A Generation of Interest Rate Illiterates

Posted on Updated on

April 9th, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, & Strider Elass – Senior Economist

An entire generation of investors has been misled about interest rates: where they come from, what they mean, how they’re determined.

Lots of this confusion has to do with the role of central banks. Many think central banks, like the Fed, control allinterest rates. This isn’t true. They can only control short-term rates. It’s true these can have an impact on other rates, but it doesn’t mean they control the entire yield curve.

Ultimately, an interest rate is simply the cost of transferring consumption over time. If someone wants to save (spend less than they earn today) in order to consume more in the future, they must find someone else who wants to spend more today than they earn, and then repay in the future.

Savers (lenders) want to be compensated by maintaining – or improving – their future purchasing power, which means they need payment for three things: inflation, credit risk, and taxes.

Lenders deserve compensation for inflation. Credit risk –the chance a loan will not be repaid – is also part of any interest rate. And, of course, those who earn interest owe taxes on that income. After taxes, investors deserve a positive return. In other words, interest rates that naturally occur in a competitive marketplace should include these three factors.

So, why haven’t they? In July 2012, the 10-year Treasury yield averaged just 1.53%. But since then, the consumer price index alone is up 1.5% per year. An investor who paid a tax rate of 25% would owe roughly 0.375% of the 1.53% yield in taxes. In other words, after inflation and taxes (and without even thinking about credit risk, which on a Treasury is essentially nil), someone who bought a 10-year bond in July 2012 has lost 0.35% of purchasing power each year, in addition to capital losses as bond prices have declined.

Something is off. The bond market has not been compensating investors for saving, it has been punishing them.

Some blame Quantitative Easing. The theory is that when the Fed buys bonds, yields fall. It’s simply supply and demand. But this is a mistake. Bonds aren’t like commodities, where if

someone buys up all the steel, the price will move higher. A bond is a bond, no matter how many exist. Just because Apple has more bonds outstanding than a small cap company doesn’tmean Apple pays a higher interest rate.

If the Fed bought every 10-year Treasury in existence except for a single $10,000 Note, why would its yield be less than the current yield on the 10-year note (putting aside artificial government rules that goad banks into buying Treasury securities)? It’s the same issuer, same inflation rate,same tax rate, same credit risk, and the same maturity and coupon. It should have the same yield. It didn’t become a collector’s item; it still faces competition from a wide array of other investments. It’s still the same bond.

The real reason interest rates have remained so low is because many think the Fed will keep holding short-term rates down below fundamental levels well into the future. If the Fed promises to hold the overnight rate at zero for 2-years then the 2-year Treasury will also be close to zero. And since the 10- year note is made up of five continuous 2-year notes, then Fed policy can influence (but not control) longer-term yields as well. The Fed’s zero percent interest rate policy artificiallyheld down longer-term Treasury yields, not QuantitativeEasing. That’s why longer-term yields have risen as the Fed has hiked rates.

And they will continue to rise. Why? Because the Fed has held short-term rates too low for too long. Interest rates are below inflation and well below nominal GDP growth. The Fed has gotten away with this for quite some time because they over-regulated banks, making it hard to lend and grow. Those days are ending and low rates now are becoming dangerous.

With inflation and growth rising, and regulation on the decline, interest rates must go higher. It’s true the Fed is unwinding QE, but that’s not why rates are going up. They’re going up because the economy is telling savers that they should demand higher rates.

 

A Generation of Interest Rate Illiterates

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, & Strider Elass – Senior Economist

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

4-10 / 7:30 am

PPI – Mar

+0.1%

+0.1%

+0.2%

7:30 am

“Core” PPI – Mar

+0.2%

+0.2%

+0.2%

4-11 / 7:30 am

CPI – Mar

0.0%

0.0%

+0.2%

7:30 am

“Core” CPI – Mar

+0.2%

+0.2%

+0.2%

4-12 / 7:30 am

Initial Claims – Apr 7

230K

229K

242K

7:30 am

Import Prices – Mar

+0.1%

-0.1%

+0.4%

7:30 am

Export Prices – Mar

+0.1%

0.0%

+0.2%

4-13 / 9:00 am

U. Mich Consumer Sentiment- Apr

100.4

101.4

101.4

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

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When Volatility is Just Volatility

Posted on Updated on

March 26, 2018

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist, &  Strider Elass – Economist

Stock market volatility scares people. But, volatility itself isn’t necessarily bad. Only if there are fundamental economic problems, something that could cause a recession, would we think volatility itself is a warning sign.

So, we watch the Four Pillars. These Pillars – monetary policy, tax policy, spending & regulatory policy, and trade policy – are the real threats to prosperity. Right now, these Pillars suggest that economic fundamentals remain sound.

Monetary Policy: We’re astounded some analysts interpreted last Wednesday’s pronouncements from the Federal Reserve as dovish. The Fed upgraded its forecasts for economic growth, projected a lower unemployment rate through 2020 and also expects inflation to temporarily exceed its long-term inflation target of 2.0% in 2020.

As recently as December, only four of sixteen Fed policymakers projected four or more rate hikes this year; now, seven of fifteen are in the more aggressive camp. Some analysts dwell on the fact that the “median” policymaker still expects only three hikes in 2018, ignoring the trend toward a more aggressive Fed.

