Thursday, 19 of April of 2018

Economics. Explained.  

Category » Inflation

Gasoline Prices

April 18, 2018

Gasoline prices at the retail level rsoe $0.05 ending April 16 to $2.75. In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.50. The Department of Energy expects national gasoline prices to average $2.64 this year which is somewhat lower than they are currently.  Hence, prices should decline somewhat in the months ahead.  However, the DOE has been expecting prices to fall for some time and, as prices steadily rise, it simply keeps boosting its projected average price for the year.  Thus, its forecasts for a decline later this year becomes questionable.

Spot prices for gasoline have been on the rise, although not in a straight line manner, for the past several months.  So while pump prices may fall later in the year, they are not going to fall any time soon.

Crude oil prices are currently about $68.00.  The Energy Information Agency predicts that crude prices will average $59.37 in 2018.  Thus, crude prices should decline significantly in the months ahead.  However, as noted earlier, the DOE has been surprised and its average gas price for the year has been steadily revised higher.  It appears that demand for crude continues to outpace supply.  See the discussion below about global supply/demand estimates.

The number of oil rigs in service  However, the number of rigs in operation has  rebounded sharply in recent months to 1,008 thousand.  Thus,  higher crude oil prices are encouraging some drillers to accelerate the pace of production.  If crude prices average about $59 per barrel this year or higher, we should expect the number of oil rigs in operation to continue to climb and further boost production.

Production in the past month surged to 10,540 thousand barrels per day which continues to climb rapidly.  The Department of Energy expects production to average 10.7 million barrels this year and 11.4 million barrels in 2019.  As U.S. production continues to rise, crude prices should decline to about $58 per barrel.

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 about $48 per barrel.  Six months from now that number will be lower still.

Oil inventories fell quickly for most of last year.    OPEC output has been reduced at the same time that global demand has picked up sharply.  While crude inventories have been sliding for a year, at 1.093 million barrels crude inventories are now roughly in line with the 2009-2014 average of 1,055 million barrels.  However, demand continuing to slightly exceed supply for the next several months, stocks may well continue to decline 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 0.5 million barrels per day between now and yearend.  If its forecasts are correct it is likely the DOE’s forecast for lower crude and gas prices between now and yearend may not materialize.  We’ll see.

Stephen Slifer


Charleston, SC*

Consumer Price Index

April 11, 2018

The CPI fell 0.1% in March after having risen 0.2% in February.  During the past year the CPI has risen 2.4%.

Food prices rose 0.1% in March after having been unchanged in February.  Food prices have risen 1.3% in the past twelve months.

Energy prices declined 2.8% in March after having edged upwards by 0.1% in February.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 7.0%.  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.  However,  U.S. production is surging and inventory levels have begun to climb.  As a result, oil prices have recently declined from about $68 per barrel to about $65.   The Department of Energy expects oil prices to average $55.33 in 2018 significantly lower than where they are currently.

Excluding food and energy the CPI rose 0.2% in both February and March.  Over the past year this so-called core rate of inflation has risen 2.1% but in the past three months it has accelerated to a 2/8% pace.  Clearly, inflation is on the upswing.  The question is still one of degree..

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 2.9%.

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 fallen for almost every major category in the past year.  New cars have fallen 1.3%, appliances 2.2%, televisions 14.3%, audio equipment 17.6%,  toys 8.5%, information technology commodities (personal computers, software, and telephones) 3.2%.  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 retailer.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 2.9% 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.

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, gradually rising labor costs, and rising producer prices.  But on the flip side, the internet is keeping a lid on the prices of goods.  So while the CPI should edge higher in 2018, it is unlikely to explode.

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 1.6% 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 2.1%.  However, with the economy growing steadily, rents rising, and wage pressures climbing, the core inflation rate should pick up from 2.1% currently to  2.4% by yearend.  And because the core PCE increases at a rate roughly 0.5% slower than the core CPI, the core PCE should increase  2.0% 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 1.7% and the year-over-year increase in the CPI at 2.4% 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

April 10, 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 rose 0.3% in March after having risen 0.2% in February.  During the past year this inflation measure has risen 3.0%.  The PPI has been moving steadily higher and the year-over-year gain of 3.0% is the highest since January 2012.

Excluding food and energy producer final demand prices also rose 0.3% in March after having climbed 0.2% in February.  They have risen 2.7% since March 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 rose 0.3% in March after having declined 0.1% in February. 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 March after having climbed 0.2% in both January and February.  During the past year the core PPI for goods has risen 2.1% (right scale).  It has been rising at about that pace for the past year .

Food prices jumped 2.2% in March after having fallen 0.4% in February.  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 2.1%.

Energy prices declined 2.1% in March after having fallen 0.5% in February.  Energy prices have risen 8.5% 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.  However, U.S. oil output is now surging and crude prices have been fairly steady in a range from $60-65 in the past couple of months which should keep a lid on energy prices in the months ahead.

The PPI for final demand of services rose 0.3% in January, February and March.  This series has risen 2.8% 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 rose 0.3% in both February and March after having climbed 0.4% in January.  It has climbed 3.0% during the past year.  This series, like the overall index, has been gradually accelerating for some time.

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, but some of the upward pressure on inflation should be countered by an increase in productivity.

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 2.4% in 2018 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

Personal Consumption Expenditures Deflator

March 29, 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 0.2% in February after having climbed 0.4% in January.  The year-over-year increase now stands at 1.8%.

Excluding the volatile food and energy components the PCE deflator rose 0.2% in January after having risen 0.3% in January.  The year-over-year increase is now 1.6%.  However, in the past three month it has escalated to 2.7%.  It was held down in first half of last year 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 has come to a halt.  This is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will reach 2.0% by mid-summer.  This inflation gauge has gone from being far below the Fed’s inflation target to being just below 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 n 2018 with a  2.2% increase for the core rate (excluding the volatile food and energy components).

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

January 31, 2018

The employment cost index for civilian workers rose at a 2.5% annual rate in the fourth quarter after having risen at a 2.8% annual rate in the third quarter.  Over the course of the past year it has risen 2.7%.  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 4.1% 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 2.2% rate in the fourth quarter after having risen 2.8% in the third quarter.  Over the course of the past year wages have been rising  at a 2.6% pace.  Wage pressures are beginning to accelerate gradually.

Benefits climbed at a 2.1% rate in the fourth quarter after having risen at a 3.0% rate in the third quarter.   As a result, the yearly increase in benefits is now 2.6%.

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 0.7% in the past year as compensation rose 0.8% while productivity increased by 1.5%.   Given that labor costs are thus far rising slightly slower than the  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% which is faster than the 0.7% decline registered last year so there will be some upward pressure on the inflation rate this year stemming from the tight labor market.  However a 1.0% increase in ULC’s is clearly compatible with the Fed’s 2.0% inflation target.

Stephen Slifer


Charleston, SC