Introduction

An incremental shift has been underway this year in the U.S. economy, from moderate growth and subdued inflation to strong growth and moderate inflation. For the Federal Reserve, which is now focused, instead of boosting inflation, on keeping it right where it is, a little less growth and no additional inflation would be very welcome. A look at the week's economic data points to such a favorable mix.

The economy

The most important economic vital sign of all is growth in consumer spending and it has been slowing slightly over the past four months in what may actually be an ideal outcome. Spending rose a month-to-month 0.35 percent in July, down from 0.37 percent in June and a February peak of 0.62 percent. Unusually strong rates of growth for consumer spending, which has averaged a monthly 0.33 percent over the 9 years of the ongoing expansion, would very likely be seen by Fed policy makers as unsustainable, raising the risk of boom and bust. The slowing in July was due to a second straight flat month for auto sales though services, which make up the bulk of consumer spending, also slowed to what is still very good monthly growth of 0.41 percent.

Another key vital sign for the economy is real growth in disposable income which is solid enough, at a year-on-year 2.9 percent in July as tracked by the blue line of the graph. Improvement, however, is down 1 tenth from 3.0 percent the prior month and back to where it was in June last year. This year's tax cut together with strength in the labor market and the moderate rate of inflation are all helping to support disposable income which, through the second half of 2015 and first half of 2016, had been in a nosedive. The green line tracks year-on-year growth in real consumer spending which has held within the 2 to 3 percent range the past 2-1/2 years. When removing the inflation adjustment, both of these lines move from the 3 percent to the 5 percent lines.

Let's now turn to the business side of the economy. Here, the effects of this year's tax cut are striking. Pre-tax corporate profits have been moving up vigorously but not nearly as much as after-tax profits. Profits were at a pre-tax annualized rate of $2.151 trillion in the fourth quarter before the tax cut took effect and came in at $2.250 trillion in the second quarter for a 4.6 percent gain in just six months. Not bad, right? But after-tax profits over the same period are up 10.8 percent from $1.817 trillion to an annualized $2.013 trillion. This contrast is visible in the squeezing between the areas on the right side of the graph. Businesses are paying less taxes and are keeping more of what they earn. The annualized rate for corporate taxes was $237.1 billion in the second quarter, down nearly $100 billion from the fourth quarter's $333.9 billion rate.

Yet another big positive for the economy, and one hidden compared to the attention on consumer spending or corporate profits, is the nation's level of inventories. Inventories are really in a sweet spot right now, lean and beginning to grow at a time when demand is strong. Inventories at the nation's wholesalers jumped a far higher than expected 0.7 percent in July and was solidly led by a 0.9 percent rise in durable goods. Inventories at retailers also rose nicely, up 0.4 percent leaving only manufacturer inventories as the missing piece for July. And based on a jump in advance data on durable inventories at manufacturers, a strong jump is indicated here as well. Inventory growth in the second quarter was apparently slowed down by unusually long delays in delivery times, the result in part of truck driver shortages which, according to anecdotal reports, are now apparently beginning to ease. And, based on final demand, inventories will continue to build, evidenced by June inventories which were up a year-on-year 4.0 percent in a mismatch compared to an 8.2 percent rise for sales.

A continuing build in inventories would prove to be a major plus for third-quarter GDP which may need a plus. Not only did consumer spending open the quarter on a flat note but the nation's trade balance in goods deepened sharply during the month. Amid ongoing uncertainty over tariffs and U.S. trade, the goods deficit totaled a much deeper than expected $72.2 billion in July. Exports of goods fell 1.7 percent to $140.0 billion showing a very steep 6.7 percent month-to-month decline in food & feeds together with a 2.5 percent dip in exports of consumer goods as well as a 1.7 percent drop in the nation's largest exports, that of capital goods. Imports also added to the widening of the deficit, up 0.9 percent compared to June to $212.2 billion with foods & feeds up 2.1 percent, vehicles up 1.6 percent, and industrial supplies, which include petroleum products, up 0.9 percent. The nation's largest import category is consumer goods which was the only category to fall on the import side of the data, down 1.5 percent in the month in what may be a trend to come should President Trump impose tariffs on $200 billion of Chinese imports early next month. But what ifs aside, July's deficit makes net exports an uphill battle for third-quarter GDP.