But all of this misses the real point. Monetary policy will still be loose at the end of 2018, whether the Fed raises rates three or four times this year. The federal funds rate is about 120 basis points below the yield on the 10-year Treasury (which will rise as the Fed hikes), and is also well below the trend in nominal GDP growth. Meanwhile, the banking system still holds about $2 trillion in excess reserves. Monetary policy is a tailwind for growth, not a headwind.

Taxes: The tax cut passed last year is the most pro-growth tax cut since the early 1980s, particularly on the corporate side. Some analysts argue that the money is just going to be used for share buybacks, but we find that hard to believe. A lower tax rate means companies have more of an incentive to pursue business ideas that they were on the fence about.

And there is a big difference between who cuts a check to

the government and who truly bears the burden of a tax, what economists call the “incidence of a tax.”

Cutting the tax rate on Corporate America will lift the demand for labor, meaning workers and managers share the benefits with shareholders. Yes, some of the tax cut will be used for share buybacks, but that’s OK with us; it means shareholders get money to reinvest in other companies. Buybacks also move capital away from corporate managers who might otherwise squander the money on “empire building,” pursuing acquisitions for the sake of growth, when returning it to shareholders is more efficient.

Spending & Regulation: This pillar is a little shaky. On regulation, Washington has moved aggressively to reduce red tape rather than expand it. That’s good. But, Congress can’t keep a lid on spending. That’s bad.

Back in June, the Congressional Budget Office was projecting that discretionary spending in Fiscal Year 2018 would be $1.222 trillion. (Discretionary spending doesn’t include entitlements like Social Security, Medicare, or Medicaid, or net interest on the federal debt.) Now, the CBO says that’ll reach $1.309 trillion, a gain of 7.1% in just nine months.

Assuming the CBO got it right back in June on entitlements and interest, that would put this year’s federal spending at 20.9% of GDP, a tick higher than last year at 20.8% – despite faster economic growth. This extra spending represents a shift in resources from the private sector to the government. The more the government spends, the slower the economy grows.

Trade: Trade wars are not good for growth. And the US move to put tariffs in place creates the potential for a trade war. We aren’t dismissing this threat, but a “full blown” trade war remains a low probability event.

The bottom line: taxes, regulation and monetary policy are a plus for growth, spending and new tariffs are threats. Things aren’t perfect, but, in no way do the fundamentals signal major economic problems ahead. The current volatility in markets is not a warning, it’s just volatility.

630-517-7756 • http://www.ftportfolios.com

When Volatility is Just Volatility

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

3-28 / 7:30 am

Q4 GDP Final Report

2.7%

2.7%

2.5%

7:30 am

Q4 GDP Chain Price Index

2.3%

2.3%

2.3%

3-29 / 7:30 am

Initial Claims – Mar 24

230K

225K

229K

7:30 am

Personal Income – Feb

+0.4%

+0.5%

+0.4%

7:30 am

Personal Spending – Feb

+0.2%

+0.2%

+0.2%

8:45 am

Chicago PMI – Mar

62.0

63.3

61.9

9:00 am

U. Mich Consumer Sentiment- Mar

102.0

102.0

102.0

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/3/26/when-volatility-is-just-volatility

The Powell Fed: A New Era

Posted on Updated on

March 19, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, & Strider Elass – Economist

In the history of the NCAA Basketball Tournament, a 16th seed has never, ever, beaten a one seed…until this year. But, on Friday, the University of Maryland, Baltimore County (UMBC) beat the University of Virginia – not just a number one seed, but the top ranked team in the USA.

We don’t expect the unexpected, however, when the Federal Reserve finishes its regularly scheduled meeting on Wednesday. Based on the federal funds futures market, there is a 100% chance that the Fed will boost the federal funds rate by 25 basis points, to a new range of 1.5% to 1.75%.

The markets are even giving a roughly 20% chance that the Fed raises rates 50 basis points. That’s better odds than UMBC had, but we suspect it’s highly unlikely given that this is Jerome Powell’s first meeting as Fed chief.

The rate hike itself is not worrisome. It’s expected and, at 1.75%, the federal funds rate is still below inflation and the growth rate for nominal GDP. There are also still more than $2 trillion in excess bank reserves in the system. The Fed is a very long way from being tight.

Instead, investors should focus on how the Fed changes its forecast of what’s in store for the economy and the likely path of short-term interest rates over the next few years.

Back in December, the last time the Fed released projections on interest rates and the economy, only some of the policymakers at the Fed had incorporated the tax cuts into their forecasts. Prior to the tax cut, the median forecast from Fed officials expected real GDP growth of 2.5% in 2018 and 2.1% in 2019. Now that the tax cut is law, we expect Fed forecasters to move those estimates noticeably higher, to near 3% growth for 2018 and 2019, which should lower unemployment forecasts.

In December, the median Fed forecast was that the jobless rate would reach 3.9% in the last quarter of 2018 and remain there in 2019 before heading back to 4.6% in following years.

We’re forecasting the unemployment rate should get to 3.3% by the end of 2019, which would be the lowest since the early 1950s. Beyond 2019, it’s even plausible the jobless rate goes below 3.0%, as long as we don’t lurch into a trade war or back off tax cuts or deregulation.

