Wednesday, 20 of June of 2018

Economics. Explained.  

Homebuilder Confidence

June 18, 2018

Homebuilder confidence declined 2 points in June after having risen a similar amount in May.  The December level of 74 was the highest for this series since July 1999 — over 18 years ago — and current confidence levels remains just a few points below the lofty December level.

NAHB Chairman Randy Noel, a homebuilder from LaPlace, Louisiana, said ,“Builders are optimistic about housing market conditions as consumer demand continues to grow.  However, builders are increasingly concerned that tariffs placed on Canadian lumber and other imported products are hurting housing affordability. Record-high lumber prices have added nearly $9,000 to the price of a new single-family home since January 2017.”

NAHB Chief Economist Robert Dietz added “Improved economic growth, continued job creation and solid housing demand should spur additional single-family construction in the months ahead.  However, builders do need access to lumber and other construction materials at reasonable costs in order to provide homes at competitive price points, particularly for the entry-level market where inventory is most needed.”

Traffic through the model homes fell 1 point in June to 50.  The December level of  58 was by far the highest level thus far in the business cycle.  Traffic volume remains high and an index level of 50 indicates that the number of people going through model homes was the same in June as in May.

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 1.3 million pace.  They should continue to climb gradually in the months ahead and reach 1.4 million by the end of 2018.

Stephen Slifer


Charleston, SC

Not too Slow, Not too Hot

June 15, 2018

The Fed’s rate hike to 1.75-2.0% this past week was widely anticipated. The modest surprise was that FOMC members are now leaning towards a total of four rate hikes this year.  When they last met in early May the committee was split about whether to raise rates three times this year or four.  Most major news organizations interpreted the Fed’s recent statement as a signal that faster rate hikes are on the way.  That is not entirely accurate.  The Fed told us in March that they plan to lift the funds rate to 3.4% by the end of 2020.  That has not changed.  They end up in the same place but given recent economic data they added an additional rate hike later this year.  What caused the Fed to alter slightly its outlook for this year?  Is the economy overheating?  Is inflation picking up too quickly?  Will the Fed’s rate hikes jeopardize the expansion?  The short answer is – all is well and the economy is on track to expand beyond 2020.

The catalyst for the Fed was a string of strong economic statistics.  Payroll employment jumped 223 thousand in May.  The unemployment rate declined 0.1% to 3.8% and (at 3.754%) was on the cusp of a 0.2% drop to 3.7%.  Fueled by tax cuts, retail sales surged 0.8% in May.  Combining these tidbits suggests that GDP growth could quicken to a 4.0% pace in the second quarter.  Interestingly, the same folks who are now worried that the economy is overheating are the same people that were worried about slow growth a couple of quarters ago.  While the economy may be accelerating in the second quarter be careful.  First quarter GDP rose at a modest 2.2% pace.  In recent years GDP has tended to register anemic growth in the first quarter followed by a rebound in the second, and trend like growth in the second half.  Thus, the trend rate for the first half of the year is about 3.0%.  While faster than the 2.6% pace registered in 2017, it can hardly be construed as a dramatic pickup.

Meanwhile, the core CPI for May rose 0.2%.  Its year-over-year growth rate is 2.2%.  This rate has been inching its way higher, but the operative word is “inching”.  For what it is worth, we expect the core CPI to rise 2.3% in 2018.  If that is accurate it is not going to bother the Fed.  However, 3.0% GDP growth and a steady pickup in inflation ensure that the Fed remains on track for gradually rising interest rates.

What makes our forecast different from others is that we believe that an impressive pace of investment spending in the wake of the corporate tax cuts will stimulate productivity growth. That will, in turn, boost potential GDP growth from 1.8% for the past couple of years to 2.8% by the end of the decade.  If that is the case, our projected 3.0% GDP growth path will not lead to any meaningful pickup in inflation.  However, this is a forecast and could be wrong.  If productivity does not pick up, 3.0% GDP growth will almost certainly lead to higher inflation.  Thus, we must monitor closely GDP growth, productivity, and inflation in the quarters ahead.

