Monday, 24 of September of 2018

Economics. Explained.  

Category » Inflation

Gasoline Prices

September 19, 2018

Gasoline prices at the retail level rose $0.01 in the week ending September 17 $2.84 per gallon.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.59. The Department of Energy expects national gasoline prices to average $2.76 this year.  

Spot prices for gasoline have been bouncing around for the past several  months and are likely to be roughly unchanged between now and yearend..

Crude prices recently have been bouncing around in a range from roughly $67-72 per barrel.   The Energy Information Agency predicts that crude prices will average $67.03 in 2018 but that may be too low.

The number of oil rigs in  operation has  been fairly steady in recent months at about 1,050 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 has surged to 11,000thousand barrels per day.  The Department of Energy expects production to average 10.7 million barrels this year but climb further to 11.5 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 1,054 million barrels crude inventories are now roughly in line with the 2009-2014 average of 1,055 million barrels.  However, with demand likely to slightly exceed supply through the end of this year, 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.  The agency reports that demand picked up somewhat in recent months and supply edged lower as production constraints have restrained output.  As a result the IEA now estimates that demand will exceed supply by about 0.5 million barrels per day between now and yearend. The IEA noted that Venezuela has cut production there to a multi-decade low, and now there is the prospect of further a reduction in global oil supply by yearend stemming from curtailment of Iranian oil exports.  If the IEA estimates of supply and demand are correct not only will inventory levels edge lower between now and yearend, prices could climb somewhat.

Stephen Slifer


Charleston, SC*

Consumer Price Index

September 13, 2018

The CPI rose 0.2% in both July and August.  During the past year the CPI has risen 2.2%.  However, that out-sized yearly increase was boosted by huge increases in energy prices in the second half of last year.  The year-over-year increase overall should drop back to about 2.4% by the end of 2018.

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

Energy prices rose 1.9% in August after having fallen 0.5% in July 0.3% in June.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 10.3%.  However, as noted earlier, energy prices rose sharply in the second half of last year, so the energy component should rise only about 5.0% in 2018.

The recent run-up in energy prices seems to reflect three factors.  First, GDP growth around the world has picked up which is bolstering the demand for both crude oil and gasoline.  Second, oil production in Venezuela has dropped to a multi-decade low level given the chaotic political environment in that country.  And third, the supply situation from Iran is now highly  uncertain given the likely re-imposition of sanctions against that country later this year.  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.  However, U.S. production is surging.  It will climb about 15% this year and another 10% in 2019 which will make the U.S. the world’s largest oil-producing country.  At the same time OPEC is talking about gradually increasing its pace of production. A s a result, crude oil prices have dropped from $74 to about $70 per barrel currently and should decline gradually between now and yearend.

Excluding food and energy the CPI rose  0.1% in August after having risen 0.2% in each of the past three months .  Over the past year this so-called core rate of inflation has risen 2.2%.  Clearly, inflation is on the upswing.  The question is still one of degree.  We expect the core CPI will rise 2.3% for the year as a whole.

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 0.2% while prices for services have risen 3.0%.

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 0.3%, televisions have declined 18.0%, audio equipment has dropped 14.1%,  toys have fallen 9.3%, information technology commodities (personal computers, software, and telephones) have declined 4.4%.  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 3.4%.  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.

While 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 of 2.3% in 2018.

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 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 2.2%. We expect it to continue to climb at a 2.3% rate through yearend.  The core PCE should increase about 2.2% 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 1.9% and the year-over-year increase in the CPI at 2.7% 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

September 12, 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 declined 0.1% in August after having been unchanged in July.  During the past year this inflation measure (the red line) has risen 2.8%.  The PPI has been moving steadily higher for some time but took a breather in August..

Excluding food and energy producer final demand prices also declined 0.1% in August after having risen 0.1% in July.  They have risen 2.4% since August of last year (the pink line).  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 was unchanged in August after having risen 0.1% in  July. These prices have now risen 3.9% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods was unchanged in August after having risen 0.3% in each of the past five months.  During the past year the core PPI for goods (the light green line) has risen 2.6% (right scale).

Food prices fell 0.6% in August after having declined 0.1% in July after having declined 1.1% in June.  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 declined 0.9%.

Energy prices rose 0.4% in August after having dropped by 0.5% in July.  Energy prices have risen 13.7% 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 has increased its crude oil output.  The Department of Energy believes that the recent surge in energy prices will be at least be partially reversed between now and yearend.

