Tuesday, 21 of February of 2017

Economics. Explained.  

Will Trump Derail the Fed’s Game Plan

February 17, 2017

For the past eight years the Fed has been the driving force behind the economic expansion.  But now President Trump has an unprecedented opportunity to re-shape the Fed’s Board of Governors.  There are currently two vacancies on the Board.  Fed Governor Dan Tarullo, who has been the Fed’s point man on financial regulation, intends to resign in the spring.  Fed Vice Chairman Stanley Fischer’s term ends in June.  And Fed Chair Yellen’s term ends in January of next year.  That means that President Trump will have the ability to appoint the next Fed Chair, Vice Chair, and three Fed governors within a year.  How might that alter the Fed’s conduct of monetary policy?  Probably very little.

The markets currently fear that President Trump’s push for wildly stimulative cuts in individual and corporate income tax rates will produce much more rapid GDP growth and trigger a re-emergence of inflation.  If so, the Fed would need to raise rates far more quickly than it currently envisions which could be the catalyst for the next recession.  That fear is overblown.  Despite changes in Fed leadership the Fed will continue on a slow but gradual path towards higher interest rates, the economy will continue to expand for several more years, and the expansion will ultimately go into the history books as the longest expansion on record.

As the economy swooned in 2008 the Fed lowered interest rates to a record-setting low level of 0%.  But now the Fed has decided the time has come to embark on a slow but steady path towards higher short-term interest rates.  Why?  Because it needs some leeway to lower rates at that point in time when the recession ultimately arrives.  The Fed envisions the federal funds rate reaching a “neutral” level of 3.0% sometime during 2020.  The direction of rates is clear regardless of who sits in the Fed Chair’s seat.

Fed Funds Rate -- Projected

The second step in the Fed’s easing process in the wake of the recession was “quantitative easing” whereby it purchased U.S. Treasury bonds and mortgage-backed securities.  In the process it flooded the banking system with more than $2 trillion of surplus reserves.  Those “excess reserves” represent the lending ability of the U.S. banking system.  If banks suddenly become willing to lend at the same time that consumers and businesses become more willing to borrow, those excess reserves could fuel an unprecedented, and highly inflationary, spending spree.  Ultimately, those surplus reserves must be extinguished.  One way to do that is to allow some of the Fed’s holdings of Treasury and mortgage-backed securities to mature and not be replaced.  But such action is as contractionary as its bond buying spree was stimulative.  To let securities run off at the same time that the Fed is raising short-term interest rates is not a good idea.  While the Fed needs to shrink its balance sheet, this process will probably not begin for another year.  But it is going to happen regardless who the Fed Chair might be.

Excess Reserves (Projected)

The most important pick for President Trump is obviously the Fed Chairman.  He could re-appoint Janet Yellen, but given his comments during the campaign about how she and the Fed were keeping interest rates artificially low in an attempt to support Hillary Clinton and the Democrats, the odds of that happening seem quite low.

The biggest challenges for the new Fed chair will be the speed with which interest rates will rise, and how soon the Fed will begin to shrink its balance sheet.  It is not going to sit idly by and let the inflation rate climb.  Why?  Because in the past the Fed has let inflation get out of control and it paid a price for doing so.  Inflation climbed to a double-digit pace in the late 1970’s as the Vietnamese War escalated.  The economy overheated and the Fed (under Arthur Burns) refused to raise rates high enough or fast enough to prevent an upsurge in inflation.  Ultimately, Paul Volcker had to push the funds rate above the 20% mark to break the back of inflation.  The Fed will not let that happen again – regardless of who is in charge.

Keep in mind also that while Fed governors and the Fed chairman may change, the Board’s staff does not.   These are people who have chosen a career at the central bank and are, in our opinion, extremely smart, capable and dedicated individuals.  We have the greatest respect for the Board staff and are quite comfortable having it oversee the process of implementing monetary policy.

