Introduction

The week's news on the economy is less than uplifting, underscoring trouble in the export sector and hinting at the risk of slowing in the labor market. The lack of upside punch is in keeping with the dovish themes out of the FOMC where wait-and-see is the majority view.

The Economy

Fighting export drag

We know that China is slowing and that Europe and Japan are only scraping along. So, all things equal, U.S. exports would likely be soft in any case. But all things are not equal. The dollar is "uncompetitive," at least that's how some U.S. exporters are putting it. Strength in the dollar makes U.S. exports more expensive to foreigners who then, quite predictably, substitute foreign products and services for the U.S. products and services they had been buying.

Don't let all the talk about offshoring and the death of U.S. manufacturing fool you, exports are big business and still a major piece of the U.S. economy, tracking in the first quarter at an annualized pace of $2.26 trillion as seen in the accompanying graph. That comes out to 12.8 percent of the nation's $17.70 trillion economy. Thanks to the disproportional growth in the exports of services, where U.S. professional and technical services are in high demand, this proportion is actually higher, not lower, than third-quarter 2007 when exports made up 11.6 percent of the economy or, for further reference, even further back in first-quarter 2000 when exports made up only 10.5 percent of the economy.

Another look at the graph shows, unfortunately, a big step down in exports in the first quarter of this year. The quarter-to-quarter drop, which comes out to 4.0 percent, is only the fourth of the recovery and is by far the biggest — the biggest in fact since the 2008-09 calamity. Exports shaved 0.8 percentage points from first quarter GDP, pulling it into the negative column at minus 0.2 percent. The first quarter, of course, was filled with special factors including unusually severe weather and also the West Coast port slowdown which choked off trade. But exports were already weak going into the first quarter. Look closely, the fourth quarter, as the graph shows, was another one of those rare quarters showing an export contraction.

This week's big highlight on the calendar was monthly export data, out of the international trade report where exports took a beating, down $1.5 billion in May to a monthly $188.6 billion. If April exports got a boost from the unwinding of the port slowdown, May didn't get one at all. Outside of February and March, May's exports were the lowest monthly total since May 2013. Yet despite May's weakness, the second-quarter comparison with the weak first quarter is very easy and exports still look to contribute modestly to quarterly GDP.

How much of the weakness in exports can we blame on the dollar? The accompanying graph tracks monthly export data against the trade weighted dollar, which is a closely followed index published by the Fed. The decline in the trade weighted dollar that began in May 2010, at the left of the graph, was followed by a steady sales build for export growth. The large spike on the right of the graph that began in August last year was predictably followed by the ongoing export slump. Since mid-year last year, the trade weighted dollar has appreciated nearly 13 percent. For comparison, exports are down not quite 5 percent over this same time.

The outlook for exports isn't improving. The dollar, up about 0.5 percent since early June, continues to strengthen at the same time that expectations for global economic growth remain soft. Past appreciation of the dollar, as the FOMC concedes, has hurt exports — continuing appreciation won't be any help.

Jobs signals mixed

Janet Yellen, in a speech on Friday, held to the FOMC's view of the labor market, that job growth is improving but much more has to be done. But it's hard to find any improvement at all in the labor market conditions index, a broadly based composite of 19 indicators that the Fed tracks. The current four month run, to be blunt, is completely pathetic, near recovery lows. The index, held down by sub-par payroll growth and declining labor participation, was barely above zero in June and May and was below zero in April and March. As the graph shows, this is the weakest run in three years. Just looking at this index, the Fed won't be in any hurry to announce their liftoff.

And unexpected signals of weakness are now coming out of jobless claims, the one labor report that had been strong most of the year. Initial claims spiked 15,000 higher to 297,000 in the July 4th week, a week however that was holiday shortened and where adjustments are notoriously volatile. Another factor possibly inflating claims is auto retooling and the temporary layoffs that sweep the sector through mid-summer. When weekly data get hit by calendar or other special effects, the trend is the key to watch and it is still tame with the 4-week average, though ticking up to just below 280,000, still no higher than early June.

But there's another current in this report that has also suddenly weakened, and that's continuing claims which jumped 69,000 to 2.334 million which is the highest level since March. And this reading, which lags by a week, is not for a holiday shortened week but the June 27th week. If the weekly jobless claims report doesn't snap back, and right away, expectations for the July employment report will start going south and with it, perhaps, expectations for a September rate hike.

But all is not lost, as the week did offer signals of labor strength. Job openings are definitely on the climb, up 0.5 percent in May's JOLTS report to a record annual rate of 5.373 million. Anecdotal evidence from a run of private economic reports is building that lead times for hiring are up and that the employers are having an increasingly difficult time filling highly skilled positions. For the wage-sensitive hawks at the Fed, this points to a lack of slack — at least a lack of slack at the high end of the labor market. The JOLTS report, which stands for Job Openings and Labor Turnover Survey, offers a number of useful readings including a hires count. The accompanying graph tracks openings against hires over the last couple of years. Hires had far outpaced openings until about a year ago. Now hires, at an annual rate of 5 million even, are below openings. It looks like employers, judging by the build in openings, have some catching up to do which has to be good news for the jobs market.

