Fed Regards Economic Growth As “Strong” For Only The Second Time This Century

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By: Kent Engelke | Capitol Securities

Was yesterday’s FOMC meeting one for the record books? According to Capital Economics, for only the second time this century, the committee described economic growth as “strong.” The only other time since 2000 that the Fed has described economic growth as strong in its policy statement was May 2006, just after the GDP posted a 5.4% annualized increase. Wow!

On inflation, the statement simply noted that headline and core inflation “remain near” 2% and that inflationary expectation have been little changed. I think the FOMC is underestimating the degree to which inflation will rise in the second half of the year. Most measures of underlying inflation are still trending higher.

Regarding trade, there was no reference surrounding the uncertainty of policy, noting only that risks to the economic outlook appear “roughly balanced.”

There was little change in the monetary policy outlook as most are convinced the Fed will increase the overnight rate two more times in 2018.

The question at hand is whether or not the economy will slow in 2019, the result of higher interest rates and the waning effects of fiscal stimulus. I think ‘no’ for three simplistic reasons.

First, the tax cuts are stimulating the supply side of the economy. It is less sexy and politically less popular than stimulating the demand side via transfer payments and the like, but typically the results are long lasting. The supply side was stimulated by President Reagan and in the late 1990s, by President Clinton.

In both instances, growth was in excess of 4% for several years.

The second is jobs. Yesterday’s release of the ADP Private Sector Employment Index suggested job creation is accelerating. I believe there is a vast pool of available workers that are now beginning to migrate back into the workforce. These potential workers are not counted in the official data for statistically they do not exist. As these workers re-enter the workforce, economic activity will accelerate.

Additionally, according to the Employment Cost Index (ECI), or the widest measure of compensation measures, US workers received their biggest pay increase in nearly a decade over the 12 months ending in June.

The third is housing. Most people measure their net worth by the value of their homes, not their stock accounts. Because of policies enacted after the financial crisis of 2008-09, home building was greatly curtailed that has created spot housing shortages and rising prices.

As evidenced by Owners’ Equivalent Rent (OER) or what someone thinks they can rent their home for if the property was indeed a rental, most believe their homes have yet to rise in value. [Note: OER dropped precipitously in 2009-10 and has not significantly rebounded… rental rates and home values are closely correlated.]

Housing prices are now rising in secondary and tertiary markets which should ultimately cause a rise in OER [and inflationary expectations], which in turn will support consumer spending and sentiment.

Some will write my views are Pollyannaish. Change is the only certainty. Multipolarity, interdependency and the massive stimulation of the demand side of the equation did not create balanced growth. In fact, it increased wealth inequality.

Society demanded a change. Based upon the Fed’s pronouncement that the economy is “strong” for only the second time this century, government is delivering on this demand.

All must remember government does not create jobs. Government can only create policies that are conducive to job creation and economic growth.

What will happen today?

Last night the foreign markets were down. London was down 1.31%, Paris was down 0.68% and Frankfurt was down 1.65%. China was down 2.19%, Japan was down 1.03% and Hang Sang was down 2.21%.

The Dow should open considerably lower as trade concerns are again rattling the markets. The 10-year is up 8/32 to yield 2.98%.

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