Introduction

The Federal Reserve raised interest rates in the week and stood firmly by its plan to continue to do so through next year. Their ultimate aim is to slow growth in the labor market where job openings are going up at the same time that the number of people looking for work are going down. In reviewing the week's run of data, we'll start with the consumer where the news is mixed, then trade where the news is bad followed by inventories, housing and a few surprises.

The economy

Consumer spending was the big highlight of the second quarter but the momentum appears to have fizzled in the third quarter. Spending rose 0.33 percent in August and 0.45 percent in July but is down compared to the second quarter which averaged a monthly 0.51 percent. Unless September proves to be a blockbuster month, and there's no early indication that it will, third-quarter consumer spending will not match the annualized and inflation-adjusted 3.8 percent rate of the second quarter. And without strength in consumer spending, the second-quarter's overall 4.2 percent GDP rate is plainly out of reach. This makes the second quarter look like an outlier and is a reminder that the 3.8 percent spending rate was the second highest in 3-1/2 years with GDP the very highest in nearly 4 years.

But when looking at inflation-adjusted data, which is the economy's real bread-and-butter, spending looks more solid. Real consumer spending, on a year-over-year basis, rose 3.1 percent in August for the best showing in nearly three years. This belies the slowing in the month-to-month nominal comparison. And for the actual nuts-and-bolts of being a consumer, real year-over-year disposable income, at 2.9 percent, is holding right at a 3-year best. Disposable income is what we get after taxes are taken out, and much of the resilience is due to this year's tax cut.

Turning now to a very clear negative for third-quarter GDP, let's look at net exports. Amid the unfolding of tariff effects, the nation's trade deficit in goods was a whopping $75.8 billion in August with exports down a very steep 1.6 percent for a second straight month. Imports are also a negative for the trade balance, rising 0.7 percent following a 0.9 price increase in July. The monthly goods deficit has been larger but not by much, eclipsed only by $76.0 billion in February this year. The monthly average so far in the third quarter is $74.0 billion which compares very unfavorably with a $67.6 billion average in the second quarter. This points to a major drag for GDP.

Exports of agricultural products plunged 9.5 percent in August to $11.9 billion which follows a 6.3 percent monthly drop in July. Whether this is an emerging trend tied to trade war or just moderation from a high level is something that has yet to be answered. Looking at imports of agricultural products, they fell 1.2 percent in August to $12.3 billion. Other details in the trade report include a sharp decline in exports of industrial supplies as well as vehicles. The import side shows an increase in vehicles and also consumer goods which are nation's two sorest spots for trade. A positive for the trade balance but not for business investment is a decline in imports of capital goods. Country balances aren't posted with the advance report on goods but will follow with the coming week's international trade report which will also include services where the U.S. runs a substantial surplus.

A major offset to the downward pull from trade is likely to be an upward push from inventory growth. The nation's businesses, enjoying strong sales, are scrambling to keep inventories high enough to meet demand. They are also stockpiling goods on concerns over tariff-related shortages as well as concerns over lengthening delivery times, with the latter tied to a lack of truckers and general constraints in the supply chain. Falling inventories, drawn down by the strength in demand, pulled GDP lower in the second quarter by a very sizable 1.2 percentage points. Without the abstraction of inventories, second-quarter GDP would have been 5.4 percent, not the 4.2 percent annualized growth rate that's in the books. But now a favorable reversal is in the works with inventories poised to rise sharply in the third quarter. Turning to the graph, the near wall is wholesaler inventories which rose to $641.5 billion in August for a 1.4 percent gain from the second quarter's closing level in June. Retailer inventories, the second wall, are at $643.0 billion for a 1.3 percent gain from June. Manufacturers' inventories, the far wall, rose sharply in July though the early indication for August is negative after a draw in durable inventories (nondurable inventories are yet to be posted). In any case, the pop higher for inventories is visible and will be a timely offset to the trouble underway for net exports.

