Corner of Wall & Main: Sizing Up the Fed

 | Jul 16, 2014 | 4:00 PM EDT
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The fun has certainly picked up this week compared to last. No more limbo, no more waiting. That's right, we are getting not only a smorgasbord of economic data and earnings commentary, but also, right from the lips of Federal Reserve Chair Janet Yellen, the latest on the Fed's view of interest rate hikes, the economy, asset bubbles and, sadly, a view on social media and other stocks. All of that came in the semi-annual Humphrey-Hawkins testimony in which the central bank chief testifies before Congress and endures a Q&A period with lawmakers in Washington.

Zeroing in on some of Yellen's economic commentary, the Fed chair spoke of better job creation thus far in 2014 than in 2013, and she pointed to the drop in the unemployment rate. Now we would caution you not to fall for the headline nature of Yellen's offered insight. Nowhere did she comment on the mix of jobs (lower wage ones) nor the types of jobs (skewed toward part-time) that were part of the reason why there has been a "slow pace of growth in hourly compensation." Yellen did comment on the sad state of the labor force participation rate, however. While there are pockets of strength in the economy -- industrials, for example -- Yellen shared concern over the lack of meaningful recovery in the housing market.

One has to wonder if she was jawboning the stock market and growth expectations for the coming half of the year lower in order to cool all that bluster lately over when the Fed will hike interest rates. She would certainly not be the first Fed chair to use these testimonies as a tool to influence expectations about the economy or otherwise.

We bring this up not only because of this morning's June PPI report (which showed final demand rose 0.4% in June after a 0.2% decline in May and 0.6% increase in April, representing a 1.9% increase on an annual basis), but also given the jump higher reported in prices paid month over month in the July Empire State Manufacturing Survey. The price paid index climbed to 25.0 in July, up from 17.2 in June and is the latest in a growing number of reports pointed toward inflation sprawl past food and energy and into other areas of the economy. As these signs continue to mount, so will questions over the likelihood of inflation and the eventual need for the Fed to raise interest rates. One other disturbing point from the July Empire State Manufacturing Survey was the drop in the forward-looking indicator section, which saw a particularly sharp drop in both new order and shipment activity in July compared to June. Could this be a blip or perhaps be one of the reasons that Yellen was as cautious as she was on the economy?

Adding fuel to the fire was another weaker-than-expected retail sales report, this time for June. Despite the better-than-expected June employment report, at least with the headline figure and motor vehicle sales for the same month exceeding 17 million SAAR for the first time since July 2006, one has to think something is up when it comes to why the consumer is not spending. We've heard commentary from Family Dollar (FDO), The Container Store (TCS), Rent-A-Center (RCII) and even Wal-Mart (WMT) that traffic has been slower than expected.

To us, this is but the latest round of confirmation that consumers are tapped out, spending where they need to vs. where they may want to. To us, the big winner is Amazon (AMZN), which continues to build sticky services and offer compelling deals. As we inch toward the back-to-school season, one can already see big sales events from Target (TGT), Office Depot (ODP), Gap (GPS), Wal-Mart, Sears (SHLD), J.C. Penney (JCP) and many others. Will it be a blood bath? In the end no, but it will be close. The bloodbath will come later this year during the holiday shopping season. If we don't get a big pickup in wages before then -- and we're not sure how you can -- the second half of 2014 will be another tough period for retailers.

Adding to our concerns over the state of the consumer is the worrying trend that banks have begun to make domestic loans again, with a troubling concentration in high-risk borrowers. According to The Wall Street Journal, banks and other lenders issued 3.7 million credit cards to subprime borrowers in the first quarter of 2014, which is a 39% increase year over year and the most since the onset of the financial crisis. Even more concerning, almost a third of all cards issued last quarter were considered subprime. So much for household deleveraging! The demand at the lower end of the credit spectrum and ratio of low-end credit extension doesn't paint a rosy picture of household finances.

Later today, we get the Fed's Beige Book report for July. Given the commentary from Yellen discussed above, one has to wonder if the Beige Report, much like June retail sales, could come in weaker than expected.

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