Thursday, 19 of April of 2018

Economics. Explained.  

Initial Unemployment Claims

April 19, 2018

Initial unemployment claims declined 1 thousand in the week ending April 14 to 232 thousand after falling 9 thousand in the previous week.  The 4-week moving average rose 1 thousand to 231 thousand.  The low for the cycle is 221 thousand which was set back in February.  Thus, claims remain close to that level which was the lowest average level of claims since December 27, 1969 (when it was 220 thousand).

Ordinarily, with initial unemployment claims (the red line on the chart below, using the inverted scale on the right) at 231 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 200 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 a bit high relative to where it was going into the recession.

They will also have to think about hiring  some of our youth (ages 16-24 years) .  But the youth unemployment rate today is the lowest it has been in 17 years so there are not many younger workers available for hire.

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.  But even if they do, the reality is that the number of discouraged workers today is quite low — close to where it was going into the recession.

The number of people receiving unemployment benefits declined 15 thousand in the week ending April 7 to 1,863 thousand after having risen 60 thousand in the previous week.  The four week moving average rose thousand to 1,859.  Last week this average dipped to 1,852 thousand which is the lowest average since January 5, 1974 (when it was 1,839 thousand).   The only way the unemployment rate can decline is if actual GDP growth exceeds potential.  Right now the economy is climbing by about 2.5%; potential growth is  projected to be about 1.8%.  Thus, going forward  the unemployment rate will continue to decline slowly.

Stephen Slifer


Charleston, SC

Gasoline Prices

April 18, 2018

Gasoline prices at the retail level rsoe $0.05 ending April 16 to $2.75. In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.50. The Department of Energy expects national gasoline prices to average $2.64 this year which is somewhat lower than they are currently.  Hence, prices should decline somewhat in the months ahead.  However, the DOE has been expecting prices to fall for some time and, as prices steadily rise, it simply keeps boosting its projected average price for the year.  Thus, its forecasts for a decline later this year becomes questionable.

Spot prices for gasoline have been on the rise, although not in a straight line manner, for the past several months.  So while pump prices may fall later in the year, they are not going to fall any time soon.

Crude oil prices are currently about $68.00.  The Energy Information Agency predicts that crude prices will average $59.37 in 2018.  Thus, crude prices should decline significantly in the months ahead.  However, as noted earlier, the DOE has been surprised and its average gas price for the year has been steadily revised higher.  It appears that demand for crude continues to outpace supply.  See the discussion below about global supply/demand estimates.

The number of oil rigs in service  However, the number of rigs in operation has  rebounded sharply in recent months to 1,008 thousand.  Thus,  higher crude oil prices are encouraging some drillers to accelerate the pace of production.  If crude prices average about $59 per barrel this year or higher, we should expect the number of oil rigs in operation to continue to climb and further boost production.

Production in the past month surged to 10,540 thousand barrels per day which continues to climb rapidly.  The Department of Energy expects production to average 10.7 million barrels this year and 11.4 million barrels in 2019.  As U.S. production continues to rise, crude prices should decline to about $58 per barrel.

How can the number of rigs rise slowly but production surge?  Easy.  Technology in the oil sector is increasing which allows producers to boost production while simultaneously shutting down wells.  A few years ago some frackers could not drill profitably unless crude oil prices were about $65 per barrel.  Today that number has declined to about about $48 per barrel.  Six months from now that number will be lower still.

Oil inventories fell quickly for most of last year.    OPEC output has been reduced at the same time that global demand has picked up sharply.  While crude inventories have been sliding for a year, at 1.093 million barrels crude inventories are now roughly in line with the 2009-2014 average of 1,055 million barrels.  However, demand continuing to slightly exceed supply for the next several months, stocks may well continue to decline in the near term.

The International Energy Agency in Paris (IEA) produces some estimates of global demand and supply.  A couple of months ago its estimate had supply and demand relatively in balance between now and yearend.  But now,as shown in the chart below, demand picked up somewhat in recent months and while supply edged lower as production constraints have restrained output.  As a result the IEA now estimates that demand will exceed supply by about 0.5 million barrels per day between now and yearend.  If its forecasts are correct it is likely the DOE’s forecast for lower crude and gas prices between now and yearend may not materialize.  We’ll see.