Speaking of trouble, there may be some brewing for housing that could spell difficultry for the residential investment component of third-quarter GDP. Home prices can have a major effect on the economy, evidenced by their 20 percent collapse that ignited the recession 10 years ago. Prices right now are far from collapsing but their upward appreciation is clearly fading as seen in the accompanying graph. The dark columns of the Case-Shiller's 20-city adjusted index managed only a 5.9 percent year-on-year showing in the latest available data which are for July. This is the lowest rate since August last year and is the fourth straight month of slowing from March's 6.8 percent peak. FHFA's house price index, the light columns, managed only a 6.4 percent rate in July, down from a 7.5 percent peak in February this year. This is the weakest result since January last year.

The fall off for prices is coinciding, not surprisingly, with erosion in sales. Home sales data are always volatile which is smoothed out by 3-month averages as tracked in the graph. This average for new home sales, the blue line, fell to 618,000 in August which is the lowest since October last year. And what traction there is, is getting a lift from home-builder discounting as the median price of a new home fell 2.4 percent in August to $320,200. Year-on-year, the median price of a new home is up a paltry 1.9 percent which doesn't quite meet the rate of inflation. The green line tracks sales of existing homes which, in data released in the prior week, managed only a 4.753 million annualized rate in August for the weakest 3-month average since March 2016. But wait, the bad news on housing keeps pouring in as the pending home sales index, which tracks initial contract signings for resales, was one of the week's low lights posting the weakest result since December 2014. And don't think the hike-happy Fed isn't noticing. Rising mortgage rates, already climbing 10 basis points in the week before the rate hike and right at 5.00 percent for 30-year loans, are not a positive for sales. However strong the labor market is and however much the stock market may be booming, housing definitely isn't participating.

Unlike housing, the labor market is one of the strong suits of the economy, if not the strongest, as underscored very clearly at September's FOMC meeting. Yet Hurricane Florence which slammed into the Carolinas at mid-month and whose after effects are still being felt probably won't have much impact on the September employment report. The sample period for the monthly employment report was the September 15 week, a period when Florence hit but very late in the week. And, for initial claims, the week showed no effect at all as the 202,000 total, tracked in the pink column to the right, was a 50-year low. Claims in the following week, the September 22 week as tracked in the green column to the right, did go up but not that much, only 12,000 to 214,000. The gain here is entirely due (technical adjustments aside) to the Carolinas with North Carolina up more than 10,000 and South Carolina up nearly 2,000. This effect is modest and in any case will be excluded from the September employment report. The pink column to the left is the sample week of the August employment report which was at 210,000 and slightly above the September 15 week. This comparison is a modestly positive indication for strength in the September report. In sum, don't expect Hurricane Florence to be a major factor that skews the monthly employment report. And Econoday's consensus for September nonfarm payroll growth reflects this, at 180,000 vs August's 201,000.

Markets: Rising confidence, rising profits and recession

It may be no accident at all that both the Dow and consumer confidence are at record highs. Well, actually the consumer confidence index, as tracked in the blue area of the graph, is not quite at record highs, it's actually at 138.4 which is an 18-year high. But this is within easy striking distance of the 144.7 record hit during the dotcom boom of 2000. What both confidence and the Dow may actually be tracking, however, is the underlying strength of the labor market. Strength or weakness in the stock market is only a background factor for the consumer confidence report which focuses primarily on the consumer's assessment of the labor market. But the report does indeed ask about the stock market and, unless you're a contrarian, the news is very good as bulls rose 2.7 percentage points in September to 42.5 percent while the bears fell 1.3 points to nearly half that, to 22.4 percent.

