Tuesday, 20 of March of 2018

Economics. Explained.  

Housing Remains Affordable Despite Rise in Mortgage Rates

March 16, 2018

Mortgage rates have risen 0.5% in the first three months of this year from 4.0% to 4.5%.  Home prices are beginning to climb more quickly.  Buyers, sellers, and realtors are getting nervous.  However, it is important to remember that solid employment growth is boosting consumer income as well.   As a result, housing remains affordable and should remain so for the foreseeable future.

With respect to mortgage rates, at the end of last year they were comfortable at the 4.0% mark.  In less than three months they have climbed to 4.5%.  That is a big increase in a short period of time.  But it is important to note a couple of things.  First, by any historical standard a 4.5% 30-year mortgage rate is still very low.  Second, the early year run up in rates was triggered by a fear that the economy was overheating, inflation was beginning to climb, and the Fed would raise rates more quickly than expected.  That assessment has now changed.

Earlier this year strong economic data led many economists to anticipate first quarter GDP growth of 3.5-4.0%.  At the same time the core-CPI rose 0.3% in January which was biggest monthly increase in more than one year.  The conclusion was that the economy was overheating, inflation was on the rise, and the Fed would accelerate its pace of tightening.  Mortgage rates rose.

But subsequent data have been less robust.  First quarter GDP growth expectations have slipped to 2.0-2.5%, and the core-CPI for February rose 0.2% which was more in line with other recent months.  The early year fear of rapidly rising interest rates has quieted down.  Mortgage rates have leveled off.

However, home prices have begun to rise more quickly.  A year or so ago home prices were rising by about 4.5%.  Today they are climbing at a 6.0% pace.

This upswing in home prices reflects the extreme shortage of homes available for sale.  There is currently a 3.4-month supply of homes on the market.  The National Association of Realtors suggests that demand and supply are roughly in balance when there is 6.0-month supply.  Thus, demand exceeds supply and — not surprisingly – faster growth in home prices reflects that imbalance.

This combination of rising home prices and higher mortgage rates has understandably made some people nervous.  But there is a third part of the housing affordability equation that is overlooked and that is consumer income.  It is on the rise as well.  Employment gains have been consistently robust and seem to be gathering momentum.  For example, payroll employment rose 182 thousand per month last year. In the past six months that has averaged 205 thousand, and in the last three months it has climbed to an even steamier 242 thousand.  Employment gains generate the income that allows consumers to spend.

Primarily because of these job gains, real disposable income – which is what is left after paying taxes and adjusting for inflation – has climbed 2.3% which is close to its long-term average of 2.7%.

So, is income rising quickly enough to counter the increases in both mortgage rates and home prices?  Not quite.  The National Association of Realtors has a series on housing affordability that encompasses all three of these variables.  Right now, consumers have 60% more income than is necessary to purchase a median-priced home.  This series peaked in January 2013 when mortgage rates were at a record low level of 3.47%.  At that time consumers had 113% more income than necessary to purchase a median-priced house.  As mortgage rates have risen, housing is less affordable today that it was five years ago.  In contrast, prior to the recession – at the peak of the housing bubble – consumers had just 15% more income than needed.  Thus, housing today remains affordable.

While mortgage rates and home prices are important in determining housing affordability, so is consumer income growth and this is the piece that people tend to miss.  If we continue to generate 200 thousand jobs a month, inflation rises moderately, and the Fed continues to pursue a go-slow approach to raising interest rates, the housing market will do just fine.  This is not to say that everybody will be able to afford to purchase a home.  They will not.  Those on the lower end of the income scale and those with lots of student debt may find home ownership more challenging.  But, in general, the housing market will remain affordable throughout 2018.

Stephen Slifer


Charleston, S.C.

Consumer Sentiment

March 16, 2018


The final estimate of consumer sentiment for March climbed 2.3 points to 102.0.  That is the highest level of sentiment since January 2004.

Richard Curtin, the chief economist for the Surveys of Consumers, said “Consumers continued to adjust their expectations in reaction to new economic policies. In early March, favorable mentions of the tax reform legislation were offset by unfavorable references to the tariffs on steel and aluminum-each was spontaneously cited by one-in-five consumers. Importantly, near term inflation expectations jumped to their highest level in several years, and interest rates were expected to increase by the largest proportion since 2004. These trends have prompted consumers to more favorably cite buying as well as borrowing in advance of those expected increases.”

Given the tax cuts we expect GDP growth to climb from 2.5% in 2017 to 2.9% 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 2.0% by the end of 2018.

The March increase in overall sentiment was caused entirely by a jump in consumers’ assessment of current economic conditions.

