Introduction

FOMC meetings that were between quarterly FOMC forecasts used to be complete non-events. But not anymore! Now every meeting includes a press conference and, against the yawns and bleary eyes of those forced to watch, the Fed actually used its first chance under the new schedule to, yes, change guidance! However dull and quiet these press events are, the latest of course rocked the global markets. But before breaking down the Fed news we start with another surprise, that the labor market is strengthening far beyond expectations and wage inflation is still nowhere in sight.

The economy

Very strong demand for labor is the key takeaway from what is a very noisy employment report for January. Nonfarm payrolls surged 304,000 to roughly double expectations though downward revisions trimmed 70,000 off December and November. Standouts in the payroll data are both construction and trade & transportation, each adding an unusually strong 52,000 jobs in the month. Professional & business services extended their strong run with a 30,000 payroll increase with manufacturing posting a respectable 13,000 gain. Government payrolls, despite the shutdown, added 8,000 as furloughed workers, on the expectation that they would receive back pay, were categorized as employed. Turning to the unemployment rate, it rose 1 tenth to 4.0 percent yet the labor participation rate also rose 1 tenth to 63.2 percent and this follows a 2 tenths gain in December. The rise in the participation rate hints at new entrants, including discouraged workers, coming into the labor market.

Despite the outsized payroll gain and rise in participation, average hourly earnings inched only 0.1 percent higher in January with the year-on-year rate unchanged at 3.2 percent. This points to still subdued wage inflation and, though a mystery that seems to defy the laws of supply and demand, will not turn up the heat on the Fed to move from its wait-and-see stance. Adding to the noise were annual benchmark revisions in January's report which, when all quirks are put aside, points clearly to unusually strong demand for labor and health for the economy.

Not to risk being as understated as the Fed, it's fair to say that the language of the FOMC statement is a bit stiff. Fedspeak going into the meeting had already dulled our shock that the boilerplate – "some further gradual rate increases" – would be thrown out but that didn't prepare anybody for all the "cross currents" this meeting will be remembered for. Well, actually "cross currents" are not actually part of the statement but were instead the descriptions of Jerome Powell who, in his press conference, filled in the missing blanks a half hour after the statement was released. But before we get ahead of ourselves, let's remember that the FOMC has yet to disavow forecasts for two more rate hikes this year. That chance comes at the March FOMC when new quarterly forecasts will be posted. And yes these forecasts will of course be "informed" by "incoming data" but unless there's a dramatic downward shift in the outlook, it may be over-reaching to assume that policy makers will step back from the two rate hikes they've already penciled in this year. And yes, the accompanying graph reminds us which way rates have been going, and it's not down.

But January's meeting definitely did leave the impression that rate hikes are a thing of the past. And it also left the impression that the unwinding of the balance sheet is about to slow down. Using the words "final stages", Powell was very clear that the long-term signal from the Fed is for less not more of balance sheet drawdown – yet the short-term signal was stated bluntly in the implementation notes: more of the same, $50 billion per month. That's $50 billion a month, which is actually very substantial, that won't be in the bond market and won't by extension, spill over into other markets either. Facing a fastball high and inside, Powell ducked a question whether policy makers see the balance sheet being drawn down another half a trillion dollars to $3.5 trillion, as generally expected, before equilibrium is reached. In the new world of quantitative tightening, guidance on monthly draw-down targets may already be exceeding the urgency of guidance on rate moves.

Powell also cited weakening in consumer confidence as part of the reason the Fed is stepping aside. And weaken it did, falling to a lower-than-expected 120.0 in January. This was at the low end of Econoday's consensus range and together with December made for a 16.2 point plunge and the worst showing since the recession during 2008. Weakness was centered in the expectations component which fell 10.4 points to 87.3. This is the lowest reading in more than three years and follows an even more severe collapse in December when the government shutdown first took hold. Details show that pessimists on the employment outlook are increasing while optimists on the income outlook are declining. But the good news in the report is the present situation component as a strong 46.6 percent said jobs were plentiful in January and a very low 12.9 percent that they were hard-to-get, offering a good clue for what turned out to be a very strong January employment report.

A strong labor market is very good for housing which, however, may be more of a risk to the economy right now than a strength. New home sales did jump sharply in data for November, up a monthly 16.9 percent to a 657,000 annualized rate. But monthly housing data, especially new home sales, are often volatile which puts the focus on monthly averages. The blue line of the graph tracks the 3-month average for new home sales, at 611,000 for a visible upturn in November. The green line, however, tracks existing home sales which are at a 4.593 million average rate that keeps on sinking to 3-year lows. Year-on-year, the 3-month average for new home sales is down 6.9 percent while the average for existing sales is down 7.4 percent.

The week also offered an indication on existing home sales, specifically pending sales in which contracts have been signed. This fell a steep 2.2 percent in December and points to more weakness for final resales especially in January and also February. The Fed hasn't been stressing the weakness in the housing sector as a major concern, at least it hasn't yet. The pending sales index can be volatile but the direction of the indication is unmistakable.