Stephen Slifer


Charleston, SC*

Housing Starts

April 17, 2018

Housing starts rose 1.9% in March to 1,319 thousand after having declined an upward revised 3.3% (previously -7.0%) in February..  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 above).   That 3-month average now stands at 1,318 thousand which is the fastest pace of starts thus far in the business cycle.

Both new and existing home sales continue to trend upward but they are being constrained by a lack of supply.   Thus, the demand for housing remains robust.

Builders remain enthusiastic in part because they see traffic through the model homes climbing at a steady rate.

Mortgage rates are at 4.4% which is quite low by any historical standard.

The average home stays on the market for 37 days currently which is down from 100 days a few years ago.  One-half of the homes coming on the market sell within one month.  This statistic provides compelling evidence that the demand for housing remains robust.

At the same time employment gains are about 200 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 which is acceptable but a shade below its long-term average of 2.7%.

Housing remains affordable for the median-price home buyer.  Mortgage rates may have risen, but income has been rising almost as quickly, hence affordability has not dropped much.  At 163.0 the index  indicates that a median-income buyer has 63.0% more income than is necessary to purchase a median-priced house.

The problem in housing is not a lack of demand.  Rather it is a constraint on the production side.  Builders have had difficulty finding an adequate supply of skilled labor.  Construction employment had been growing by about 20 thousand per month but in recent months has picked up to 40 thousand per month,

As one might expect there is a fairly 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 1.3 million currently.  However,  as noted above, many home builders  report an inability to get the skilled workers they require.   Overcoming the labor shortage on a long-term basis 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.

Another 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 growth in households.  And because housing starts were substantially below the growth in households for so long, there is pent-up demand.  We expect starts to reach 1.4 million by the end of 2018.

What is interesting is that beginning in mid-2016 single family starts have begun to climb while multi-family buildings such as apartments have been slowing down.  It appears that many of the millennials who chose to rent for the last decade are getting older, perhaps starting families, and are now choosing to purchase a single family house.  In the past year single family starts have risen 6.0% while multi-family units have risen by 6.9% (although the March data appear to be an aberration.  In most months multi-family sales have registered a significant decline on a year-over-year basis)..

As a result, multi-family construction as a percent of the total has slipped from 37% in mid-2015 to 31%.

Building permits rose 2.5% in March to 1,354 thousand after having fallen 4.1% in February.  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 1,351  thousand which is the fastest pace thus far in the business cycle and continues to point towards 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 1,350 thousand, housing starts should surpass the 1.4 million mark by yearend.

Stephen Slifer

Charleston, SC

Industrial Production

April 17, 2018

Industrial production climbed 0.5% in March after having jumped 1.0% in February.   The strength in the final three months of last year probably reflects post-hurricane rebuilding, but the pace does not seem to be slowing much in the first quarter of this year.  During the past year industrial production has risen 4.3%.  It has not risen that rapidly in a 12-month period of time since January 2011.

Breaking industrial production down into its three major sub-components,  the Fed indicated that manufacturing production (which represents 75% of the index) rose 0.1% in March after having surged by 1.5% in February. During the past year  factory output has risen 3.0% (red line, right scale) which is the largest 12-month increase since June 2012.  The factory sector is gathering considerable momentum.

Mining (14%) output rose 1.0% in March after having jumped 2.9% in February.  Over the past year mining output has risen 10.8%.  Most of the recent upturn in mining has been concentrated in oil and gas drilling activity.  Oil and gas drilling jumped 4.1% in March after having jumped 6.7% in February.     Over the course of the past year oil and gas well drilling has risen 17.0%.  The number of  oil rigs in operation has been rising steadily for about one year.  The rise in oil prices in the past year or so has begun to boost drilling activity.

Utilities output rose 3.0% in March after having fallen 5.0% in February.  During the past year utility output has risen 5.3%.

