Monday, 11 of December of 2017

Economics. Explained.  

Category » Inflation

Gasoline Prices

December 6, 2017

Gasoline prices at the retail level fell $0.03 in the week ending December 4 to $2.50.  In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.25. The Department of Energy expects national gasoline prices to average $2.45 next year.

Crude oil prices are currently about $57.00.  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.  Wage pressures are 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 some modest 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 929 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 was 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 9,707 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.

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 wells 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

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

Employment Cost Index

October 31, 2017

The employment cost index for civilian workers rose at a 2.8% annual rate in the third quarter after having climbed at a 2.2% annual rate in the second quarter.  Over the course of the past year it has risen 2.5%.  Thus, the labor market is slowly beginning to get tighter, and to attract the workers that they want employers are having to work employees longer hours, and offer higher wages and/or more attractive benefits packages.

With the unemployment rate at 4.2% and full employment also presumably at 4.5-5.0%, it is not surprising that we are beginning to see a hint of upward pressure on compensation.

Wages climbed at a 2.8% rate in the third quarter after having risen at a 2.2% rate in the second quarter.  Over the course of the past year wages have been rising  at a 2.5% pace.  Wage pressures are beginning to accelerate gradually.

Benefits climbed at a 3.0% rate in the third quarter after having risen 2.4% pace in the first quarter.   As a result, the yearly increase in benefits is now 2.5%.

What happens to labor costs is important, but what we really want to know is how those labor costs compare to the gains in productivity.  If I pay you 3.0% more money but you are 3.0% more productive, I really don’t care.  In that case, unit labor costs were unchanged.

Currently, unit labor costs  have declined 0.2% in the past year as compensation rose 1.1% while productivity increased by 1.3%.   Given that labor costs are thus far rising in line with gains in productivity, there is not yet upward pressure on the inflation rate from the obvious tightness in the labor market.  As we look forward into 2018 we expect compensation to climb to about the 3.0% mark, but at the same time we expected productivity to rise by 2.0%.  Thus, unit labor costs at the end of next year are likely to be rising at a 1.0% race which is clearly compatible with the Fed’s 2.0% inflation target.

Stephen Slifer


Charleston, SC

Personal Consumption Expenditures Deflator

June 30, 2017

There are many different measures of inflation, but the one that the Federal Reserve considers to be most important is the personal consumption expenditures deflator, in particular the PCE deflator excluding the volatile food and energy components.

The PCE deflator declined 0.1% in May after having risen 0.2% in April.  The year-over-year increase now stands at 1.4%.

Excluding the volatile food and energy components the PCE deflator rose 0.1% in both April and May.  The year-over-year increase is now 1.4%.  It is being held down in recent months by a price war in the wireless cell phone industry and falling prescription drug prices as Trump is putting pressure on the industry.  Falling prices in those two sectors will not continue.  This is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will reach the 1.8% mark by the end of 2017 and 2.2% by the end of next year.  This inflation gauge has gone from being below the Fed’s inflation target to being almost to its target.  The Fed is likely to raise the funds rate one more  time in 2017 which would lift the funds rate to the 1.25% mark (which is still very low).

The more widely known inflation measure, the CPI ex food and energy, has been rising at a somewhat faster pace and is projected to increase 2.0% in 2017 and 2.5% in 2018.

Why the difference?  The CPI measures price changes in a fixed basket of goods each month.  The deflator captures price changes, but also changes in consumer spending habits.  If we try to save money by switching from butter to lower-priced margarine, from beef to chicken, or if builders substitute PVC pipe for more expensive copper,  the deflator would come in lower than the CPI in that particular month.  For our money, we think that the CPI which strictly measures price changes is a better barometer of inflation.  The Fed disagrees.

Stephen Slifer


Charleston, SC