Sunday, 18 of February of 2018

Economics. Explained.  

Category » Commentary for the Week

Consumer Finances in Good Shape

February 16, 2018

The Federal Reserve Bank of New York recently released its quarterly report on household debt and credit.  It noted that household debt balances increased last year and are at a record high level.  That is an eye-catching headline and is factually correct.  However, it is grossly misleading.  By any metric consumers can easily afford this higher level of debt.  Debt in relation to income is far below its historical average.  Stock market gains and rising home prices in recent years have boosted consumer net worth.  And delinquency rates on consumer debt are the lowest they have been in a decade.

The New York Fed report accurately noted that consumer debt outstanding climbed last year to a record high level.

This debt is highly concentrated.  Mortgage loans are by far the biggest category and account for $8.9 trillion – or almost 70% — of $13.1 trillion of consumer debt outstanding.

Rather than focus on the amount of debt outstanding it is more appropriate to focus on its growth rate which last year was 4.5%, only marginally faster than in other recent years.  Consumers have not suddenly become spendthrifts.  Can consumers afford this higher, record amount of debt?  Absolutely!

The New York Fed does not point out that while consumer indebtedness has been climbing, steady job gains have also boosted consumer income.  As a result, debt in relation to income remains quite low.  The financial obligations ratio shown below measures consumer payments on mortgage and consumer loans, auto lease payments, rent, homeowners’ insurance, and property taxes in relation to income.  That ratio has been gradually rising for the past two years but, at 15.9%, it is not only below its long-term average of 16.5%, it is essentially where it was back in the mid-1990’s.  It will take several years for this ratio to return to its trendline, and even longer for it to reach an uncomfortable level.

Furthermore, the stock market has been on a steady uptrend since the recession ended in June 2009.  Stock market gains combined with rising home prices have boosted consumer net worth for the past eight years.   It is currently climbing at an 8.0% pace.  As a result, consumers feel good about their financial position and are more willing to spend a bit more freely.

Some economists have noted that the savings rate has fallen to a historically low level of 2.4% which is far below the 5.5% average rate for the past 15 years.  They further suggest that consumers will have to cut back their spending in the months ahead to boost savings.  We disagree.  Given what has been happening to their net worth, consumers do not have a compelling need to save as much of their paycheck as in the past.  That is certainly an understandable reaction.  Remember, the consumer is not dipping into savings.  Rather, he or she is simply saving 2.4% of their paycheck today rather than tucking away the more normal portion of 5.5%.  Note, too, that prior to the most recent recession the savings rate stayed at a comparable level for about three years before the economy finally slipped into recession.  A low savings rate is not a harbinger of slower growth any time soon.

The real proof of the pudding is in delinquency rates.  The percent of consumer loans 90 days or more delinquent has been steadily falling since the recession ended and is now at its lowest level in a decade.

As shown below, delinquency rates have been falling for all types of consumer debt, mortgages and credit cards in particular.

As an aside, whenever the discussion turns to delinquency rates on consumer debt, student loans quickly come to mind.  Two points are worth noting.  First the growth rate of student loans has been steadily slowing from a 15% pace shortly after the end of the recession to about 5.0% currently.  Second, as shown in red on the chart above, the delinquency rate on student debt, while high at 11.0%, has not changed in the past five years.

The important point to note is that consumer debt continues to climb, but steadily rising consumer income and net worth ensure that this higher level of debt is affordable.  There is nothing in the consumer’s financial position today that should warrant concern.

Stephen Slifer


Charleston, S.C.

A Stock Market Event, Not an Economic Event

February 9, 2018

The S&P 500 index has now retreated 10% from its record high level which means that it has officially experienced a “correction”.  The decline was triggered by a report that wages have risen 2.7% in the past year which suggested to some market participants that the economy is overheating, inflation is about to accelerate, and the Fed could raise interest rates more quickly than anticipated.  News that the budget deal will increase the deficit by $300 billion over the next two years further spooked the bond market and exacerbated the stock market drop.