Production of high tech equipment rose 1.2% in March after having climbed 0.5% in February.  Over the past year high tech has risen 8.9%.   Thus, the high tech sector sector appears to be on a roll. This is an indication that the long slide in nonresidential investment has come to an end which would, in turn, signal an upturn in productivity growth.

Capacity utilization in the manufacturing sector declined 0.1% in March to 75.9% after having  jumped 1.1% in February.  It is getting close to the 77.4% that is generally regarded as effective peak capacity.  Factory owners are soon going to have to spend more money on technology and re-furbishing or expanding their assembly lines to boost output.

Stephen Slifer


Charleston, SC

Retail Sales

April 16, 2018

Retail sales rose 0.6% in April after having declined declined in each of the previous three months.  Our sense is that sales rose sharply in the months immediately following the two hurricanes and some sales shifted into those months at the expense of sales that would typically have occurred in December, January, and February.  The trend rate has not change during that period of time, just the monthly pattern of sales.  In addition, extremely bitter cold and snow undoubtedly dampened sales in the winter months.  We should see a healthy snapback this spring.

Sometimes sales can be distorted by changes in autos which tend to be quite volatile.  In this particular instance car sales rose 2.0%.

Fluctuations in gasoline prices can also distort the underlying pace of retail sales.  If gas prices rise, consumer spending on gasoline can increase even if the amount of gasoline purchased does not change.  Gasoline sales fell 0.3% in March after having risen 0.1% in February.  While higher gas prices boost the overall increase in sales, they typically do not reflect an actual increase in the volume of gasoline sold.

Perhaps the best indicator of the trend in sales is retail sales excluding the volatile motor vehicles and gasoline categories.  Such sales rose 0.3% in both February and March.   In the last year retail sales excluding cars and gasoline have risen 3.9%.

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 which have been growing rapidly. Consumers like the ease of purchasing items on line.  While sales at traditional brick and mortar general merchandise stores have risen 3.2% in the past year, on-line sales have risen 9.4%.  As a result, their share of total sales has been rising steadily and now stands at a record 11.2% of all retail sales.

We believe that retail sales will continue to chug along at a 2.4% pace for some time to come..  First of all,  existing home sales are selling at a rapid clip and would be selling at a faster pace if there were more homes available for sale.  Car sales are solid at a 17.4 million pace.  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.

Second, the stock market is close to a record high level despite its recent correction.  That increase in stock prices boosts consumer net worth.

Third, all measures of consumer confidence are close to their highest levels thus far in the business cycle, and consumer confidence from the Conference Board is at its highest level since the early part of 2004.

Fourth, cuts in individual income tax rates will boost sales in 2018.

Finally, the economy is cranking out 200 thousand new jobs every month which boosts consumer income.  Consumers have paid down a ton of debt and debt to income ratios are very low.  That means that consumers have the ability to spend more freely and boost their debt levels if they so choose.

Thus, the pace of consumer spending seems steady.  We continue to expect GDP growth to quicken from 2.5% last year to 2.8% this year.

Stephen Slifer


Charleston, SC

Homebuilder Confidence

April 16, 2018

Homebuilder confidence edged 1 point lower in April to 69 after having declined 1 point in March.  The December level of 74 was the highest for this series since July 1999 — over 18 years ago.

NAHB Chairman Randy Noel, a homebuilder from LaPlace, Louisiana, said,“Strong demand for housing is keeping builders optimistic about future market conditions.  .“However, builders are facing supply-side constraints, such as a lack of buildable lots and increasing construction material costs. Tariffs placed on Canadian lumber and other imported products are pushing up prices and hurting housing affordability.”

NAHB Chief Economist Robert Dietz added “Ongoing employment gains, rising wages and favorable demographics should spur demand for single-family homes in the months ahead.  The minor dip in builder confidence this month is likely due to winter weather effects, which may be slowing housing activity in some pockets of the country. As we head into the spring home buying season, we can expect the market to continue to make gains at a gradual pace.”

