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Industrial Production: Up Close & Personal

Note: We are looking at long term trends here so this isn’t a big deal, but the Federal Reserve pointed out that Hurricane Harvey is responsible for approximately three-quarters of the decline in the latest industrial production report. Expect the Harvey and Irma effects to be with us for a long time.

Industrial production is the red-headed step-child of coincident economic statistics. The entire market stops, and then quickly restarts, when the BLS releases the employment report. The Census’s retail sales number receives less fanfare, but it does have a certain amount of headline grabbing power despite its unruly nature. In contrast, the Federal Reserve’s industrial production release receives no attention. This is unfortunate, because it contains a great deal of salient information. And there is no disputing its economic importance: according to BEA industry output data, manufacturing is one of the largest contributors to total industry output.

Before looking at the latest report, let’s consider some context:

The above chart shows all the primary coincident indicators shifted to base 100. All – except industrial production – have risen above their respective pre-recession highs. It peaked at the end of 2015, dipped for a few years, and only recently increased to higher levels.

Next, consider capacity utilization:

This statistic has hit consistently lower peaks for the last three expansions. This has two important ramifications. First, it weakens investment demand. Why add to your physical plant when you’re employing a lower percentage of it? Second, this may be a fundamental reason for weak price pressures. Why raise prices when instead all you have to do is bring more of your dormant capacity online?

There are two categorization systems used by the Federal Reserve to break down industrial production: major industry groups and major market groups. We will take those in turn.

Major Industry Groups

We’ll break this data down into 4 sub-components, starting with durable and nondurable manufacturing.

Durable manufacturing (in red) first peaked in mid-20124 and again in 2017. But it still hasn’t advanced much beyond its pre-recession level. It’s doubtful it will do so; auto sales are declining and the auto dealer sales/inventory ratio is near a multi-decade high. Non-durable goods dropped about 10% during the recession and only recently started to rise from the pre-recession lows.

Here are the charts of the final two industry groups:

Utilities (top chart) have moved sideways for the duration of this expansion. We suspect increased energy efficiency is having an impact, a good thing. That leaves mining (bottom chart) to provide the sold growth engine. It declined for 30 years (1980-2010) before growing strongly because of the fracking revolution. That has proved to be an unstable thing, but if it weren’t for fracking, there would be no major move in industrial production along industry lines.

Market Groups

Let’s first look at industrial production for consumer goods:

Durable production (in red) has risen to slightly above pre-recession levels, but has yet to move meaningfully beyond that level. Nondurable production (in blue) remains below its prerecession level – so much so that it’s highly doubtful it will advance beyond its previous high.

Next, here is business equipment:

Business equipment (in green) is stuck near its pre-recession level. Construction production (in red) was understandably high during the housing bubble. It dropped sharply during the recession and has been rising consistently since. General business supplies (in blue) is still far below pre-recession levels.

Defense and space production has recently declined:

Next is durables and nondurables materials production:

Durables production (in blue) is slightly above it pre-recession level while nondurable goods are sharply lower. There has been no meaningful growth in either measure dor at least several years.

Energy is the last industry classification:

And it is the only one that has meaningfully grown during this expansion.

Regardless of how you slice the data, The United States’ physical production hasn’t grown meaningfully during this expansion. The best performing sector in the consumer areas is durables, and they’re still near pre-recession levels. Overall business supplies levels are also lackluster. If it weren’t for oil, we’d be seeing no growth in industrial production.

by admin· September 18, 2017· 2 comments · Employment & Productivity

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% inflation—or perhaps Godot—all 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:

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:

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· September 13, 2017· 1 comment · Red Flags, Uncategorized

2% target? Inflation Didn’t Get the Memo

The Fed has publicly stated it has a 2% inflation target, but inflation has been stubbornly uncooperative in reaching that level. The PCE price deflator moved above 2% earlier this year, but has since fallen back, bringing both the overall and core rates back to 1.4%.

The latest Fed minutes show, yet again, that the Fed is concerned about weak price pressures. We’re harping on this subject both because it’s very important, and because it reveals a bit of a dust-up within the Fed. Apparently there has been an ongoing debate within the Fed over showing a united front or encouraging dissent. We, of course, go with dissent, so to us the current inflation debate is encouraging.

Hale Stewart put together the following round-up of recent FOMC speak on that debate.