From an investor’s viewpoint perhaps more troubling than the magnitude of the drop, was the volatility that occurred during the week.  The Dow Jones Industrial Index declined 665 points on Friday, plunged an additional 1,175 points the following Monday, rebounded 567 points on Tuesday, only to resume its slide with a 1,033-point drop on Thursday.

As a result, the Vix Index of volatility soared.  Our sense is that with the steady ascent of the stock market over the past year, some investors had a risk profile that was probably acceptable in the low volatility environment that has existed for the past two years, but their positions became intolerable once volatility surged and they panicked.

Interestingly, economists have not changed their view about the economy.  They continue to expect GDP growth to pick up to some degree this year, they believe inflation will also climb but only slightly, and they continue to anticipate three or perhaps four rate hikes by the Fed.  With tax cuts on the way, a pickup in investment spending already positively impacting growth, and still low interest rates, that view seems well-justified.  We believe that the recent stock market selloff is a speed bump that will have little discernable impact on either economic growth or inflation.

Having said that we respect the market and, given this hiccough, we should pay close attention to the data going forward.  Is there any hint that the economy is overheating?  Is inflation headed higher than we expect?  Is the Fed under the leadership of a new chairman likely to change its game plan and accelerate the pace of interest rate hikes?

The next potentially market-moving piece of information will be the CPI report for January which will be released on Wednesday morning, February 14.  The market is expecting the so-called “core CPI”, which excludes the volatile food and energy components, to increase 0.2% in January.  If so, the year-over-year increase will slip from 1.8% currently to 1.6% and perhaps eliminate some of the fear of higher inflation.

The increase in the overall CPI index will also get some attention but, regardless of the outcome for January, keep in mind that crude oil prices plunged this past week as U.S. production soared and crude inventories began to build.  If sustained, which seems likely, this will keep the inflation rate in check for months to come.

On Wednesday we will get a look at retail sales for January.  This is important because it is the first month of the quarter and determines the goods portion of consumption spending for that month.  Since consumer spending is two-thirds of GDP it will help economists refine their estimates of first quarter GDP growth.  Like the CPI, economists strip out the volatile categories, like autos and gasoline, to derive “core retail sales”.  This series has been strong for the past six months with an average monthly increase of 0.6% some of which undoubtedly reflects post-hurricane rebuilding which should soon begin to taper off.

On Thursday the Federal Reserve will release industrial production data for January.  The focus will be on the change in production in the manufacturing sector.  (The mining category largely reflects changes in oil prices, and the utility component is whipsawed by unusually cold or snowy weather which is subsequently reversed.)  The manufacturing sector has been gathering momentum.  Orders have been steadily climbing, and production has risen 2.5% in the past year or 0.2% per month.

Then, there is the all-important employment report for February which will be released on March 2.  The markets will anticipate an increase in employment of 180 thousand and no change in the 4.1% unemployment rate.  But the focus will undoubtedly be on the change in average hourly earnings.  It has been increasing 0.3% per month since October.  Another 0.3% increase will boost the year-over-year increase from 2.7% to 2.9%.   The pickup to 2.7% a month ago is what triggered the initial market drop on Friday morning, February 2.  While the year-over-year increase might climb to 2.9%, a steady diet of monthly increases of 0.3% will eventually boost the annual increase to 3.6%.  While fatter paychecks are a good thing, the market may not see it that way.  As we have pointed out on numerous occasions, more rapid wage growth can be partially or entirely offset by a commensurate increase in productivity and that is what we expect.  But that is a story for another day.  We will not see productivity and unit labor cost data for the first quarter until the end of April.

The bottom line is that markets have become nervous about the possibility of the economy overheating, inflation on the rise, and an expedited pace of Fed tightening.  We think market fears are overblown.  However, turn downs in the economy are always foreshadowed by declines in the stock market.  Consumers and businesses are seemingly unaffected by the recent 10% drop.  But what if stock prices fall by an additional 10% and we experience a full-blown bear market?  Will consumers and the business community continue to maintain the faith?  Such a scenario could be more problematic.  We do not expect that to happen.  But for our moderate growth/ moderate inflation/slow Fed tightening scenario to be accurate, we need confirmation from the data.  We think we will ultimately get that reassurance, but it is important to constantly monitor the tea leaves.