We doubt the new Fed forecast gets that aggressive, but with the jobless rate already at 4.1%, faster economic growth should push Fed forecasts well below 3.9% in spite of faster labor force growth.

For the Fed, lower unemployment rates mean faster wage growth and higher inflation. This may force a change in the Fed’s “dot plot,” which puts a dot on each member’s expected path of short-term interest rates.

Back in December, the dot plot showed a median forecast of 75 basis points in rate hikes this year – basically, three rate hikes of 25 bps each. Four Fed officials expected four or more rate hikes in 2018, while twelve expected three or fewer. This time, we expect the dots to show a much more even split between “three or fewer” and “four or more.”

At present, the futures market is pricing in three rate hikes as the most likely path this year, with a 36% chance of a fourth rate hike (or more). Look for the market’s odds of that fourth rate hike to go up by Wednesday afternoon, which means longer-term interest rates will also likely move higher.

In addition, the markets will be paying close attention to Jerome Powell’s performance at his first Fed press conference. With journalists planning “gotcha” questions, some negative headlines could result. If so, and if equities drop, the smartest investors should treat it as yet another opportunity to buy.

Since 2008, the Fed has embarked on unprecedented monetary ease. Rather than boosting the actual money circulating in the economy, however, quantitative easing instead boosted excess bank reserves, which represent potential money growth and inflation in the years ahead.

The Fed has decided that it can pay banks to hold those reserves, and not push them into the economy. Four rate hikes in 2018 mean the Fed will be paying banks 2.5% per year to hold reserves. Never in history has the Fed tried this. The jury is out. The Fed thinks it will work, we’re not so sure. The odds of rising inflation in the next few years, because of those excess reserves, are greater than the chance of a number 16 seed beating a number one seed. Granted, that’s not high odds, but we suggest investors, especially in longer-dated fixed income securities, should be worried. Stay tuned.

630-517-7756 • http://www.ftportfolios.com

The Powell Fed: A New Era

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

3-21 / 9:00 am

Existing Home Sales – Feb

5.400 Mil

5.430 Mil

5.380 Mil

3-22 / 7:30 am

Initial Claims Mar 17

225K

225K

226K

3-23 / 7:30 am

Durable Goods – Feb

+1.7%

+2.5%

-3.6%

7:30 am

Durable Goods (Ex-Trans) – Feb

+0.5%

+1.0%

-0.3%

9:00 am

New Home Sales – Feb

0.624 Mil

0.626 Mil

0.593 Mil

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/3/19/the-powell-fed-a-new-era

Stay Invested: Economy Looks Good

Posted on Updated on

March 12th, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, & Strider Elass – Economist

The current recovery started in June 2009, 105 months ago, making it the third longest recovery in U.S. history.

The longest – a 120-month recovery in the 1990s – saw real GDP expand an annual average of 3.6%. The current recovery has experienced just a 2.2% average annual growth rate – what we have referred to as “plow horse” economic growth.

That’s changing. In particular, the labor market is gathering strength. In February, nonfarm payrolls rose 313,000, while civilian employment, an alternative measure of jobs that includes small-business start-ups, rose 785,000.

Hourly wages rose a tepid 0.1% in February, but in the past six months, average hourly earnings are up at a 2.7% annual rate while the total number of hours worked is up at a 2.6% annual rate. Total earnings are up at 5.4% annual rate in the past six months, which is faster than the trend in nominal GDP growth the past few years.

New orders for “core” capital goods, which are capital goods excluding defense and aircraft, were up 6.3% in the year ending in January, while shipments of these capital goods were up 8.7%. Sales of heavy trucks – trucks that are more than seven tons – are up 17.4% from a year ago.

The pace of home building is set to grow in the year ahead, in spite of higher interest rates or the new tax law

limiting mortgage and property tax deductions. In the fourth quarter of 2017, there were 1.306 million new housing permits issued, the highest quarterly total since 2007.

A better economy also means higher interest rates, but this doesn’t spell doom. Housing has been strong despite rising mortgage rates many times in history. In fact, both new and existing home sales were higher in 2017 than they were in 2016 in spite of higher mortgage rates.

Yes, the new tax law will be a headwind for homebuyers and builders in high-tax states, but it’s going to be a tailwind for construction in low tax states like Texas, Florida, and Nevada. Housing starts have increased eight years in a row. Look for 2018 to be the ninth.

In the past two months, both ISM surveys – for Manufacturing and Services – have beaten consensus expectations. The US economy is not going to grow at a 3.0% pace every quarter, but all of this data suggests that our forecast for an average pace of 3% growth this year is on steady ground.

The bottom line is that the U.S. economy is accelerating, not decelerating, and the potential for any near-term recession is basically zero. Corporate earnings growth, and forecasts of future earnings, have accelerated, and our 2018 year-end forecast for Dow 28,500 and S&P 500 3,100 remain intact. Even with higher interest rates! Stay invested.

