May 18, 2012

 The market turmoil in the wake of the recent election in Greece is important for a couple of reasons.

1.  U.S. GDP growth could fall somewhat short of the 3.0% pace we expected for 2012.
2. U.S.  policy makers have received yet another budget wake-up call.  Significant delay in devising a meaningful budget reduction plan will make the ultimate solution far more difficult to achieve.  The situation in Greece today should remind us all of the consequences of protracted inaction.  What is happening in Greece today can happen here.

We have argued for some time that the U.S. economy has sufficient momentum to withstand any temporary setback caused by Europe.   Furthermore, U.S banks and corporations have ample cash reserves to buffer any such difficulty.  All of that remains true. 

However, uncertainty regarding the situation in Europe has caused the stock market to fall by about 7.0% thus far.  While not a huge drop, it may well make consumers more nervous and somewhat less willing to spend.  At the same time employers may be hesitant to hire as many workers that they had planned in 2012.  Will any of this derail the U.S. economy?  Absolutely not.  But it may make it more challenging to achieve the 3.0% GDP growth rate we had been expecting.  The places where softening will first become apparent are initial unemployment claims (a measure of layoffs), consumer confidence (particularly the expectations component), and factory orders.  If weakness emerges in these indicators we will need to temper our growth expectations for the year.  Stay tuned.

Is the problem in Greece this year different from earlier years?  Absolutely.  In previous episodes the issue was whether the European Union would provide sufficient funding to allow Greece to make interest payments on its outstanding debt.  Ultimately, European leaders agreed but only if Greece signed on to a reform program designed to reduce budget deficits and, ultimately, shrink debt outstanding.  That part was relatively easy.  It was designed to buy time for Greece to get its fiscal house in order.

But with the Greek economy now in its fifth year of recession and GDP likely to contract 4.7% in 2012, and with an unemployment rate just shy of 20%, voters clearly believe that the austerity program is too severe and the new government wants to cancel the earlier agreement.  In the eyes of Greek voters, the pain of compliance is too great.  It is hard to imagine a quick solution to this difficulty.

 Alexis Tsipras, leader of the Coalition of the Radical Left, known as Syriza, and potentially the country’s new Prime Minister, wants to scrap plans to lay off 150,000 government workers by 2015.  He says that by not paying its debts, the country would have enough cash to pay its workers and retirees.  While that may well be true, it is precisely the size of the government sector and its cushy wages and benefits that created the budget deficit and debt problems in the first place.  Tsipras seems unwilling to address the core problem that exists in Greece – the government sector is far too big.  Even if Greece wipes its debt slate clean, continued government spending at its current pace will mean that debt once again begins to accumulate.  Furthermore, not paying its debts is hardly going to attract the badly needed foreign capital that Greece needs.

It is inconceivable that European leaders would agree to make the previously agreed upon funding available unless Greece makes some movement towards fiscal responsibility.  This apparent stalemate has given rise to the unthinkable just a few months ago – Greece leaving the monetary union.  If the difficulty were confined to Greece, the consequences might be minimal.  But if Greece exits the common currency, speculation will shift to other highly indebted European countries like Portugal and Spain.  Where all this will end is highly uncertain, and the damage to the global economy is difficult to assess.  Markets hate uncertainty.

For an economist, any forecast includes implicit assumptions, one of which is that the political landscape does not change in any meaningful way over the forecast horizon.  When changes do occur, the forecast must be modified.  In this particular instance, the notion that Greece would reject the previously adopted austerity measures was certainly not incorporated in our beginning-of-the-year forecast and we must be prepared to adjust accordingly.  We have not made any adjustments thus far, but we have clearly become more anxious.

 Stephen Slifer

NumberNomics

Charleston, SC

May 17, 2012

Initial unemployment claims were unchanged in the week ending May 12 at 370 thousand.   We always tell people to look at the 4-week moving average of claims because the weekly data are so volatile.  And, indeed, that is what is shown in the chart above.  Given the high levels earlier in the month, that 4-week average edged declined 5 thousand to 375 thousand.  If the current weekly level holds  it is going to decline  further over the next couple of weeks.  

The markets were marginally disappointed because earlier in the year claims had averaged a bit lower at roughly 355 thousand.  Thus, the current level is somewhat higher than it was at its low point in mid-February.  While that is an entirely accurate statement, it can hardly be construed as evidence of emerging “weakness” in the labor market.  Sometimes we need a bit of perspective.  How low might we reasonably expect claims to fall?

From 2005 through the first half of 2007, prior to the onset of recession, claims averaged 320 thousand, with a few very brief periods when the average dipped a shade under the 300 thousand mark.   Thus, today’s level of 370 is higher than it was prior to the recession, but it is indicative of a labor market that is expanding at a reasonable pace.

Payroll employment gains during that same period of time just prior to the recession averaged about 200 thousand.  Indeed, there are very few times when employment gains are more sizeable.  In the latter part of both  the 1980’s and 1990’s, when the economy was red hot, monthly employment gains averaged 250 thousand.  So in today’s world monthly employment gains that average 200 thousand are quite respectable.  If, as we expect, payroll employment rises on average 225-250 thousand for the year as a whole, that is about as fast as it ever gets.