At their latest meeting, explanations for ongoing low inflation offered by the fed includedoffered by the Fed 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.

Fed Governors James Bullard and Lael Brainard have been the most vocal on the problem that inflation, in Bullard’s words, “doesn’t seem to be related to the variables that we think it should be related to.”

Last week Bullard posted comments on the St. Louis Federal Reserve’s blog focused exclusively on the Phillip’s Curve, which argues that as unemployment decreases, wages increased. This relationship was first observed in the 1950s and became part of central bank policy making soon thereafter. While the 1970s stagflation experience soured the Fed on this theory, it returned to prominence in the 1990s. As many, including the gang here, have argued, the relationship between employment growth and wages is weak at best. The table below shows that even a nearly impossible 2.5% unemployment rate would cause only a minimal increase in PCE inflation (36 basis points). This research indicates that a basic relationship assumed by the Fed is no longer supported by the data, if it ever truly was.

With the Phillips’ Curve either very flat or broken, what should we consider as the causes of current very low inflation? Lael Brainard – one of the Fed’s brightest lights – offers several explanations starting with import prices:

One key factor that may have played a role in the past three years is the decline in import prices, reflecting the dollar’s surge, especially in 2015. By contrast, in the 2004‑07 period, non-oil import prices increased at roughly a 2 percent annual rate and had a more neutral effect on inflation. Nonetheless, while the decline in non-oil import prices likely accounts for some of the weakness in inflation over the past few years, these prices have begun rising again in the past year at a time when inflation remains relatively low.

The following graph illustrates her point:

The trade-weighted dollar (in green, of course) decreased 25% between 2002-2008. At the same time, import prices rose at fairly sharp rates. The exact opposite happened during this expansion: the dollar increased a little over 30% causing import prices to contract from 2012 to the beginning of 2017.

She also argues that underlying inflation–as well as inflation expectations–has decreased, which is best illustrated by the breakeven inflation rate, which subtracts the yields of TIPS, Treasury Inflation Protected Securities, from the corresponding treasury.

The 5-year (in red) and 10-year (in purple) breakeven rate each fluctuated around 2.5% during the previous expansion. But each has decreased in fairly pronounced ways in the last 4 years. The 5-year has dropped about 100 basis points while the 10-year is down about 75 basis points. This graph indicates that people believe price pressures are declining, so they’re demanding less interest as compensation.

Brainard offers two reasons why inflation expectations are declining:

One simple explanation may be the experience of persistently low inflation: Households and firms have experienced a prolonged period of inflation below our objective, and that may be affecting their perception of underlying inflation. A related explanation may be the greater proximity of the federal funds rate to its effective lower bound due to a lower neutral rate of interest. By constraining the amount of policy space available to offset adverse developments using our more effective conventional tools, the low neutral rate could increase the likely frequency of periods of below-trend inflation. In short, frequent or extended periods of low inflation run the risk of pulling down private-sector inflation expectations. (Note: Bullard has argued that the recent trend is the best indicator of inflation’s direction.)

The first theory has been advanced to explain Japan’s low inflation expectations, but while there is a correlation between the two statistical events, we don’t know if there is causation. The second is related to recent research from the San Francisco Fed, which observed that the natural rate of interest is abnormally low and has been for the duration of this expansion. Low interest rates can’t exist if inflation is high because at some point, the markets will demand sufficient compensation to the natural devaluation of this money.

As we noted last week, the Fed moves at a glacial pace, so don’t expect a sea change in their collective inflation thinking. In fact, several other speeches this week indicate that some governors are continuing to argue low inflation is transitory. However, Bullard and Brainard have at least put the ball in play and offered substantive evidence supporting a rethinking of the Fed’s recent inflation targeting failures. And we believe they won’t drop that ball.

by admin· September 9, 2017· 0 comments · Fed Focus

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%.

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· September 7, 2017· 0 comments · Uncategorized

Charlottesville

This commentary was co-authored by Philippa Dunne (The Liscio Report) and David Kotok (Cumberland Advisors). It reflects their personal views. Philippa notes it was a real honor to write this with David. And that it was so very “David” of him to remind her that James Alex Fields, Jr., is innocent until proved guilty.

A saga unfolds. First, snippets of online news, followed by TV images and “breaking news” reports. “Another one,” she thinks. “Ugh!” he exclaims, “madness! Why? What is the matter with these people?”