630-517-7756 • http://www.ftportfolios.com March 12, 2018

Stay Invested: Economy Looks Good

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

3-13 / 7:30 am CPI – Feb +0.2% +0.2% +0.5%

7:30 am “Core” CPI – Feb +0.2% +0.2% +0.3%

3-14 / 7:30 am PPI – Feb +0.1% +0.2% +0.4%

7:30 am “Core” PPI – Feb +0.2% +0.2% +0.4%

7:30 am Retail Sales – Feb +0.3% +0.5% -0.3%

7:30 am Retail Sales Ex-Auto – Feb +0.4% 0.5% +0.0%

9:00 am Business Inventories – Jan +0.6% +0.6% +0.5%

3-15 / 7:30 am Initial Claims – Mar 10 228K 225K 231K

7:30 am Import Prices – Feb +0.2% +0.3% +1.0%

7:30 am Export Prices – Feb +0.2% +0.2% +0.8%

7:30 am Philly Fed Survey – Mar 23.0 23.5 25.8

7:30 am Empire State Mfg Survey – Mar 15.0 15.0 13.1

3-16 / 7:30 am Housing Starts – Feb 1.290 Mil 1.283 Mil 1.326 Mil

8:15 am Industrial Production – Feb +0.4% +0.5% -0.1%

8:15 am Capacity Utilization – Feb 77.7% 77.8% 77.5%

9:00 am U. Mich Consumer Sentiment- Mar 99.1 100.2 99.7

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/3/12/stay-invested-economy-looks-good

Deficits, the Fed, and Rates

Posted on Updated on

February 26, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, & Strider Elass – Economist

Forgive us our incredulity. The bond vigilantes were certain that as the Federal Reserve hiked short-term rates, long- term interest rates would barely budge, the yield curve would invert, and the economy would fall into recession.

That theory has been blown to smithereens, so now we hear that it’s rising long-term rates that will cause a recession.

According to the vigilantes, which ascribe deep meaning to every move in long-term interest rates, the U.S. has gone from secular stagnation and permanent low rates, to huge (impossible to fund) deficits and rising rates – overnight.

No wonder the average investor is completely confused. So, let’s start at the beginning.
Yes, the Fed drove short-term interest rates to zero and held them there for seven years. And, yes, the Fed bought $3.5 trillion in bonds during Quantitative Easing. And, yes, the Fed is reversing course. It’s lifted the federal funds rate five times since 2015, and it’s slowly allowing its bond portfolio to shrink.

The federal government enacted tax cuts and spending increases, and the budget deficit ($665 billion in 2017) is now expected to approach $1 trillion or more in 2018 and beyond.

So, how much impact does each of these things have on interest rates?

Here’s our list:

  1. 1)  If the budget deficit were no higher in 2018, than it was in 2017, long-term bond yields would still be higher today.
  2. 2)  If the Fed had just lifted short-term interest rates, but had not started unwinding QE, longer-term bond yields would still be higher today.

3) When the Fed promises to hold short-term interest rates down, they pull longer-term rates down as well. Long-term rates (say a 5-year bond) are just a series of short-term rates (five 1-year bonds). So, rising 1- year yields mean rising 5-year yields.

When tax cuts and regulatory reform lead to stronger economic growth, a pick up in the velocity of money, and rising inflationary pressures, the bond market begins to realize that short-term interest rates need to rise – across the yield curve. Rising interest rates have everything to do with better economic data and nothing to do with QE and deficits.

Every dollar the government spends has to be paid for with either tax revenue or borrowing from bondholders. Either way, the money is “crowded-out.” If you pay higher taxes, but need to buy a machine, you have to borrow; if the government borrows the money first and doesn’t tax you, you still need to buy the machine. Either way, debt is created. But, it’s not the debt itself that drives interest rates up or down.

So, what about the QE-unwind? At this point, the Fed is only reducing its holdings of Treasury debt by $12 billion per month, versus a total pool of publicly-held Treasury debt of $14.8 trillion. A drop in the bucket.

Interest rates are determined by fundamental factors, not who owns what, or how many, bonds. Right now, fundamental factors in the US – faster growth, rising inflation and a tightening Fed – are pushing yields up….not deficits. In other words, the Vigilantes may think they have us on the run, but they’re not close to being dangerous.

630-517-7756 • http://www.ftportfolios.com February 26, 2018

Deficits, the Fed, and Rates

 

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

2-26 / 9:00 am New Home Sales – Jan 0.647 Mil 0.648 Mil 0.593 Mil 0.643 Mil

2-27 / 7:30 am Durable Goods – Jan -2.0% -2.7% +2.8%

7:30 am Durable Goods (Ex-Trans) – Jan +0.5% +0.1% +0.7%

2-28 / 7:30 am Q4 GDP Second Report 2.5% 2.5% 2.6%

7:30 am Q4 GDP Chain Price Index 2.4% 2.4% 2.4%

8:45 am Chicago PMI – Feb 64.1 66.8 65.7

3-1 / 7:30 am Initial Claims – Feb 24 225K 226K 222K

7:30 am Personal Income – Jan +0.3% +0.2% +0.4%

7:30 am Personal Spending – Jan +0.2% +0.2% +0.4%

9:00 am Construction Spending – Jan +0.3% +0.6% +0.7%

9:00 am ISM Index – Feb 58.7 59.2 59.1

afternoon Total Car/Truck Sales – Feb 17.2 Mil 16.7 Mil 17.1 Mil

afternoon Domestic Car/Truck Sales – Feb 13.3 Mil 12.9 Mil 13.1 Mil

3-2 / 9:00 am U. Mich Consumer Sentiment- Feb 99.5 99.9 99.9

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/2/26/deficits,-the-fed,-and-rates

Snatching Slow Growth from the Jaws of Fast Growth

Posted on Updated on

February 12, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, and Strider Elass – Economist

The U.S. economy continues to be lifted by an incredible wave of new technology. Fracking, 3-D printing, smartphones, apps, and the cloud have boosted productivity and profits. Yet taxes, regulation and spending all increased markedly in the past decade, raising the burden of government and dragging down the real GDP growth rate to a modest 2.2% from mid- 2009 to early 2017.