Thus far the markets do not seem worried that the faster current rate of GDP growth and the gradual upswing in inflation will be a problem.  Comparing the nominal interest rate on the Treasury’s 10-year note to its inflation-adjusted equivalent provides a market-based estimate of inflationary expectations.  This rate has been gradually rising for the past two years but, at 2.1% currently, participants are clearly not alarmed.  The Fed would be concerned if that rate were to pick up markedly because a pickup in inflationary expectations often leads to a pickup in the actual inflation rate.  If the economy is overheating and the Fed is not raising rates quickly enough, businesses will anticipate higher inflation and begin to raise prices.   If expectations were to climb to 2.5% the Fed would almost certainly accelerate its pace of tightening and more quickly return to a neutral funds rate which it believes is around the 3.0% mark.  That is not our call, but it is something to watch.

For the economy to slip into recession we need two things.  First, the funds rate must climb a couple of percentage points above the neutral rate to perhaps 5.25%.  Second, short-term interest rates must become higher than long rates (which means that the yield curve” inverts”).  With the rate on the 10-year not at the end of 2020 likely to be 4.2% and the funds rate at 3.5%, the yield curve would retain its positive shape.  Neither of the two requirements for a recession are on the horizon.  A recession is looming out there somewhere, but not through the end of 2020.

Stephen Slifer


Charleston, S.C.

Consumer Sentiment

June 15, 2018

The preliminary reading for consumer sentiment for June rose 1.3 points to 99.3.  March’s level of 101.4 was the highest level of sentiment since January 2004.  Thus, it remains at a very lofty level.

Richard Curtin, the chief economist for the Surveys of Consumers, said, “At some point in every economic expansion, favorable income and job prospects act to offset higher inflation and interest rate expectations. Only when inflation and interest rates are expected to persistently exceed income and job prospects will consumers begin to curtail their discretionary spending.”

Given the tax cuts we expect GDP growth to climb from 2.6% in 2017 to 3.0% 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 3.5% 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 2.3% in 2018.  Such a scenario would keep the Fed on track for the very gradual increases in interest rates that it has noted previously.  Specifically, we expect the funds rate to be 2.1% by the end of 2018.

The May changes in both the current conditions and expectations components were statistically insignificant.

Consumer expectations for six months fell 1.7 points from 89.1 to 87.4.

Consumers’ assessment of current conditions roe 6.1 points to 117.9.

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

Industrial Production

June 15, 2018

Industrial production declined 0.1% in May after having climbed 0.9% in April and 0.5% in March.   Production took a breather in May after having risen sharply in other recent months.  During the past year industrial production has risen 3.5%.  A growth rate of that magnitude was last seen in late 2014.  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) declined 0.7% in May after having risen 0.6% in April. Much of this decline is attributable to a drop in auto output and presumably reflects a somewhat earlier-than-normal end-of-model-year changeover.  Manufacturing ex autos fell just 0.2% in May.  During the past year  factory output has risen 1.7% (red line, right scale).  The factory sector is gathering momentum despite the May decline.

Mining (14%) output rose 1.8% in May after having climbed 1.0% in April.  Over the past year mining output has risen 12.6%.  Most of the recent upturn in mining has been concentrated in oil and gas drilling activity.  Oil and gas drilling jumped 3.9% in April after having gained 3.0% in April.     Over the course of the past year oil and gas well drilling has risen 13.8%.  However, in the past three months that figure has climbed to a 45.5% pace.

Utilities output rose 1.1% in May after having jumped 3.2% in April.  During the past year utility output has risen 4.0%.

Production of high tech equipment rose 0.2% in May after having jumped 1.8% in April.  Over the past year high tech has risen 6.2%.   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 fell 0.6% in May to 75.3% from 75.9% in April.  It remains below the 77.4% that is generally regarded as effective peak capacity.  However, factory owners will soon have too have to spend more money on technology and re-furbishing or expanding their assembly lines to boost output.

Stephen Slifer


Charleston, SC

Retail Sales

June 14, 2018

Retail sales climbed 0.8% in May after having risen 0.4% in May and having jumped 0.8% in April.  The trend rate seems to be edging upwards.

Sometimes sales can be distorted by changes in autos which tend to be quite volatile.  In this particular instance car sales rose 0.5%.

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 2.0% in May after having gained 1.0% in April.  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 jumped 0.8% in May after having risen 0.3% in April and 0.5% in March.   In the last year retail sales excluding cars and gasoline have risen a solid 5.1% and are showing no signs of abating.

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 5.0% in the past year, on-line sales have risen 9.1%.  As a result, their share of total sales has been rising steadily and now stands at a near record 11.1% 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 sale.  Car sales are reasonably solid at a 17.1 million pace.  Consumers do not purchase homes and cars — the two biggest ticket items in their budget — unless they are feeling confident about their job and the future pace of economic activity.