Now let's turn to housing where bad news is this year's theme and with more trouble apparently in store. Initial contract signings for resales, as tracked by the red line of pending home sales, fell 0.7 percent in July to an index level of 106.2. Final sales, as tracked in the green columns, have been trending lower since late last year, down from a November peak at 5.720 million to a 5.340 million rate in July and a fourth straight month of slowing. These results for pending sales will further lower expectations for housing, the weakest sector of the economy and one that has pulled GDP down in four of the last five quarters.

For policy makers looking for trouble spots, housing is increasingly standing out. Home values are essential to the welfare of the nation's households and this year's trend is clearly slowing. Case-Shiller's adjusted 20-city index, the dark red columns in the graph, fell to year-on-year growth of 6.3 percent in data for June. This reading peaked at 6.7 percent earlier in the year while the FHFA house price index, the pink columns, peaked at 7.6 percent in February. Price weakness in the Case-Shiller data is coming out of the major cities of the Northeast and Midwest including New York and Chicago. The price slowdown no doubt reflects the slowdown underway in home sales though the good news is that lower prices, in a standard economic balance, should help give sales a boost.

Home prices move us to another economic vital sign and that's inflation. Inflation is running very similar to the latest indications on overall economic growth, and that is slight slowing at a very favorable level. The core PCE price index rose barely 0.2 percent in July, actually 0.16 percent as tracked in the graph's dark columns which just about matches the 0.17 percent monthly average over the last 12 months. Costs related to housing, in a reflection of the downturn in home values, have been moderating as have food and apparel costs with medical care stable.

Not only is the monthly inflation rate favorable but the year-on-year rate is right on target, up 1 tenth at 2.0 percent in July as tracked by the lower line in the graph. If the Fed should be judged by their inflation results, so far they get a perfect score for the year. Policy makers at the central bank probably don't want any greater acceleration in the economy and the related risk that it could lift inflation above target. The top line of the graph is average hourly earnings which likewise have been on a sideways trend, at 2.7 percent in the last report for July. This reading will be a key highlight of the upcoming week where Econoday's consensus is calling for an incremental rise to 2.8 percent.

Vital signs for inflation not only include actual inflation but perceived inflation, that is the outlook for inflation. Jerome Powell focused on the need to keep inflation expectations stable in his Jackson Hole speech of the prior week, attributing the lack of inflation this expansion to steady inflation expectations which he describes as the central precondition for monetary policy. But these expectations are perhaps becoming less favorable. Business expectations, as measured by the Atlanta Fed, have been steady at just over the 2 percent line but consumer expectations, as measured by the University of Michigan, have been creeping higher to the 3 percent line. It's this movement here, however slight, that also perhaps points to the desirability of a little less momentum in the economy.

We can't close out the week's data run without pointing to the August consumer confidence report, the green line of the graph which spiked 5.5 points higher to 133.4 for the strongest result since the dotcom fever and irrational exuberance of October 2000. The gain reflects unusually strong assessments of the labor market and unusual optimism over job and income prospects. The rival sentiment index, the blue line of the graph, is not rising but the report is still warning that optimism over job and income prospects are unusually optimistic. This it warns has preceded economic downturns in the past. How can we read these two reports which are going in opposite directions?  Perhaps a middle ground is the best answer, that is accelerating optimism at a solid and favorable pitch.

Markets: Stock markets advances, rates edge higher

Stocks moved higher in the week, benefiting from a trade agreement with Mexico, expectations of a trade agreement with Canada, and despite the prospect that the U.S. may impose heavy tariffs on China early in the coming week. But Treasury yields also moved higher and are a reminder that Federal Reserve policy is a headwind for economic growth. The 10-year Treasury yield ended at 2.86 percent for a 5 basis point gain on the week with the 2-year up 3 basis points to 2.64 percent, results that eased back the spread between the two to 22 basis points. It's the convergence of these two yields as the Fed raises short-term rates that has focused attention on the risk of recession. The dollar, meanwhile, has not been showing increasing strength, posting little change on the week and up only 3.1 percent so far this year, a small reversal of the prior year's 10 percent drop. The Dow posted a 0.7 percent gain on the week to 25,964 while the Nasdaq had a much better week, up 2.1 percent. Year-to-date gains are a respectable 5.0 percent for the Dow and an overheated looking 17.5 percent for the Nasdaq.