Then 2017 saw the tides start to shift. Regulation was cut dramatically and the U.S. saw the most sweeping corporate tax reform in history. Guess what? Growth picked up to almost 3% annualized in the last three quarters of 2017 and real GDP looks set for about 4% growth in the first quarter of 2018.

But the dream of getting back to long-term 4% growth died this week in a bipartisan orgy of government spending. Congress lifted the budget caps on “discretionary” (non- entitlement) spending by about $300 billion over the next two years, and spending is now set to rise by 10% this year.

No, this won’t kill the economy tomorrow (or this year), but unless the Congress gets control of federal spending, the benefits from the tax cuts and deregulation will be short-lived.

Many argued that making corporate tax cuts temporary would limit their effectiveness because corporations would not change their behavior. So, what does a corporate CFO do now? Trillion dollar deficits as far as the eye can see mean Congress has a reason – and an excuse – to raise tax rates in the future. This doesn’t mean they’re going back to 35%, but massive

deficits will make it hard to sustain a 21% tax rate over time. In other words, while Congress passed permanent tax cuts, it now makes them almost impossible to sustain.

Every dollar the government spends must be either taxed or borrowed from the private sector. The bigger the government, the smaller the private sector. Not only does increased spending mean higher tax rates are expected in the future, but also a smaller private sector as it’s forced to fund a bigger government. It’s the Spending that crowds out growth, not deficits themselves

Look, we get it. The world is a dangerous place and we are sure there are parts of our military that need better funding. But the government can’t do everything. If we need more spending on defense, those funds should be found by reducing spending elsewhere. Otherwise, eventually, the country won’t be able to afford to defend itself, either.

But, in order to reach the minimum of 60 votes needed in the US Senate, Republicans capitulated to Democrats demands for more non-military spending. The result was a budget blow- out.

So, where does that leave us? Optimistic about an acceleration in growth this year and 2019, which will help lift stock prices as well, but not as optimistic beyond that as we were before the budget deal. The Plow Horse is not coming back overnight, but unless we get our fiscal house in order, it’s still lurking in the barn.

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

2-14 / 7:30 am Retail Sales – Jan +0.2% +0.2% +0.4%

7:30 am Retail Sales Ex-Auto – Jan +0.5% +0.5% +0.4%

7:30 am CPI – Jan +0.3% +0.3% +0.2%

7:30 am “Core” CPI – Jan +0.2% +0.2% +0.2%

9:00 am Business Inventories – Dec +0.3% +0.4% +0.4%

2-15 / 7:30 am Initial Claims – Feb 10 228K 225K 221K

7:30 am PPI – Jan +0.4% +0.3% -0.1%

7:30 am “Core” PPI – Jan +0.2% +0.2% -0.1%

7:30 am Philly Fed Survey – Feb 21.5 22.2 22.2

7:30 am Empire State Mfg Survey – Feb 17.9 18.0 17.7

8:15 am Industrial Production – Jan +0.2% 0.0% +0.9%

8:15 am Capacity Utilization – Jan 78.0% 77.9% 77.9%

2-16 / 7:30 am Housing Starts – Jan 1.235 Mil 1.232 Mil 1.192 Mil

7:30 am Import Prices – Jan +0.6% +0.5% +0.1%

7:30 am Export Prices – Jan +0.3% +0.3% -0.1%

9:00 am U. Mich Consumer Sentiment- Feb 95.4 96.0 95.7

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/2/12/snatching-slow-growth-from-the-jaws-of-fast-growth

New Policies, New Path

Posted on Updated on

February 5, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, & Strider Elass – Economist

Back in the 1970s, supporters of the status quo said there was nothing to be done about stagflation (high inflation and slow growth). It was a “fact of life” that Americans had to accept after experiencing faster growth and lower inflation during the decades immediately following World War II.

Then, along came the supply-side and monetarist economists with new ideas about how the “policy mix” mattered, that marginal tax rates affected the incentive to work and invest and that the supply of money helped determine inflation. Simple ideas, in retrospect, but decried as radical notions at the time by supporters of the stagflation status quo. Supply-side economics was dismissed as “voodoo economics.”

Similar arguments have come back into vogue in the past decade, with apologists for slow growth arguing the US simply can’t grow as fast as it used to. “Secular stagnation” means growth will be permanently slow. Rapid growth, they claim, is a thing of the past.

In the 1980s, when supply-side policies were tried, they worked. Growth picked up, inflation fell. Now, the U.S. is going through another major shift in the “policy mix,” with the federal government focusing on deregulation and tax cuts. In a nutshell, we’ve gone from a political philosophy that said “you didn’t build that” to one that says “please build that.”

