Wednesday, 17 of October of 2018

Economics. Explained.  

2019 Economic Outlook Conference

2019 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 2019.


Growth can’t continue at this pace.  Or can it?

When will higher interest rates spoil the party?

Inflation is low for one very important reason.  What is that?

What are the two best leading indicators of recession?

All expansions end.  Is the end for this one in sight? 


DATE:     Thursday, December 6, 2018

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                                                Cetera Advisors

Baird                                                                Trident Technical College

Wells Fargo Advisors


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Homebuilder Confidence

October 16, 2018

Homebuilder confidence was rose 0.1 point in October to 68 after having been unchanged in September.  The December level of 74 was the highest for this series since July 1999 — over 18 years ago — and current confidence levels are somewhat below the lofty December level.

NAHB Chairman Randy Noel said, “Builders are motivated by solid housing demand, fueled by a growing economy and a generational low for unemployment.  Builders are also relieved that lumber prices have declined for three straight months from elevated levels earlier this summer, but they need to manage supply-side costs to keep home prices affordable.”

NAHB Chief Economist Robert Dietz said  “Favorable economic conditions and demographic tailwinds should continue to support demand, but housing affordability has become a challenge due to ongoing price and interest rate increases.”

Traffic through the model homes jumped 4 points in October to 53 after having been unchanged in September.  The December level of  58 was by far the highest level 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 1.25 million pace.  They should continue to climb gradually in the months ahead and reach 1.30 million by the end of 2018 and 1.35 million by the end of next year.

Stephen Slifer


Charleston, SC

Industrial Production

October 16, 2018

Industrial production rose 0.3% in September after having risen 0.4% in August.   During the past year industrial production has risen 5.1%.  A growth rate of that magnitude was last seen in November 2010.  So despite monthly wiggles, production continues to trend upwards.

Breaking industrial production down into its three major sub-components,  the Fed indicated that manufacturing production (which represents 75% of the index) rose 0.2% in September after having risen 0.3% in August.  During the past year  factory output has risen 3.5% (red line, right scale).    The factory sector is clearly gathering considerable momentum.

Mining (14%) output rose 0.5% in September after having climbed 0.4% in August.  Over the past year mining output has risen 13.4%.  Most of the recent upturn in mining has been concentrated in oil and gas drilling activity.  Oil and gas drilling fell 1.4% in September after having declined 0.5% in August.     Over the course of the past year oil and gas well drilling has risen 13.5%.

Utilities output was unchanged in September after having risen 1.1% in August.  During the past year utility output has risen 5.4%.

Production of high tech equipment jumped 0.6% in September after having risen 0.3% in August.  Over the past year high tech has risen 6.9%.  Thus, the high tech sector sector appears to be expanding nicely. 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 rose 0.1% in September to 75.9%%.  It remains below the 77.4% level that is generally regarded as effective peak capacity.  However, factory owners will soon have to spend more money on technology and re-furbishing or expanding their assembly lines to boost output.

Stephen Slifer


Charleston, SC

Unemployment vs. Job Openings

October 16, 2018

The  Labor Department reported that job openings rose 0.8% in August to 7,136 thousand after having risen 3.7% in July.   It is worth noting that there are more job openings today than there were prior to the recession (4,123 thousand in December 2007).   There were 6.2 million people unemployed in August.

As shown in the chart below, there are currently 0.9 unemployed workers for every available job.   Think of that — there are more job openings today than there are unemployed workers.  Prior to the recession this ratio stood at 1.7 so the labor market is clearly in far better shape now than it was prior to the recession.  Further, at the end of the recession there were 6.6 times as many unemployed workers as there were job offers so, clearly, the job market has come a long ways in the past 9-1/2 years.

In  this same report the Labor Department indicated that the quit rate in August was  at 2.4 which is the highest level since January 2001.   This is a measure of the number of people that voluntarily quit their jobs in that  month.  During the height of the recession very few people were voluntarily quitting because jobs were scarce.  So the more this series rises, the more comfortable workers are in leaving their current job to seek another one.  The quit rate today is 2.4.  At the beginning of the recession it was at 2.0 and the record high level for this series was 2.6 back in January 2001.