Consumer expectations for six months from now fell 1.4 points from 90.0 to 88.6.

Consumers’ assessment of current conditions jumped 7.9 points from 114.9 to 122.8.

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

Housing Starts

March 16, 2018

Housing starts declined 7.0% in February to 1,236 thousand after having jumped 10.1% in January and having fallen 7.1% 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 above).   That 3-month average now stands at 1,257 thousand which is marginally less than the 1,278 thousand pace recorded in January which was 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 42 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 2.3% 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 160.0 the index  indicates that a median-income buyer has 60.0% 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 1.25 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 1.35 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 5.0% while multi-family units have declined by 11.6%.

As a result, multi-family construction as a percent of the total has slipped from 37% in mid-2015 to 29%.

Building permits fell 5.7% in February to 1,298 thousand after having climbed 5.9% in January.  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 1,325  thousand which is the fastest pace thus far in the business cycle and 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 1,325 thousand, housing starts should surpass the 1.35 million mark by yearend.

Stephen Slifer

Charleston, SC

Industrial Production

March 16, 2018

Industrial production jumped 1.1% in February after having declined 0.3% in January, but that follows increase of  1.6% in October, 0.3% in November and 0.5% in December.   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 4.4%.  It has not risen that rapidly in a 12-month period of time since March 2011.

Breaking industrial production down into its three major sub-components,  the Fed indicated that manufacturing production (which represents 75% of the index) rose 1.2% in February after having declined 0.2% in January. During the past year  factory output has risen 2.5% (red line, right scale) which is the largest 12-month increase since July 2014.  The factory sector is gathering considerable momentum.

Mining (14%) output jumped 4.3% in February after having declined 1.5% in January.  Over the past year mining output has risen 9.7%.  Most of the recent upturn in mining has been concentrated in oil and gas drilling activity.  Oil and gas drilling surged by 11.6% in February.     Over the course of the past year oil and gas well drilling has risen 27.2%.  The number of  oil rigs in operation has rebounded in recent months.  The rise in oil prices in the past several months is beginning to boost drilling activity.

Utilities output fell 4.7% in February after having risen 1.3% in January.  During the past year utility output has risen 10.5%.

Production of high tech equipment rose 1.0% in February after having declined 0.2% in January.  Over the past year high tech has risen 8.3%..   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 jumped 0.9% in February to 76.9%.  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

Homebuilder Confidence

March 15, 2018

Homebuilder confidence edged 1 point lower in March to 70 after having declined 1 point in February.  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,“Builders’ optimism continues to be fueled by growing consumer demand for housing and confidence in the market.  However, builders are reporting challenges in finding buildable lots, which could limit their ability to meet this demand.”

NAHB Chief Economist Robert Dietz added “A strong labor market, rising incomes and a growing economy are boosting demand for homeownership even as interest rates rise.”

Traffic through the model homes fell 3 points in March to 51 after having been unchanged in February.  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

Initial Unemployment Claims

March 8, 2018

Initial unemployment claims declined 4 thousand in the week ending March 10 to 226 thousand after having risen 20 thousand in the previous week.  The 4-week moving average is at 222 thousand which is essentially the lowest average since December 22, 1969 when it was 220 thousand — 49 years ago.

Ordinarily, with initial unemployment claims (the red line on the chart below, using the inverted scale on the right) at 222 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 rose 4 thousand in the week ending March 3 to 1,879 thousand after having declined 59 thousand in the previous week.  The four week moving average declined 17 thousand to 1,891 thousand which is close to the lowest level thus far in this cycle (1,889 thousand) and close to the lowest reading January 12, 1974 (when it was 1,881 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

March 14, 2018

Gasoline prices at the retail level were unchanged in the week ending March 12 at $2.56.  In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.31. The Department of Energy expects national gasoline prices to average $2.60 this year which is almost exactly where they are currently.

Spot prices for gasoline have fallen about $0.25 from their late January peak which suggests that pump prices should fall a bit further.

Crude oil prices are currently about $61.00.  The Energy Information Agency predicts that crude prices will average $58.17 in 2018.  With a huge increase in production in the past couple of months  (see below) and a small increase in inventories (see below) it is likely that crude prices will decline somewhat in the weeks ahead.

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 984 thousand.  Thus,  higher crude oil prices are encouraging some drillers to step up slightly the pace of production.  If crude prices average about $58 per barrel this year, we should expect the number of oil rigs in operation to increase gradually and further boost production.