Some would like the Fed to implement a “rules-based” policy whereby rate changes are determined by formula rather than what some see as a rather arbitrary decision-making process.  We strongly disagree with that concept.  Models are based on history.  As long as the structure of the economy does not change they may work well enough.  But the economy is dynamic and constantly evolves.  During the Great Recession consumers and businesses reassessed their attitude towards debt and are far less willing to hold debt today than at any time in recent history.  Technological changes have made the economy far more reliant on the service sector today than in the past.  Financial developments can result in never-before-seen instruments whose impact on the economy are unpredictable in advance.  Reliance on a simple model to determine the course of monetary policy would be a disaster.

In our view, tax cuts of some magnitude will be adopted this year.  However, with the prospect of $1 trillion budget deficits looming by the end of this decade President Trump will be unable to get Congress, or even Republicans, on board for untethered tax cuts.  Some offsets in the form of reduced government spending will be required to temper the impact of the tax cuts.  Hence, the economy will receive only mild stimulus this year, and the resultant increase in inflation should be relatively small.

Thus, regardless of changes in future Fed leadership, monetary policy for the next several years will not change much from what was described earlier – a moderate increase in interest rates followed by an eventual runoff of Fed holdings of U.S. Treasury and mortgage-based securities.  If those things happen gradually the expansion is poised to become the longest expansion on record.  It will hit the 10-year mark by June 2019.  If the Fed can engineer a record-breaking length period of expansion, why in the world would anyone want to tinker with the process?

Stephen Slifer


Charleston, SC

Housing Starts

February 16, 2017

Housing Starts

Housing starts declined 2.6% in January after having jumped 11.3% in December. Because these data are particularly volatile on a month-to-month basis, it is best to look at a 3-month moving average of starts (which is the series shown in blue above).   That 3-month average now stands at 1,225 thousand which is essentially the fastest pace of construction thus far in the cycle and it should continue to climb slowly.

Both new and existing home sales continue to climb.   Thus, the demand for housing is particularly robust.

New Home Sales

Builders remain enthusiastic in part because they are seeing traffic through the model home accelerating.

Homebuilder Confidence -- Traffic

Mortgage rates have risen almost 0.75% since the election in early November but at 4.2% they are still quite low by any historical standard.

Interest Rates -- 30 Year Mortgage

At the same time employment gains are about 170 thousand per month which is boosting income.  As a result, real disposable income (what is left after inflation and taxes) is growing at a 2.1% pace.

Disposable Income -- Real Monthly yoy

As a result housing remains affordable for the median-price home buyer.  Mortgage rates may have risen, but income has been rising at almost as quickly, hence affordability has not dropped much.  At 160.9 the index indicates that a median-income buyer has 60.9% more income than is necessary to purchase a median-priced house.

Housing Affordability

The problem in housing is not a lack of demand.  Rather it is a constraint on the production side.  Builders are simply unable to find an adequate supply of skilled labor.  Employment in the construction industry is growing slowly.

Payroll Employment -- Construction

As one might expect there is a tight correlation between home builder confidence and the starts data which probably makes a great deal of sense.   Judging by the homebuilder confidence data we should expect starts to eventually climb to 1.5 million or so from about 1.2 million currently.  However,  as noted above, many home builders  report an inability to get the skilled workers they require.   Overcoming the labor shortage will be challenging.  Employment in the construction industry will continue to climb, but slowly, which will limit the speed with which starts rise in the months ahead.

Homebuilder Confidence

The other thing worth noting is that about 1.3 million new households are being formed every year.  Those families all need a place to live, either a single-family home or an apartment.  Thus, we need to see housing starts rise by 1.3 million just to keep pace with demand.  At their current pace of 1.2 million there continues to be a shortage of available housing.  We expect starts to reach 1.3 million by the middle of 2017.

Housing Starts Projected

Building permits jumped 4.6% in January to 1,285 thousand after having risen 1.3% in December.  Because  permits are another volatile  indicator it is best to look at a 3-month average (which is shown below).  That 3-month moving average now stands at 1,242 thousand which continues to point towards slow but steady improvement in housing.   The reason people look at permits is because a builder must first attain a permit before beginning construction.  Thus, it is a leading indicator of what is likely to happen to starts several months down the road.  If permits are currently at 1,242 thousand, housing starts will gradually approach the 1.3 million mark.

