles in August and September, sinking noticeable from the low 90s to the mid-80s before bouncing back at the end of September to 87.2. A further 2-point bounce is expected for the October flash, to 89.5.

 

Consumer Sentiment Index - Consensus for September, Preliminary: 89.5

Range: 87.5 to 93.0


 

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