Stephen Slifer


Charleston, S.C.

Inflation Fears Arise and Stock Market Retreats – But Not for Long

February 2, 2018

The stock and bond markets have finally begun to fear faster-than-expected GDP growth and worry that inflation might finally be on the rise.  If that is the case, the Fed could raise the funds rate more quickly than is currently anticipated.   But is it fear justified?   We continue to believe the pickup in inflation will be modest.

In the past couple of weeks, the fear of faster growth and higher inflation has caused the yield on the Treasury’s 10-year to climb from 2.4% in December to 2.8%.

The rise in the 10-year yield caused the S&P to retreat by almost 3% in recent weeks.  Is this the beginning of the long-awaited stock market correction?  Maybe. But even if it is, we believe it will be of relatively short duration and magnitude and that the longer-term trend remains higher with the S&P reaching 3,000 by the end of the year.

Part of the market’s fear is from faster GDP growth.  Fourth quarter came in at 2.6% which was less than had been expected, but it was held down by a miniscule increase in business inventories.  Final sales growth, which excludes the inventory change, came in at a solid 3.2%.  That captured the markets’ attention.  Early estimates of first quarter GDP growth are around the 3.0% mark.  That is clearly faster than we have seen for some time and partially justifies the markets’ fear.

Faster GDP growth will generate upward pressure on both hourly earnings and worker compensation, which then boosts the inflation rate.  While the direction is right, how much of a pickup should we expect?  Our bet is that it will be relatively modest.

The January employment report indicated that average hourly earnings have risen 2.9% in the past year.  The yearly increase seems to reflect a solid uptrend.   This tidbit of information spooked the markets.

Hourly earnings are only a small part of worker compensation.  Many workers are not paid hourly but receive an annual salary.  Others may receive an annual bonus payment.  And total worker compensation includes various types of benefits.  The employment cost index combines all that additional information.  It, too, is on the upswing with a year-over-year increase of 2.7%.

But there is a missing piece and we continue to stress it.  Increases in labor costs can be offset by commensurate increases in productivity.  We should focus specifically on what economists’ call “unit labor costs” which makes that adjustment.  It will determine the extent to which high labor costs translate into higher inflation. Last year the Bureau of Labor Statistics reported that compensation increased 2.4%, but at the same time productivity growth quickened to 1.1%.  As a result, unit labor costs – labor costs adjusted for the increase in productivity — rose 1.3%.  But the Fed has a 2.0% inflation target.  An adjusted 1.3% increase in labor costs is not putting upward pressure on inflation.

But that is history.  What do unit labor costs look like in 2018?  Given the tightness in the labor market we anticipate a 3.0% increase in worker compensation this year.  With investment spending on the upswing we suggest that productivity will climb by 1.8%.  If that is the case, unit labor costs are likely to increase 1.2% which is virtually identical to last year’s increase.  Thus, the tightness in the labor market is still not putting upward pressure on the inflation rate.  We would begin to worry if unit labor costs jumped to 2.5% or higher.  We are not even close.

We believe that the core CPI will increase from 1.8% last year to 2.2% in 2018 which is roughly in line with the Fed’s 2.0% inflation target.  If that forecast is correct, the Fed will not be alarmed and will have no reason to raise the funds rate more than the three times that it has previously indicated.  And if inflation remains in check, the yield on the 10-year note by yearend should be about 3.0% — not much higher than it is currently.

Markets always tend to overreact.  If our economic scenario is accurate the pickup in inflation will be modest and the stock and bond markets will eventually settle down.

Stephen Slifer


Charleston, S.C.

The Dollar – Lots of Chatter but Expect Little Change

January 26, 2018

The dollar has fallen 7.5% in the past year.  Treasury Secretary Mnuchin said this week that a weaker dollar is good for trade.  That is in sharp contrast to the strong dollar policy advocated by every administration for the past 20 years and such a declaration sent the foreign exchange market into a tizzy and accelerated the dollar’s decline.  But then, one day later, President Trump says that Mnuchin’s comments were taken out of context and that a strong dollar is desirable.  So, what is the administration’s trade policy?  We don’t know.  This administration has routinely made conflicting statements on many topics in the past year.  So, why has the dollar been declining?  And what might it do for the balance of this year?