There is one other point that should be made about this report.  Janet Yellen used to  claim that there were a large number of unemployed workers just waiting for jobs if only the economy were to grow fast enough.  She is assuming that these people have the skills and are qualified for employment.  We tend to disagree.  There are plenty of job openings out there.  What is not happening as quickly is hiring.  Take a look at the chart below.  Job openings (the green line) have been rising rapidly (and are far higher now than they were prior to the recession); hires (the red line) have been rising less rapidly.

Indeed, if one looks at the ratio of openings to hires the reality is that this ratio  has not been higher at any point in time since this series began in 2000.  There are plenty of jobs out there, but employers are having a hard time filling them.  Why is that?

A couple of thoughts come to mind.  First and foremost, many unemployed workers simply do not have the skills required for the jobs available.  If they did, why aren’t they being hired?  Why aren’t some current part time workers stepping into the void for those full time positions? Why haven’t discouraged workers begun to seek employment with so many jobs available?  Why haven’t long-term unemployed workers bothered to go back to school and acquire the skills that are necessary to land a  job?

Or perhaps many of these people flunk the drug tests.  They might not be qualified for employment for a variety of possible reasons.

Perhaps also some people in this group find the combination of unemployment benefits and/or welfare benefits sufficiently attractive that there is little incentive to take a full time job when you can sit at home do nothing and make almost as much.

Whatever the case, it appears that the decline in the unemployment rate in the past couple of years is not simply a reflection of workers dropping out of the labor force.  Jobs are plentiful and the only reason the unemployment rate is not falling faster is because the remaining unemployed/discouraged/part time workers do not have the skills required by employers today, flunk the drug tests, or are unwilling to take the jobs that are available.

Stephen Slifer


Charleston, SC

Retail Sales

October 15, 2018

Retail sales rose 0.1% in both August and September after having risen 0.6% in July.  However, Hurricane Florence blasted the North Carolina coast and parts of South Carolina in that month.  It is not too surprising that sales got dinged.  In October we will have some rebound from Hurricane Florence, but then Hurricane Michael slammed the Florida panhandle.  While these weather events can subdue sales in the months they occur, they do not change the longer-run picture.  As nearly as we can tell, sales still seem solid but it will take us several more months to get a clean read on the true pace of sales.  Over the  past year retail sales have risen 4.7%.

Sometimes sales can be distorted by changes in autos and gasoline which tend to be quite volatile.  In this particular instance car sales rose 0.8% in September, but gasoline sales fell 0.8%.  Changes in gas prices  impact the overall change in sales, but they typically do not reflect any significant change 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 were unchanged in September after having risen 0.1% in August and having jumped 0.8% in July.   In the last year retail sales excluding cars and gasoline have risen a solid 5.0%.

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 3.4% in the past year, on-line sales have risen 10.8%.  As a result, their share of total sales has been rising steadily and now stands at a record 11.4% 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, all measures of consumer confidence are at their highest levels in a decade.

One of the reasons consumers are feeling so positive is that the stock market is still near a record high.  That increase in stock prices boosts consumer net worth.  Given that the economic fundamentals seem so solid, we conclude that the early October drop-off reflects nothing more than normal stock market gyrations rather than being an earlier indicator of slower growth ahead.

As long as the economy continues to crank out 200 thousand jobs a month, consumer income will continue to climb.

Real disposable income is currently climbing at a solid 2.9% pace which is somewhat higher than its 25-year average growth of 2.7%.

If the Fed keeps raising rates very slowly consumers will be able to continue to borrow at a reasonable rate.  At 4.9% mortgage rates are well below the 6.25% average over the past 25 years.

In addition, 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 3.1% this year.

Stephen Slifer


Charleston, SC

Stock Market Jitters Send a False Signal

October 12, 2018

A broad-based, dramatic decline in the stock market is always nerve-wracking.  Most of the time it has little economic significance and reflects nothing more than normal stock market volatility.  But when the end of an economic expansion is approaching, a similar-looking stock drop will be an early signal of trouble ahead.  For this reason, we must always focus and try to determine the cause of the slide.  In this case, we are firmly convinced that the recent decline falls into the “false signal” category.

The fundamentals are solid:

Consumer confidence is the highest it has been in 18 years.

Ditto for business confidence.  Tax cuts and deregulation are working their magic.

Short- and long-term interest rates, while rising slowly, remain low by any historical standard or when looked at in inflation adjusted terms.