Traffic through the model homes was unchanged in April at 51 after having fallen 3 points in March.  However, the December level of  58 which was by far the highest level thus far in the business cycle.  Traffic volume remains high and is a sign that buyer demand is on the rise.

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 1.25 million pace.  They should continue to climb gradually in the months ahead and reach 1.35 million by the end of 2018.

Stephen Slifer


Charleston, SC

Budget Deficits Back to $1 Trillion – By Next Year!


April 13, 2018

The Congressional Budget Office (CBO) this week completed its annual 10-year projection of budget deficits and federal debt outstanding for 2018-2028.  This exercise is typically completed in January but was released later than normal this year to give CBO an opportunity to fully evaluate the combined effect of the tax cut legislation enacted in December of last year and the Budget Act passed in February.   Given CBO’s preliminary estimate late last year that the tax cuts would increase budget deficits by a total of $1.5 trillion over the next ten years, it is not surprising that its final forecast shows a significant erosion in the budget outlook.

CBO acknowledges that their projections for the upcoming 10-year period are subject to more uncertainty than usual.  The issue centers largely on the extent to which the recent tax cuts – the corporate tax cut in particular– will stimulate investment spending and the country’s potential GDP growth rate.   CBO estimates that potential growth will quicken from the 1.5% pace registered in the 2008-2017 period, to 2.0% for 2018-2022 but slip back to 1.8% between 2023-2028.  We are more optimistic and envision a pickup in potential GDP growth to 2.8% or so by the end of this decade.

The reality is that nobody knows which view may be more correct.  Thus, budget projections beyond the next couple of years should be viewed cautiously.  Having said that, the direction and general magnitude are clear.  The recent policy changes have boosted budget deficits significantly which will, in turn, increase the amount of debt outstanding.  Both deficits and debt will climb to unsustainable levels.  The United States had a problem with budget deficits and debt outstanding prior to the recent policy changes, and the forecasts have gotten worse even though the exact dimensions of the erosion have yet to be determined.

In June of last year, the CBO estimated that the fiscal 2018 budget deficit would be $563 billion.  It now expects it to be $804 billion as tax cuts have reduced tax revenues and an increase in defense spending has boosted government expenditures.  Last June the CBO thought that the budget deficit would not climb to the $1.0 trillion level until 2021.  Now it thinks that is likely to happen next year – fiscal 2019 – and expects the deficits to climb further to $1.5 trillion by 2028.

Those are eye-popping, and disturbing, numbers.  But the best way to evaluate them is to calculate the projected deficits as a percent of GDP.  Economists believe that the U.S. can run a sustained budget deficit that is about 3.0% of GDP.  In fact, deficits for the past four years have been in that general ballpark.  But within two years the projected deficits will climb to roughly 5.0% of GDP.  The actual deficit estimates are the same as shown in the chart above, but a deficit that is 5.0% of GDP sounds somewhat less threatening.  It is not.  It is still troubling.

Keep in mind that every year that the government runs a budget deficit the Treasury must issue an equivalent amount of debt to finance the budget gap.  Hence, a $1.0 trillion budget deficit in any given year will increase the amount of debt outstanding by $1.0 trillion.  A string of $1.0 trillion deficits will boost debt outstanding by $1.0 trillion each year!  It is cumulative.

The deficits indicated above will lift Treasury debt outstanding as a percent of GDP from 76.5% last year to the 96% mark by 2028.  Economists suggest that a debt to GDP ratio of 50% is sustainable.  But once the debt/GDP ratio climbs to 90% it can be a problem.  Debt holders, particularly foreigners, may question the willingness and/or the ability of the Treasury to pay its future debt obligations.  That is especially true if projected budget deficits beyond the forecast period lift the debt/GDP ratio even higher.  With the deficit projected to be $1.5 trillion in 2028, deficits are certain to persist well beyond the forecast period and the debt/GDP ratio will continue to climb.