Building Permits

Stephen Slifer

Charleston, SC

Initial Unemployment Claims

February 16, 2017

Initial Unemployment Claims

Initial unemployment claims rose 5 thousand in the week ending February 11 to 239 thousand.

Because these weekly data can be volatile the focus should be on the 4-week moving average of claims (shown above), which is a less volatile measure.  It was unchanged at 245 thousand which is . the lowest level for this average since November 3, 1973

Ordinarily, with initial unemployment claims (the red line on the chart below, using the inverted scale on the right) at 265 thousand  we would expect monthly  payroll employment gains to exceed 300 thousand.  However, employers today are having difficulty finding qualified workers.  As a result, job gains are significantly smaller than this long-term relationship suggests and are currently about 170 thousand.


With the economy essentially at full employment, employers will have steadily increasing difficulty getting the number of workers that they need.  As a result, they will be forced to offer some of their part time workers full time positions.  This series is still high relative to where it was going into the recession.

Unemployment Rate -- Part Time Economic Reasons

They will also have to think about hiring  some of our youth (ages 16-24 years) .  But the youth unemployment rate today is lower than where it was going into the recession so there may not be too many younger workers available for hire.

Unemployment Rate -- Youth

Finally, employers may also consider some workers who have been unemployed for an extended period of time.  But these workers do not seem to have the skills necessary for today’s work place.  Employers may have to offer some on-the-job training programs for  those whose skills may have gotten a bit rusty.

Unemployment Rate -- Discouraged Workers

The number of people receiving unemployment benefits declined 3 thousand in the week ending February 4 to 2,076 thousand.  The four week moving average rose 4 thousand to 2,080 thousand. That is close to the lowest 4-week average since April 1, 2000.  The only way the unemployment rate can decline is if actual GDP growth exceeds potential.  Right now the economy is climbing by about 2.0%; potential growth is  projected to be about 1.8%.  Thus, going forward  the unemployment rate will decline quite slowly.

People Receiving Benefits

Stephen Slifer


Charleston, SC

Gasoline Prices

February 15, 2017

Gasoline Prices -- Projected

Gasoline prices at the retail level rose $0.02` in the week ending February 13 to $2.31 per gallon.   In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.06. The Department of Energy expects national gasoline prices to average $2.38 this year — almost exactly where they are currently.

As the price of gasoline declined the economy got a tailwind. However,  oil prices today are 34% higher today than they were a year ago.  Hence, the tailwind effect on the economy has run its course but has not yet turned into a headwind.

Crude oil prices were about unchanged last week at $53.00.  The Energy Information Agency predicts that crude prices will average $53.46 in 2017.  As crude oil and gas prices have leveled off the underlying inflationary pressures have become more apparent.

Gasoline Prices -- Crude Projected

The number of oil rigs in service dropped 79% to 404 thousand  after reaching a peak of 1,931 wells in September 2014.  However, the number of rigs in operation has actually rebounded in recent months to 741 thousand.  Thus,  higher crude oil prices are encouraging some drillers to step up slightly the pace of production.

Gasoline Prices -- Oil Rif Count

While the number of oil rigs in production has been cut by 79% during the past year, oil production has declined much less than that.  The Department of Energy expects production to average 9.0 million barrels per day in 2017.

Gasoline Prices -- Production

How can the number of rigs go down but production be relatively steady?  Easy.  Technology in the oil sector is increasing rapidly which allows producers to boost production while simultaneously shutting down wells.  For example, output per oil rig has increased by 35% in the past twelve months.  Put another way, a year ago some frackers could not drill profitably unless crude oil prices were about $70 per barrel.  Today that number has declined to about about $44 per barrel.  Six months from now that number will be lower still.