Production in the past month surged to 10,381 thousand barrels per day which continues to climb at a record pace.  The Department of Energy expects production to average 10.7 million barrels this year and 11.3 million barrels in 2019.  As U.S. production continues to climb, 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 1.096 million barrels crude inventories are now roughly in line with the 2009-2014 average of 1,058 million barrels and in the past month or so registered their first increases in a while.  Increased U.S. production and inventory levels should cause crude prices to retreat somewhat as the year progresses.

The International Energy Agency in Paris (IEA) produces some estimates of global demand and supply.  Note how demand picked up sharply in the second quarter of last year (the yellow line) and continued to climb through the end of last year.  Demand should climb further throughout 2018.  Note also that global demand far exceeded supply (the blue bars) for most of last year.  However the IEA believes that demand and supply are now roughly in balance.

OPEC’s production cuts, which are now in their second year, have been successful in reducing bloated inventories and lifted prices to $67 per barrel.  But OPEC could become a victim of its own success.  If prices remain at their current level of about $60 per barrel, the IEA warned that U.S. oil output is set for “explosive” growth this year  as U.S. producers re-open closed wells which would produce a wave of shale oil and potentially trigger another price decline like that experienced in 2014.  OPEC ministers recently voted to maintain the production cuts through yearend.  At some point crude prices should begin to fall.

Stephen Slifer


Charleston, SC*

Retail Sales

March 14, 2018

Retail sales declined 0.1% in January which is the third straight month with sales slipping by that amount.  However sales surged by 2.0% in  September, 0.7% in October and 0.8% in November.  During the course of the past year sales have risen 4.1%.  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.

Sometimes sales can be distorted by changes in autos which tend to be quite volatile.  In this particular instance car sales fell 0.9%.

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 1.2% 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 February after having fallen 0.1% in January after having been unchanged in December.  But such sales rose 0.8% in September, 0.5% in October and 1.0% in November.  As noted above, this pattern seems to reflect a post-hurricane surge in sales which shifted some sales into the September-November period at the expense of sales between December and February.   In the last year retail sales excluding cars and gasoline have risen a healthy 4.1%.

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 storeshave risen 3.2% in the past year, on-line sales have risen 9.9%.  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 2.7% 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 sales.  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 at 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 2.9% this year.

Stephen Slifer


Charleston, SC

Producer Price Index

March 14, 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 0.2% in February after having climbed 0.4% in January.  During the past year this inflation measure has risen 2.9%.  It had been bouncing around in a range from 2.0-2.5% for the some time but has now begun to rise somewhat more rapidly.

Excluding food and energy producer final demand prices also rose 0.2% in February after having risen 0.4% in January.  They have risen 2.6% since January 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 declined 0.1% in February after having jumped 0.7% in January. These prices have now risen 3.1% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 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 fell 0.4% in February after having declined 0.2% in January.  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 0.6%.

Energy prices declined 0.5% in February after having jumped 3.4% in January.  Energy prices have risen 9.3% 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 fallen from about $69 per barrel  to about $60 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 both January and February.  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 February after having climbed 0.4% in January.  It has climbed 2.8% 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

Small Business Optimism

March 13, 2018

Small business optimism rose 0.7 point in February to a record high level of 107.6 after climbing 2.0 points in January.

NFIB President Juanita Duggan said, “When small business owners have confidence and certainty in the economy, they’re able to hire more workers and invest in their businesses. The historically high readings indicate that policy changes – lower taxes and fewer regulations – are transformative for small businesses. After years of standing on the sidelines and not benefiting from the so-called recovery, Main Street is on fire again.”

NFIB Chief Economist added that, “Small business owners are telling us loud and clear that they’re optimistic, ready to hire, and prepared to raise wages – it’s one of the strongest readings I’ve seen in the 45-year history of the Index.  The fact that several components saw significant increases tells us that small businesses are flourishing in a way we haven’t seen in over a decade.”

In our opinion the economy is expected to gather momentum in coming months in response to a number of significant policy changes.  Specifically, we believe that the cut in the corporate income tax rate, legislation that will allow firms to repatriate corporate earnings currently locked overseas back to the U.S. at a favorable 15.5% rate, and the steady elimination of unnecessary, confusing and overlapping federal regulations will boost investment.  That, in turn, 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 close a record high level despite the recent correction.   Jobs are being created at a reasonably robust pace.  The unemployment rate is below the full employment threshold.  The housing sector is continuing to climb.  And now investment spending should pick up after essentially no growth in the past three years.  We expect GDP growth to climb from 2.5% in 2017 to 2.9% in 2018.  The core inflation will  climb from 1.8% in 2017 to 2.4% in 2018.  The Fed will continue to raise short-term interest rates very slowly.  Accelerating GDP growth, low inflation, and low interest rates should propel the stock market to new record high levels.

Stephen Slifer


Charleston, SC