The Treasury’s 30-year budget forecast should become available sometime around midyear.  Last year it had the debt/GDP ratio climbing to 127% by 2030 and 155% by 2047.  That is far beyond the 90% danger threshold.  The recent revisions are certain to push those estimates higher.  To put those numbers in context, Greece is expected to have a debt/GDP ratio this year of 184%.  The U.S. is not Greece.  But to allow debt outstanding to climb to the percentages noted above is irresponsible.  The U.S. has a budget deficit and debt outstanding problem that is on the verge of spiraling out of control.  It needs to address the problem at some point, but it probably will not do so until it becomes a crisis.   What is clear is that the issue will not be addressed by this president.

Stephen D. Slifer


Charleston, S.C.

Consumer Sentiment

April 13, 2018

Consumer sentiment for April fell 3.6 points to 97.8 from March’s level of 101.4 which was the highest level of sentiment since January 2004.  The market had expected sentiment to slip to 101.0.

Richard Curtin, the chief economist for the Surveys of Consumers, said, “The small decline was widely shared by all age and income subgroups and across all regions of the country. Importantly, confidence still remains relatively high, despite the recent losses that were mainly due to concerns about the potential impact of Trump’s trade policies on the domestic economy. Uncertainty surrounding the evolving trade policy has caused many small (and at times inconsistent) changes in expectations.”

Given the tax cuts we expect GDP growth to climb from 2.5% in 2017 to 2.8% in 2018.  We expect the economic speed limit to be raised from 1.8% to 2.8% within a few years.  That will accelerate growth in our standard of living.  We expect worker compensation to increase 3.0% in 2018 vs. 1.8% last year. The core inflation rate (excluding the volatile food and energy components) rose 1.8% in 2017 but should climb by 2.4% in 2018.  Such a scenario would keep the Fed on track for the very gradual increases in interest rates that it has noted previously.  Specifically, we expect the funds rate to be 2.1% by the end of 2018.

The April drop in overall sentiment was caused entirely by a drop in both the current conditions and expectations components.

Consumer expectations for six months from now fell 2.0 points from 88.8 to 86.8.

Consumers’ assessment of current conditions declined 6.2  points from 121.2 to 115.0.

Trends in the Conference Board measure of consumer confidence and the University of Michigan series on sentiment move in tandem, but there are often month-to-month fluctuations.  Both series remain at levels that are consistent with steady growth in consumer spending at a reasonable clip of about 2.6% in 2018.

Stephen Slifer


Charleston, SC

Consumer Price Index

April 11, 2018

The CPI fell 0.1% in March after having risen 0.2% in February.  During the past year the CPI has risen 2.4%.

Food prices rose 0.1% in March after having been unchanged in February.  Food prices have risen 1.3% in the past twelve months.

Energy prices declined 2.8% in March after having edged upwards by 0.1% in February.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 7.0%.  The recent run-up in energy prices seems to reflect strengthening GDP growth around the world which is bolstering the demand for both crude oil and gasoline.  However,  U.S. production is surging and inventory levels have begun to climb.  As a result, oil prices have recently declined from about $68 per barrel to about $65.   The Department of Energy expects oil prices to average $55.33 in 2018 significantly lower than where they are currently.

Excluding food and energy the CPI rose 0.2% in both February and March.  Over the past year this so-called core rate of inflation has risen 2.1% but in the past three months it has accelerated to a 2/8% pace.  Clearly, inflation is on the upswing.  The question is still one of degree..

The most interesting development in the CPI in recent years has been the dichotomy between the prices of goods (excluding the volatile food and energy components) and services.  For example, in the past year prices for goods have fallen 0.3% while prices for services have risen 2.9%.

With respect to goods prices, it appears that the internet has played a big role in reducing the prices of many goods.  Shoppers can instantly check the price of any particular item across a wide array of online and brick and mortar stores.  If merchants do not match the lowest price available, they risk losing the sale.  Thus, they are constantly competing with the lowest price available on the internet.  Looking at specific items in the CPI we find that prices have fallen for almost every major category in the past year.  New cars have fallen 1.3%, appliances 2.2%, televisions 14.3%, audio equipment 17.6%,  toys 8.5%, information technology commodities (personal computers, software, and telephones) 3.2%.  Prices for all of these items are widely available on the internet and can be used as bargaining chips with a traditional brick and mortar retailer.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 2.9% in the past year.  The increase in this  broad category has been led by shelter costs which have climbed 3.3%.  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.

