Introduction

Economic policy is now facing the inevitable moment of crunch between an aggressive fiscal policy aimed at spurring growth and a monetary policy aimed at cooling growth. Tweeting on Friday that "tightening now hurts all we have done," President Trump made clear this last week what his economic advisor Larry Kudlow had said earlier this month, that the Fed should go easy on rate hikes and not offset stimulus from the tax cut and the rise in government spending.

The economy

In the classic days of monetary policy during the 1980s and 1990s, calls for easier monetary policy from elected leaders often raised talk of retaliatory rate hikes by the central bank, a demonstration of independence that the old Bundesbank was famous for. This is not the risk right now as Jerome Powell repeated during his semi-annual testimony on Capitol Hill that "we stay in our lane at the Fed" and, in reference to the administration, "it's not our job to criticize their activities." Powell's comments were made at mid-week but comments from St. Louis Fed President James Bullard at week's end offer what can likely be expected for Fedspeak to come, that the president has a right to enter the debate but Fed monetary policy makers, who by statute are narrowly focused on keeping inflation low and employment high, won't be swayed. And in fact the unmistakable takeaway from Powell's testimony is that the Fed, wanting to limit capacity stress and needing to build out policy room for future rate cuts should a recession loom, is committed to a continuing series of gradual rate hikes. The graph tracks the 2-year Treasury, the shortest maturity on the coupon yield curve and one, as you can see, that moves directly in line with the Federal funds target rate. The FOMC in their last meeting in June raised the number of 25-basis-point rate hikes they expect for the remainder of the year from one to two and along with the three hikes they see for next year, would take the funds rate over 3 percent. And where should we expect the 2-year yield to move along the way? Up is the short answer.

What's also at stake is the administration's trade efforts as rising rates hint at a rising dollar, a result that would make U.S. goods and services more expensive to foreign buyers and less competitive globally. And a rate-based rise in the dollar could be extended if foreign competitors, in an effort to offset the effects of U.S. import tariffs, are tempted to actively lower the value of their currencies. Devaluations among our trading partners would stimulate their imports and, by pushing up dollar prices, make U.S. exports yet more expensive. The Chinese currency hit a one-year low during the week with forward contracts pointing to deeper lows ahead. The president, in further tweets, blamed the strength of the dollar on currency "manipulation" by both China and the European Union. Yet the effect of a rising funds rate on the dollar is much less clear than for the 2-year Treasury yield. As seen on the graph, the dollar, whose value is tied not only to U.S. rates but also to the strength or weakness of foreign currencies, doesn't necessarily move in line with the funds rate.

Aside from the 2-year yield and the value of the dollar, the 10-year Treasury yield is a third major financial factor to watch. This yield, as tracked in the blue line of the graph, only vaguely shadows the direction of the funds rate though it has been on the rebound the last several years as the Fed started raising rates. The comparatively low level of the 10-year yield in part reflects the economy's low inflation risk which gives investors confidence to lock in a rate for the long term. Global uncertainty is another factor keeping the rate low, that is investors seeking to lock in safety are bidding down the yield. The green line in the graph is the 30-year fixed mortgage rate which, as you can see, is tied directly to the 10-year Treasury. Whether these long-term rates will rise as the funds rate rises is unknown, but their ongoing rise, though limited, may already be holding back the housing sector.

In an unexpected downturn, housing starts as well as permits both fell sharply to their lowest rates since September last year. Housing starts dropped a monthly 12.3 percent to a 1.173 million annualized rate in June with permits down 2.2 percent to 1.273 million, both far below Econoday's consensus range. Weakness was most pronounced in the Midwest though all regions showed declines. The only good news in the report came from single-family permits which rose 0.8 percent to an 850,000 rate which, however, was far from reversing a 2.3 percent drop in May. Housing completions were unchanged in June with a gain for multi-units offsetting an unwelcome decline in single-family homes for a new home market that is starving for immediate supply. Mortgage rates are still affordable yet they are, along with the 10-year Treasury yield, at 4-1/2 year highs. But perhaps a more urgent factor holding down starts and permits is economic not financial, that is physical shortages of construction goods and available labor.

The Federal Reserve was heavily in the news during the week not the least of which with the Beige Book at mid-week, a compilation of verbal assessments based on the Fed's nationwide business contacts. After getting what proved to be a very brief upgrade in the May edition, the Beige Book's July assessment slipped back to modest-to-moderate. The step back is to blame in part on early tariff effects for metals and lumber where prices are rising and shortages and dislocations are appearing. Lack of available labor was cited across all 12 of the Fed's districts especially shortages of specialized construction and manufacturing workers. The graph tracks input prices (light green area) along with selling prices (dark green area) of the New York Fed's Empire State manufacturing survey, both of which are at the highest levels since the early days and easy comparisons of the ongoing economic expansion.