Housing has softened a bit, but the problem does not seem to reflect a drop-off in demand.  Rather, it reflects an inability of builders to get enough workers to significantly boost the pace of production, and an unwillingness of existing homeowners to put their house on the market perhaps in anticipation of even higher prices down the road.  Thus, we are apparently looking at a supply constraint rather than any significant weakening in demand.

Inflation continues to be well contained.  The CPI for September, released in the middle of the recent stock market rout, rose 0.1% both overall and excluding the volatile food and energy categories.  The CPI core rate has risen 2.2% in the past year.  But remember that the Fed’s 2.0% inflation target is not for the CPI, but the so-called personal consumption expenditures deflator.  The 12-month increase in the core PCE deflator currently stands at 2.0% and has been steady at that pace for the past six months.  While inflation is inching its way higher, the operative word is “inching”.

Inflation expectations (which are important to the Fed) have been steady at the 2.1% mark for almost a year.

None of these factors are going to cause the Fed to panic. The economy is showing no sign of overheating.  The current rate of inflation as well as inflation expectations are steady at a rate close to the Fed’s target.  But because the economy continues to expand at a solid pace, and because inflation seems to be inching its way higher, it is entirely appropriate for the Fed to continue its journey to bring rates back to “neutral”.  The market’s fear that the Fed is going to accelerate its previously-announced pace of rate hikes seems unwarranted.

What about trade and an escalation of the trade war with China?  Could that negatively impact GDP growth in the U.S. and elsewhere?  Yes.  We are happy that the trade skirmish now seems focused on China rather a more broad-based attack that included Mexico, Canada, Europe and Japan.  The conflict with China is long overdue.  The Chinese are notorious for not respecting copyrights and patents.  They force U.S. tech companies to share their secrets in exchange for doing business in that country.  We clearly support the notion of “free” trade, but it must also be “fair” trade and China fails that test.  President Trump is right to curtail access to U.S. technology.  U.S. security issues are involved, and they should supersede any free trade argument.  Will that knock a couple of tenths off U.S. GDP growth?  Probably.  But it will curtail growth in China to an even greater extent which could provide some incentive for Chinese leaders to re-think their business practices.  The good news is that this trade war comes at a time when the U.S. economy is strong and any modest drop-off in growth will go largely unnoticed.

In our view, the economic fundamentals are solid and seem to be pointing towards a surprisingly favorable combination of strong growth, contained inflation, and low interest rates for the foreseeable future.

As a result, we conclude that the stock market decline this past week has been largely technical and has little if any economic significance.  We have noticed that the markets seem to become unglued late in the day and plunge several hundred points in a matter of moments.  Perhaps the increased popularity of exchange-traded funds, which try to mimic the performance, of a particular stock  index are contributing to the problem.  Fund managers are required to keep their portfolios closely aligned with whatever index they track.  They can most closely match that index by executing trades late in the day.  We see the market collapsing and gasp, but the exaggerated slide largely reflects a very normal technical trading phenomenon.

One other point worth noting.  Oil prices in recent months climbed to about $75 per barrel before sliding late in the week to $71 as investors concluded that the stock decline might trim GDP growth around the globe and thereby curtail the demand for crude oil.  However, we continue to worry about further reductions in the supply of oil in the months ahead which could once again push prices higher.

The rise in oil prices the past few months largely reflects curtailment in the supply of oil from Venezuela, and the fear of a sharp reduction of Iranian output once sanctions go into effect next month.

Oil production has collapsed in Venezuela as the country’s economy has sunk into depression.  However, the drop-off has been gradual and other OPEC countries have been largely able to fill the gap.

In Iran the decline in production in Iran thus far has been modest, but one wonders what will happen once the U.S.-imposed sanctions go into effect on November 4.  The goal is to reduce Iran’s oil exports to zero.  No one knows at this point how big the impact will be.  India has joined South Korea and France in ceasing to buy Iranian oil. Other countries have sharply curtailed their purchases. OPEC has said it stands ready to counter any loss of oil from Iran and claims that its spare capacity is ample.  However, those wells have been unused for some time and it is not clearly exactly how much can be tapped quickly.  Thus, there is the potential for a further run-up in oil prices between now and yearend.

In conclusion, the October stock drop is disquieting, but there is no reason to believe it is a harbinger of slower growth ahead.   As always, there are potential dangers lurking and we will continue to monitor them.  For now, breathe easy.