Let’s back up for a moment.  The dollar began a dramatic increase of 20% between mid-2014 and January 2016.  Why?  Because the Fed told us in mid-2014 that it intended to raise rates “soon” and thereby signaled its intention to end the ultra-easy monetary policy that had existed for the previous six years.  It followed through on that promise and raised the funds rate from 0% to 0.25% in December 2015. and it has continued to boost rates gradually for the past two years.  The funds rate today stands at 1.25%.  Meanwhile, central banks elsewhere – the U.K., Europe, and Japan — showed no interest in ending their ultra-easy monetary policies. As a result, the dollar rose dramatically.

Following Trump’s surprising election as president last year the dollar rose further as the expectation of individual and corporate income tax cuts, repatriation of overseas earnings, and a reduction in the rather stifling regulatory environment created the prospect of even faster U.S. GDP growth in the U.S., which made it an even more attractive place to invest.  The dollar rose farther.  But Trump ran into a stumbling block when he was unable to reform health care and the markets began to question his ability to deliver the promised tax cuts.  The dollar began to slide in February of last year.

In the middle of last year, it became apparent that economic activity in the rest of the world was on the upswing.  In October the IMF raised its global GDP forecast for 2018 by 0.1% to 3.7% which would be the fastest global growth rate since 2011.  This past week it raised that forecast by another 0.2% to 3.9%.  Growth rates were revised higher not only for the U.S., but for Europe, China, Japan and many of the emerging countries.

The reasons for faster growth vary depending upon exactly where you look.  Tax cuts – the corporate tax cut in particular – have boosted the U.S. GDP outlook.  Super easy monetary policies throughout much of the world – the U.S., the U.K., Europe, and Japan – finally seem to be paying dividends.  And oil prices are rebounding.  When oil prices plunged in 2014-2015 oil exporting economies were crushed.  Growth slowed for all and some oil-exporting countries slipped into recession.  But as oil prices have rebounded the GDP outlook for all oil-exporting countries like Canada, Nigeria, Brazil and many OPEC countries is far brighter.

The point is that, since the middle of last year, investors have decided that the prolonged period of slow growth in Europe, Japan, and steadily diminishing growth in China and many emerging economies has finally come to an end.

Stock markets in all regions of the globe have soared.  The MSCI All World Stock Index has risen 27% in the past year eclipsing even the eye-popping 24% increase in the S&P 500 index.  Suddenly, the rest of the world is as attractive – if not more attractive – then the United States.  Against this background, it is not surprising that the dollar’s slide, which started in February of last year, has continued.

The world has been reacting to the changes in relative growth rates around the world for the past year.  The question is how much farther the dollar will slide.  Trump keeps talking about building his wall along the border with Mexico, branding China as a currency manipulator, imposing sharply higher tariffs on a broad array of goods imported from China, and withdrawing from NAFTA.  He may get some funding for his wall as a quid-pro-quo for passing an immigration reform bill.  But he cannot threaten China very much because he needs them to help keep North Korea in check.  He is not going to withdraw from NAFTA, but he could re-negotiate some parts of the agreement which actually need to be re-vamped.  The bottom line is that his trade agenda this year is unlikely to trigger a further sharp decline in the value of the dollar.  And despite Mnuchin’s comments, we do not believe that the administration wants a weaker dollar.  But who knows what they will say tomorrow.

The bottom line is that we expect the dollar to fall about 3.0% this year.  Compared to the 20% run-up in 2014-2015, the further drop expected for this year should have little impact on either GDP growth in 2018 or on the inflation rate.  We look for GDP growth rate of 3.0% in 2018 compared to a 2.5% gain last year.  But that growth comes from solid 2.8% growth in consumer spending combined with a robust 7.0% pace of investment spending.   Trade should have little impact on GDP growth in 2018.

Stephen Slifer


Charleston, S.C.

Several Pieces for You to Read This Week

January 19, 2018

I got inspired this week and wrote a couple of pieces that might be of interest to you.