The number of people receiving unemployment benefits rose 18  thousand in the week ending May 5  to 3,265 thousand.  That makes the four week average 3,283 thousand.   That is the lowest 4-week average for people receiving unemployment benefits since July 2008.     Thus, the labor market continues to improve, fewer people are being laid off, others are finding jobs, and the unemployment rate is heading lower.  The unemployment rate has fallen 1.0% in the past eight months to 8.1% and should decline another 0.1% in May.    We expect it will end 2012 at about 7.6%.

But once again a bit of perspective might be helpful.  Prior to the recession the number of people receiving benefits averaged about 2,500 thousand.  When it was that low, the unemployment rate was roughly 4.5%.  In today’s world there appears to be a mismatch between the skill sets that unemployed workers (particularly long-term unemployed workers) have to offer and the skills that employers are seeking.  Thus,  it is highly unlikely that the number of people receiving benefits will ever fall back to its pre-recession level and, commensurately, the unemployment rate will never again shrink to 4.5%.  Having said that, with today’s benefits level of 3,300 thousand and the unemployment rate at 8.1%, there is room for further improvement.

Stephen Slifer

NumberNomics

Charleston, SC

May 16, 2012

Industrial production jumped 1.1% in April, more than offsetting the 0.6% decline in March.    Over the past year production has risen by a solid 5.2%.

Breaking this down into its three major subcomponents,  the Fed indicated that manufacturing production (which represents 75% of the index) climbed 0.6% in April.    That is the 31st increase in this series in the last 34 months.  Over the past year factory production has risen 5.8%.

Mining (14%) rose 1.6%, and utilities (11%)  surged 4.5% as the weather returned to normal following a surprisingly mild winter.   

All-in-all, production is doing just fine.  The economy appears to be accelerating and the order book is climbing so it is likely that production will quicken in the months ahead.

Stephen Slifer

NumberNomics

Charleston, SC

May 16, 2012

Capacity utilization in the manufacturing sector rose 0.3% to 77.9%.   This rate reached a low of 64.4% in June 2009 and has been climbing steadily ever since.

Two things are important about capacity utilization at this level.  First, it is getting very close to the peak levels that were reached just prior to the recession.  With demand in the economy strengthening, it is imperative for manufacturers to begin to add to their plant capacity and perhaps refurbish some of the equipment on the factor floor in order to quicken the pace of production.  As they do so, they will contribute to a faster pace of GDP growth in the months ahead.

Second, most economists would view a level of 80.0% as roughly consistent with “full capacity” in the factory sector, and a level at which inflationary pressures could tend to rise.  Capacity utilization is still well below this so-called danger point and it is likely to remain below that danger level for another year or so.   If that is the case, then a target date of mid-2013 seems about right for the Fed’s first tightening move.  While the Fed has indicated that policy is on hold until the latter part of 2014.  It would be surprising if they were able to wait that long.

Stephen Slifer

NumberNomics

Charleston, SC 29492

May 16, 2012

Gasoline prices at the retail level declined $0.04  in the week ending April 14  to $3.75.   Oil prices clearly reached a peak five weeks ago at $3.94 and, thus far, have dropped about 5%.

The recent drop in prices at the pump is no fluke given that gasoline prices in the spot market have fallen sharply in recent weeks.  They reached a peak of $3.41 in the week of April 3, but have now fallen $0.51 or 15% to $2.90.  Thus, we should probably expect pump prices to fall further in the weeks ahead.  Gasoline prices typically rise sharply in the early part of any year, but then begin an extended decline usually beginning in about June.  Last year the peak was in early May.  For them to have peaked in early April is unusual, but given the drop in prices in the gasoline spot market, the decline in pump prices appears legitimate.

And for what it is worth, crude oil prices have demonstrated a similar decline.  They peaked at $109.30 in late February and are now 14% lower at $93.97.  All of these prices should fall considerably farther in the weeks ahead.

Stephen Slifer

NumberNomics

Charleston, SC

May 16, 2012

Housing starts rose 2.6% in April to an annual rate of 717 thousand.  This exactly offsets the 2.6% drop reported for March. 

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 purple above).   That 3-month average now stands at 711 thousand which is essentially the highest level of starts since November 2008. 

Both single-family and muti-family construction have risen sharply although multi-family starts have climbed most rapidly.  As shown, single family starts have climbed 19% from 414 thousand to 492 thousand since April of last year.  Multil-family starts have risen 75% in that same period of time fom 124 thousand to 217 thousand.    This is probably not a surprising development given that so many more people are interested in renting today than in owning their own home.  But whether they are building single family homes or apartments, construction workers are actually doing something and that contributed to GDP growth in the first quarter and will continue to boosts grsowth on into 2012.

We have been arguing for some time that the housing sector is poised for a rebound.  With mortgage rates at a record low level of  4.0%, home prices having fallen 30% from their peak, and jobs becoming a bit more plentiful, housing seemed poised for the long-awaited turnaround.   That rebound in housing is finally underway.