Stephen Slifer


Charleston, S.C.

GDP, Inflation, and Interest Rate Forecasts

October 12, 2018

The final revision to second quarter GDP growth came in at 4.2% compared to an initial reading of 4.1% and a first revision of 4.2%.  First quarter growth was 2.2%.

Hurricane Florence will probably trim third quarter growth by about 0.2%.  But whatever growth is lost in Q3 will be recaptured in Q4.  Accordingly, we now expect 3.1% GDP growth in the third quarter followed by 3.0% growth in the fourth quarter.  Growth for the year remains at 3.1%.

Consumer spending rose 3.8% after having risen 0.5% in the first quarter and we expect it to rise 2.3% in 2018.  The consumer and corporate tax cuts should lift the stock market to yet another record high level by yearend.  The increase in stock prices and rising home prices are boosting household wealth.  The gains in employment are generating income which gives consumers the ability to spend.  Consumer debt is very low in relation to income.  Consumer confidence is at an 18-year high.  Interest rates  are rising very slowly but remain low.

Investment spending climbed 8.7% in the second quarter after having jumped 11.5% in the first quarter.  Investment spending was essentially unchanged for 2014-2016.  It appears that the corporate tax cuts, repatriation of earnings at a favorable tax rate, and a reduction in the regulatory burden is giving business leaders confidence to open their wallets and spend on new equipment and technology.  Not only will this boost GDP growth in the short term, if investment continues to climb it will boost productivity growth which will, in turn, raise the economic speed limit from about 1.8% today to 2.8% or so by the end of this decade.

The trade gap narrowed by $61.4 billion in the second quarter after having widened by $3.1 billion in the first quarter.  This means that the trade component added 1.4% to GDP growth in the second quarter.  We expect the trade component to add 0.1% to GDP growth in 2018 and to have no effect on GDP growth in 2019.

Nonfarm inventories declined $36.8 billion in the second quarter and subtracted 1.2% from GDP growth in that quarter.  Inventories never decline by that magnitude.  Inventory restocking in the final two quarters of the year should boost GDP growth by as much in the second half of the year as they subtracted in Q2.

Expect GDP growth of 3.1% in 2018 after having registered growth of 2.5% in 2017 as investment spending surges.  We then expect it to climb by 2.9% in 2019.

The inflation rate is gradually beginning to climb.  The economy is at full employment which finally appears to be boosting wages.  Both manufacturing and non-manufacturing firms are paying high prices for their raw materials so commodity prices are on the rise.  There is a shortage of available homes and apartments in the housing sector which is raising rents.  Thus inflation does, in fact, seem headed higher as the year progresses.   However, the pickup in inflation will be limited as internet price shopping will keep goods prices falling in 2018.  As a result we expect the core CPI to climb from  1.8% last year to 2.2% in 2018.  The overall CPI should increase 2.4% in 2019.

Slightly faster inflation will push long-term interest rates higher with the 10-year hitting 3.3% by the end of 2018 and 4.1% in 2019.  Mortgage rates should climb to 4.9% by the end of this year and 5.7% by the end of 2019.

With GDP likely to expand in 2018 at a rate slightly faster than its current potential and inflation expected to rise slightly above its target, the Fed will feel compelled to continue on a path towards gradually higher interest rates.  It needs to do so to get itself into position to lower rates when the time comes, but it appears to have the luxury of taking its time.  We expect one more rate hike in 2018 which would put the funds rate at 2.2% by the end of the year.  It should rise further to the 3.2% mark by the end of 2019.  The Fed will also continue to run off some of its security holdings throughout 2018 and 2019.

Stephen Slifer


Charleston, SC


Consumer Sentiment

October 12, 2018

The initial estimate for consumer sentiment for October declined 1.1 points to 99.0 after having jumped 3.9 points in September.   The October level was 2.4 points lower than March’s level of 101.4 was the highest level of sentiment since January 2004.  Thus, sentiment remains at a very lofty level.

Richard Curtin, the chief economist for the Surveys of Consumers, said, “Consumer sentiment slipped in early October, although it remained at quite favorable levels and just above the average reading during 2018 (98.5).   It should be noted that the sharp selloff in equities overlapped interviewing by only one evening, having virtually no influence on the early October data. In addition, there was no evidence of a spillover from the Kavanaugh hearings to economic prospects. Indeed, confidence in the government’s economic policies rose in October to its highest level in the past fifteen years.”