Parallel data from the Mid-Atlantic manufacturing survey published by the Philly Fed are clearly at their highest levels of the expansion. The Philly Fed's index on input prices (light blue) surged more than 11 points this month to 62.9, one of the highest readings on record to indicate the sharpest rise in month-to-month prices since July 2008. And some of these costs, like in the Empire State sample, are being passed through to customers as selling prices (dark blue) rose more than 3 points to 36.3 which is also among the highest on record. What's also notable in July's Philly Fed report is a down move, one likely tied to tariffs, in the overall 6-month outlook which fell nearly 6 points to 29.0 and a 2-year low. But tariff effects or not, orders keep pouring in and raise the question whether this sample, given shortages and delivery delays, can keep up with all the demand.

Not keeping up with demand, in what so far is a positive for the economy, are inventories. But inventories are up, rising a solid 0.4 percent in lagging data for May with wholesalers and retailers showing the biggest builds. Rising inventories are an immediate positive for GDP and, because these increases are well behind sales growth, the need to build inventories further is a future positive for both production and employment. Sales growth for this data set jumped 1.4 percent in May in a mismatch with inventories that pulled the inventory-to-sales ratio down to an even leaner 1.34 vs 1.35 in April and March. Year-on-year comparisons really tell the story with inventories up only 4.4 percent vs an 8.6 percent gain for sales. Sales data in May were led by wholesalers and retailers which calls to mind the prior week's producer price report where trade services, which track costs at wholesalers and retailers, showed visible price pressures. Businesses may be having trouble keeping up with demand but inventories still need to move higher.

Strength in the economy is nowhere more apparent than in the labor market. The complement to the labor shortages cited in the Beige Book is the unusually low level of unemployment claims being filed, an indication that employers are holding tightly to their existing staffs. Initial jobless claims fell 8,000 in the July 14 week to a 207,000 level that is the lowest since December 1969. Continuing claims, where data lag by a week, edged 8,000 higher to 1.751 million which is just off a low last seen in 1972. And summing it up best, the unemployment rate for insured workers remains at only 1.2 percent. Timing and related statistical adjustments for summer retooling shutdowns in the auto sector are always wildcards at this time of year, yet the signal from this report is nevertheless crystal clear: demand for labor is unusually strong.

Markets: Foreign disinvestment in U.S. stocks

Strength in the dollar means that foreign buyers of U.S. stocks get fewer shares for their money, which may help explain a recent exodus of foreign money from the domestic stock market. Foreign accounts sold a net $26.6 billion of U.S. stocks in May in what was the heaviest selling in nearly four years. This follows heavy selling in February as well as, at $21.5 billion, and also helps explain this year's relatively tame gains for some of the indexes including the Dow which is only up a year-to-date 1.4 percent. Rising Treasury yields may also be a factor, offering foreign investors an increasingly attractive alternative to stocks. Buying of Treasuries by private foreign accounts was very heavy in April and May, totaling $93.8 billion.

The bottom line

The unfolding clash between the increasing stimulus of fiscal policy and the slowing stimulus of monetary policy is a tractor pull of sorts, powerful forces working in opposite directions. And a key financial instrument that is gaining more and more in importance is the 2-year Treasury yield. Should it continue to climb as the Fed raises rates, short-term borrowing costs will rise and slow economic growth at the same time that a likely cross with the 10-year yield -- yield curve inversion -- will have the Fed under more pressure than just from the president.

Week of July 23 to July 27

Fedspeak is on hold ahead of the following week's FOMC meeting which puts the focus on Friday's GDP report. A 4.2 percent growth rate is Econoday's call with consumer spending seen picking up sharply to a 2.9 percent rate. Narrowing in the net export deficit is seen as another major plus in data that will offer new talking points for the trade dispute. The national activity index opens the week on Monday, where housing may be a negative, followed later in the morning by existing home sales which are not expected to show much momentum. More housing data follow on Tuesday with the FHFA house price index, which has turned flat, followed by new home sales on Wednesday which have been the sector's key area of strength. Durable goods orders are Thursday's highlight and a big rebound in aircraft orders is expected to lift the headline sharply for a factory sector that, despite price and supply dislocations, is approaching double-digit growth.

