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Just around the Corner? Maybe Not.

A very smart analyst joked yesterday that the Consumer Price Index is the new Nonfarm Payroll. Since the FOMC has made it clear that they are waiting for 2% inflationor perhaps Godotall eyes are searching for signs we might be getting there, so all price indexes are good fodder, especially the PCE, the Fed’s favored index.

The FOMC’s models have continually demonstrated a “just around the corner,” feature where, despite currently weak PCE measures, the expectation is that higher inflation would occur in the near future.
Unfortunately, a historical look at the broad components of this inflation measure belies their optimistic projections:

pce-log

Above is a logarithmic graph of the three components of the PCE price index: durable goods prices (in blue), non-durable goods prices (in red) and service prices (in green). Two key visual elements are apparent: durable goods prices have been consistently declining since the mid-1990s. Non-durable goods prices have been stagnant to slightly lower for the last 5 years. That leaves services as the only PCE price index component that can exert upward pressure.

Let’s look at the same data from a Y/Y percentage change perspective:

pc-yy

Durable goods prices (in blue) have been subtracting from price growth for the last 20 years. Non-durable goods prices (in read) have been declining since 2011-2012; they subtracted from PCE price growth for most of 2015 and only recently turned positive. Only service prices (in green) have increased PCE price pressures on a consistent basis.

There are several important lessons to draw from this data. First, the PCE price index looks at prices from a business perspective. According to the Cleveland Fed, “the PCE is based on surveys of what businesses are selling.” The above charts indicate that neither durable goods nor non-durable goods companies have any pricing power. Second, the Y/Y percentage change in service prices has been declining. Third, price growth for 31% of PCEs are either negative or very weak. That means the remaining 70% of prices would have to increase at a faster Y/Y rate to hit the Fed’s 2% PCE Y/Y inflation target. This runs counter to the second conclusion regarding service prices, that the y/y rate of change is narrowing.

Those trends mean the Fed cannot hit its 2% y/y target under the current circumstances.

by admin· · 0 comments · Red Flags, Uncategorized

Around the Web in a Couple of Clicks

around-the-net

September 11

Hurricanes and economic data

Weak inflation may force the Fed to pause its rate setting policy

After appearing weakened a year ago, Merkel is now the German front-runner.
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The Atlanta Fed’s GDP Nowcast is trending lower

NY Fed’s GDP nowcast at 2.06%

Gavyn Davies: Global Nowcasts are improving
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Gavyn Davies: The Global Upswing Could Be Stronger This Time
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Cleveland Fed’s Yield Curve Recession Predictor: 12.9%

See also: A recent look at term spreads

Scott Grannis: A better PE ratio

What to watch for in the Census’ earnings, income, and poverty release

Are weaker oil prices responsible for stronger global growth?

See also, James Hamilton’s research at the NBER

September 8–Focus: Income Inequality

Those of us who don’t want to think about this as an ethical issue might want to give it some thought as a pragmatic economic bummer. The details matter a great deal for an economy based on consumption, as is ours here in the U.S., especially since those who spend the largest percentage of their incomes are the very ones getting shorted.

The Facts:
Striking it Richer: The Evolution of Top Incomes in the United States

Mobility Report Cards: The Role of Colleges in Intergenerational Mobility

Economic Inequality: It’s Worse than You Think

A deep dive into the history, with those Gini Coefficients you wanted for your birthday:
Income Inequality

Distributional National Accounts: Methods and Estimates for the United States

And finally, apologies for the “self link,” but here’s our summary of an un-linkable paper outlining public opinion on the matter. The facts were very different from what we often hear.

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Spidery Views on Inflation and Employment

We are happy that our interpretation of Fed Governor Lael Brainard’s speech on Tuesday, May 30th, to the New York Association of Business Economists seems to have had an effect on how analysts are viewing the current economy. As we wrote here, her talk was not the shedding of her dovish feathers, but a continuation of her focus on ongoing weakness in inflation despite, as she put it, the growing number of forecasters who believe the U.S. economy is at or very close to full employment. We decided to let the spiders do the talking on the state of US employment, and on inflationary pressure, or lack thereof, the now ubiquitous tag.

First employment. Here’s an updated employment spider inspired by one put together by James Bullard, the president of the St. Louis Fed, when he was feeling “Halloweenish” back in 2015.

job-spider

The graph uses an integer measure showing the percentage of recession losses that have been regained in recovery and expansion. (For example, an 0.5 reading means that 50% of the losses have been regained; 1.5, 150% have been regained. In most of what follows, the numbers are well above 1, meaning that they’ve recovered and then some.) In a phrase, we’re well beyond the recovery phase and firmly into expansion.