The PPI for final demand of services declined 0.1% in both July and August after having risen 0.4% in June.  This series has risen 2.3% over the course of the past year (left scale).   The August drop was partly caused by a 0.9% decline in the trade services category which largely reflects the change in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular). In addition, the trade, transportation and warehousing component declined 0.6%.  The PPI for final demand of services excluding trade and transportation (the light blue line) increased 0.3% in June, July and August.  It has climbed 2.7% 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 manufacturing firms.  In the case of manufacturing firms the chart looks like the one below.  Price pressure were steadily building for six consecutive months.  Specifically, the price component rose steadily from 64.8 in November of last year to 79.5 in May.  The fact that every month was above 50.0 meant that prices producers were paying increased every single month.  Given that the level of the index steadily rose during that period of time indicates that price pressures were intensifying every single month.  However, from June through August this series actually declined to 72.1.  This means that prices continued to climb in those three months, but the rate of increase was less than in other recent months.  Hopefully, this means that the steady upward pressure on the PPI is beginning to abate.

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 3.9 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 2.2% in 2018 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

Personal Consumption Expenditures Deflator

August 30, 2018

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 rose 0.1% in both June and July.  The year-over-year increase now stands at 2.3%.

Excluding the volatile food and energy components the PCE deflator rose 0.2% in July after having risen 0.1% in June.  The year-over-year increase is now 2.0%.  This is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will reach the 2.2% mark for 2018 as a whole.  This inflation gauge has gone from being far below the Fed’s inflation target to being right at target currently.

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 2.4% overall in 2018 with a  2.4% increase for the core rate (excluding the volatile food and energy components).  For details of this forecast see the CPI write-up.

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

Employment Cost Index

July 31, 2018

The employment cost index for civilian workers climbed at a 2.4% pace in the second quarter after having risen 3.3% pace in the first quarter.  Over the course of the past year it has risen 2.8%.  Thus, the labor market continues to get tighter, and to attract the workers that they want firms are having to work employees longer hours, and offer higher wages and/or more attractive benefits packages.

With the unemployment rate at 4.0% 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 2.1% rate in the second quarter after having climbed 3.7% in the first quarter.  Over the course of the past year wages have been rising  at a 2.7% pace.  Wage pressures are beginning to accelerate gradually.

Benefits climbed at a 3.5% annual rate in the second quarter after having risen 3.0% in the first quarter.   As a result, the yearly increase in benefits is now 2.9%.

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 risen 1.1% in the past year as compensation rose 2.5% while productivity increased by 1.3%.    As we look forward into 2018 we expect compensation to climb to about the 3.5% mark, but at the same time we expected productivity to rise by 1.5%.  Thus, unit labor costs at the end of this year are likely to be rising at a 2.0% which means that there will be only slight upward pressure on the inflation rate this year stemming from the tight labor market.  A 2.0% increase in ULC’s is clearly compatible with the Fed’s 2.0% inflation target.

Stephen Slifer


Charleston, SC

Gross Domestic Purchases Deflator

July 30, 2018

There are many different deflators that are available.  This one is for gross domestic purchases which measures prices paid by U.S. residents.  It is the one measure of inflation that the Commerce Department talks about when it releases the GDP report.   It is our broadest measure of inflation and contains more than 5,000 goods and services.

The gross domestic purchases deflator rose 2.4% in the second quarter versus a 2.5% increase in the first quarter. Over the past year this index has risen 2.3%.

Excluding the volatile food and energy components this index rose 2.4% in both the first quarter and second quarters.

Remember that these deflators are weighted measures of inflation.  That means that when a builder switches from using copper pipe to PVC to save money, it registers as a price decline in these particular inflation measures.  Or when a consumer switches from buying butter to less expensive margarine the result is the same.  Thus, the deflator represents a combination of price changes and changes in consumer and business behavior.

The CPI, however, is a fixed basket of goods and services.  So what it shows are price changes only which, to us, is what inflation is all about.   We believe that the inflation rate is headed higher.  With the unemployment rate at 3.8% the economy is at full employment which should boost wages and, at last, that seems to be happening.  Both manufacturers and non-manufacturing firms are reporting sharply higher prices for their raw materials so commodity prices are also on the rise.  A very short supply of available rental properties is boosting rents.  Hence we expect  the core CPI to climb from 1.8% last year to 2.3% in 2018.  The one thing that is keeping the inflation rate in check is technology.  People are able to search the internet and find the lowest price available from Amazon or some other on-line website.  Thus, sellers of goods have absolutely no pricing power.  Prices of goods have fallen 0.3% in the past year while prices for services have risen 2.9%.

Stephen Slifer


Charleston, SC