Also unmistakable, like the direction of home sales, is the direction of home prices. Appreciation began to flatten in the spring last year before showing a little life late in the summer. But Case-Shiller indications for November are not pointing to renewed acceleration as the 20-city adjusted index managed only a 0.3 percent gain which missed the consensus and was 1 tenth lower than October. Taking out a sharp jump in September, most of 2018 was a story of weakness. Year-on-year price growth in November at 4.7 percent was down 3 tenths from October and a 3-1/2 year low.

A lot of the trouble for housing seems to be coming from the once high flying West. Both LA and San Diego were flat in Case-Shiller's November data with perennial leaders San Francisco and Seattle down 0.5 percent and 0.3 percent, to index levels of 266 and 248 as tracked in the graph. Year-on-year, San Diego home prices are up a mere 3.3 percent in what is a dismal showing for any California city. Only two of the 20 cities in the index have lower appreciation and they are Chicago and Washington DC. Price trouble in the West is a reminder of bubble warnings in the region over the last several years. Whether this weakness may begin to sap strength in other regions is a developing question right now for the housing sector.

Markets: Lots of friendly news, stocks add to gains

After rallying sharply at midweek on the Federal Reserve's decision to step aside and not raise rates for now, stocks couldn't get much boost from the jobs report. But on the week the Dow rose 1.3 percent to lift its year-to-date gain to a very strong 7.4 percent. One building issue for the stock market is weakness for chip makers and also weakness among global industrial firms like heavy machinery maker Caterpillar. These companies are increasingly warning of slumping demand centered in China. All this talk of weakness together with less risk of rate hikes from the Fed are increasing demand for U.S. Treasuries where interest rates, especially on the short end of the yield curve, are falling sharply. The 2-year yield fell 10 basis points in the week to 2.50 percent with the 10-year down 6 basis points to 2.69 percent. Lower U.S. yields lower the opportunity cost of gold which doesn't pay a yield. Gold, near $1,325, rose almost $20 in the week and is up nearly $35, or 3 percent, so far this year.

The bottom line

The labor market remains by far the economy's greatest strength and should continue to drive consumer spending even if wage gains continue to be modest. As far as consumer confidence goes, the labor market provides a solid floor and a reversal from January's dip is in the cards if the government doesn't shut back down. But housing is clearly a trouble spot and Powell could have cited the weakness in sales and perhaps even prices as emerging risks to the outlook.

Week of February 4 to February 8

A lull before the flood may be the theme of the coming week's minimal slate of economic data. Delayed reports for factory orders on Monday and international trade on Wednesday are the week's highlights though both, due to January's government shutdown, will cover data from way back in November. Still, both reports especially trade will offer key inputs into fourth-quarter GDP, the outlook for which, given the lack of updates especially on consumer spending, is still foggy. Lack of data looks to trim details in the first estimate of fourth-quarter productivity and unit labor costs which appears to be preceding the quarterly GDP report. "Appears" is the warning given the day-to-day scramble at the Census and Bureau of Economic Analysis and the possibility that delayed reports may suddenly make a re-appearance.

Monday

Factory Orders for November

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

Consensus Range: -0.5% to 1.0%

Advance data for the durables side of the November factory orders report rose 0.8 percent reflecting a swing higher for both civilian and defense aircraft. Ex-transportation orders, however, fell 0.3 percent with core capital goods orders down 0.6 percent. Forecasters see factory orders in November, which will include initial data on non-durable goods, rising 0.3 percent. Note this report was delayed because of the government shutdown.

Tuesday

PMI Services for January Final

Consensus Forecast: 54.2

Consensus Range: 54.0 to 54.2

Output was strong but growth in new orders and employment modest in the PMI services flash for January. The consensus for January's final is no change from the flash at 54.2. This index ended December at 54.4.

ISM Non-Manufacturing Index for January

Consensus Forecast: 57.1

Consensus Range: 56.0 to 58.0

Business activity slowed and delivery times improved but December's order growth proved strong. Forecasters see ISM's non-manufacturing index for January coming in at a consensus 57.1, down moderately from 58.0 in December (revised from an initial 57.6).

Wednesday

International Trade Balance for November

Consensus Forecast: -$54.0 billion

Consensus Range: -$55.0 to -$51.8 billion

Forecasters see the November international trade balance at a consensus deficit of $54.0 billion. This would compare with a $55.5 billion deficit in October and a monthly average deficit of $52.8 billion in the third quarter. Note this report was delayed because of the government shutdown.

Nonfarm Productivity, 1st Estimate, 4th Quarter

Consensus Forecast, Annualized Rate: 1.6%

Consensus Range: 1.0% to 1.9%

Unit Labor Costs

Consensus Forecast, Annualized Rate: 1.7%

Consensus Range: 1.3% to 2.2%

Expectations for slowing growth in output points to slowing growth for nonfarm productivity where forecasters are looking a quarterly 1.6 percent gain vs a 2.3 percent increase in the third quarter. Unit labor costs in the third quarter rose 0.9 percent and a rise of 1.7 percent, very near the productivity rate, is the fourth quarter's call. Note that details in this report, due to the government shutdown and the still pending release of fourth-quarter GDP, are likely to be limited.

Thursday

Consumer Credit for December

Consensus Forecast: $18.0 billion

Consensus Range: $15.0 to $19.5 billion

Slightly softer growth of $18.0 billion is expected for consumer credit in December following November's sharp increase of $22.1 billion that did, however, show some slowing in revolving credit.