Bullard sorted ten major employment indicators into four groups: employer activity (payroll employment, job openings and hires from JOLTS), confidence (“jobs plentiful” from the Conference Board’s confidence survey, quits from JOLTS), slack (narrow and broad unemployment, share working part-time for economic reasons), and leading (initial claims and temp employment). The measures of slack are the least recovered, with the share working part-time for economic reasons the only one of the 10 still in a hole. Hires are lagging both openings and employment. The leading indicators are looking good, though with the growing casualization of employment, temporary firms may have lost some of their leading characteristics. And the confidence measures have also picked up nicely.

Which takes us to the next spider (or radar, if you prefer) graph. With the job market relatively strong, how would a such a graph look for inflation? Much, much weaker.

inflation-spider

In this graph, we’re not looking at losses recovered but how the inflation-related indicators look compared to their levels at the onset of recession in December 2007. Following Bullard’s model, we sorted twelve inflation-related indicators into five groups: CPI measures, GDP measures, earnings, prices, and expectations. Headline year-to-year inflation is 60% below its pre-recession level; core, 30% below. Even medical inflation is down by half. That’s true even though real GDP growth in 2017Q2 was a little above where it was in 2007Q4. Underscoring the point about the lack of inflation, nominal GDP growth is well below end-2007 rates, unlike its real counterpart. That speaks to calls by Fed advisor Michael Woodford to track nominal GDP as a way of getting around problems with inflation adjustments Average hourly earnings growth is more than a sixth lower than it was ten years ago, and the employment cost index, over a third lower. Price indexes in the ISM surveys, especially services, are also below where they were at the end of 2007—and the oil price is down by half. And inflation expectations—measured by the Michigan survey of consumers, and what is implied by the spread between 10-year Treasuries and comparable TIPS—are about a quarter below where they were then.

With monetary policy gently lifting and fiscal policy in great disarray for now, deflation looks like more of a risk than inflation.

Spotlight on shelter inflation

It’s been nearly a year since we looked at the outsized contribution of shelter to the overall inflation. It’s still outsized.

For the year ending in July 2017, both headline and core inflation were up 1.7%. That’s about where the headline number was a year ago; core was half a point higher. But inflation in shelter was 3.2%, down only 0.1 from a year ago. Take shelter out of core inflation, and prices are up 0.6% for the year, less than half the rate twelve months earlier.

Now we realize that taking food, shelter, and energy out of the CPI takes slightly more than half out of the market basket. Our dear John Liscio used to joke that some analysts wanted to take so many things out of the price indexes that poor Hampton Pearson of CNBC would have to report the numbers while standing in front of the BLS in the dark, wearing only a barrel. But inflation that’s largely concentrated in shelter and (from time to time) energy doesn’t have much to do with the shape of the labor market.

cpi-shelter-etc

Tire kicking

Quite the buzz arose on the release of the June Job Opening and Labor Turnover Survey (JOLTS) numbers, showing record-tying openings in the private sector. (There wasn’t much else of note in the report; the hires rate was flat, and the layoff rate was up 0.1pp from May and the prior year.) The inability to find qualified employees is the standard explanation; a creative variation that’s arisen recently is that too many fail their drug tests, or would if they had the nerve to take them.

We’re flipping that argument. How can the high level of openings coexist with a less exuberant quit rate (which, by the way, slipped a notch in June)? In 2006, openings ran 0.9 points above quits, the spread tightened into 2009, and then widened again. It’s averaged 1.7 since 2015, and in June was 1.9. Why has the gap widened so?

jolts-openings-and-quits

Presumably the already-employed are qualified and capable of passing a drug test. It seems odd that employers with all those openings don’t bid them away. Could it be that employers just don’t want to pay up, or can’t with productivity so weak?

Perhaps, also, the already employed are aware that their own employers are putting out feelers but reluctant to follow up with actual hires.

We’re not even talking about drawing the unemployed or marginally attached in from the sidelines. If there is real information in the openings rate, we are confident there would be more job-switching.

