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Economy May Be Stronger Than The Fed Thinks

The Fed is underestimating some of the risks, particularly inflation, says Morningstar’s Bob Johnson.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. In a speech this week Fed chair Janet Yellen expressed some caution about further rate increases this year. I'm here with Bob Johnson, who is our director of economic analysis, see if this caution is warranted.

Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: Let's start with the speech that obviously moved the market higher, but do you think that [Yellen] is underestimating some of the risks, particularly to inflation, in the U.S. economy right now?

Johnson: You know I think they are, and certainly her speech was tame, and it certainly calmed markets and certainly caused a little bit of a run in prices, as everybody said "Oh, well she is not planning to raise rates immediately." But I do think that they are thinking everything is kind of fine, and the economy might be a little bit dicey is probably not the right analysis. I think inflation appears to be heating up, and sure a couple of the consumption numbers looked weak. We can talk about that, but I really think that the economy is stronger than they are thinking, especially here in the U.S. and that inflation is running perhaps higher than they think it is.

Glaser: Well, let's look at some of that data that we have this week. That consumption number was disappointing, some disappointing revisions to previous data, what did it show us about strength of the consumer?

Johnson: Yeah, it showed us that the January number was revised sharply downward. But we knew that might happen, because the retail sales report was revised down sharply, and recall there were a lot of things going on. There wasn't much utility usage, because it was such a warm winter and that's a big number in the consumption calculation and certainly that weighed on it. Some of the auto data, some of the clothing data weighed on it. Clothing, because again the weather; autos, because of seasonal factors.

So, we really think that the consumption numbers that looked a little bit weak even when you combine the first two months of the year, were not as weak as they look, and again, those are the kinds of things when we have anomalies that can bounce back in a single month and it's all of a sudden, oh, yes, we grew 3% another month, and then you average out and you look pretty good.

Glaser: So that's some caution there. But in housing there was some good news.

Johnson: Yes. The pending home sales has been like a key indicator of the housing market and especially existing home sales. And existings didn't look so good a couple of weeks ago, but the pendings kind of relieved some of those worries, because the pending data has been relatively steady in a very tight band for the last five or six months, kind of between 106 and 109, and now we're at the high end of that at 109. And existing homes kind of been all over the place as we've had problems with paperwork and weather and a couple of other factors have kind of played with the numbers a little bit.

The fact that pendings have been so consistent and now are at the higher end of their normal band, seems to suggest to us, that isn't falling apart, if anything. That seems to be strengthening and that's probably a better gauge than some of the existing home data we've seen lately.

Glaser: Housing is looking stronger. How about employment? We've got a preview of Friday's report with the ADP numbers. 200,000 jobs added, is that about what you'd expect right now?

Johnson: It is. As a matter of fact I mean that's the private sector number, but I think even when you add the government in, on Friday's report, the official government report we'll probably also see about 200,000 jobs, I think that's a consensus estimate and that's where we are at. You know we are kind of get there in that we had a very strong month in February above expectations at 242,000, 12-month average has been about 220,000-222,000. And so I think we are going to come back to average this time around and we'll undershoot right about say 200,000 and we average the two months together you'll get to our average of 220,000 or so jobs added. And that number is relatively consistent with kind of the 2% to 2.5% GDP growth.

So I think the numbers there are beginning to fit together and we're pleased to see that the employment numbers are looking good because I think although I have railed against those numbers is being coincident or maybe even lagging, jobs added is relatively concurrent, it's the unemployment rate that is kind of the lagging one of the batch. I think the fact that they've been so relatively stable for many months here seems to indicate to us that the overall underlying strength of the economy is pretty good. We've got weather; we've got inventories; we've got different financial shocks; we got oil prices jumping around. All those things are moving some of the data around. But to see underlying employment growing at this kind of relatively consistent rate seems to indicate to us that economy is pretty steady. 

Glaser: So you see maybe some of the steady or good data from some sectors. What would you be looking at then in terms of inflation where we can start to really get worried? What's going to be on your radar screen there? 

Johnson: On the inflation front, we're deeply worried about the services sector, which has got inflation according to CPI well over 3%, not well over but 3.1%. So I think that, that's certainly a problem area anytime you get near 4% of anything that's a real danger sign and that's when you've got a real problem. I don't think we're there yet, but I think you do have to worry. And certainly gasoline prices we were just checking this morning were up about 11% in March after a substantial month down in February kind of offsetting each other almost. Even when you adjust for the big seasonal factor, which was a huge one in March, the 11% hike still translates into a 3% seasonally adjusted hike, which is something we haven't seen for a little bit. So that's, that's certainly something that's going to weigh on the headline inflation not just in maybe some of the people will pay more attention to core when they see the headline number is strong as it's going to be. 

Glaser: Well Bob thanks for your take on this data today and we'll talk to you on Friday when we get those official numbers for your read on that report. 

Johnson: Thank you.

Glaser: From Morningstar I'm Jeremy Glaser. Thanks for watching.