Two thousand miles apart, each in their own home, these two friends experience a similar aching angst over the futility of their efforts to try to improve a world that now seems to be rejecting their vision. After all, hate and anger triumphed in Charlottesville. Death arrived on scene, and innocents and innocence were among the casualties. Hate always seems to end that way.

Is hate learned, or is it embedded in some strand of DNA passed down through every human generation? Nazis hated, and Jews died. Then millions more died worldwide. Generations were seared and scarred. For what? To what end?

Geneticists who have decoded the human genome tell us that there is really only one human race, not multiple races within the species, yet the notion of a color scheme still grips some human imaginations, with disastrous results. White hated, and black and red died. And within this awful spectrum, each race’s history is replete with its own internecine murder and torture. Yellow on yellow, brown on brown. White on white. Red on red. That’s our history.

Bling! That little noise is now nearly continuous, announcing incoming mail in the wake of tragedy. A quick look. She has written:

“I am guessing you are sharing my grief today. I know grief isn’t much better than hope as a tactic – perhaps worse, but…”

Yes, he thinks. Grief, like regret, is an emotion that is not very effective, since it occurs after the damage is done.

He taps her cell number on his iPhone. They chat, just as if they are in the same room. How can his miracle of communications and the hate that ripped through Charlottesville occupy the same space and time? How can humanity have come so far and yet never seem to progress?

How can the many heroes who put their own lives on the line to shelter Jews and fleeing slaves people the same world as an individual who decides to plow his car into a group of people he has never met, or one who feels OK about walking down our streets wearing a T-shirt quoting Hitler. Quoting Hitler, you understand.

Pained, each recalls the writings of Joseph Conrad, and they share that sad understanding. Each feels the heaviness of this latest door opened into a “heart of darkness”.

Those of good will must not succumb, she and he agree, as futile as their efforts may seem at times. That is their closing pledge.

Conversations like ours must have taken place among friends all over the country, as we as a nation reckon with the events that unfolded in Charlottesville, Virginia, last week.

How do we brighten that dark heart? Platitudes abound, but first, we should take an honest look at our own motives. Listen to the stories we tell about why the economy is the way it is, why there is a growing number of disenfranchised citizens in our country.

If our theories are overly complicated, they are likely constructed to obscure basic truths. Think, by way of an analogy, of the tortuous paths the planets were said to follow in order to keep the Earth at the center of the old Ptolemaic view, obscuring for centuries the simple beauty of the heliocentric system.

Reality insists that we seek answers to life’s puzzles – and answer to ourselves. We’re forced to admit that we’re probably not up to sitting down and having a chat with someone who believes certain groups of people are subhuman. How do you shake hands with someone who was happy to call Sasha Obama a monkey on her sixteenth birthday? You don’t.

But we can do something about the decades of reckless neglect that are an integral part of our heritage. Targeting each other is clearly not working; targeting the neglect that drives the anger is, perhaps, the only way through.

Jobs are just one telling example: Yes, jobs are being generated by the sharing economy, but many of them are makeshift and do not make up for jobs lost to globalization and displacement of industry. The state of our workers is not an artifact of poor measurement. If that’s your argument, you aren’t looking at the facts on the ground.

There are many simple things to do. Someone recently suggested that PTAs in rich districts might take some of the money they raise to struggling sister schools. We’d add: Don’t mail it to them. Walk it over and tell the kids you are funding a specific project.

The US economic pie isn’t growing as it once did. Maybe we can do something about that through broader capital investment, especially in research & development.

Maybe we can’t… or maybe we won’t. We have to think about what it means that our workers are worse off today than they were in the 1950s. We need to recognize how easy it is for some to manipulate the anger that hardship generates. Set up a straw man, and by and by, someone succumbs to the urge to drive his car into a group of people he has never met. Wherever did those guys marching by eerie torchlight last Friday get the idea that Jews are out to “replace” them? Many of them are feeling shunted aside, that’s for sure.

We get to decide if the threat of manipulated anger is something we want our children to live with. Yes, that’s right. We get to decide. Note indecision or do nothing is also a decision.

As it is, everyone loses. Though James Alex Fields, Jr., is innocent until proven guilty, if he took Heather Heyer’s life as alleged, it’s hard to believe he didn’t also ruin his own.

(Photograph: The thousand-foot garden at Monticello)

by admin· September 6, 2017· 0 comments · Comments & Context