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The Debt Limit is a Sham

June 23, 2017

Here we go again.  Every year we go through the same useless exercise of raising the debt limit.  First, Congress votes to spend money.  Then, the Treasury tries to pay its bills but eventually bumps up against a constraint on how much debt it can issue.  It announces that the “debt limit” must be raised so that it can continue to pay its bills.   Finally, Congress is horrified!  It declares that expenditures must be slashed to curtail this runaway spending!

But wait a minute!  Congress authorized that spending when it passed its budget for that year.  In that process Congress authorizes each government agency to spend a certain amount of money.  If Congress believes that government spending is excessive – and it is – it should use the budget process to rein it in.  Congress should not vote to spend money, and then slap the Treasury’s hands when it is forced to borrow to finance the previously-authorized spending.  That makes no sense.  The debt limit is a superfluous piece of legislation that chews up endless days of negotiation and wasted time.  In the end the debt limit is raised.  Every year.  And it will be raised again this year.

The most important thing to know about the budget process is that when Congress approves a budget that will result in a deficit of, say, $500 billion, the Treasury must issue an additional $500 billion of debt to finance that deficit.  Thus, debt outstanding is cumulative.  It increases every single year that the U.S. government incurs a budget deficit – which is to say that it increases annually.  For the current fiscal year the Treasury faces an estimated budget deficit of $585 billion and will issue that amount of additional debt.  The Treasury estimates that it will reach the statutory debt limit by early September.

Each month, in addition to its regular bills, the Treasury must pay off maturing securities and the interest on the remaining debt outstanding.  If it cannot do so, it will default on its debt obligations.  That has never happened.  Why?  Because a default by the Treasury would be unthinkable.  If it becomes unable to pay its debts the Treasury would have to pay a higher interest rate on future debt because investors – both foreign and domestic — would demand higher interest rates given the possibility of default.  Confidence in U.S. Treasury debt as a safe haven in times of uncertainty would be shaken.  Foreign investors could reduce their willingness to buy U.S. debt.

Because the president and members of Congress are well aware of these potential adverse consequences the Treasury is not going to default.  Congress will raise the debt limit in the nick of time.

Increasing the debt limit has become an almost annual ritual.  It has been raised 72 times since 1960, of which 18 occurred between 2001 and 2017 and the Treasury has never defaulted on its debt.  And it is not going to happen this year.  Having said that, negotiations will continue right up to the last minute and make us all nervous.  Nancy Pelosi and the House Democrats say they will not increase the debt ceiling to finance tax cuts for the rich.  Senate Republicans want a vote on the debt ceiling in July, but that comes at the exact same time that it wants a vote on its proposed health care legislation.  In September the administration would like to turn its attention to its proposed cuts in individual and corporate income taxes.  These issues could become politically entangled.  We do not know exactly how this will play out but, most likely, at the last possible moment there will be a temporary increase in the debt limit.

The bottom line is, be prepared for some scary headlines during the next two months about a possible default by the Treasury on its debt obligations and a potential government shutdown.  The stock market could get hit.  Consumer confidence might decline.  But rest assured the Treasury is not going to default on its obligations and, once the debt limit is raised, the potentially nasty near term consequences will be quickly reversed.

We wholeheartedly support the notion of cutbacks in government spending in order to shrink future budget deficits which are projected to climb from $585 billion today to $1.4 trillion by 2026.  But Congress should have the courage to make the required spending cuts during the budget process.  Then eliminate the debt ceiling requirement entirely.  It is not only distracting, it is unnecessary.  It does nothing to actually constrain government spending.

Stephen Slifer

NumberNomics

Charleston, S.C.


New Home Sales

June 23, 2017

New home sales rose 2.9% in May to 610 thousand after having fallen 7.0% in April.  This is typically an extremely volatile series.  A much better representation of the pace of home sales is the 3-month average which stands at 616 thousand (shown above) which is within an eyelash of being the fastest sales pace thus far in the cycle (peak was 616 thousand in March).   Keep in mind that builders are still having difficulty finding an adequate supply of skilled labor.  If they could find more workers, builders would build and sell more homes.  Also do not forget that new home sales are single family homes and do not include sales of condos.

The supply of available homes for sale rose 4 thousand in May to 268 thousand.  The small increase in inventories combined with a similar-sized increase in sales means that there continues to be a 5.3 month supply of new homes available for sale.  Realtors suggest that a 6.0 months supply is that point at which the demand for and supply of housing are roughly in balance.

The National Association of Realtors series on housing affordability for existing homes peaked at 214 in January 2013.  It has since slipped from that lofty level and now stands at 156.2.   That means that consumers have 56.2% more income than is necessary to purchase a median priced home.  Existing homes remain quite affordable despite a post-election increase in mortgage rates to 4.0% We have made an attempt to estimate affordability if 30-year mortgage rates  climb to 4.3% by the end of this year.  We estimate the affordability index at that time will be about 151 — still very affordable.  The reason affordability has not been hit harder by the increase in mortgage rates is because consumer income continues to climb.