As a result, expectations about the economy are changing rapidly. The Atlanta Fed is now projecting real GDP growth at a 5.4% annual rate in the first quarter, which would be the fastest growth for any quarter since 2003. We think that’s on the optimistic side and expect growth at more like a 4.0% annual rate, but, either way, the economy is showing signs of an overdue acceleration and we are now projecting growth of 3.5% for 2018 (the fastest “annual” growth since 2003).

Friday’s jobs report brought news that wages are now accelerating as well. Average hourly earnings grew 0.3% in January and are up 2.9% from a year ago. Some analysts said wages were probably lifted in January due to unusually bad weather, which was also the culprit behind the drop in the number of hours worked for the month.

It is true that the number of workers missing work due to weather was the second highest for any January in the past 20 years. But we’ve had other months with nasty weather since

2009, and this is the first time since then that wages were up 2.9% over a twelve-month period. Meanwhile, jobs increased 200,000 for the month, so we doubt bad weather was the key trigger.

Surprisingly, even uber-dove Minneapolis Fed President Neel Kashkari, who has dissented against rate hikes in recent Fed meetings, waxed enthusiastic on Friday about the faster pace of wage growth, saying it “could have an effect on the path of interest rates.” Kashkari and the rest of the policymakers at the Fed will have more than six more weeks to mull over the incoming data and decide whether they warrant a new path for short-term interest rates. We think a steeper path is not only warranted, but likely.

At the last meeting in 2017, which was the last time the Fed issued it’s “dot plot” for the expected path of interest rates over the next few years, the median forecast was three rate hikes this year, with the odds of two rate hikes or less outweighing the odds of four rate hikes or more. At the press conference following that meeting, Fed Chief Janet Yellen said some, but not all, of the policymakers had incorporated the tax cut into their forecasts.

But now that the tax cut is a fact and the economy is accelerating, we think the new forecast to be released on March 21 will show close to an even split between advocates of three or four rate hikes. We’d put our money on four, and we don’t see a slowdown in economic growth during 2018, like we might have seen in some recent years, giving the Fed an excuse to pause its rate hikes during the year.

No wonder the yield on the 10-year Treasury has gone from 1.86% on Election Day 2016 to 2.84% on Friday. The “animal spirits” are restless, monetary policy is gaining traction, and the “secular stagnation” of the past several years is looking less secular by the day.

In this environment, as markets reassess what’s possible, we may have more days like Friday in the equity market. But more economic growth will ultimately be a tailwind for equities, not a headwind. Stock market investors who can’t take a one-day 2.1% drop in equities, or even a 10% correction, shouldn’t be in the stock market to begin with. Those who can remain calm and stay invested will be rewarded.

630-517-7756 • http://www.ftportfolios.com

New Policies, New Path

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

2-5 / 9:00 am

ISM Non Mfg Index – Jan

56.7

56.9

59.9

56.0

2-6 / 7:30 am

Int’l Trade Balance – Dec

-$52.1 Bil

-$51.4 Bil

-$50.5 Bil

2-7 / 2:00 pm

Consumer Credit– Dec

$20.0 Bil

$17.9 Bil

$28.0 Bil

2-8 / 7:30 am

Initial Claims – Feb 3

232K

234K

230K

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

 

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/2/5/new-policies,-new-path

Clear Skies Ahead

Posted on Updated on

January 29, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Economist

You know the old saying about every cloud having a silver lining? Well, if you listen to some of the financial press, you’d think their motto was that clear skies are just clouds in disguise.

Friday’s GDP report showed the economy grew 2.5% in 2017, an acceleration from the average rate of 2.2% from the start of the recovery in mid-2009 through the end of 2016. Notably, what we call “core” GDP – inflation-adjusted GDP growth excluding government purchases, inventories, and international trade – grew at a 4.6% annual rate in the fourth quarter and was up 3.3% in 2017.

However, some pessimistic analysts were calling attention to a drop in the personal saving rate to 2.6% in the fourth quarter, the lowest level since 2005. The pessimists’ theory is that if the personal savings rate is so low, consumers must be in over their heads again, so watch out below!

But this superficial take on the saving rate leaves out some very important points.

First, consumers don’t just get purchasing power from their income; they also get it from the value of their assets. And asset values soared in 2017 as investors (correctly) anticipated better economic policies. The market cap of the S&P 500 rose $3.7 trillion, while owner-occupied real estate looks like it increased about $1.5 trillion. That could be a problem if we thought stock market or real estate was

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

overvalued, but our capitalized profits approach says the stock market is still undervalued and the price-to-rent ratio for residential real estate is near the long-term norm, not wildly overvalued like in 2005.

Second, the tax cut that’s taking effect is going to raise after-tax income. According to congressional budget scorekeepers, the tax cut on individuals should reduce tax payments by $189 billion in 2019, which is equal to 1.3% of last year’s after-tax income. So, consumers are going to be able to save more in the next few years, even if we don’t include the extra income that should be generated by extra economic growth.

Third, the personal saving rate doesn’t include withdrawals from 401Ks and IRAs, many of which are swollen with capital gains. So, let’s say a worker contributed $5,000 of their income into a 401K at the end of 1988 and kept that money in the S&P 500 ever since. Today they can withdraw more than $97,000 and spend it. When calculating the saving rate, the government counts every penny of that spending while not counting a penny of it as income. As the population ages and spends down wealth they’ve already made, the saving rate tells us less and less about the saving habits of today’s workers.