First, the stock market has been on a roll for some time.  A correction is inevitable at some point.  When that occurs everybody will get nervous and chatter about an impending recession will arise.  The first piece assures you that a recession is not in store this year or for the next several years.

Second, a government shutdown may occur at the end of the day today.  While annoying it will not significantly alter the economic outlook.  This is unlike what happens when the government shuts down because the U.S. Treasury is bumping up against the debt ceiling.  That is worrisome.  This is not.

Third, read the piece on gasoline prices.  Crude prices have reached $63 per gallon.  But the Intentional Energy Agency as well as OPEC members warn that at this price we could see an explosion of production by U.S. producers which could trigger a drop in oil prices like we saw in 2014.  OPEC finance ministers are meeting in Oman over the weekend.  Pay attention to what they decide.

Stephen Slifer


Charleston, S.C.

If Stock Market Corrects, Will a Recession Follow?  No Chance!

January 19, 2018

The economy is in its ninth year of expansion.  The stock market is on a powerful upswing.  It is inevitable that between now and yearend it will hit a speed bump and correct by 10% or more.  People will get nervous.  There will be talk of a recession.  How can you tell whether the downturn is a signal that the expansion is coming to an end?  Or merely the latest hiccough?  Here is what we are watching.

Federal Funds Rate.  The Fed is gradually raising the federal funds rate.  It is currently at 1.25%.  With three more one-quarter point moves later this year it will reach the 2.0% mark by yearend.  But it will remain well below the so-called “neutral” level of about 3.0%.  We have repeatedly highlighted the fact that the U.S. economy has never, ever gone into recession without the Fed first pushing the funds rate above the neutral rate.  Going into the last recession the funds rate reached the 5.0% mark before the economy went over the edge.  Regardless of what happens to the stock market this year, this necessary pre-condition for a recession will not be met any time soon.

Inflation on the Rise.  The CPI excluding the volatile food and energy components rose 1.8% last year.  The Fed has a 2.0% target.  The Fed has indicated that it will be willing to tolerate an above-target inflation rate for a while because it has been below its target for so long.  What is that acceptable upper limit?  Nobody knows.  3.0% perhaps?  Once inflation surpasses 3.0% or so the Fed will feel compelled to raise the funds rate significantly above the neutral rate of 3.0%, and actively shift into “tightening” mode.   At that point we should be hyper-alert, but we are not even close.

Stock Market Drop.  Once the two conditions above have been met, a stock market swoon will be an important leading indicator.  A 10% drop this year will mean nothing because rates are not even close to a level that might trigger a recession.  But a 10% drop once rates have climbed above the neutral rate of 3.0% — on their way to 4.0% or 5.0% — will almost certainly be a harbinger that the good times will soon end.

Yield Curve Inverts.  This means that short-term interest rates have risen above long-term rates.  It is an indicator that the Fed is aggressively trying to slow the economy by raising short rates significantly.  It is a relatively reliable indicator that the economy will soon enter a recession. Some fear the yield curve might invert this year.  That is not going to happen.  It has flattened a lot in the past year.  In December 2016 long rates were almost 2.0% higher than short rates.  In December of last year that spread had narrowed to 1.2%.  Between now and yearend we expect short rates to rise 0.75% to 2.0%, while long rates rise by 0.5% to 2.9%.  The curve will get flatter still, but remain positive at 0.9%.

Consumer confidence.  At some point we will begin to get nervous and all measures of consumer confidence will turn downwards.  Most confidence measures split the overall index into a “current conditions” component and an “expectations” component.  When we get nervous the expectations component will be the first to turn fall.

Housing.  Once the bad times arrive housing and autos will turn downwards first.  Why?  Because they are the two biggest ticket items in our budget.  Realtors and builders are the canaries in the coal mine for the rest of the economy.  Pay attention to building permits.  They will turn downward before builders cut back on the construction of new houses.

Car sales.  Same as above.  This is a big-ticket item.  It will get hit quickly.  Car sales are reported on the first business day of the month for the month that has just ended.  Thus, they are one of the timeliest economic indicators.