New home prices jumped 11.5% in May to $345,800 after having fallen 3.1% in April.   Because this is an inherently volatile series we tend to focus on a 3-month moving average of prices (shown below) which is $325,400.  During the course of this past year prices have risen 5.1%.

Given that the demand for housing far exceeds supply the housing sector will continue to do well in 2017.  Sales will be at a reasonably robust pace of perhaps 640 thousand by yearend, builders will continue to boost production, and prices should rise slowly.  Mortgage rates should end 2017 at 4.3% which is still quite affordable.

Stephen Slifer

NumberNomics

Charleston, SC


Initial Unemployment Claims

June 22, 2017

Initial unemployment claims rose 3 thousand in the week ending June 17 to 241 thousand.  Because these weekly data can be volatile the focus should be on the 4-week moving average of claims (shown above), which is a less volatile measure.  It rose 2 thousand to 245 thousand.  The late February average of 234 thousand was the lowest level for this series since April 14, 1973 — 44 years ago!

Ordinarily, with initial unemployment claims (the red line on the chart below, using the inverted scale on the right) at 245 thousand  we would expect monthly  payroll employment gains to exceed 300 thousand.  However, employers today are having difficulty finding qualified workers.  As a result, job gains are significantly smaller than this long-term relationship suggests and are currently about 170 thousand.

With the economy essentially at full employment, employers will have steadily increasing difficulty getting the number of workers that they need.  As a result, they will be forced to offer some of their part time workers full time positions.  This series is still a bit high relative to where it was going into the recession.

They will also have to think about hiring  some of our youth (ages 16-24 years) .  But the youth unemployment rate today is the lowest it has been in 20 years so there are not many younger workers available for hire.

Finally, employers may also consider some workers who have been unemployed for an extended period of time.  But these workers do not seem to have the skills necessary for today’s work place.  Employers may have to offer some on-the-job training programs for  those whose skills may have gotten a bit rusty.  But even if they do, the reality is that the number of discouraged workers today is quite low — toughly in line with where it was going into the recession.

The number of people receiving unemployment benefits rose 8 thousand in the week ending June 10 to 1,944 thousand.  The four week moving average rose 5 thousand to 1,932 thousand. In mid-May the 4-week average came in 1,916 which was the lowest level for this 4-week average since January 12, 1974 when it was 1881.   The only way the unemployment rate can decline is if actual GDP growth exceeds potential.  Right now the economy is climbing by about 2.0%; potential growth is  projected to be about 1.8%.  Thus, going forward  the unemployment rate will decline quite slowly.

Stephen Slifer

NumberNomics

Charleston, SC


Gasoline Prices

June 21, 2017

Gasoline prices at the retail level fell $0.05 in the week ending June 19 to $2.32 per gallon.   In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.07. The Department of Energy expects national gasoline prices to average $2.39 this year — almost exactly where they are currently.

As the price of gasoline declined the economy got a tailwind. However,  oil prices today are 1.5% lower today than they were a year ago.  Hence, the tailwind effect on the economy has run its course but has not yet turned into a headwind.

Crude oil prices are currently about $44.00 mark.  The Energy Information Agency predicts that crude prices will average $50.68 in 2017.  As crude oil and gas prices have leveled off the underlying inflationary pressures have become more apparent.

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 933 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 has been 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 and at 9350 million barrels it is now only about 3% lower than its June 2015 peak pace of production which was 9,610 thousand barrels.  The Department of Energy expects production to average 9.3 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.  For example, output per oil rig has increased by 27% in the past twelve months.  Put another way, a year ago some frackers could not drill profitably unless crude oil prices were about $70 per barrel.  Today that number has declined to about about $44 per barrel.  Six months from now that number will be lower still.

While oil inventories gradually declined for most of 2016 the increase in production earlier this year caused inventory levels to climb to a record high level in February.  Since that time inventory levels have been shrinking.  We know that OPEC output has been reduced, but its cutback has been partially offset by a significant pickup in U.S. production.  The other thing thing that could reduce inventory levels is strong demand which, in this case, seems consistent with an apparent quickening of GDP growth not only in the U.S. but around the world.

Stephen Slifer

NumberNomics

Charleston, SC


Existing Home Sales

June 21, 2017

Existing home sales rose 1.1% in May to 5,260 thousand after having fallen 2.3% in April.  While these sales bounce around a bit from month to month they clearly continue to trend higher.  The March sales pace of 5,700 thousand was the fastest since February 2007.

Lawrence Yun, NAR chief economist  says, “The job market in most of the country is healthy and the recent downward trend in mortgage rates continues to keep buyer interest at a robust level,”

The months’ supply of unsold homes rose slightly to 4.2 months.  Realtors consider a 6.0 month supply as  being the point at which demand for and supply of homes are roughly in balance.  Thus, housing remains in short supply.  If sales were not being constrained by the limited supply it would almost certainly be at a 6,000 thousand pace.