Sometimes good news is really just good news. Unfortunately, some analysts can’t look at clear skies without imagining clouds.

630-517-7756 • http://www.ftportfolios.com January 29, 2018

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

1-29 / 7:30 am Personal Income – Dec +0.3% +0.3% +0.4% +0.3%

7:30 am Personal Spending – Dec +0.4% +0.6% +0.4% +0.8%

1-31 / 8:45 am Chicago PMI – Jan 64.0 67.7 67.8

2-1 / 7:30 am Initial Claims – Jan 28 235K 238K 233K

7:30 am Q4 Non-Farm Productivity +0.8% +0.1% +3.0%

7:30 am Q4 Unit Labor Costs +0.9% +1.3% -0.2%

9:00 am ISM Index – Jan 58.6 58.7 59.3

9:00 am Construction Spending – Dec +0.3% +0.8% +0.8%

afternoon Total Car/Truck Sales – Jan 17.2 Mil 17.0 Mil 17.8 Mil

afternoon Domestic Car/Truck Sales – Jan 13.5 Mil 13.2 Mil 13.7 Mil

2-2 / 7:30 am Non-Farm Payrolls – Jan 180K 180K 148K

7:30 am Private Payrolls – Jan 181K 175K 146K

7:30 am Manufacturing Payrolls – Jan 20K 18K 25K

7:30 am Unemployment Rate – Jan 4.1% 4.1% 4.1%

7:30 am Average Hourly Earnings – Jan +0.2% +0.2% +0.3%

7:30 am Average Weekly Hours – Jan 34.5 34.5 34.5

9:00 am Factory Orders – Dec +1.4% +1.6% +1.3%

9:00 am U. Mich Consumer Sentiment- Jan 95.0 95.0 94.4

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

 

First Trust Monday Morning Outlook

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/1/29/clear-skies-ahead

No More Plow Horse

Posted on Updated on

January 22, 2018

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, & Strider Elass – Economist

 

We’ve called the slow, plodding economic recovery from mid-2009 through early 2017 a Plow Horse. It wasn’t a thoroughbred, but it wasn’t going to keel over and die either. Growth trudged along at a sluggish – but steady – 2.1% average annual rate.

Thanks to improved policy out of Washington, the Plow Horse has picked up its gait. Under new management, real GDP grew at a 3.1% annualized rate in the second quarter of 2017 and 3.2% in the third quarter. There were two straight quarters of 3%+ growth in 2013 and 2014, but then growth petered out. Now, it looks like Q4 clocked in at a 3.3% annual rate, which would make it the first time we’ve had three straight quarters of 3%+ growth since 2004-5.

Some say a government shutdown would make it tough to get another 3% quarter to start 2018, but we disagree. Yes, some “nonessential” government workers might pull back on their spending temporarily, but there’s no historical link between government shutdowns and economic growth.

The economy grew at a 2.8% annual rate in late 1995 and early 1996 during the two quarters that include the prolonged standoff under President Clinton. That’s essentially no different than the 2.7% pace the economy grew in the year before the shutdowns. The last time we had a prolonged standoff was in late 2013, under President Obama. The economy grew at a 4% rate that quarter, one of the fastest of his presidency.

Right now, taxes are falling, regulations are being reduced, and monetary policy remains loose. With these tailwinds, the acceleration of growth in 2017 should continue into 2018.

Here’s how we get to 3.3% for Q4.
Consumption: Automakers reported car and light truck

sales rose at a 16.4% annual rate in Q4, in part due to a surge after Hurricanes Harvey and Irma. “Real” (inflation-adjusted) retail sales outside the auto sector grew at a 6.6% rate, and growth in services was moderate. Our models suggest real personal consumption of goods and services, combined, grew at

a 3.9% annual rate in Q4, contributing 2.7 points to the real GDP growth rate (3.9 times the consumption share of GDP, which is 69%, equals 2.7).

Business Investment: Looks like another quarter of solid growth, with investment in equipment growing at about a 16% annual rate, and investment in intellectual property growing at a trend rate of 5%, but with commercial construction unchanged. Combined, it looks like business investment grew at an 8.8% rate, which should add 1.1 points to real GDP growth. (8.8 times the 13% business investment share of GDP equals 1.1).

Home Building: Given the major storms in Q3, we expected a larger pickup in home building than was realized in the fourth quarter. But it still grew at about a 2.6% annual rate in Q4, which would add 0.1 points to the real GDP growth rate. (2.6 times the home building share of GDP, which is 4%, equals 0.1).

Government: Both military spending and public construction projects were way up in the quarter, suggesting real government purchases up at a 2.7% annual rate in Q4, which would add 0.5 points to the real GDP growth rate. (2.7 times the government purchase share of GDP, which is 17%, equals 0.5).

Trade: At this point, we only have trade data through November. Based on what we’ve seen so far, it looks like net exports should subtract 1.2 points from the real GDP growth rate in Q4.

Inventories: We have even less information on inventories than we do on trade, but what we have so far suggests companies stocked shelves and showrooms at a slightly faster rate in Q4, which should add 0.1 points to the real GDP growth rate.