July sales tax collections

In July, 54% of the states in our survey met or exceeded their forecasted sales tax collections, down from June’s 70%, and 97% reported growth over the year. That’s better than June’s 82%, but was padded by the fact that July 2016 ended on a weekend, forcing payments into August last year. The average over-the-year rate of change moved to 4.7% from June’s 52%, and the margin from forecast rounded down to 1% having rounded up to 1% in June.

sdi-7-17

July collections tend to be a “throw away” month in revenue departments. Some of the collections accrue back to June, and July is what’s left, so trend watching resumes in earnest in August. The positive comments were subdued. Our contact in a large western state noted that they are continuing their “trend of beating forecast,” but that’s a conservative 1.2% for the current quarter.

The energy extraction states had another strong month, but recent state detail on job gains in those states does not suggest that extraction employment is leading the way. No surprise there, it’s a tiny sector. For example, in Texas, logging and mining work constitutes just under 2% of total employment, so its 7% contribution to the over-the-year gain of 313,000 jobs is impressive. But that contribution is eclipsed by professional & business services, and government work’s contributions of 20%, or 60,000 jobs each. Each of those sectors comprise about 14% of total employment.

In some states collections soared toward the end of the month and faded in the early days of August, reflecting the calendar effect. Our contact in one such state noted that his conversations with industry leaders does not suggest a consistent “more jobs=more spending” scenario, but rather that perhaps the better job gains among college students this summer is contributing to decent withholding and quite strong sales revenues. He’s also concerned that debt may be creeping up.

State-level GDP: Down on the farm with energy rising

During first quarter of 2017, economic growth declined in five of the seven Plains states. Within this region, only Missouri and North Dakota saw their economies grow during the quarter. North Dakota’s growth came from a reviving energy sector that contributed 1.7pp and offset almost the entire 1.9pp drop in its agriculture sector. Missouri’s agriculture sector declined by 0.8pp, but this was offset by relatively strong growth in durable goods manufacturing and wholesale trade.

The states that experienced the greatest declines in output were Nebraska (-4.0%), South Dakota (-3.8%), and Iowa (-3.2%). Lower prices for row crops likely explain the decline. During the first quarter of 2017 corn prices averaged 4.4% below the prior year and wheat prices were down 11.7%. Soybean prices were up somewhat compared to 2016 but were trending lower.

Nationwide the agriculture, forestry, fishing and hunting sector subtracted 0.41pp from the overall annualized growth, which totaled 1.1%. As the accompanying chart shows, absent the agriculture sector national GDP grew by 1.6% during the first quarter.

The fasted growing sector in Q1 was mining, which includes oil extraction. It was up 0.3%. As shown in the accompanying chart, excluding the mining sector national GDP would have only increased by 0.8%.

gdp-xag-xmin

Texas 3.9% gain was the strongest. Its mining sector increased by 2.1pp. West Virginia experienced the second highest rate of overall growth at 3.0% and its mining sector contributed 3.2pp. New Mexico had the third highest growth rate at 2.8% with its mining sector contributing 1.8pp. Other energy states also experienced increased growth. Oklahoma’s 1.9% growth in output ranked 11th and noisy Alaska’s 1.8% growth ranked 14th. (A revenue estimator from the state told us they basically don’t even try to forecast revenue growth in the state because the economy is so volatile.)

But other energy states did not fare as well. Lousiana’s economy grew by only 1.0% (ranked 28th). Growth in Wyoming clocked at just 0.9% (32nd), and Montana saw a 0.5% decline (45th)

Finally, a couple of standout states for the quarter were Washington and Wisconsin. Washington continued a pattern of strong performance from 2016 when it took the blue ribbon. Its economy grew at an annualized rate of 2.7% during the first quarter and by 3.8% for all of 2016. This growth was driven by its information sector, which accounted for 1.7pp, and durable goods manufacturing, which accounted for 0.7pp, of the overall growth. Wisconsin’s 2.1% annualized growth for the first quarter represents a reversal of fortune from 2016 during, when its economy grew by only 0.9%. The sectors that contributed the most to its first quarter 2017 growth were real estate (0.6pp), durable goods manufacturing (0.4pp) and nondurable goods manufacturing (0.4pp).

by admin· · 0 comments · Uncategorized

The Fed: Climate Change Ahead?

My formative years stretched from the mid-1970s to mid-1980s. While my economic awareness of the time was at best weak, I do remember that inflation was a very important issue that was constantly on my father’s mind. In case you’re wondering, the “I” in this piece is Hale Stewart.

It’s also obvious that this period haunts today’s central bankers as they continue to worry about inflationary pressures despite all evidence to the contrary. But the latest minuteswhich were released on Wednesdayshow a Fed that is beginning to realize some of them just may have it wrong.

