THE ECONOMY:
The economic data, particularly the PPI, was heralded as a problem for inflation. A deeper look, however, reveals that the Tuesday economic data, other than housing, shows some easing that was not necessarily picked up by the headlines.
Producer Prices Rise Again & Core Picking Up Speed, But Some Signs of Slowing.
April's overall 0.6% rise was more than the 0.4% expected, but it was lower than March's 0.7% gain. Year over year producer prices rose 4.8% versus a 4.9% annual rise through March. Thus far this year they are rising at a 5.5% clip. Autos and gasoline pushed the number higher, and given the timing of the survey, it apparently did not capture the full declines in energy costs. Thus the number is likely overstated given the recent declines in energy. The core (less food and energy) rose more than expected as well (0.3% versus 0.2%), the highest move in 3 months as it climbed from a 0.1% gain in March. That put the year over year core rise at 2.6%, holding steady with the March level. This year core PPI is rising at a 3.3% pace.
With oil prices falling and gasoline prices easing some, the May report should fare better. Indeed, core intermediate prices rose just 0.2%, the smallest rise since 12-2003. Prices rises for raw materials are starting to slow. Steel prices are falling as inventories build. Hot-rolled sheet steel fell 20% from October ($714/ton) to April ($575/ton). US Steel (X) cut its domestic shipments for the second time in three weeks and is going to shut an Indiana plant to keep inventories from bulking up.
Still, the core continues to rise and that increases fears that producer prices will bleed a bit more over into the CPI. The past two months there has been some push of producer prices into consumer prices, but the crossover has still been modest. Indeed, it is the atypical situation when producer prices are pushed through to the CPI anywhere near a 1 to 1 ratio. Producer prices are volatile month to month, and producers cannot run their prices to their customers up and down each month. Thus they tend to smooth out the transition. Only when prices turn sharply higher and remain that way for long periods do you start to see them creep into the consumer arena.
Thus, all of the discussion of producer prices is simply time spent chewing the fat until the CPI is released. That tells the story as to what the consumer is paying and thus what the Fed is looking at. The one important take away from this, however, is the indications that producer prices are indeed starting to slow. That takes the pressure off of prices in general in the future, and that is important to the Fed because if it sees intermediate goods losing their momentum then whatever pressure there may be on consumer prices will diminish as well.
Production and Capacity Utilization Soften.
Actual results fell a good bit short of expectations. Production fell 0.2% in versus an expected 0.2% rise. The culprits were reduced auto production in order to reduce inventories, and warmer weather that slowed utility output (production includes mines and utilities). Take out the autos and manufacturing rose 0.4% with business equipment, home electronics and construction supplies leading the way higher. Thus the drop in production was more of an auto thing than any overall slowdown. Get the auto inventory problem under control over the next couple of months and you then have solid overall production gains once more.
That means capacity will continue to struggle along. It came in at 79.2% for April, lower than the 79.5 expected and March's 79.4. With US Steel and auto makers going into idle on some of their plants, capacity is in no danger of putting the squeeze on manufacturing and creating bottlenecks. At the same time, it remains at a healthy pace, indicating some continued expansion though not surging manufacturing.
Housing starts re-start after weak March.
When the March numbers were released, a 14 year low -17.6%, there was renewed talk of a housing bubble ready to burst given that number. The April 11% gain (5.6% rise in permits) suggests some weather related slowing in March did occur. The housing market bulls looked at this as a confirmation of a strong housing market, the bears looked at it as just another indication the end is near.
Our position is that the housing market is undergoing a natural peak after a rather unnatural growth period. Unnatural for two primary reasons. First, after 9-11 there people stayed home and made their houses more accommodating whether renovating the old or buying the new. That helped make housing very strong even during the recession and has also helped keep housing going 2.5 years into the recovery. Housing is typically an early cycle sector, and it has instead been a leading sector, an early cycle sector, and a late cycle sector.
The cocooning effect is part of that, but it is also due to another unnatural cause, i.e. interest rates held down at historical lows. No doubt 9-11 started the homebody effect, but low interest rates have kept the housing market alive well past its prime. There is nothing like 40 year historical lows in mortgage rates to keep buying alive. Second homes abound, current owners are upgrading their primary residences, and first time buyers are getting in as well given the low rates and 'creative' financing available.
The 'creative' financing and stretched budgets to cover debt service is one of the primary reasons the bears are bearish. There will indeed be strife when the economy slows again given that many got into houses they could not normally afford but for the mortgage rates. Those with variable rates or that are stretched too far will suffer. There is always a level of pain in economic slowdowns, and typically the housing market is not immune. Will it cause a crash? Many predict that, but what we are seeing is a somewhat gentle topping in the market. The up and down volatility the past two months is not a good sign in that respect; volatility is a sign of a top, and not necessarily the gentle top we want to see, particularly when you get a 25 point swing in the numbers.
In sum, the housing market continues to peak. The April number was not a signal that the housing market has recovered and is ready to soar further. After the March drop, the sudden rebound is a sign that the top is indeed being put in place. The key now is whether it continues a more orderly decline or rolls over. The Fed is hiking rates gradually to allow everyone to get out of variable rate mortgages, but the Fed is clear it intends to get the long end higher. Thus the writing is on the wall: the housing market will continue to peak as rates climb AND as the Fed continues draining the money supply.
The Fed and the Housing Market.
Hand in hand with the housing market's future, however, is the Fed's ability to avoid sending the economy into recession with this hiking. With the bond market and gold showing basically no inflation in the future, the Fed has either hit the nail on the head with its current policy or it is once more hiking into a slowdown and thus exacerbating the problem. With the recovery 2.5 years old (average lifespan is 3 years) and housing having lasted well beyond its typical lifecycle, we are very skeptical that the Fed has got it just right. If it has, great. Likelihood it has, not so great. |