Share buybacks tied to this year's corporate tax cut have been part of what's behind this year's stock market rally. Second-quarter after-tax corporate profits have been finalized and they totaled $2.008 trillion as shown in the dark blue area for a 15.8 percent gain from second-quarter 2017. But it's less that profits are going up than taxes are going down. Pre-tax profits, the light blue area, rose at half that rate, at 7.3 percent to $2.242 trillion. The pinching difference between the two areas is visible, equalling $234.8 billion which is what is going to Uncle Sam and which is 34.0 percent less than a year ago. And when excluding accounting adjustments for inventory valuation and capital consumption adjustment, pre-tax profits are actually down from a year ago, 0.1 percent lower at $2.197 trillion. After-tax corporate profits by this measure are up only 6.4 percent from a year ago to $1.962 trillion. However much profits are up, the key question is whether companies plan to use the funds for more than buybacks, specifically for productivity investment in the future which is something that Jerome Powell mentioned at his press conference. But if productivity investment takes a back seat, pre-tax profits, even with accounting adjustments, could flatten over the long run making additional tax cuts necessary to keep after-tax profits on the climb.

Jerome Powell also spoke the day after the FOMC rate hike, saying there is "no reason to think" the risk of recession has been elevated. But when the federal funds rate goes up, chances of a recession also go up, or do they? A look at the graph shows that the federal funds rate had already peaked and was already beginning to come down ahead of the last two recessions. This pattern suggests that the next recession may hit only after the funds rate has already leveled which it clearly has yet to do and won't do until 2020 based on the FOMC's projections. There may be some substantial room yet for the economy to expand and for the stock market to rally. But in any case, are two prior patterns really enough to base a conclusion on? Absolutely not.

The bottom line

Recession is always an odd thing to talk about especially when the labor market is so strong and the stock market so high. But busts are busts because they take everyone by suprise. And though there are really no trouble spots in the economic data, the upward path of interest rates creates the risk, if not of recession, than at least of emerging cracks.

Week of October 1 to October 5

The coming week culminates on Friday with the international trade and employment reports but starts off Monday with ISM manufacturing where unusual strength has been feeding gains in assorted composites including the national activity index and index of leading economic indicators. Construction spending and the latest indications for third-quarter residential investment will also be posted Monday. If we haven't had enough of Jerome Powell and the FOMC, we'll get some more midday Tuesday when he speaks to an economics group in Boston. The service sector is on Wednesday's slate starting with the PMI, which slowed sharply at mid-month on concerns over rising costs, followed by the ISM non-manufacturing report where a steady rate of strong growth is the expectation. Thursday's jobless claims will offer one last look at the labor market before Friday's employment data followed later in the morning by the final verdict on August manufacturing with the factory orders report. International trade will be overshowed by employment on Friday but will still be very important, setting up base levels going into what appears to be a running trade war. Nonfarm payrolls are expected to rise 180,000 in September with average hourly earnings, where upward pressure was the unpleasant surprise in August, expected to moderate.

Monday

PMI Manufacturing for September Final

Consensus Forecast: 54.5

Consensus Range: 52.9 to 55.6

Boosted by production and orders, PMI manufacturing firmed in the September mid-month flash after slowing noticeably in August. But an unexpected step back is the call for September's final with Econoday's conesnsus at 54.5 vs 55.6 for September's flash. This index ended August at 54.7.

ISM Manufacturing Index for September

Consensus Forecast: 59.9

Consensus Range: 59.0 to 61.0

Easing strength at a very high level is what Econoday's forecasters see for the September ISM manufacturing index where the consensus is 59.9 vs an unusually strong 61.3 in August that far exceeded high-end expectations. Orders surged in August which should keep production and employment strong in the September report.

Construction Spending for August

Consensus Forecast, Month-to-Month Change: 0.5% 

Consensus Range: 0.0% to 0.6%

Construction spending has been bumping along in uneven monthly performances though the year-on-year trend has remained favorable, rising consistently in the mid-single digits. Forecasters see August construction spending rising a monthly 0.5 percent vs July's marginal 0.1 percent gain which showed a surge in home improvement spending that offset outright declines for new homes.