The bottom line

There has been plenty of concern this year over capacity stress, an issue highlighted by the sub-4 percent unemployment rate not to mention delivery disruptions and rising input costs for producers. The stimulative effects of tax cuts and rise underway in government spending are further concerns. These are all traditional risks for the inflation outlook. Yet the moderate July showing for consumer spending and the deepening in the trade deficit make another 4 percent quarter for GDP a less likely outcome and with it lower the risk of more aggressive than expected rate hikes from the Fed.

Week of September 3 to September 7

A heavy and important week made more compact by Monday's Labor Day holiday opens with manufacturing data on Tuesday starting with Markit's PMI, which softened at mid-month, followed by the ISM where a second month of moderation is the call. Shortages and tariff effects have been holding down construction with the latest update on spending also out on Tuesday. International trade data for July will be posted on Wednesday and, based on advance data for goods, a very slow start for third-quarter net exports seems certain. The week's sleeper is motor vehicle sales which will be posted late Wednesday amid expectations for yet another month of subdued results. The next day will offer last looks at August's labor market ahead of Friday's employment report including ADP, pushed to Thursday from Wednesday because of Monday's holiday, together with Challenger's layoff count and jobless claims data both of which have been unusually stable, low and favorable. Later Thursday morning will see service-sector updates from both Markit and ISM amid expectations for a flat reading in the former and reacceleration in the latter. The week caps off with what is expected to be a tangibly strong employment report for August which is expected to show a 198,000 rise in nonfarm payrolls, a downtick in the unemployment rate to 3.8 percent, and an uptick in average hourly earnings to a 2.8 percent yearly gain.

Tuesday

PMI Manufacturing for August Final

Consensus Forecast: 54.5

Consensus Range: 54.5 to 54.7

The PMI manufacturing index posted its slowest reading of the year in the August flash as orders, output and hiring all slowed. No change is expected for the flash with Econoday's consensus at 54.5 for the final August score. This index ended July at 55.5

ISM Manufacturing Index for August

Consensus Forecast: 57.6

Consensus Range: 56.5 to 58.1

Continuing moderation is what Econoday's forecasters see for the August ISM manufacturing index where the consensus is 57.6 vs a 58.1 result in July that barely made the low end of the consensus range. On the plus side, July's slowing likely gave this sample some breathing room as delivery delays, input costs, and the build in backlogs have been unusually severe this year.

Construction Spending for July

Consensus Forecast, Month-to-Month Change: 0.4% 

Consensus Range: 0.1% to 2.3%

In what has been an even more volatile year than usual for construction spending, the expectation for July is a moderate 0.4 percent bounce higher following a 1.1 percent drop in June that followed a 1.3 percent spike in May. Both residential and non-residential spending fell back in June with multi-unit housing showing significant weakness. Note that shortages of labor and high costs for materials are common complaints coming out of the construction sector.

Wednesday

International Trade Balance for July

Consensus Forecast: -$50.2 billion

Consensus Range: -$51.2 to -$44.8 billion

Tariff effects are still hard to isolate in the nation's data but the consensus for July's international trade balance is a sharp widening in the deficit, to $50.2 billion following $46.3 billion in June and a second-quarter average of $45.2 billion. July's forecast is based on advance data for goods which showed a very sharp drop in exports together with a rise in imports; the outcome in July will mark a key early entry in third-quarter GDP.