Let’s start with their observations about the current state of inflation:

Total U.S. consumer prices, as measured by the PCE price index, increased 1-1/2 percent over the 12 months ending in May. Core PCE price inflation was also 1-1/2 percent over that same period. Over the 12 months ending in June, the consumer price index (CPI) rose 1-1/2 percent, while core CPI inflation was 1-3/4 percent. The median of inflation expectations over the next 5 to 10 years from the Michigan survey edged up both in June and in the preliminary reading for July. Other measures of longer‑run inflation expectations were generally little changed, on balance, in recent months, although those from the Desk’s Survey of Primary Dealers and Survey of Market Participants had ticked down recently.

Let’s put that into quantitative perspective:

fredgraph-5

The chart above show 12 months of the Y/Y percentage change in core and overall CPI and PCE prices. Core CPI is purple. It was greater than 2% until April and has been below the Fed’s target since. The green bar is overall CPI, which was greater than 2% for five months but fell below 2% in April. The bottom chart tracks the same data over the most recent 5-year period; none of these measures meaningfully breached 2% in that stretch. The conclusion is clear: inflation has not meaningfully penetrated the Federal Reserve’s 2% target since 2012.

The next paragraph discussing inflation highlights the fed’s inflation projections:

The staff’s forecast for consumer price inflation, as measured by the change in the PCE price index, was revised down slightly for 2017 in response to weaker-than-expected incoming data for inflation. As a result, inflation this year was expected to be similar in magnitude to last year, with an upturn in the prices for food and non-energy imports offset by a slower increase in core PCE prices and weaker energy prices. Beyond 2017, the forecast was little revised from the previous projection, as the recent weakness in inflation was viewed as transitory. The staff continued to project that inflation would increase in the next couple of years and that it would be close to the Committee’s longer-run objective in 2018 and at 2 percent in 2019.

This line of reasoning is becoming increasingly perplexing. Although the Fed acknowledges that near-term inflationary pressures are weak and are getting slightly weaker–the Board once again concludes that prices will hit the Fed’s 2% target in the coming years. For the last few years, the Board has consistently believed that price pressures will perform as projected despite all evidence to the contrary.

A later paragraph not only explains why the Fed continues to use this thinking, but also presents several reasons why perhaps they should drop it:

A number of participants noted that much of the analysis of inflation used in policymaking rested on a framework in which, for a given rate of expected inflation, the degree of upward pressures on prices and wages rose as aggregate demand for goods and services and employment of resources increased above long-run sustainable levels. A few participants cited evidence suggesting that this framework was not particularly useful in forecasting inflation. However, most participants thought that the framework remained valid, notwithstanding the recent absence of a pickup in inflation in the face of a tightening labor market and real GDP growth in excess of their estimates of its potential rate. Participants discussed possible reasons for the coexistence of low inflation and low unemployment. These included a diminished responsiveness of prices to resource pressures, a lower natural rate of unemployment, the possibility that slack may be better measured by labor market indicators other than unemployment, lags in the reaction of nominal wage growth and inflation to labor market tightening, and restraints on pricing power from global developments and from innovations to business models spurred by advances in technology. A couple of participants argued that the response of inflation to resource utilization could become stronger if output and employment appreciably overshot their full employment levels, although other participants pointed out that this hypothesized nonlinear response had little empirical support.

The Fed’s model is based on a standard economic cause and effect theory: increased demand absorbs excess supply; this increases resource utilization beyond current production capacity; which forces producers to raise prices. Increased demand is also a signal to producers that they have pricing power – the ability to raise prices without negatively impacting demand.

Let’s take a look at some of the reasons the Fed raises as possible reasons for the disconnect between growth and prices late in the paragraph.

First up, a lower natural rate of unemployment: Consider Japan, where unemployment is currently below 3% yet inflationary pressures remain nonexistent.

Next, the possibility that slack may be better measured by labor market indicators other than unemployment: here, the Atlanta Fed’s the labor market spider chart provides the necessary detail.

atlanta-fed_labor-market-historical-distributions-spider-chart

The lower left-hand corner of the chart shows three data points that quantify labor utilization: the employment to population ratio, employees working part time for economic reasons, and employees who are marginally attached to the labor force. Despite a nearly record long expansion, all three levels are still below previous peaks.

Restraints on pricing power from global developments and from innovations to business models spurred by advances in technology are real and here to stay. U.S. business is now competing against any company who has access to the U.S. market. Some of foreign competitors have lower cost structures, lowering their input costs. This, in turn, constrains prices.