Wednesday

ADP, Private Payrolls for September

Consensus Forecast: 177,000

Consensus Range: 155,000 to 195,000

Econoday's consensus for ADP's private payroll estimate in September is 177,000 which would compare with 163,000 for ADP's August estimate and against 204,000 in the government's data for August.

PMI Services for September Final

Consensus Forecast: 52.9

Consensus Range: 52.9 to 54.6

Weakness in the year-ahead outlook tied to concerns over rising costs pulled down PMI services in the September flash to a much slower-than-expected 52.9. The consensus for September's final is no change at 52.9.

ISM Non-Manufacturing Index for September

Consensus Forecast: 58.0

Consensus Range: 57.0 to 59.0

Marginal slowing is the consensus for ISM's non-manufacturing index for September, at a consensus 58.0 vs 58.5 in August that came in well above expectations. New orders, including for exports, were very strong in August as were backlogs which all point to strength for general activity in September's report.

Thursday

Initial Jobless Claims for September 29 week

Consensus Forecast: 210,000

Consensus Range: 210,000 to 220,000

Initial jobless claims are expected to come in at 210,000 in the September 29 week with data out of hurricane-hit Carolinas still a wild card. Claims in the prior week rose only modestly, up 12,000 though both North and South Carolina showed sharp increases.

Factory Orders for September

Consensus Forecast, Month-to-Month Change: 2.0%

Consensus Range: 0.7% to 3.1%

Advance data for the durables side of the September factory orders report showed a sharp aircraft-related 4.5 percent jump at the headline level but a step back for core capital goods which, however, had been very strong in prior reports. Forecasters see factory orders in August, which will include initial data on non-durable goods, rising 2.0 percent.

Friday

Nonfarm Payrolls for September

Consensus Forecast: 180,000

Consensus Range: 150,000 to 195,000

Unemployment Rate

Consensus Forecast: 3.8%

Consensus Range: 3.8% to 3.9%

Private Payrolls 

Consensus Forecast: 171,000

Consensus Range: 145,000 to 190,000

Manufacturing Payrolls 

Consensus Forecast: 10,000

Consensus Range: 6,000 to 15,000

Participation Rate

Consensus Forecast: 62.7%

Consensus Range: 62.6% to 62.8%

Average Hourly Earnings

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

Consensus Range: 0.2% to 0.4%

Average Hourly Earnings

Consensus Forecast, Year-on-Year Change: 2.9%

Consensus Range: 2.8% to 3.0%

Average Workweek

Consensus Forecast: 34.5 hours

Consensus Range: 34.4 to 34.5 hours

A solid 180,000 rise in nonfarm payrolls is Econoday's consensus for the September employment report with the unemployment rate seen edging down to 3.8 percent. Average hourly earnings, after a strong showing in July, are expected to rise a noticeable 0.3 percent with the year-on-year rate expected to hold unchanged at 2.9 percent. Private payrolls are seen rising 171,000 with manufacturing payrolls expected to bounce back from a rare decline in August with a solid increase of 10,000. The workweek is seen unchanged at 34.5 hours with the labor participation rate also unchanged at 62.7 percent.

International Trade Balance for August

Consensus Forecast: -$53.6 billion

Consensus Range: -$54.0 to -$47.6 billion

After narrowing sharply in the second quarter, the trade deficit opened the third quarter with a steep deepening to $50.1 billion in July and further deepening is expected for August. Based on advance data for the goods portion of the trade report, forecasters see the August international trade deficit at a consensus $53.6 billion. This would compare very unfavorably with a monthly average of $44.8 billion in the second quarter. The results for August will mark a key entry into third-quarter GDP.

Consumer Credit for August

Consensus Forecast: $15.0 billion

Consensus Range: $13.4 to $16.0 billion

Steady growth of $15.0 billion is expected for consumer credit in August, after posting a July increase of $16.6 billion despite a second month of subdued results for revolving credit.