Factory orders.  The orders component of the ISM (Institute Supply Management) survey will fall sharply.  This is another very timely indicator.  It is reported on the first business day of the month for the month that just ended.

Factory workweek.  The factory workweek will decline.  Rather than lay off workers at the first sign of emerging weakness, manufacturers first cut back on the hours worked of existing employees.  This is part of the employment report which is released on the first Friday of the month for the previous month which means it is also very timely.

If these indicators all begin to turn downwards, you can be sure we are in the soup.

How will we know when the recession has actually begun?  Industrial production. The National Bureau of Economic Research (NBER) is the official arbiter of the beginning and ending dates of business cycles. In the most recent cycle industrial production registered its first decline in January 2008.  The NBER said that the expansion ended in December 2007.  On the flip side, industrial production first turned upwards in July 2009.  The NBER said the recession ended in June 2009.

We mention all of this not because we expect a recession any time soon.  We don’t.  We think the expansion has at least 3 to 5 years to go.  But once the stock market swoon begins you can be assured that many economists will significantly boost the odds of a recession later this year.  We want to assure you that will not happen.

Maintain the faith.  When the stock market begins to fall it will be a correction, not a harbinger of recession.

Stephen Slifer


Charleston, S.C.

Don’t Sweat a Shutdown

January 19, 2018

As this is being written a federal government shutdown is scheduled to go into effect at the end of the day on Friday, January 19.  Should it occur it will be more of an annoyance than anything else because only some government functions will be affected.  Government shutdowns do not occur often.  The last one was from September 30, 2013 to October 16 a total of 16 days.   Prior to that was a 21-day closure between December 15, 1995 and January 6, 1996.  The Congressional Research Service recently published a document entitled “Shutdown of the Federal Government:  Causes, Processes, and Effects” which describes the process.

It is important to recognize that not all federal government activities will cease.  The Office of Management and Budget (OMB) determines which workers are affected.  Generally, agencies that protect life and property are exempted.  This would include medical care at VA hospitals, air traffic controllers, border and coastal protection, protection of federal lands, buildings, and waterways, care of prisoners, law enforcement and criminal investigations, emergency and disaster assistance workers, agencies that ensure the production of power, and the military.  All U.S. Treasury auctions of government securities will be held as usual.  The Post Office continues to deliver the mail because it is a self-funded agency.  Social Security and Medicare payments are made on time.  Food stamps continue to be distributed.

OMB reported that in the 2013 standoff roughly 850,000 executive branch workers were laid off daily at its peak in early October.  That represented about 40% of the federal workforce.  While there is no guarantee that those workers will be paid, the reality is that they have never gone unpaid.  Once the shutdown comes to an end Congress routinely approves legislation to pay those workers retroactively.

Perhaps the most visible part of government that is affected are the national parks and monuments as well as the Smithsonian museums in Washington, D.C.  Howls of protest arise as visitors find their vacation plans have been interrupted.  The State Department will stop processing applications for passports and visas.  Experimental programs at the National Institutes if Health will cease.  The Centers for Disease Control will stop monitoring disease surveillance.  The Bureau of Alcohol, Tobacco, and Firearms will stop processing alcohol, tobacco, firearms and explosives applications.  Many federal government contract workers will not get paid.

While annoying, it is unlike the type of shutdown that occurs once the U.S. Treasury has reached the debt ceiling limit.  That has far more serious repercussions.  On those occasions the Treasury can roll over its outstanding debt, but is unable to raise any new cash.  Thus, it can live off its cash balance for a while but, eventually, it will run out of cash and be forced to default on its debt obligations.  That has never happened, but the specter that it could occur is enough to send a wave of fear through the financial markets.