Gasoline Prices -- Oil Rif Count

While oil inventories gradually declined for most of 2016 the recent increase in production has caused inventory levels to rebound.  If oil prices remain around $53 per barrel it appears that supply will once again exceed supply and prices will soon begin to turn downward.

Gasoline Prices -- Inventory Levels

In December OPEC agreed to cut production, but it remains to be seen how meaningful the cut will turn out to be.  In the past, various countries would begin to cheat and the whole thing would unravel.  And if they should be successful in pushing oil prices higher, U.S. producers will return in droves and prices will once again begin to fall.  They have risen recently, but they are not going to go far.

Stephen Slifer


Charleston, SC

Homebuilder Confidence

February 15, 2017

Homebuilder Confidence

Homebuilder confidence surged upwards by 6.0 points in December  to 69, but gave back 2 points in both January and February and now stands at 65.  That is still a very high level.  Clearly, builders believe that housing market will perform well in 2017.

Robert Dietz, Chief Economist for the home builders association said, “The HMI rose sharply in December as the election results raised hopes among builders that a new Congress and administration will help create a better business climate for small businesses, particularly with respect to improving regulatory costs, which increased more than 29% over the last five years.  However, ongoing industry concerns include rising mortgage interest rates as well as a lack of lots and access to labor.

Traffic through the model homes declined 5 points in February to 46 after having reached a high of 52 in December . Despite its recent setback traffic remains close to its highest level in 11 years.

Homebuilder Confidence -- Traffic

Not surprisingly there is a close correlation between builder confidence and housing starts.  Right now starts are lagging considerably because builders are having some difficulty finding financing, building materials, an adequate supply of finished lots, and skilled labor.  Starts  currently are at a 1.2 million pace.  They should continue to climb gradually in the months ahead and reach 1.4 million by the end of 2017.

Homebuilder Confidence -- versus Starts

Stephen Slifer


Charleston, SC

Retail Sales

February 15, 2017

Retail Sales (Growth 3 month avg)

Retail sales rose 0.4% in January after having climbed a solid 1.0% in December%.   During the course of the past year sales have risen 5.9%.

Sometimes sales can be distorted by changes in autos which tend to be quite volatile.  In this particular instance unit auto sales declined 4.6% in January but the trend is clearly upwards.  Keep in mind that existing home sales are selling at the fastest rate thus far in the cycle.  Consumers do not purchase homes and cars — the two biggest ticket items in their budget — unless they are feeling confident about their job and the future pace of economic activity.

Car & Truck Sales

Existing Home Sales

Fluctuations in gasoline prices can also distort the underlying pace of sales.  If gas prices rise, consumer spending on gasoline can increase even if the amount of gasoline purchased does not change.  Gasoline sales rose 2.3% in January which appears to largely reflect an increase in gasoline prices and not any particular change in the volume of gasoline sales.

Perhaps the best indicator of the trend in sales is retail sales excluding the volatile motor vehicles and gasoline categories.  Such sales rose 0.7% in January after having climbed 0.1% in December.   In the last year retail sales excluding cars and gasoline have risen 4.2%.

Retail Sales Ex Autos and Gas -- (Growth 3 mo. avg)

While there has been a lot of disappointment about earnings in the traditional brick and mortar establishments (like Macy’s, Sears, K-Mart, and Limited) the reality is that they need to develop a better business model.  The action these days is in non-store sales where have been growing rapidly. Consumers like the ease of purchasing items on line.  With on-line sales having risen a steamy 12.9% in the past year, their share of total sales has been rising steadily and now stands at 88% of fall general merchandise sales.  That percentage has risen 10.0% (from 78%) at this time last year.

Retail Sales -- Nonstore retailers as % Total

On balance consumer spending on goods seems to be holding up well and should climb at about a 2.5% pace in both 2017 and 2018.

Later this year we expect cuts in both individual and corporate income tax rates to give the economy a boost.  Firms will be able to repatriate earnings to the U.S. at a favorable 10% tax rate.  And Trump promises to eliminate all unnecessary, overlapping, and confusing Federal regulations.  These policy changes should boost the potential GDP growth rate from 1.8% today to 2.8% within a couple of years.  .