At least the service is good

It's now time to take our hat off to a great call. The flash PMI services report offered a very early signal of weakness for the month of the June, weakness later confirmed by the month's employment report and vehicle sales. The services index fell 1.7 points in the flash reading (which of course doesn't sound like much) to a level of 54.8 (which is still well above 50 and doesn't sound that bad). But some of the vital signs in the report weren't that great including slowing in output and hiring and contraction for backlog orders. And the 12-month business outlook fell noticeably, underscoring FOMC concerns that lack of business confidence points unfortunately to lack of business investment. All that said, growth in new orders, which is the most important vital sign of all, rose to a four-month high underscoring the solid headline reading.

Now let's turn to the ISM non-manufacturing report. What makes the non-manufacturing report different than the services report? It's the inclusion in the non-manufacturing report of construction and mining, two of 18 sectors tracked in the ISM report and, unfortunately, two of three sectors that reported contraction in June. But the weakness was isolated, as the index rose slightly to a very solid 56.0. The big positive in this report, as it was for the services index, is a strong reading for new orders. The ISM report also offers a separate reading on new export orders which has held safely above the break-even level of 50 every month since April last year. This is a reminder that the strong dollar, in contrast to goods exports, has yet to dent export demand on the services side.

Markets: A sudden conception

For some of us, the first thing we do when we turn our computers on in the morning is look at the Shanghai composite. Why not? It's always interesting. And, unfortunately lately, it's been even more than interesting. Up 6 percent one day, down 6 percent the next. All sorts of new trading rules everyday. Presumably, all this has been triggered by the sudden conception that Chinese growth, instead of rebounding, will continue to slow. A sudden conception magnified perhaps by the extending dominance of high frequency trading.

For the markets, there's always the risk of incoming shells out of nowhere, whether it's stability in China or the latest headline out of Greece. The Fed's coming hike may also prove to be an incoming shell but certainly won't be a surprise, on the contrary. The Fed's communications process has been deliberate and slow and is still not over! Nevertheless, people who appear to be perfectly rational sometimes make less than rational decisions when it comes to the markets. And there's always the risk for the Fed, however totally remote, that some of these people may also be high frequency traders.

It was a volatile week for the U.S. markets though nothing compared to China. Stock market losses approached 2 percent on Wednesday as a technical mishap shut down trading on the New York Stock Exchange for half the session. Stocks then rallied on Friday to end the week little changed, fractionally higher for the Dow at 17,760.

The Bottom Line

Despite weakness in exports and only limited strength in the labor market, the services economy remains solid and the economy keeps chugging along. If GDP begins to settle into a 2-1/2 percent pace, as forecast by the FOMC, that will be the time to expect the Fed's rate hike.

Looking Ahead: Week of July 13 to July 17

Retail sales on Tuesday dominate the week's busy calendar. Solid gains for sales excluding autos could lead to a positive reassessment of the second quarter. Wednesday will follow with industrial production which will offer the first definitive look at the June factory sector – and a positive surprise here could also lead to a second-quarter reassessment. The latest on new homes, one of the emerging sectors of 2015, will be posted later in the week with the housing market index and the closely watched housing starts & permits report. The week will also offer a heavy run of inflation data, from import prices to consumer prices with all, due to food and energy, expecting to show rising pressure at the headline level but not rising pressure for core rates.

Monday

The Treasury budget is expected to show a $51.0 billion surplus in June, down from an unusually large $70.5 billion surplus in June last year. Otherwise, the Treasury's balance sheet has been improving and, seven months into the government's fiscal year out to May, was running 16 percent below the prior year.

Treasury Budget - Consensus Forecast for June: $51.0 billion

Range: $41.0 to $51.0 billion

Tuesday

The NFIB small business optimism index has been accelerating with earnings trends and the outlook both on the rise. The index for June, having jumped 1.4 points in May, is expected to hold steady at 98.3.

ISM Small Business Optimism Index - Consensus Forecast for June: 98.3

Range: 97.5 to 99.2  

Retail sales were May's biggest surprise, jumping 1.2 percent and triggering a run of upward GDP revisions. But June, likely held down by vehicle sales, isn't expected to see an outsized gain, at least on the headline level. The ex-auto reading, however, is seen rising a very strong 0.6 percent as is the ex-auto ex-gas reading.  