The way the budget process works, every year Congress must pass 12 different appropriations bills which specify the amount of money each federal agency is permitted to spend in the upcoming fiscal year.  These bills are rarely passed by the time the new fiscal year begins on October 1.  Instead, Congress will pass a “continuing resolution” which allows each agency to spend temporarily at the same rate as in the prior fiscal year.  This year the first continuing resolution provided funding through December 8.  It has since been extended through January 19.  Republicans and Democrats always vie over spending priorities and this year is no exception.  Each side tries to achieve the best possible deal.  But, inevitably, each side also wants to attach unrelated legislation to these spending bills.  In this case, the Republicans want to include funding for President Trump’s wall along the border with Mexico.  The Democrats want to extend the Deferred Action for Childhood Arrivals (DACA) program which will permanently prevent the deportation of about 700,000 undocumented immigrants who were brought to the U.S. as children.  Each side blames the other.  How all this will be resolved is uncertain but, at the very least, a government shutdown expedites the process.

Stephen D. Slifer


Charleston, S.C.

Overheating Fears Awaken the Bond Bears

January 12, 2018

Solid economic data and a string of record high levels for the stock market are stoking fears that the economy may soon overheat which would boost the inflation rate and induce the Fed to accelerate the pace of rate hikes.  Such fears have boosted long-term interest rates and encouraged investors to reallocate a portion of their investment portfolios from bonds into stocks.  Expect more of the same.  In the months ahead, bond rates and stock prices are headed higher.

One gauge of the expected inflation rate is to compare the actual yield on the 10-year note to the comparable inflation-adjusted rate.  The difference between the two is a measure of the bond market’s expected inflation rate during the next 10 years.  It recently climbed above the 2.0% mark which is the highest it has been since mid-2014.  Because we believe the overall CPI inflation rate in 2018 will climb to 2.4% and average 2.3% or so for the next decade, the expected inflation rate is probably headed higher.

This combination of robust economic growth and higher inflation has boosted the yield on the 10-year note to 2.56% which is the highest rate since mid-2014.  Three expected rate hikes by the Fed later this year and a gradual pickup in the inflation rate to 2.4% should boost the yield on the 10-year note to 2.9% by yearend.

The market is suddenly awakening to the fact that inflation and long-term interest rates are going to rise in the months ahead.  As a result, investors are likely to re-think their portfolio allocation between stocks and bonds. Their investment advisor is likely to recommend a shift out of bonds (the price of which declines as interest rates rise) into stocks.  Indeed, portfolio reallocation may explain some of the stock market’s exuberance in the first two weeks of January.

Does any of this change our view of the economy?  Not at all.  We continue to expect GDP growth to quicken from 2.7% in 2017 to 2.9% this year as investment spending accelerates.  We expect the core CPI to rise from 1.8% in 2017 to 2.2% in 2018.  And we think the Fed will raise rates three times as the year progresses.  The reality is that interest rates – both short and long rates – remain low by any historical standard.  For example, at its projected yearend 2018 level of 2.0% the federal funds rate is about one percentage point lower than the so-called “neutral”” rate of about 3.0%.  Even though rates should continue to climb as the year progresses, they remain well below the level that could threaten the expansion.  That point is unlikely to be reached until sometime in the early 2020’s.

The other financial market indicator that would worry us is if the U.S. Treasury yield curve were to ”invert”, which means that short rates are higher than long rates.  Such an event is frequently a precursor to recession because it means that the Fed is aggressively raising short rates (the federal funds rate) to slow down the pace of economic activity and short circuit a further pickup in the inflation rate.  Note that prior to both the 2000 and 2008-09 recessions the Fed raised short-term rates to about 0.5% higher than long-rates, i.e., the yield curve was inverted.  With the funds rate today at 1.3% and the yield on the 20-year note at 2.5% the yield curve has a positive slope of 1.2%.  It has been getting steadily flatter for the past couple of years and some worry about a possible inversion later this year.  That is not going to happen.  Yes, the Fed will raise short-term interest rates by about 0.75% this year to 2.0%, but with the inflation rate climbing we expect the yield on the 10-year note to climb to 2.9%.  So by yearend our expectation is that the curve will be 0.9% — somewhat flatter than it is currently, but in no danger of inverting.

So, all is well.  The earlier anticipation and now the reality of tax cuts is having the desired effect of stimulating growth in the economy.  Our first look at fourth quarter GDP growth will be on Friday morning, January 26 and it should be about 3.5%.  If that forecast is accurate, it would be the third consecutive quarter with GDP growth above the 3.0% mark.  There can no longer be any doubt that the economy has shifted onto a faster growth track.