Stephen Slifer


Charleston, SC

Industrial Production

February 15, 2017

Industrial Production (pch)

Industrial production declined 0.3% in January after having jumped 0.6% in December after having fallen 0.3% in November.  However the wide swings are largely attributable to the output at the nation’s utilities caused by a mild/normal/mild seasonal pattern.    Over the past year industrial production has been unchanged.

Breaking industrial production down into its three major sub-components,  the Fed indicated that manufacturing production (which represents 75% of the index) rose 0.2% in January after having risen 0.2% in December. During the past year  factory output has risen 0.3% (red line, right scale).  It appears to have hit bottom.  While it has risen just 0.3% in the past year, it has climbed at an 0.9% pace in the past six months, and 1.8% in the past three months.

Industrial Production -- Mfg

The manufacturing sector had to cope with a significant 22% increase in the value of the dollar during the course of the 18-month period ending in December of 2015.  A higher dollar makes U.S. goods more expensive for foreigners to purchase and, as a result, tends to slow the rate of growth of exports.  The dollar dropped moderately in the first ten months of this year, but jumped in November following Trump’s election, and jumped again following the Fed’s announcement that not only did it choose to raise rates 0.25% in December (no surprise), but it planned to raise rates 3 times in 2017 instead of 2 (surprise).  However, our expectation is that the dollar may not climb too much higher.  Right now everybody is expecting this huge increase in Federal stimulus and inflation.  We are not sure about either of those arguments.  We expect some stimulus and some pickup in inflation, but not a lot.  We expect GDP growth this  year of 2.3% (versus 2.0% in 2016), and the core CPI to increase 2.7% in 2017 (versus 2.2% in 2016).  If that is the case, the Fed will not raise rates any more quickly than what it suggested previously, and may perhaps raise them more slowly.  Right now the dollar is only about 4% higher than where it was at this time last year.  If it settles down the trade component  should subtract just 0.2% from GDP growth in 2017 (versus 0.4-0.5% per year in 2014 and 2015.

Trade-weighted dollar

Mining (14%) output jumped 2.8% in January after having declined 1.4% in December.   Over the past year mining output has risen 0.4%%.  But over the past three months mining production has actually increased at a 5.8% pace.

Most of the drop in mining last year was concentrated in oil and gas drilling activity  which rose 8.5% in January.  It has now risen for eight consecutive months.  Over the course of the past year oil and gas well drilling has risen 3.0%%.  However, the number of  oil rigs in operation has begun to inch upwards after a long slide so the drag on production from shrinkage of the oil sector has come to a halt.

Industrial Production -- Oil and Gas Well Drilling

Utilities output fell 5.7% in January after  having risen 5.1 in December as  the weather was below normal in December but above normal in January.  This category bounces all over the  place depending upon the weather in any particular month, but its yearly growth is usually fairly flat.

Production of high tech equipment was unchanged in January after having risen 0.7% in December.  Over the past year high tech has risen 5.4%.   The high sector sector appears to have gathered some momentum during the past several months. This may be an early indication that the long slide in nonresidential investment may be coming to an end.

Industrial Production -- High Tech

Capacity utilization in the manufacturing sector rose 0.1% in January to 75.1%.  It is still below the 77.5% that is generally regarded as effective peak capacity.  Above that level the factory sector is running too hot and prices begin to rise.  We are a  ways from that so-called danger level.

Capacity Utilization

Stephen Slifer


Charleston, SC

Consumer Price Index

February 15, 2017


The CPI jumped 0.6% in January after having risen 0.3% in December.  During the past year the CPI has risen 2.5%.  The big jump in January was largely attributable to a 4.0% increase in energy prices so the gain is not nearly as troublesome as it might appear at first blush.  The core rate (excluding food and energy) was unchanged in January after having risen 0.2% in December.  During the past year it has risen 1.0%%.