The Fed is slow to act, so don’t expect them to radically change their policies or outlook overnight. However, it does appear they are re-evaluating their understanding of how inflation materializes in the economy and the looking for new relationships to explore. This is a very good development.

We hope they will take their own advice on that score. In a recent interview outlined here St. Louis President James Bullard brought up what drives inflation as a key issue, noting that, “…the answer you get from various angles is always the same: that inflation doesn’t seem to be related to the variables that we think it should be related to.” The Phillips Curve seems to have lost its swag. Bullard maintains it never had much, and that we’re better off looking at the recent trend to gauge inflation.

by admin· · 0 comments · Fed Focus, Uncategorized

Stanley Fischer: “Reasonable People Can Disagree”

Stanley Fisher bravely gave a talk on labor productivity last week—bravely because Robert Solow was in the audience, which Fischer acknowledged as an honor, a joy, and something of a difficulty. In his talk Fischer touched on a number of possible measurement problems, but, like the majority of serious researchers on the topic we have quoted over the years, sees no reason to believe there has been an increase in any measurement bias, meaning the long standing decline in productivity is not a measurement problem.

Fischer hauls out the old, and we’d say true, saw that public-sector research is responsible for the R part of the R&D pair, and the private sector is responsible for the D. This of course is a controversial statement, how many arguments have we all had on one side or the other? But the research in favor is pretty conclusive. The private sector has done wonders with the applications, but the basic materials are close to entirely produced in government or government-funded labs. (If you have evidence to the contrary, please send it along.)

That’s why Fischer calls the stunning trend shown below disturbing. We’d add it may go a long way toward debunking the idea that there’s any mystery cloaking current weakness in productivity.

pubpri

John Fernald, researcher at the San Francisco Fed who has had tremendous influence on the Federal Reserve’s overall thinking on the issue, has shown that labor’s contribution to productivity, driven by gains in educational attainment, etc., has been stable in the periods shown on the graph below, which were derived from his team’s work on the subject. Investment has been a dragging factor, but the real culprit appears to be innovation, the residual tracked by Total Factor Productivity. Somewhat elusive by nature, it’s designed to measure changes in output that cannot be explained by labor and capital. Belief in the power of that component of TFP was the Kool-aid of belief in the New Economy, but the contributions of formal and informal R&D, better management, gains driven by government-provided infrastructure (there would be no farming west of the Mississippi without federal water projects), and the creative destruction wreaked by highly productive firms on the trailers are certainly real.

inno

While we’re not graphing this, Fernald’s research shows that productivity contributions from IT producing industries peaked between 1995-2000, the contribution of IT-intensive firms increased ten-fold between 2000 and 2004, and then shrunk back to where it had been by 2007. Non IT-intensive firms plucked their low-hanging fruit by 2007, and their contribution disappeared by 2011. Many of the revolutionary increases in productivity took place in retail and wholesale trade, and in online brokerage back then. Nothing comparable is happening now.

Fischer believes that AI, his example is self-driving cars, medical technology (gene-driven treatments), and cheaper alternative fuels all suggest that we can reach for higher fruit, and raises the possibility that we may be in a productivity lull as these advances spread through the economy. He notes that it took decades for the steam-engine to make its changes. One hopes.

the Rule of 70

And Fischer cuts to the chase. In answering his rhetorical what does this matter?, he turns to his favored measure: how long it takes for productivity and, therefore, income, to double. During the 25 years between 1948 and 1973 when labor productivity was growing at 3.25%, it took labor productivity 25 years to double (70/3.25); in the 42 years between 1974 and 2016, with labor productivity growing an average 1.75%, it took 41 years to double. What is the difference between the prospects facing the young when per capita incomes are doubling every 22 years and when they are doubling every 41 years. An excellent reason to work to shift the tide.

Noting that reasonable people can disagree on how best to advance the objective, Fischer points out that another restraining factor may be uncertainty related to government policies, which stabilized in 2013, but was on the rise again in late 2016. Damping such uncertainty by more clarity is “highly desirable—particularly if the direction of policy itself is desirable.”

Perhaps we could harness some creative destruction and dismantle our $125 billion-dollar-a-year Grid Lock industry. (Forbes noted about 56% of that is direct, wasted time and fuel while sitting in traffic.) It’s a far cry from what we hoped for from the innovation residual, but perhaps we should try to recoup the kind of productivity gains that came with the interstate highway system in the 1950s and 1960s—only maybe with some 21st century modes of transportation instead?

by admin· · 0 comments · Fed Focus, Uncategorized