Monday

National Activity Index for June

Consensus Forecast: 0.23

Consensus Range: 0.10 to 0.40

A big jump in industrial production together with strength in employment should offset trouble in the housing sector, making for a plus 0.23 consensus in the national activity index for June, which would be up from minus 0.15 in May.

Existing Home Sales for June

Consensus Forecast, Annualized Rate: 5.450 million

Consensus Range: 5.350 to 5.520 million

Existing home sales have been soft this Spring selling season, coming in below Econoday's consensus range in April and May. But the number of homes on the market has been on the rise which should help sales in June. But forecasters aren't calling for much strength, at a consensus 5.450 million annualized rate in June vs 5.430 million in May.

Tuesday

FHFA House Price Index for May

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

Consensus Range: 0.1% to 0.5%

Home prices have been cooling along with sales and are part of the cracks appearing in the housing sector. The FHFA house price index has managed only very small gains the past two reports though a better gain, at 0.4 percent, is the consensus for May.

PMI Composite for July, Flash

Consensus Forecast: 56.3

Consensus Range: 54.3 to 56.5

PMI Manufacturing

Consensus Forecast: 54.9

Consensus Range: 54.7 to 55.0

PMI Services

Consensus Forecast: 56.4

Consensus Range: 54.2 to 56.8

Moderate-to-strong growth has been the signal from the PMIs with manufacturing reaccelerating a bit in late June. The flash July consensus for the PMI composite is 56.3 with PMI manufacturing seen at 54.9 and PMI services at 56.4.

Wednesday

New Home Sales for June

Consensus Forecast, Annualized Rate: 669,000

Consensus Range:  590,000 to 685,000

New home sales have been the backbone for what is otherwise a mixed housing sector. Econoday's consensus for June new home sales is 669,000 vs 689,000 in May, a month when sales got a boost from lower prices.

Thursday

Durable Goods Orders for June

Consensus Forecast, Month-to-Month Change: 3.2%

Consensus Range: 0.5% to 5.0%

Durable Goods Orders, Ex-Transportation

Consensus Forecast: 0.5%

Consensus Range: 0.0% to 0.8%

A pent-up surge in aircraft orders is expected to make for a big bounce higher in durable goods orders where the consensus for June is a 3.2 percent gain vs May's 0.6 percent decline. But strength elsewhere is expected to be more limited with the ex-transportation consensus at a 0.5 percent gain. May's data included slowing in orders for steel and aluminum which spiked in March and April following the imposition of import tariffs.

International Trade In Goods for June

Consensus Forecast, Month-to-Month Change: -$67.2 billion

Consensus Range: -$69.2 to -$65.0 billion

The goods deficit is expected to widen to a consensus $67.2 in June vs an unexpected low $64.8 billion in May. June's report will update progress on second-quarter net exports and offer the latest on the bilateral deficit with China.

Advance Wholesale Inventories for June

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

Consensus Range: 0.3% to 0.4%

Wholesale inventories are expected to rise 0.3 percent in June vs 0.6 percent in May. Inventories have been low relative to sales.

Initial Jobless Claims for July 21 week

Consensus Forecast: 217,000

Consensus Range: 215,000 to 220,000

Initial claims are expected to come in at 217,000 in the July 21 week vs 207,000 in the prior week which was the lowest since December 1969. Other readings in this report are also at or near historic lows and consistent with strong demand for labor.

Friday

Real GDP: 2nd Quarter, 1st Estimate, Annualized Rate

Consensus Forecast: 4.2%

Consensus Range: 3.0% to 4.8%

Real Consumer Spending, Annualized Rate

Consensus Forecast: 2.9%

Consensus Range: 2.3% to 3.2%

GDP Price Index

Consensus Forecast: 2.2%

Consensus Range: 1.5% to 2.5%

The first estimate for second-quarter GDP is expected to come in at a very strong 4.2 percent annualized rate vs the first quarter's mediocre 2.0 percent. Consumer spending is seen rising at a 2.9 percent rate vs the prior quarter's very soft 0.9 percent. A significant narrowing in the net export deficit and another rise for business investment are also expected to be positives. The GDP price index is seen at 2.2 percent, unchanged from the first quarter.

Consumer Sentiment Index, Preliminary July

Consensus Forecast: 97.2

Consensus Range: 97.1 to 98.5

The consumer sentiment index has been easing back and not much of a rebound is expected for the preliminary July reading, at a consensus 97.2 vs 97.1 in June.