Stephen Slifer
NumberNomics
Charleston, SC

May 16, 2012

Building permits fell 7.0% in April to 715 thousand.  But this following an 8.8% increase in March.  Because permits are an inherently volatile series it is best to look at a 3-month average (which is shown above).  That 3-month moving average now stands at 730thousand which is the highest since October of 2008.  Clearly the housing sector is showing signs of life for the first time in several years.

Most of the recent gains have been in the multi-family sector which means that apartment buildings are being constructed.  But whether it is single-family homes or apartment buildings, construction workers are doing something for the first time in a long while.

We have been arguing for some time that housing should begin to improve for a variety of reasons.  The biggest positives for the housing market are that mortgage rates are at a record low level of 4.0%, home prices have fallen by about 30% from their peak, and jobs are now becoming more plentiful.   That long-awaited turnaround in housing is finally upon us.

Stephen Slifer

NumberNomics

Charleston, SC

May 15, 2012

Firms are always trying to keep their inventories in line with sales.  When the economy falls into recession, typically businesses do not cut back production as quickly as sales decline, so the inventory/sales ratio rises sharply  — which is exactly what happened during the 2008-2009 recession.  Then, as the economy recovers and sales once again begin to rise, corporate leaders are able to  get inventory levels into closer alignment with sales.

In the fourth quarter GDP growth came in at 3.0% while final sales rose by just 1.1%.  The inventory increase in that quarter of $52.2 billion accounted for the remaining 1.9% of growth.  Many argued that pace of inventory accumulation was excessive and could not be sustained.  But in the first quarter GDP rose 2.2%, final sales rose by 1.6%, and inventory accumulation of $69.5 billion accounted for the remaining 0.6% of GDP growth.  What is not important is the dollar increase in inventories in any quarter, but the extent to which those inventory gains compare to the increase in sales.

Throughout this entire time period businesses kept inventories closely in alignment with sales so that the inventory/sales ratio was quite steady at about 1.28.  Specifically, in March it edged lower to 1.27.  So while busines sales continue to climb (0.6% in March), inventories have risen by slightly less than that amount (or just 0.3% in March).  The steady inventory/sales ratio is not indicative of any imbalances which will have to be offset in the months ahead.  If anything, firms need to slightly accelerate their pace of inventory accumulation in the months ahead or risk losing sales.

Stephen Slifer

NumberNomics

Charleston, SC

May 15, 2012

Retail sales rose just 0.1% in April, but this follows gains of 0.6%, 1.0%, and 0.7% in the first three months of the year.  It is becoming increasingly clear the the extremely mild winter weather has biased many series  over the past several months — first on the upside, and now on the downside.  Thus, the result in any given month can create a misleading impression of what is happening with sales.  However, over the past three months sales have risen at a healthy 7.5% pace (shown above).   That compares to a year-over-year increase of 6.4%.  Thus, there is no reason to believe that the pace of consumer spending has slowed in any way.   

Because automobile sales can be rather volatile, most economists like to look at nonauto retail sales.  Like the overall retail sales series, nonauto retail sales also rose 0.1% in April.   But in the first three months of the year this series climbed by 1.1%, 1.0%, and 0.8%.  Once again it appears that weather distortions have biased the early year data.  Over the past three months non-auto sales have gained 7.4% (shown below) which compares to a more modest 5.9% year-over-year increase.  The conclusion, once again, is that sales are gradually gathering  momentum.

We expect the consumer to continue to do his/her part for the foreseeable future.  The consumer feels good,  jobs are being created,  the unemployment rate is declining, income is rising, and interest rates remain low.  While sales can bounce around from month to month, the overall trend  seems to be steadily upwards.

Stephen Slifer

NumberNomics

Charleston, SC

May 15, 2012

The CPI was unchanged in April as a big drop in energy prices offset increases elsewhere.  Over the past year the CPI has risen by 2.3%. 

Food prices rose 0.2% in April.  They have climbed 3.0% in the past year. 

Energy prices fell 1.7% in April after having risen in each the three previous months .  Gasoline prices declined 2.6% which accounted for the bulk of the decline, but natural gas and fuel oil prices also fell.  Over the past year energy prices have risen 0.9%.

Excluding the volatile food and energy components, the so-called “core” CPI rose 0.2% in April, roughly the same as in each of the first three months of the year.  This core rate has now risen 2.3% over the past year and, as shown above, has been edging its way higher for more than one year, primarily as the price of shelter creeps upwards. 

We continue to believe that inflation is not a problem.  With the unemployment rate currently at 8.1% there is considerable slack in the labor market which should keep the pressure off of wages which is the biggest factor affecting inflation.  The overall CPI should increase 2.1% in 2012 while the core rate of inflation should rise by 2.4%.  Keep in mind that the Fed wants an inflation rate of about 2.0%.  This should not be alarming to the Fed, but it takes off the table any discussion of a further Fed easing initiative.

Stephen Slifer

NumberNomics

Charleston, SC