Food prices rose 0.1% in December after having been unchanged for seven consecutive months.  Food prices have fallen 0.1% in the past twelve months.

CPI -- Food

Energy prices jumped 4.0% in January after having risen 1.2% in December.   Over the past year energy prices have risen 11.1%.  Given that oil prices have leveled off in the spot markets, the run up in energy prices at the consumer level should have about run its course.

CPI -- Energy

Excluding the volatile food and energy components, the so-called “core” CPI was unchanged in January after having risen 0.2% in both November and December.  The year-over-year increase now stands at 1.9%.

The core rate of inflation will have an upward bias in 2017 because of what has been happening to shelter and medical care.

Shelter costs rose 0.2% in January after having risen 0.3% in each of the previous five months.  I in the  past year they have climbed 3.5%.  This undoubtedly reflects the shortages of both rental properties and homeowner occupied housing. Indeed, the vacancy rate for rental property is at a 30-year low. This steady rise in the cost of shelter  will continue for some time to come and, unlike monthly blips in food or energy, it is unlikely to reverse itself any time soon.  It has been a long time since we have any component of the CPI show any upward pressure, so this category needs to be watched particularly since it makes up 33% of the overall index.

CPI -- Shelter


Medical costs rose 0.2% in both December and Janaury.  The recent increases have been led by a run-up in the hospital services index, an increase in prescription drug prices, and a jump in the price of health insurance.  Over the past year medical costs have increased 3.9%.  They are now beginning to climb rapidly and should produce upward pressure on the core rate of inflation in 2017.

CPI -- Medical

The Fed’s preferred measure of inflation is not the CPI, but rather the personal consumption expenditures deflator, specifically the PCE deflator excluding the volatile food and energy components which is currently expanding at a 1.6% rate and is poised to head higher.  The Fed has a 2.0% inflation target.  However, going forward we have to watch out for the acceleration in shelter which, as noted above, is being pushed higher by the shortage of both rental properties and homeowner-occupied housing.   Shelter is a long-lasting problem and given its 33% weighting in the CPI it will introduce an upward bias to inflation for some time to come.  We also have to watch rising medical costs.

Why the difference between the CPI and the personal consumption expenditures deflator?  The CPI is a pure measure of inflation.  It measures changes in prices of a fixed basket of goods and services each month.

The personal consumption expenditures deflator is a weighted measure of inflation.  If consumers feel less wealthy in some month and decide to purchase inexpensive margarine instead of pricey butter, a weighted measure of inflation will give more weight to the lower priced good and, all other things being unchanged, will actually register a decline in that month.  Thus, what the deflator measures is a combination of both changes in prices and changes in consumer behavior.

As we see it, inflation is a measure of price change (the CPI).  It is not a mixture of price changes and changes in consumer behavior (the PCE deflator).  The core CPI currently is at 1.9%.  However, with the economy growing steadily, rents rising, and the unemployment rate falling, the inflation rate should pick up during 2017 and rise by 2.5% in 2017 and 2.7% in 2018.  And because the core PCE increases at a rate slightly slower than the core CPI, the core PCE should increase  2.3% in both 2017 and  2018.  Both rates are trending higher.

+CPI -- Projected

CPI -- Versus PCE Deflator

Stephen Slifer


Charleston, SC


February 14, 2017

PPI -- Final Demand

The Producer Price Index for final demand – intermediate demand  includes producer prices for goods, as well as prices for construction, services, government purchases, and exports and covers over 75% of domestic production.

Producer prices for final demand rose 0.6% in January after have risen 0.3% in December.  During the past year this inflation measure has risen 1.7%  which is the largest 12-month increase since August 2014 which is, not surprisingly, that point in time when oil prices began to plunge.

Excluding food and energy producer prices rose 0.4% in January after having risen 0.1% in December.  They have risen 1.2% since January of last year.  However, in the past three months this series has risen at a 3.6% pace so even apart from the upswing in energy prices, the prices of all goods have begun to accelerate.

This overall index can be split apart between goods prices and prices for services.