Second, after having experienced a correction earlier this year the stock market is only about 2% below its record high.  That increase in stock prices boosts consumer net worth.

Third, all measures of consumer confidence are close to their highest levels in a decade.

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

Finally, the economy is cranking out 190 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 2.6% last year to 3.0% this year.

Stephen Slifer


Charleston, SC

Initial Unemployment Claims

June 14, 2018

Initial unemployment claims fell 4 thousand in the week ending June 9 to 218 thousand after  having declined 1 thousand in the previous week.  The 4-week moving average declined 2 thousand to 224 thousand.  The average of 214 thousand on May 12 was the lowest level for this average since December 13, 1969 (when it was 211 thousand).

Ordinarily, with initial unemployment claims (the red line on the chart below, using the inverted scale on the right) at 224 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.  This series is a bit higher than it was going into the recession so they might have some 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 April 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 — close to where it was going into the recession.

The number of people receiving unemployment benefits declined 49 thousand in the week ending June 2 to 1,697 thousand after having risen 4 thousand in the previous week.  The four week moving average declined 4 thousand to 1,726 thousand which is the lowest 4-week average since December 8, 1973 when it was 1,716 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

GDP, Inflation, and Interest Rate Forecasts

June 13, 2018

First quarter GDP growth initially came in at 2.3%.  The first revision lowered this by 0.1% to 2.2%.  But the downward revision came entirely from the inventory component.  Inventory accumulation is sure to rebound in the final three quarters of the year.  Final sales, which is GDP excluding the change in business inventories actually revised slightly higher in the fourth quarter.  As a result of all this, we now expect GDP growth this year of 3.0% compared to our previous forecast of 2.8%..

Consumer spending rose 1.0% but that follows a steamy 4.0% growth rate in the fourth quarter.  The consumer and corporate tax cuts should list 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 a multi-year high.  Gas prices are expected to decline somewhat as the year progresses.  Interest rates remain low and are rising very slowly.

Investment spending jumped 9.2% in the first quarter after growing 6.8% in the fourth quarter.  However, investment spending was essentially unchanged for the previous three years.  It appears that the prospect of 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 in the years ahead.

The trade gap narrowed by $3.0 billion in the first quarter after having widened by $56.4 billion in the fourth quarter.  We expect the trade component to have no impact on GDP growth in 2018.

Expect GDP growth of 3.0% in 2018 after having registered growth of 2.6% in 2017 as investment spending surges.  We then expect it to climb at the same 3.0% rate 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 2.3% in 2018.  The recent increase in oil prices should cause the overall CPI to increase 2.5% this year.

Slightly faster inflation will push long-term interest rates higher with the 10-year hitting 3.1% by the end of 2018 and 3.8% in 2019.  Mortgage rates should climb to 4.7% by the end of this year and 5.4% 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 two more rate hikes in 2018 which would put the funds rate at 2.2% by the end of the year.  It should rise further to the 3.1% 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


Producer Price Index

June 13, 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 (the red line) jumped 0.5% in May as energy prices surged.  This series rose 0.1% in April.  During the past year this inflation measure has risen 3.1%.  The PPI has been moving steadily higher.

Excluding food and energy producer final demand prices (the pink line) rose 0.3% in May after having climbed 0.2% in April.  They have risen 2.4% since April 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 jumped 1.0% in May after having been unchanged in April. These prices have now risen 4.3% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 0.3% in March, April, and May.  During the past year the core PPI for goods has risen 2.5% (right scale).  It has been rising at about that pace for the past year.

Food prices rose 0.1% in May after having fallen 1.1% in April.  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 0.5%.

Energy prices surged upwards by 4.6% in May after having risen 0.1% in April.  Energy prices have risen 16.0% 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, the cutback in global supply by OPEC, and a state of complete chaos for oil production in Venezuela.  However, U.S. oil output is now surging and OPEC is talking about an increase in its crude oil output.  As a result, oil prices have fallen about 8.5% in the past several weeks from a mid-May peak of $72 to about $66 currently.  Thus, the May surge in energy prices will quickly be reversed.

The PPI for final demand of services rose 0.3% in May after having risen 0.1% in April.  This series has risen 2.4% 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 was unchanged in May after having fallen 0.1% in April.  It has climbed 2.2% during the past year.  This series, like the overall index, has been gradually accelerating for some time.