While the CPI, both overall and the core rate, have been very well contained in the first half of this year we believe that as the year progresses the core rate of inflation will have an upward bias  because of what has been happening to both shelter prices, gradually rising labor costs, and rising producer prices.  But on the flip side, the internet is keeping a lid on the prices of goods.  So while the CPI should edge higher in 2018, it is unlikely to explode.

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 but is poised to head higher.  The Fed has a 2.0% inflation target.  However, going forward we have to watch out for the steady increases 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(prescription drug prices in particular) and the impact of higher wages triggered by the shortages of available workers in the labor market.

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 pricy 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 2.1%.  However, with the economy growing steadily, rents rising, and wage pressures climbing, the core inflation rate should pick up from 2.1% currently to  2.4% by yearend.  And because the core PCE increases at a rate roughly 0.5% slower than the core CPI, the core PCE should increase  2.0% in 2018.  Both rates are beginning to trend higher.

Keep in mind that real short-term interest rates are negative.  With the funds rate today at 1.7% and the year-over-year increase in the CPI at 2.4% the “real” or inflation-adjusted funds rate is negative 0.7%.  Over the past 57 years that “real” rate has averaged about plus 1.0% which should be regarded as a “neutral” real rate.  Given a likely pickup in GDP growth this year and next and a gradual increase in the inflation rate, we regard a negative real interest rate inappropriate in today’s world.  The Fed should continue to push rates higher and gradually run off some of its longer term securities.

Stephen Slifer


Charleston, SC

Producer Price Index

April 10, 2018

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 0.3% in March after having risen 0.2% in February.  During the past year this inflation measure has risen 3.0%.  The PPI has been moving steadily higher and the year-over-year gain of 3.0% is the highest since January 2012.

Excluding food and energy producer final demand prices also rose 0.3% in March after having climbed 0.2% in February.  They have risen 2.7% since March of last year.  This series has been steadily accelerating for the past two years.  Inflationary pressures are gradually re-surfacing.

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

The PPI for final demand of goods rose 0.3% in March after having declined 0.1% in February. These prices have now risen 3.3% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 0.3% in March after having climbed 0.2% in both January and February.  During the past year the core PPI for goods has risen 2.1% (right scale).  It has been rising at about that pace for the past year .

Food prices jumped 2.2% in March after having fallen 0.4% in February.  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 risen 2.1%.

Energy prices declined 2.1% in March after having fallen 0.5% in February.  Energy prices have risen 8.5% in the past year.  These prices are also very volatile but the recent upswing seems to reflect a significant quickening of GDP growth around the globe.  However, U.S. oil output is now surging and crude prices have been fairly steady in a range from $60-65 in the past couple of months which should keep a lid on energy prices in the months ahead.

The PPI for final demand of services rose 0.3% in January, February and March.  This series has risen 2.8% over the course of the past year (left scale).   Changes in this component largely reflect a change 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 0.3% in both February and March after having climbed 0.4% in January.  It has climbed 3.0% during the past year.  This series, like the overall index, has been gradually accelerating for some time.

The recent increases in producer prices was foreshadowed by the results of the Institute for Supply Management’s series on prices paid by both manufacturing and non-manufacturing firms.  In the case of manufacturing firms the chart looks like this:

And for non-manufacturing firms it looks like this:

In both cases, the run-up in prices was widespread.  It was not just energy prices.  Once again, we believe this escalation in the prices that producers are having to pay reflects stronger GDP growth around the globe.

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 4.1%, the labor market is beyond full employment.  As a result, 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, but some of the upward pressure on inflation should be countered by an increase in productivity.

Some upward pressure on labor costs, rents, and the cost of materials will put upward pressure on inflation.  We expect the core CPI to increase 2.4% in 2018 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC