Wednesday, 22 of November of 2017

Economics. Explained.  

2018 Economic Outlook Conference

 2018 Economic Outlook Conference

In times of uncertainty whether you are running a business or planning your investments,

knowledge can be your most valuable asset.

Stephen Slifer, Owner and Chief Economist at NumberNomics  will provide insight regarding what to expect in 2018.

Why is growth so slow?  Will it ever accelerte?

When will interest rates begin to bite?

Why is inflation so low?  When will it accelerate?

Can Trump pass anything that will help?

When might the expansion end?

DATE:., Tuesday, December 5, 2017

TIME: 7:30 to 9:00 A.M.

PLACE: Daniel Island Club, 600 Island Park Drive, Charleston, SC 29492

COST: ..$40.00 includes breakfast

Stephen Slifer:  From 1980 until his retirement in 2003, Mr. Slifer was the Chief U.S. Economist for Lehman Brothers in New York City.  In that role he directed the firm’s U.S. economics group and was responsible for the firm’s forecasts and analysis of the U.S. economy.

Prior to that, he spent a decade as a senior economist at the Board of Governors of the Federal Reserve in Washington, D.C.  He has written two books about the various economic indicators and how they can be used to forecast economic activity.  He writes a regular bi-weekly economics column for the Charleston Regional Business Journal.

Proudly sponsored by:

Charleston Digital Corridor ……………… ..Charleston Regional Business Journal

Daniel Island Business Association ………Daniel Island Town Association

NumberNomics …………………………….. Wells Fargo Advisors

Baird ………………………..                      ..Trident Technical College


To Register:  Click Here

Oil Prices on the Rise – Where Are They Headed?

November 17, 2017

Crude oil prices reached a low of $42.50 in late June.  They have since climbed to $57 per barrel.  What has caused the recent run-up in prices, and what will crude and gasoline prices be in 2018?

Since mid-year it has become increasingly apparent that global GDP growth has accelerated in virtually every region.  In October the IMF raised its global GDP growth forecast for 2018 to 3.7% which would be the fastest pace of global economic activity since 2011.  The United States had GDP growth of 3.1% in the second quarter, 3.0% growth in the third quarter, and fourth quarter growth is projected to be about 3.5%.  This would be the first time growth has exceeded 3.0% for three consecutive quarters in more than a decade.  An acceleration of growth is evident in Europe where the IMF expects growth of 1.9% in 2018 – the fastest pace since 2010.  The IMF boosted its 2018 forecast for China by 0.2% to 6.5%.   It has similarly lifted its growth expectation for emerging market nations, Latin America, and Africa.  Thus, growth is accelerating all over the world and reflects a combination of tax cuts in the U.S., ultra-easy monetary policy in the U.S., the U.K., Europe, and Japan, and higher oil prices which have allowed many oil-exporting nations to emerge from recession.

As demand has risen, previously bloated oil inventory levels have declined almost weekly since early February.  Thus, the pre-September rise in oil prices from $42.50 to about $50 per barrel cannot be dismissed.  It is being driven clearly by a pickup in demand.

But the subsequent rise in crude prices from around $50 in late August to $57 began almost to the day when Hurricane Harvey struck the Gulf Coast.  Hence, one suspects that damage to production and refinery facilities in the region has been largely responsible for the additional price run-up.

Oil production statistics from the Energy Information Administration show that production plunged in late September but has quickly rebounded to a near-normal pace of 9.6 million barrels per day.  The IEA estimates that production will continue to climb to a record pace of 10.0 million barrels per day in 2018 (which eclipses the previous record of 9.6 million barrels per day set in 1970).  But will that be sufficient to satisfy demand and reduce prices?

The IEA expects crude oil prices to slip from their current level of $57 per barrel and average $51.00 in 2018.  But that is a forecast which may or may not prove to be accurate.  However, it strikes us as a plausible scenario given that much of the recent run-up in prices appears to be the result of a hurricane-induced interruption in supply which means that it is likely to be reversed.

With respect to gasoline prices the situation is similar.  Pump prices rose from $2.25 in the middle of this year to about $2.70 per gallon in the wake of the two hurricanes.  They are currently at $2.60.  The EIA expects gas prices to fall $0.15 further and average $2.45 next year.  For those of us in the low country prices are generally about $0.25 lower than the national average which works out to about $2.20 per gallon.

The recent run-up in both crude oil and gasoline prices is impressive and perhaps somewhat alarming.  While some of the rise since midyear reflects a pickup in global demand, a significant portion of the recent increase is hurricane related and will be reversed in the weeks and months ahead.  If that is the case oil will not be a problem for 2018.  But oil prices are notoriously volatile, and the EIA expectation of relatively stable prices next year reflects its estimate of the actual pickup in global demand, an estimate of the speed-up in production in the U.S., and some guess about the likely response by OPEC.  OPEC ministers will next meet in Vienna on November 30 and are widely expected to continue the previously-adopted production cuts through March 2018.  Thus, there are a lot of balls in the air and oil price movements may or may not behave as expected.  For now, oil prices are not expected to be a major factor in the estimates of either GDP growth or inflation next year but, as always, we will see.

Stephen Slifer


Charleston, S.C.

Housing Starts

November 17, 2017

Housing starts surged 13.7% in October to 1,290 thousand in October after having fallen 3.2% in September and 1.1% in August.  Given that the initial slowdown and subsequent rebound occurred largely in the South it is clear that the recent swings reflect the impact from Hurricanes Harvey and Irma.   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 1,199 thousand which has fallen off from the 1,264 thousand peak pace in the cycle which was registered back in February.    While starts will continue to climb in coming months as the rebuilding effort continues, it is worth asking why starts have fallen so much relative to where they were earlier in the year?  Is it a drop in demand?  Or a constraint on the part of builders?  We  believe it is the latter.

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 quite steady at a rapid rate.

Mortgage rates are at 3.9% which is quite low by any historical standard.

The average home stays on the market for about 30 days currently which is down from 90 days a few years ago.  This statistic provides compelling evidence that the demand for housing remains robust.

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 1.2% pace.  That is not particularly robust, but disposable income does hit slack periods from time to time and then rebounds.

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 150.0 the index  indicates that a median-income buyer has 50.0% 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 is growing by about 15 thousand per month.  Slow, but steady.

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 1.2 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 in 2018.

What is interesting is that beginning late last year 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 8.4% while multi-family units have declined by 14.2%.

As a result, multi-family construction as a percent of the total has slipped from 36.2% in July of last year to 27%.

Building permits jumped 5.9% in October to 1,297 thousand after having fallen 3.7% in September.  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 1,265 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 1,265 thousand, housing starts will soon surpass the 1.3 million mark.

Stephen Slifer

Charleston, SC

Homebuilder Confidence

November 16, 2017

Homebuilder confidence rose 2 points in November to 70 after having jumped 4 points in October.  This level is just a shade below the highest reading for the business cycle which was 71 in March of this year.

NAHB Chairman Granger MacDonald, a home builder and developer from Kerrville, Texas said, “November’s builder confidence reading is close to a post-recession high — a strong indicator that the housing market continues to grow steadily.  However, our members still face supply-side constraints, such as lot and labor shortages and ongoing building material price increases.”


NAHB Chief Economist Robert Dietz said “Demand for housing is increasing at a consistent pace, driven by job and economic growth, rising homeownership rates and limited housing inventory.  With these economic fundamentals in place, we should see continued upward movement of the single-family housing market as we close out 2017.

Traffic through the model homes rose 2 points in November to 50 after having risen by 1 point in October.  The March reading of 53 was the highest reading thus far in the business cycle.

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 1.35 million by the end of 2018.

Stephen Slifer


Charleston, SC

Industrial Production

November 16, 2017

Industrial production jumped 0.9% in October after having risen 0.4% in September and  having declined 0.5% in August.  However, hurricanes Harvey and Irma biased downwards the results for August and September, and Hurricane Nate reduced oil and gas drilling activity in October.  The Fed estimates that in the absence of the three hurricanes IP would have risen 0.2% in August (versus a published 0.5% decline), risen 0.6% in September (versus a published 0.4% increase), and risen 0.3% in October (versus a published 0.9% increase).  Thus, production continues to climb steadily.  During the past year industrial production has risen 2.9%.  With rebuilding following Hurricanes Matthew and Irma just getting underway robust gains in production should be expected through the spring of next year.

Breaking industrial production down into its three major sub-components,  the Fed indicated that manufacturing production (which represents 75% of the index) jumped 1.3% in October after  having risen 0.4% in September after having declined 0.2% in August. During the past year  factory output has risen 2.5% (red line, right scale).  That is its largest 12-month increase since July 2014.

The manufacturing category has been dragged down by recent cuts in the production of motor vehicles.  However, car and truck sales surged in September and October because all those vehicles lost during the two hurricanes have to be replaced.  A pickup in production will not be far behind.

Auto output rose 1.0% in October after having risen 1.7% in September and 3.5% in August,  but it has still declined 1.6% during the past year.  Industrial production ex motor vehicles has risen 3.2% in the past year.  Thus, factory output has been climbing, but its rate of increase has been curtailed by the first  half of the year  slowdown in the sales and production of motor vehicles.

Mining (14%) output declined 1.3% in October after having risen  1.5% in September   Over the past year mining output has risen 6.4%.  Most of the recent upturn in mining has been concentrated in oil and gas drilling activity , however, oil and gas drilling fell 2.8% in  September and 1.9% in October as Hurricanes Harvey and Nate took their toll.   This category will rebound in the months ahead.  Over the course of the past year oil and gas well drilling has risen 61.1%.  The number of  oil rigs in operation continues to climb.

Utilities output  climbed by 2.0% in October after having declined 1.0% in September and 1.3% in August.  The August and September drops seem to reflect the inability of utility companies to keep the lights on during hurricane season  During the past year utility output has risen 0.9%.

Production of high tech equipment rose 1.1% in both September and October.  Over the past year high tech has risen 4.1%.   The high tech sector sector appears to have gathered some momentum in recent months. This may be an early indication that the long slide in nonresidential investment may be coming to an end which would, in turn, signal some upturn in productivity growth.

Capacity utilization in the manufacturing sector rose 0.9% in October to 76.4%.  It is still slightly below the 77.5% that is generally regarded as effective peak capacity.

Stephen Slifer


Charleston, SC

Initial Unemployment Claims

November 16, 2017

Initial unemployment claims rose 10 thousand in the week ending November 11 to 249 thousand after having risen 10 thousand in the previous week.  The 4-week moving average is at 238 thousand.  Thus, claims remain close to the lowest level for this average since March 31, 1973 when it was 228 thousand.

Ordinarily, with initial unemployment claims (the red line on the chart below, using the inverted scale on the right) at 238 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 190 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 — roughly in line with where it was going into the recession.

The number of people receiving unemployment benefits declined 44 thousand in the week ending November 4 to 1,860 thousand.  The four week moving average fell 9 thousand to 1,887 thousand which was the lowest level for this 4-week average since January 12, 1974 when it was 1,881.   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

November 15, 2017

Gasoline prices at the retail level rose $0.03 in the week ending November 13 to $2.59.  In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.34. The Department of Energy expects national gasoline prices to average $2.45 next year.

Crude oil prices are currently about $56.00.  The Energy Information Agency predicts that crude prices will average $51.04 in 2018.  As crude oil and gas prices have leveled off underlying inflationary pressures have become more apparent.  While subdued at the moment, wage pressures are apparently beginning to escalate.  At the same time producers — both manufacturing and non-manufacturing firms — are having to pay considerably higher prices for their inputs.  It appears that upward pressure on the inflation rate has finally begin to emerge.

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 898 thousand.  Thus,  higher crude oil prices are encouraging some drillers to step up slightly the pace of production.

While the number of oil rigs in production has been cut by 79% between late 2015 and the middle of last year, oil production has declined much less than that.  Since that time the rebound in oil prices has encouraged oil firms to step up the pace of production.  Production this past week jumped to 9,645 thousand barrels per day which surpasses the previous record pace of production of 9,610 barrels per day set in 1970.  The Department of Energy expects production to average 9.2 million barrels per day in 2017 and 10.0 million barrels next year.

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.  Two 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.  Recent productivity numbers for September and October have been distorted by the drop-off in production associated with Hurricanes Harvey and Irma but they will rebound in the next month or two.

While oil inventories have been falling quickly for most of this year.    We know that OPEC output has been reduced but its cutback has been partially offset by a pickup in U.S. production.  But inventories keep falling.  The conclusion is that global demand has picked up sharply.  That is consistent with the upward revisions to GDP growth recently released by the IMF which shows projected growth in 2011 of 3.6% and 3.7% growth in 2018 which would be the fasted growth rates since 2011.

The International Energy Agency produces some estimates of global demand and supply.  Note how demand picked up sharply in the second quarter (the blue line) and is projected to rise further in the second half of the year.  Note also that global demand currently exceeds supply (the blue line compared to the bars). That has not been the case for the past several years.  Furthermore, demand and is projected to continue to exceed supply through the end of this year.  Hence, the recent upward pressure on oil prices.  If they persist, U.S. producers will re-open closed well and, at some point, OPEC will begin to boost its output.  Hence, oil prices are unlikely to rise too much farther.

Stephen Slifer


Charleston, SC

Retail Sales

November 15, 2017

Retail sales jumped 1.6% in September after having fallen 0.1% in August.  The August drop reflects the downward bias to sales in the wake of Hurricane Harvey which clobbered Texas between August 25 and August 29.  The September surge in sales reflects the beginning of the rebuilding effort in both Texas and Florida.  During the course of the past year sales have risen a solid 4.3%.  Consumer spending continues to chug along despite the hurricane-induced distortions.

Sometimes sales can be distorted by changes in autos which tend to be quite volatile.  In this particular instance the unit selling rate for car sales surged in September as cars lost during the two hurricanes must be replaced.

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 rose 5.8% in September after  having risen 4.1% in August.  Clearly, higher gas prices are boosting the overall increase in sales, but 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  0.1% in August and then 0.5% in September.   In the last year retail sales excluding cars and gasoline have risen 3.8%.  No slowdown evident from looking at these sales data despite the hurricane-affected August and September distortions.

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 sales have risen 2.9% in the past year, on-line sales have risen 7.4%.  As a result, their share of total sales has been rising steadily and now stands at 10.7% of all retail sales.

We believe that retail sales will continue to chug along at a 2.5% 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.  If home sales are holding up well, car sales should  remain solid in the months ahead.

Second, the stock market is at a record high level.  That increase in stock prices boosts consumer net worth.

Third, all measures of consumer confidence areat their highest levels thus far in the business cycle, and consumer sentiment from the University of Michigan is at its highest level since the early part of 2004.

Fourth, cuts in individual income tax rates are likely later this  year or in 2018.

Finally, the economy is cranking out 170 thousand new jobs every month which boosts consumer income.  Consumers have paid down a ton of debt and debt to income ratios are the lowest they have been in 20 years.  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 to 2.8% next year.

Stephen Slifer


Charleston, SC

Consumer Price Index

November 15, 2017

The CPI rose 0.1% in October after having jumped 0.5% in September and 0.4% in August.  During the past year the CPI has risen 2.0%.  The year-over-year increase climbed to 2.8% in February but has backtracked in the past 8 months. .  Excluding food and energy the CPI rose 0.2% in October after having climbed 0.1% in September.  Over the past year this so-called core rate of inflation has risen 1.8%, but in the past three months this inflation rate has climbed to 2.4%.  It seems to be gradually climbing.

Food prices rose were unchanged in October after having risen 0.1% in both August and September.  Food prices have risen 1.3% in the past twelve months.

Energy prices declined 1.0% in October after having jumped 6.1% in September and 2.8% in August .  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 6.4%.  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.  Hence, it is unlikely that energy prices will retreat by any significant amount in the months ahead.  On the flip side, should prices remain much beyond $50 per barrel, U.S. producers was well as oil exporters around the globe will boost production which should cap the increase in prices.

Excluding the volatile food and energy components, the so-called “core” CPI rose 0.2% in October after climbing 0.1% in September.  The year-over-year increase now stands at 1.8%.  The year-over-year increase in the core CPI had risen to as high as 2.3% in January before retreating.  But a lot of this softening reflects a price war amongst telecommunications firms and thereby distorts the overall run-up.  But that exaggerated price drop appears to have run its course as phone prices rose 0.4% in both September and October.  The CPI will lose the downward  bias from this component in the months ahead.

The core CPI has also benefited from a sharp slowdown in the rate of increase of prescription drug prices.  That appears to reflect President Trump’s threat to the pharmaceutical industry that he intends to cut the prices of prescription drugs by allowing consumers to purchase such drugs overseas, and by having Medicare negotiate prices directly with the insurance companies.  That caused prescription drug prices to slow markedly late last year and in the first five months of this year.  But one wonders the extent to which price increases associated with the yearend increase in health care premiums will boost medical care prices in the months ahead.

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 and gradually rising labor costs which reflects the tightness in the labor market as well as rebounding prescription drugs prices and a leveling off of wireless communications services.  And now, for the first time, producer prices are beginning to rise.

Shelter costs rose 0.3% in both September and October after having jumped 0.5% in August.  In the  past year they have climbed 3.2%.  This undoubtedly reflects the shortages of both rental properties and homeowner occupied housing. Indeed, the vacancy rate for rental property is close to 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.

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 1.3% 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 1.8%.  However, with the economy growing steadily, rents rising, and the unemployment rate falling, the core inflation rate should pick up  and rise by  2.3% in 2018.  And because the core PCE increases at a rate roughly 0.5% slower than the core CPI, the core PCE should increase  1.8% 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 1.1% and the year-over-year increase in the CPI at 1.8% 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

November 14, 2017

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 0.4% in both September and October.  During the past year this inflation measure has risen 3.1%.  It had been bouncing around in a range from 2.0-2.5% for the some time but has broken out of that range to the upside.

Excluding food and energy producer final demand prices jumped 0.4% in both September and October.  They have risen 2.7% since October of last year.  This is the largest year-over-year increase since November 2011 .  This series has been quietly accelerating for the past two years.  Inflationary pressures are 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 October after  having jumped 0.7% in September and 0.5% in August. 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 both September and October.  During the past year the core PPI for goods has risen 2.3% (right scale), but in the  past three  months the rate of increase has climbed further to 2.8%

Food prices rose 0.5% in October after having been unchanged in September.  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 2.9%.

Energy prices were unchanged in October after having jumped 3.4% in September after having risen 3.3% in August.  Energy prices have risen 7.9% 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.  Hence, we should not expect energy prices to fall substantially any time soon.  But by the same token they should not rise too much further.  Should they do so, U.S. producers as well as oil exporting nations around the world will begin to open the spigots and thereby cap the increase.

The PPI for final demand of services rose 0.5% in October after having risen 0.4% in September and 0.1% in August.  This series has risen 3.0% over the course of the past year (left scale).  This is the biggest 12-month increase since the BLS began collecting producer prices for services in November 2009.  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 0.1% in both August, September, and October.  It has climbed 2.1% during the past year.  The 2.2% year-over-year increase for June was the largest 12-month increase in the history of this series which dates back to November 2009.

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.

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 1.9% in  2017 and 2.5% in 2018.

Stephen Slifer


Charleston, SC