The recent increases in producer prices were 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 3.8%, the labor market is beyond full employment.  As a result, wages pressures have begun to climb, but much of the upward pressure on inflation should be countered by an increase in productivity.  Nevertheless, the tighter labor market should exert at least moderate upward pressure on the inflation rate.

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 2.3% in 2018 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

Gasoline Prices

June 13, 2018

Gasoline prices at the retail level declined $0.03 in the week ending June 11 to 2.91 per gallon.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.66. The Department of Energy expects national gasoline prices to average $2.77 this year.  They are projected to peak at $2.97 per gallon in June, but then decline to $2.75 by the end of the year. 

Spot prices for gasoline have been on a steady upswing for the past several  months.  However, talk about OPEC possible increasing its crude oil output has caused gasoline prices to decline about 7.5% since reaching a peak of $2.20 in late May.

Crude oil prices recently jumped to $72 per gallon.  However, as noted above, talk about an increase in crude oil output by OPEC nations has caused the price to decline 8.5% from a mid-May high of $72 per gallon to $66.The Energy Information Agency predicts that crude prices will average $64.53 in 2018.  If that is the case, oil prices should decline gradually in the second half of the year.

The number of oil rigs in service  However, the number of rigs in operation has  rebounded sharply in recent months to 1,062 thousand.  Thus,  higher crude oil prices are encouraging drillers to accelerate the pace of production.  If crude prices remain above $60 per barrel this year or higher, we should expect the number of oil rigs in operation, and production, to continue to climb.

Production in the past week surged to 10,900 thousand barrels per day and it continues to climb rapidly.  The Department of Energy expects production to average 10.8 million barrels this year and 11.8 million barrels in 2019.

To put those production levels in perspective, keep in mind that if U.S. crude oil production picks up as expected the U.S. will become the world’s largest oil producer by the end of this year.

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 $35 per barrel.  Six months from now that number will be lower still.

Oil inventories fell quickly for most of last year.    OPEC output was reduced at the same time that global demand picked up sharply.  While crude inventories have been sliding for a year, at 1,100 million barrels crude inventories are now roughly in line with the 2009-2014 average of 1,055 million barrels.  However, with demand continuing to slightly exceed supply for the next several months, stocks may well decline slightly further in the near term.

The International Energy Agency in Paris (IEA) produces some estimates of global demand and supply.  A couple of months ago its estimate had supply and demand relatively in balance between now and yearend.  But now,as shown in the chart below, demand picked up somewhat in recent months and while supply edged lower as production constraints have restrained output.  As a result the IEA now estimates that demand will exceed supply by about 0.2 million barrels per day between now and yearend. A significant portion of the recent production shortfall was unintentional.  The IEA noted “chronic mismanagement” in Venezuela has cut production there to a multi-decade low,and Iranian production could slip further as a result of the U.S. sanctions.

OPEC is expected to boost output somewhat at its meeting next week to counter the shortfall from Venezuela and Iran.  That would put demand in supply roughly in balance between now and yearend and allow the price of crude oil to decline somewhat.

Stephen Slifer


Charleston, SC*

Small Business Optimism

June 12, 2018


Small business optimism jumped 3.0 points in May to 107.8 after having edged upwards by edged upwards by 0.1 point in April to 104.8.  The May level was a record high level for this series.

NFIB President Juanita Duggan said,  “Main Street optimism is on a stratospheric trajectory thanks to recent tax cuts and regulatory changes. For years, owners have continuously signaled that when taxes and regulations ease, earnings and employee compensation increase.”  Buried in the details of the report were such milestones as compensation hitting a 45-year high record, positive earnings trends reached a survey high, positive sales trends are the highest since 1995, and expansion plans are the most robust in survey history.  It does not get any better than that.

NFIB Chief Economist added that, “Small business owners are continuing an 18-month streak of unprecedented optimism which is leading to more hiring and raising wages.”

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.

The stock market has experienced a correction in the past several months but has rebounded but has rebounded and is now only 3% below its record high level.    Jobs are being created at a brisk pace.  The unemployment rate is well below the full employment threshold.  The housing sector is continuing to climb.  And now investment spending has picked up after essentially no growth in the past three years.  We expect GDP growth to climb from 2.6% in 2017 to 2.8% 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 prior to yearend.

Stephen Slifer


Charleston, SC