Stephen Slifer


Charleston, S.C.

The Rosy Economic Environment Remains Intact

January 5, 2017

The trick in economic forecasting is figuring out how much importance to attach to the data for any given month.  And sometimes that requires examining a broad range of economic indicators rather than just one.  So, as we start a new year perhaps it is worthwhile to sniff the air for possible threats to our view that the economy will perform well in 2018.

The December employment report was on the soft side with a reported jobs gain of 148 thousand.  However, that follows much-larger-than-expected increases in October and November of 211 thousand and 252 thousand, respectively.  Thus, the 3-month average increase in employment is now 204 thousand which compares to an average increase for the past twelve months of 171 thousand.  Payroll employment, like every economic indicator, can be volatile from month to month.  With the 3-month increase still quite solid there is no evidence of any emerging weakness in the labor market.

Then there is the stock market.  It has picked up in early 2018 right where it left off last year.  It has risen 3.5% since the beginning of December and reaches a record high level every couple of days.  That will continue to bolster consumer and business confidence which should encourage both groups to spend freely in the early stages of 2018.

Thus far we only have retail sales data through November, but they appear to be on a roll.  The overall retail sales data incorporate auto sales which can be volatile from month to month, and gasoline prices which can be distorted by price changes.  Thus, most economists will look at “core” sales which exclude those two volatile categories.  In the past year such spending has risen at a 4.8% pace.  But with gains of 0.8%, 0.4%, and 0.9% in the September-November period such spending has skyrocketed to an 8.2% pace in the past three months.  We do not yet know much about December, but car sales in that month climbed 2.0% to a 17.8 million pace, and retailers apparently registered particularly robust Christmas sales.  Thus, there is no reason to believe that the pace of sales softened in the final month of the year.

Putting all of this together we continue to expect fourth quarter GDP growth to increase 3.2%.  Most estimates we have heard range from 2.9-3.9%.  Thus, it is likely that GDP growth will register growth in excess of 3.0% for the third consecutive quarter. Our first look at that growth rate will be Friday morning, January 26.   If that forecast is accurate, we feel quite comfortable in anticipating GDP growth for 2018 of 2.9%.

The recent acceleration in GDP growth is primarily attributable to business leaders’ decisions to spend more money on investment, whether that is on technology to enhance productivity or building a new factory.  After languishing for three years investment spending surged in the first three quarters of last year to 6.0% pace and is expected to continue its enhanced pace in the fourth quarter.  There can be little doubt that this pickup is a direct result of economic policy decisions.  Business people anticipated early on that the proposed combination of cuts in individual and corporate income tax rates, an ability to repatriate overseas earnings at a favorable tax rate, and significant relief from the stifling regulatory environment, would significantly bolster GDP growth and corporate earnings in the months and quarters ahead.  And now, of course, those anticipated policy changes have been enacted.

We have noted on many occasions that a pickup in investment spending will boost growth in productivity and that, too, seems to be happening.  After barely growing for a couple of years, productivity climbed 1.5% in the second quarter of last year and a hefty 2.9% in the third quarter.  The year-over-year increase has risen to 1.5%.  Remember, in the past three years productivity growth averaged just 0.8% but it appears to be expanding more rapidly.  As long as investment spending continues its upward trajectory, productivity growth will also grow more rapidly.  And if that is the case, our economic speed limit is likely to climb from 1.8% today to perhaps 2.8% by the end of the decade.  That means faster growth in our standard of living.

There is nothing new in the analysis just presented.  But our job is to read to economic tea leaves and give you, our readers, a heads up when something surfaces that might short-circuit our particularly rosy economic climate.  In our view the December employment report was nothing more than statistical noise.  Everything else from consumer and business confidence, the stock market, investment spending, and GDP growth are starting out 2018 with as much momentum as they had in the final few months of last year.

Stephen Slifer


Charleston, S.C.

Happy Holidays to All

December 22, 2017

No weekly commentary this week or next.  Back to writing in early January.

It has been a great year in 2017 and 2018 appears to be even better.

All the best to you and your family during this holiday season.

Steve Slifer