Total Unit Vehicle Sales for August

Consensus Forecast, Annualized Rate: 16.9 million

Consensus Range: 16.7 to 17.2 million

Domestic-made Unit Vehicle Sales

Consensus Forecast, Annualized Rate: 13.0 million

Consensus Range: 12.9 to 13.2 million

Not contributing much to growth in consumer spending, vehicle sales have been flat this year including the last three results with very little strength the call for August. The consensus for August unit vehicle sales is a 16.9 million rate vs 16.8 million in July which was the lowest showing since August last year. Looking at just domestic-made unit sales, the consensus is calling for a slight decline, to a 13.0 million rate vs July's 13.1 million.

Thursday

ADP, Private Payrolls for August

Consensus Forecast: 182,000

Consensus Range: 170,000 to 205,000

Econoday's consensus for ADP's private payroll estimate in August is 182,000 which would compare with 219,000 in ADP's July estimate and against 170,000 in the government's data for July. ADP sharply over-estimated July's strength in the labor market after underestimating strength in the prior two reports.

Initial Jobless Claims for September 1 week

Consensus Forecast: 213,000

Consensus Range: 205,000 to 217,000

Initial claims are expected to come in at 213,000 in the September 1 week, unchanged from the prior week. The 4-week average in the prior week, at 212,250, hit a 50-year low.

Nonfarm Productivity, 2nd Estimate, 2nd Quarter

Consensus Forecast, Annualized Rate: 3.0%

Consensus Range: 2.8% to 3.2%

Unit Labor Costs

Consensus Forecast, Annualized Rate: -1.0%

Consensus Range: -1.1% to -0.7%

A sharp rise in the growth of output together with slowing growth in the number of hours worked made for a sizable 2.9 percent rise in the first estimate of second-quarter productivity and, along with slowing growth in compensation, pulled down labor costs which fell 0.9 percent. Expectations for the second estimate of nonfarm productivity are 3.0 percent and minus 1.0 percent for unit labor costs.

PMI Services for August Final

Consensus Forecast: 55.2

Consensus Range: 55.2 to 55.7

Reflecting slowing in orders and employment, PMI services sank back 1 point at the mid-month August flash, coming in at a still very solid 55.2 though down from 56.2 in the final reading for July. The consensus for the final reading of August is for no change from the flash, at 55.2.

Factory Orders for July

Consensus Forecast, Month-to-Month Change: -0.7%

Consensus Range: -1.2% to -0.4%

Advance data on the durables side of the factory orders report showed a sharp aircraft-related decline at the headline level which, however, masked a very strong showing for core capital goods. Forecasters see factory orders in July, which will include initial data on non-durable goods, slipping 0.7 percent.

ISM Non-Manufacturing Index for August

Consensus Forecast: 56.8

Consensus Range: 55.5 to 57.5

Re-acceleration is what forecasters expect for ISM's non-manufacturing index for August, at a consensus 56.8 vs a 55.7 in July that came in below Econoday's consensus range. Despite the softening in July, input costs continued to accelerate.

Friday

Nonfarm Payrolls for August

Consensus Forecast: 198,000

Consensus Range: 150,000 to 237,000

Unemployment Rate

Consensus Forecast: 3.8%

Consensus Range: 3.8% to 3.9%

Private Payrolls 

Consensus Forecast: 190,000

Consensus Range: 160,000 to 237,000

Manufacturing Payrolls 

Consensus Forecast: 21,000

Consensus Range: 12,000 to 29,000

Participation Rate

Consensus Forecast: 62.8%

Consensus Range: 62.7% to 62.9%

Average Hourly Earnings

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.2% to 0.3%

Average Hourly Earnings

Consensus Forecast, Year-on-Year Change: 2.8%

Consensus Range: 2.7% to 2.8%

Average Workweek

Consensus Forecast: 34.5 hours

Consensus Range: 34.4 to 34.5 hours

In what is expected to be a strong August report, a 198,000 rise is Econoday's consensus for nonfarm payrolls with the unemployment rate seen falling 1 tenth to 3.8 percent. A 0.3 percent increase is the call for monthly average hourly earnings with this year-on-year rate also expected to rise 1 tenth, to 2.8 percent. Private payrolls are seen rising 190,000 with manufacturing payrolls expected to show another very solid increase at a consensus 21,000. The workweek is seen unchanged at 34.5 hours with the labor participation rate down 1 tenth to 62.8 percent.