It is the month of the dead cat bounce. Just like employment, retail sales rebounded in July after three strong months in January, February and March followed by three weak months in April, May and June. Industrial production in manufacturing followed a similar pattern, except its strong months were December, January and February, followed by weakness in March, April and May. Now June and July have leveled out at roughly the earlier average growth rate. All these indicators tell us that the see-saw pattern of the past three years is still with us, but that the worst of this summer’s uncertainties may now be in the rear view mirror as the certainty of the election approaches. Firms no longer need to retrench to offset the earlier weather related pop, but they are still on hold before committing to whichever new direction policy will take. There is little doubt a Romney victory will bring a groundswell of activity as businesses anticipate a lower tax, less regulatory environment – even if it may take a while to develop. An Obama victory would bring less of a pop, but some businesses – especially in health care – would feel they were winners with the certainty that Obamacare would survive. For others, while the situation would get no better, it likely would not be worse than the current stalemate. Even the certainty of stalemate would allow some firms to commit to increased investment. In the short term, the conventions will cloud the polls, but the uncertainty on policy will be coming to an end in less than twelve weeks.
The somewhat better statistics on the economy of late have reduced the consensus expectation of a new round of quantitative easing. We feel even more certain that the Federal Reserve will not tempt the legislature by creating more unused reserves before the election – barring a serious collapse in growth that does not seem imminent. Both Romney and Ryan have argued against quantitative easing, and many within the tea party and more conservative edges of the Republican Party openly question the need for the Fed. This is not just about Bernanke keeping his job. This is about the independence of the institution. Anyone who does not believe the Fed is concerned about outside influence need only look at the European Central Bank – long the bastion of a low inflation only mandate – to see how a central banks culture can be warped. The Bundesbank is appalled at where Draghi has gone, but to fail to adjust to political realities threatens the longer term viability of the institution. First, do no harm applies to the Federal reserve’s own self protection even more than to the economy in the current polarized political environment. We see the bar for fresh quantitative easing as far higher than the consensus – putting the onus for policy change right back on the executive and legislative branches of government, where it belongs.
Despite the see saw pattern so far this year, the economy is muddling along with decent growth in part due to weak year ago comparisons. Retail sales for the past three months are up 4.3% from the same period a year ago. Much of this was due to strong auto sales as they rebounded 6.8% over the past year rising from the post-Tsunami lows. Excluding the auto surge, retail sales were up 3.3%, practically matching the 3.4% rise in wages and salaries (as measured by hours worked times average hourly pay) during the same period. With headline CPI running at a muted 1.4% gain over that period, real retail sales ex-auto rose at 2.0%, muddling along with the rest of the economy. As we have noted many times before, the biggest plus for the economy is likely to come from a reduction in layoffs in the government sector, which allows for stronger overall wage growth and a modest upside to the economy driven by increased spending as austerity fades.
Industrial production in manufacturing has also moved largely sideways over the past year, and is currently running 5.3% for the past three month average compared with the same three months a year ago. Again, autos provided some of the boost as production of motor vehicles and parts is up 18% from a year ago. Excluding autos, factory output is up 4.2%. The pattern has been wavy, as with all data this year – but current indicators of near term growth are not bright. New orders in the Philadelphia Federal Reserve Index were negative for a fourth straight month, suggesting the pause in factory activity will continue in the near term. However, as year ago comparison are easy, since manufacturing output rose just 0.2% last August, for firms that focus on year on year growth the picture still looks decent through the end of the year.
Other indicators this week confirm the muddle through. The closely watched initial claims data had improved in recent weeks back down to the lows seen during the strong period earlier this year. However, the less volatile series on actual benefit receivers has been flat at roughly 3.3 million recipients for several months.
Finally, housing permits continued to climb this month – with single family permits rising to 498,000. This is a 20% rise in the three quarter average compared to a year ago, but still below the 536,000 reached back in March 2010. Similarly, single family starts are up 21% from a year ago, but at 502,000 this month, still well below the 566,000 annual pace set in April 2010. Housing has benefitted from the sharp decline in mortgage rates over the past year as the flight to quality has driven down all rates. Now, ten year note rates are rising again as conviction that the Federal Reserve will undertake a new round of quantitative easing wanes. We are clearly among those who will wait and see if housing can survive even this minor back up in rates.