Retail Sales - Consensus Forecast for June: +0.3%

Range: +0.2% to +0.6%

Retail Sales, Ex Autos - Consensus Forecast for June: +0.6%

Range: +0.1% to +0.8%

Retail Sales, Ex Autos, Ex Gasoline - Consensus Forecast for June: +0.6%

Range: +0.2% to +0.6%

Import and export prices have been trending deeply in the negative column though headline readings popped higher in May and are expected to show incremental gains in June. Fed policy makers are waiting for price pressures to stabilize and begin moving to their 2 percent year-on-year goal.

Import Prices - Consensus Forecast for June: +0.1%

Range: -0.2% to +0.5%

Export Prices - Consensus Forecast for June: +0.1%

Range: -0.3% to +0.3%

After an unwanted build during the disruptions of the first quarter, business inventories have stabilized this quarter and have been rising in line with business sales. A modest 0.2 percent rise in inventories is expected for May.

Business Inventories - Consensus Forecast for May: +0.2%

Range: +0.1% to +0.5%

Wednesday

Producer prices showed some much wanted upward pressure in May and, at a consensus of plus 0.3 percent, are expected to show pressure again in June. Food and energy prices have been on the rise in recent months but excluding these groups, the core reading for June is only expected to rise 0.1 percent.  

PPI-FD - Consensus Forecast for June: +0.3%

Range: +0.1% to +0.4%

PPI-FD, Less Food & Energy - Consensus Forecast for June: +0.1%

Range: +0.1% to +0.2%

PPI-FD, Less Food, Energy & Trade Services - Consensus Forecast for June: +0.1%

Range: +0.1% to +0.1%

The Empire State index has been dead flat the last several months, pointing to no growth whatsoever for the New York state manufacturing sector. And not much growth is expected in June with the Econoday consensus at a very soft plus 3.5.

Empire State Manufacturing Survey - Consensus Forecast for July: +3.5

Range: -0.5 to +6.0

Industrial production has been consistently weak all year but is expected to inch 0.2 percent higher in June. But this won't be due to strength in manufacturing, at least based on the Econoday consensus which sees only a 0.1 percent gain for the component. Manufacturing production has declined in three of the last five readings.

Industrial Production - Consensus Forecast for June: +0.2%

Range: -0.1% to +0.4%

Capacity Utilization Rate - Consensus Forecast for June: 78.2%

Range: 77.9% to 78.5%

Manufacturing Production - Consensus Forecast for June: +0.1%

Range: +0.1% to +0.4%

Thursday

All Econoday forecasters see improvement for jobless claims with the consensus at 282,000 vs a surprisingly high 297,000 in the July 4 holiday shortened week. The high forecast, at 295,000, is below the prior week's level while the low forecast, at 265,000, would mark a return to one of the lowest levels of the recovery. A downward surprise would boost expectations for the July employment report while an upward surprise, one that would confound the forecasters, would sink expectations for the employment report.

Jobless Claims - Consensus Forecast for July 11 week: 282,000

Range: 265,000 to 295,000

The Philadelphia Fed was the only manufacturing report to signal solid strength in June with a headline of 15.0. Forecasters see less strength this month but the consensus is still very respectable at 12.0. A breakout to the high estimate at 18.9 would raise talk of upside surprises for July's manufacturing sector.

Philadelphia Fed General Conditions Index - Consensus Forecast for July: 12.0

Range: 9.0 to 18.9

The housing market index is expected to hold onto its entire 5-point surge in June, holding at 59 for July. The new home market has been building steam and looks to become a leading sector for the second half of the year.

Housing Market Index - Consensus Forecast for July: 59.0

Range: 58.0 to 61.0

Friday

Consumer prices showed life in May with a 0.4 percent increase and are expected to rise 0.3 percent in June. But the gain is expected to be tied in part to food and energy, excluding which the core reading is forecast to rise 0.2 percent.

Consumer Price Index - Consensus Forecast for June: +0.3%

Range: +0.2% to +0.4%

CPI, Less Food & Energy - Consensus Forecast for June: +0.2%

Range: +0.1% to +0.2%

Housing starts and permits have been volatile and strong in recent months and are expected to remain so in June, with an expected 8.6 percent monthly gain in starts to 1.125 million but a 7.6 percent decline for permits to 1.178 million. Even with such a mix, both readings would point to solid health for residential construction.

Housing Starts - Consensus Forecast for June: 1.125 million

Range: 1.085 to 1.200 million

Building Permits - Consensus Forecast for June: 1.178 million

Range: 1.070 to 1.265 million

Consumer sentiment has been very strong and is expected to remain so in the first reading for July, at a consensus 96.0 vs May's 96.1. Expectations have been the standout component, pointing to confidence in the jobs outlook and the income outlook. The current conditions component has also been solid and will offer indirect hints on consumer spending during July.

Consumer Sentiment - Consensus Forecast for Preliminary July: 96.0

Range: 94.5 to 98.0