Your Weekly Economic Cheat Sheet – 6.30.2014

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Last Week

There were three important economic takeaways last week:  First, housing appears to be finally bouncing from its winter dip.  Second, capital spending (businesses buying a new machine or some other high-cost investment) continues to not rebound like the rest of the economy has since the winter.  Third, inflation has clearly accelerated over the past three months, but economic growth doesn’t appear to be keeping pace with the recent acceleration in inflation.

Of the three, the final point is by far the most important. While it’s very early yet, if the economy can’t keep pace with accelerating inflation, then we risk stagflation, which is bad for most assets (bonds and stocks).  We aren’t anywhere close to stagflation, but after the data last week, it’s something we need to keep an eye on.

Looking at the actual data, the Personal Income and Outlays report was the most important release last week, and the main cause of the “stagflation” worries.  Core PCE, the Fed’s preferred measure of inflation, rose +0.2% in May and is now up +1.5% year-over-year (yoy), and that met expectations.  More importantly, though, Core PCE has gone from rising +1.1% yoy in February to +1.5% in May. If we annualize the last three months’ gains, we get an annual core PCE increase of +2.1%, basically at the Fed’s target.  This recent acceleration confirms what we’re seen recently in CPI.

At the same time, though, while the economy is continuing to recover, it’s not matching the gains in inflation over the past three months.  Case in point: May consumer spending slightly missed expectations, increasing +0.2% vs. (E) +0.4%, and real consumer spending (consumer spending less inflation) was actually negative in April and May.  So, the key here isn’t that the economic recovery has stalled—it has not.  But, over the last few months, the economy hasn’t grown as quickly as inflation has.

Capital spending, however, still isn’t seeing the rebound in activity that other sectors of the economy have enjoyed since April.  The May Durable Goods report headline declined, but the real number to watch (Non-Defense Capital Goods Excluding Aircraft) rose +0.7% and the three-month rolling average showed a +1.5% gain.  But, while it’s a positive number, it’s not strong growth.

With housing now showing clear signs of a rebound, capital spending (again, think investment by businesses in machines, etc.) is the one sector of the economy that still hasn’t gotten a bounce. This probably reflects continued caution by businesses on the future of the economy (i.e., things are getting better, but not enough to make large investments because people aren’t confident in revenue visibility).

Bottom line with last week: Nothing resulted in a material change in the outlook for the economy or Fed policy. But the recent acceleration in inflation/less than impressive consumer spending report (and extrapolating it out to potential stagflation) bears watching.

This Week

It is going to be a busy holiday-shortened week (the market closes at 1 p.m. EST Thursday and Friday is off).

Probably the most important number of the week has already been released, and it was the European flash HICP for June (their CPI).  The annual inflation rate ticked slightly higher to 0.8% vs. 0.7% in May (meeting expectations) so that’s slightly encouraging, but overall the deflation threat in Europe remains and this will keep the ECB fully “engaged” in the deflation fight.

Turning back to the future data, it’s “jobs week” this week, although be aware the May jobs report will be released Thursday at 8:30, at the same time as weekly claims.  Prior to that we get ADP on Wednesday.  The jobs report isn’t as critical as it has been in recent months, but it still is important.  In the context of our “stagflation” point earlier, markets will be watching for jobs growth in line with recent reports (so around 200K). If there is an increase in wages and hours worked, this will imply tightening in the labor market (which is both inflationary and positive for consumer spending).

Tomorrow we get global official June manufacturing PMIs, which should continue to confirm the consensus that: The pace of economic growth in China has stabilized, Europe’s economy continues to slowly recover, and the manufacturing sector of the U.S. economy is seeing the recovery accelerate.

The biggest risk of disappointment in this report is in Europe, as France’s flash PMI was pretty bad (47.8) while the overall EMU was stagnant.

Finally, as if all that wasn’t enough, Fed Chair Janet Yellen speaks Wednesday (we can expect similarly “Dovish” remarks like the last FOMC meeting) and there is an ECB meeting.  But, after their attempt to “shock and awe” the market last month, this meeting should be a non-event.