Some more reports on inventories and trade due this week could change our forecast slightly, assuming a shutdown doesn’t interfere with the data schedule. But, for now, we get an estimate of 3.3%. The US economy is confirming the optimism behind the stock market rally.

630-517-7756 • http://www.ftportfolios.com

No More Plow Horse

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

1-24 / 9:00 am

Existing Home Sales – Dec

5.70 Mil

5.690 Mil

5.810 Mil

1-25 / 7:30 am

Initial Claims – Jan 21

235K

241K

220K

9:00 am

New Home Sales – Dec

0.675 Mil

0.677 Mil

0.733 Mil

1-26 / 7:30 am

Q4 GDP Advance Report

3.0%

3.3%

3.2%

7:30 am

Q4 GDP Chain Price Index

2.3%

2.1%

2.1%

7:30 am

Durable Goods – Dec

+0.9%

+1.3%

+1.3%

7:30 am

Durable Goods (Ex-Trans) – Dec

+0.6%

+0.4%

-0.1%

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/1/22/no-more-plow-horse

Don’t Time a Correction

Posted on Updated on

January 16, 2018

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist, & Brian S. Wesbury – Chief Economist

The stock market is on a tear. The S&P 500 rose 19.4% in 2017 excluding dividends, and is already up over 4% in 2018. It’s not a bubble or a sugar high. Our capitalized profits model, says the broad U.S. stock market, is, and was, undervalued.

We never believed the “sugar high” theory that QE was driving stocks. So, slowly unwinding QE and slowly raising the federal funds rate, as the Fed did in 2017, was never a worry. But, now a truly positive fundamental has changed – the Trump Tax Cut, particularly the long-awaited cut in business tax rates. With it in place, we think our forecast for 3,100 on the S&P 500 by year-end is not only in reach, but could be eclipsed.

Before you consider us overly optimistic, we did not expect the stock market to surge like it has so early in the year. In fact, we would not have been surprised if the market experienced a correction after the tax cut. There’s an old saying; “buy on rumor, sell on fact.” So, with tax cuts approaching, optimism could build, but once they became law, the market would be left hanging for better news.

We would never forecast a correction, because we’re not traders. We’re investors. Anyone lucky enough to pick the beginning of a bear market never knows exactly when to get back in. In 2016, it happened twice and we know many investors are still bandaging up their wounds from being whipsawed.

The market got off to a terrible start in 2016, one of the worst in years. The pouting pundits were talking recession and bear market, only to experience a head-snapping rebound. Then, during the Brexit vote, the stock market fell 5% in two days – which was seen as another indicator of recession. But, it turned out to be a great buying opportunity, like every sell- off since March 2009.

The better strategy for most investors is don’t sell. Some sort of correction is inevitable but no one knows for sure when it will happen and few have the discipline to take advantage of the situation.

This is particularly true when risks to the economy remain low and the stock market is undervalued, which is exactly how we see the world today.

Earnings are strong (even with charge-offs related to tax reform), and according to Factset, since the tax law passed analysts have lifted 2018 profit estimates more rapidly than at any time in the past decade. Even the political opponents of the tax cuts are saying it will likely lift economic growth for at least the next couple of years.

Continuing unemployment claims are the lowest since 1973, payrolls are still growing at a robust pace, and wages are growing faster for workers at the lower end of the income spectrum than the top. Auto sales are trending down, but home building has much further to grow to keep up with population growth and the inevitable need to scrap older homes. Consumer debts remain very low relative to assets, while financial obligations are less than average relative to incomes.

In addition, monetary policy isn’t remotely tight and there is evidence that the velocity of money is picking up. Banks are in solid financial shape, and deregulation is going to increase their willingness to take more lending risk. The fiscal policy pendulum has swung and the U.S. is not about to embark on a series of new Great Society-style social programs. In fact, some fiscal discipline on the entitlement side of the fiscal ledger may finally be imposed.

Bottom line: This is not a recipe for recession.

It’s true, rising protectionism remains a possibility, but we think there’s going to be much more smoke than fire on this issue, and that deals will be cut to keep the good parts of NAFTA in place.

Put it all together, and we think the stock market, is set for much higher highs in 2018. If you’re brave enough to attempt trading the inevitable ups and downs of markets, more power to you, but as hedge fund performance shows, even the so-called pros have a hard time doing this. Stay bullish!

630-517-7756 • http://www.ftportfolios.com

Don’t Time a Correction

Brian S. Wesbury – Chief Economist Robert Stein, CFA – Dep. Chief Economist Strider Elass – Economist

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

1-16 / 7:30 pm

Empire State Mfg Survey – Jan

19.0

18.0

17.7

19.6

1-17 / 8:15 am

Industrial Production – Dec

+0.5%

+0.5%

+0.2%

8:15 am

Capacity Utilization – Dec

77.4%

77.4%

77.1%

1-18 / 7:30 am

Initial Claims – Jan 13

250K

251K

261K

7:30 am

Housing Starts – Dec

1.275 Mil

1.262 Mil

1.297 Mil

7:30 am

Philly Fed Survey – Jan

24.8

31.8

27.9

1-19 / 9:00 am

U. Mich Consumer Sentiment- Jan

97.0

97.0

95.9

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook: https://www.ftportfolios.com/Commentary/EconomicResearch/2018/1/16/dont-time-a-correction