The PPI for final demand of goods rose 1.0% in January after having risen 0.6% in December. These prices have now risen 3.2% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 0.4% in January after having risen 0.3% in December .  During the past year the core PPI for goods has risen 2.0% (right scale).  It has been steadily rising for more than a year.

PPI -- Final Demand -- Goods

Food prices were unchanged in January after having risen 0.5% in December.  Food prices are always volatile.  They can fall sharply for a few months, but then reverse direction quickly.  Over the past year food prices have declined 2.2%.

ppi -- Final Demand -- Food

Energy prices jumped 4.7% in January after  having climbed 1.9% in December.  Energy prices have risen 14.5% in the past year.  The earlier drop was due to a sharp increase in oil production in the U.S., and weaker demand from China.  However, energy prices rose steadily throughout 2016 and are expected to remain at about their current level in 2017 despite the recent OPEC agreement to cut production.  These agreements tend to not hold together too well.  In addition, the current level of U.S. production appears to be picking up slightly.  OPEC cuts should encourage U.S. producers to turn on the spigots which would counter most of the impact of the OPEC cuts.

ppi -- Final Demand -- Energy

The PPI for final demand of services rose 0.3% in January after having increased 0.1% in December.  This series has risen 0.9% over the course of the past year (left scale).  Changes in this component largely reflect a drop in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular).  The PPI for final demand of services excluding trade and transportation rose declined 0.1% in January after having risen 0.1% in December .  It has climbed 1.2% during the past year.

PPI -- Final Demand -- Services

Because the PPI measures the cost of materials for manufacturers, it is frequently believed to be a leading indicator of what might happen to consumer prices at a somewhat later date.   However, that connection is very loose.

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 4.8%, the labor market is at full employment.  At that point wages pressures are sure to rise, and once that happens firms are almost certain to pass that along to the consumer in the form of higher prices.

Some upward pressure on labor costs, rents, and medicare care will further increase the upward pressure on inflation.  We expect the core CPI to increase 2.7% in both 2017 and 2018.

Stephen Slifer


Charleston, SC

Small Business Optimism

February 14, 2017

Small Business Optimism

Small business optimism edged upwards by 0.1 point in January to 105.9 after having surged 7.4 points in December.  This is the highest level for this index since 2004.

“We haven’t seen numbers like this in a long time,” said NFIB President and CEO Juanita Duggan. “Small business is ready for a breakout, and that can only mean very good things for the U.S. economy.”

The NFIB indicated that “While the January optimism data did not match last month’s unprecedented 7.3 point increase, it demonstrates that small business owners remain positive about the overall direction of the economy and business climate. Despite little movement this month, we anticipate improvement in business conditions and sales to help drive up small business optimism throughout 2017.”

In our opinion the economy is bouncing along at a respectable pace and should gather momentum in coming months as the new Trump Administration produces a number of significant policy changes.  Specifically, we believe that in the first six months of next year we will see both individual and corporate income tax cuts, legislation that will allow firms to repatriate corporate earnings currently locked overseas back to the U.S. at a favorable 10% rate, elimination of all unnecessary, confusing and overlapping federal regulations, and re-vamping of our health care system to a less expensive and less complicated health care system consisting of tax-advantaged health savings accounts combined with a high deductible health insurance plan to ensure against catastrophic problems.  These changes should boost our economic speed limit should from 1.8% or so today to 2.8% within a few years.

Already we see the stock market at a record high level.   Jobs are being created at a reasonably robust pace.  The unemployment rate is  at full employment.  The housing sector is booming.  And now investment spending should pick up after essentially no growth in the past three years.  We expect GDP growth to climb from 2.0% in 2016 to 2.3% in 2017 and 2.6% in 2018.  The core inflation will  probably quicken from 2.3% in 2016 to 2.7% in 2018 and 2019, but that will not derail the Fed’s plan to raise short-term interest rates very slowly.  Accelerating GDP growth, low inflation, and low interest rates should propel the stock market to even higher high levels..

Stephen Slifer


Charleston, SC