Given the tax cuts we expect GDP growth to climb from 2.5% in 2017 to 3.1% in 2018 and 2.9% in 2019.  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 3.5% 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 2.2% in 2018 and 2.4% in 2019.  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 2.2% by the end of 2018.

The modest September decline was attributable to both the expectations and current conditions components.

Consumer expectations for six months declined from 90.5 to 89.1.

Consumers’ assessment of current conditions slipped from 115.2 to 114.4.

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 2.5% in 2018.

Stephen Slifer


Charleston, SC

Initial Unemployment Claims

October 11, 2018

Initial unemployment claims continue to fall to multi-decade lows.  Specifically, claims rose 7 thousand in the week ending October 6 to 214 thousand after  having  fallen 8 thousand in the previous week.  The 4-week moving average rose 3 thousand to 210 thousand.  The lowest level for this series in the cycle was set back in mid-September at 206 thousand.  It obviously remains close to that level.  That, in turn, was the lowest level since December 6, 1969 when it was 205 thousand.

As one might expect there is a fairly close inverse relationship between initial unemployment claims and payroll employment.  With initial claims (the red line on the chart below, using the inverted scale on the right) at 210 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 might choose to offer some of their part time workers full time positions.  But this series is exactly where it was going into the recession so they will have limited success in finding necessary workers from this source.

They will also have to think about hiring  some of our youth (ages 16-24 years) .  But the September level for the youth unemployment rate today was the lowest on record (for a series that goes back to 1970) 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 — it is essentially where it was going into the recession.

The number of people receiving unemployment benefits rose 4 thousand in the week ending September 29 to 1,660 thousand.  The 4-week moving average declined 10 thousand to 1,656 thousand.  This was the lowest 4-week average since August 18, 1973 when it was 1,647 thousand.  The only way the unemployment rate can decline is if actual GDP growth exceeds potential.  Right now the economy is climbing by about 2.8%; potential growth has probably picked up from 1.8% previously to perhaps 2.3% today given faster growth in productivity.  Thus, going forward  the unemployment rate should continue to decline slowly.

Stephen Slifer


Charleston, SC

Consumer Price Index

October 11, 2018

The CPI rose 0.1% in September after having risen 0.2% in both July and August.  During the past year the CPI has risen 2.3%.

Food prices rose 0.1% in July, August, and September.  Food prices have risen 1.4% in the past twelve months.

Energy prices fell 0.5% in September after having jumped 1.9% in August.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 4.8%.

The recent run-up in energy prices seems to reflect two factors.  First,  oil production in Venezuela has dropped to a multi-decade low level given the chaotic political environment in that country.  Second, the supply situation in Iran is now highly  uncertain given the imposition of sanctions against that country that will take effect on November 4.  As a result, the International Energy Administration projects that demand will exceed supply by about 0.5 million barrels per day between now and yearend.   That is likely to put further  upward pressure on oil prices between now and yearend.

Excluding food and energy the CPI rose  0.1% in both August and September.  Over the past year this so-called core rate of inflation has risen 2.2%.  We expect the core CPI will rise 2.2% in 2018 and 2.4% in 2019.

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 2.8%.

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 been unchanged for almost every major category in the past year.  New cars have risen 0.5%, televisions have declined 18.6%, audio equipment has dropped 14.3%,  toys have fallen 10.0%, information technology commodities (personal computers, software, and telephones) have declined 3.1%.  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 retailers.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 3.0% 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.

The CPI, both overall and the core rate, will have an upward bias  in the months ahead because of what has been happening to 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.  We look for an increase in the corer CPI of 2.2% in 2018 and 2.4% in 2019.

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 2.0% rate but is  likely to head somewhat higher.  We expect it to climb 2.2% in 2019.  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.  Also,  higher wages triggered by the shortages of available workers in the labor market could also put upward pressure on the inflation rate.

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 PCE should increase 2.0% in 2018 and 2.2% in 2019.  That compares to the Fed’s targeted rate of 2.0%.

Keep in mind that real short-term interest rates are negative.  With the funds rate today at 2.0% and the year-over-year increase in the CPI at 2.3% the “real” or inflation-adjusted funds rate is negative 0.3%.  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