Keep in mind that properties typically stayed on the market for just 27 days in May which is down from 29 days in April and 32 days a year ago.  This is the shortest time frame since the NAR began tracking these data in May 2011.

The National Association of Realtors series on affordability reached a peak of 213.6 in January of 2013.  It now stands at 156.2 in April.  At 156.2  it means that a household earning the median income has 56.2% more income than is necessary to get a mortgage for a median priced house.  Going into the recession consumers had only 14% more money than was required to purchase that median priced home.  Thus, housing remains quite affordable despite the backup in mortgage rates.  That is because sizable job gains are boosting income almost as fast mortgage rates are rising.

The housing sector will continue to expand in the quarters ahead.   Jobs growth is expected to remain solid which should boost  income.  Builders are trying hard to boost production to increase the supply of available homes which should slow the pace of price appreciation. Finally, mortgage lenders should become slightly less restrictive as the economy remains healthy and default rates decline.
Existing home prices rose 3,2% in May to $252,800 after climbing 3.6% and 3.7% in March. Because this is a relatively volatile series we tend to focus on the 3-month average of prices which now stands at $236,400.  Over the course of the past year existing home prices have risen 5.8% and have generally been bouncing around in a 4.5-8.0% range.

Stephen Slifer

NumberNomics

Charleston, SC


Fed Policy Not “Neutral” until 2020 – or Later

June 16, 2019

The Federal Reserve’s Open Market Committee met this week and, as expected, raised the funds rate to the 1.0% mark.  It continues to expect a slow but steady pace of additional rate hikes over the next several years, eventually pushing the funds rate to 3.0% sometime in the first half of 2020.  That part of the Fed’s “normalization” process has not changed.  But there is a necessary second step.  Following the Fed’s bond buying binge between October 2008 and October 2014, its balance sheet skyrocketed from $900 billion to its current level of $4.4 trillion.  It needs to shrink its portfolio dramatically and, at its meeting earlier this month, it laid out a game plan for how it intends to proceed.  It will be a very gradual, lengthy process which will drag on well into the 2020’s.  The Fed is not going to trigger a recession by shrinking its balance sheet too quickly.

As the Fed purchased its combination of U.S. Treasury and mortgage-backed securities, it flooded the banking system with surplus reserves which skyrocketed from about $0.1 billion in late 2008 to $2.25 trillion currently.  Because those funds represent the ability of the banking system to lend to consumers and businesses, they need to be eliminated to prevent a potentially inflationary spending spree at some point down the road.  The Fed will accomplish that objective by shrinking its balance sheet.  But how will it go about that?

Basically, the Fed has two options.  First, it could go into the market and sell some of its current holdings of securities.  Doing so would shrink its balance sheet quickly.  But the Fed is concerned that such action would be disruptive to the bond market and could push long-term interest rates sharply higher which would pose a risk to the ongoing expansion. That is not the desired outcome.

Second, it could accomplish the same objective by running off some of its holdings of U.S. Treasury and mortgage-backed securities by simply not replacing them when they mature.  But given that the Fed’s portfolio has an average duration of almost ten years, this will be a very slow process.

Once this program begins later this year (presumably at its early November meeting) it will initially run off $6 billion of U.S. Treasury securities per month for the first three months.  At the same time it will run off $4 billion of its holdings of U.S. agency and mortgage-backed securities.  Thus, at the beginning it will allow a total of $10 billion of its security holdings to run off for the first three months.  It then plans to increase that total amount by $10 billion every three months until it reaches a cap of $50 billion per month.  It would reach that limit at the end of its first year of implementation.  Doing the math, it means that the Fed’s portfolio will have shrunk to the desired level by the end of 2022.

Keep in mind that the Fed does not need to shrink its balance sheet back to the $900 billion level that existed prior to the recession.  It wants its portfolio to grow roughly in line with growth in nominal GDP, or about 4.0% annually.  That means that the desired balance sheet level at the end of this year will be about $1.3 trillion and it will grow at roughly a 4.0% pace every year thereafter to $1.6 trillion by the end of 2022.

If the Fed does what it is suggesting, the Fed’s balance sheet will have shrink by $2.8 trillion from $4.4 trillion currently to the $1.6 trillion target level during the next five years.  But that is not going to happen.

According to data reported by the Fed, it has only $1.5 trillion of securities maturing within the next five years, and an additional $0.4 trillion maturing between 5-10 years.  All the rest of its security holdings have a maturity date in excess of ten years.  Thus, more realistically, Fed holdings will not return to their target level until 2031.

The point is that the Fed will have a two-pronged approach towards “neutralizing” monetary policy.  First, it intends to use the funds rate as its primary policy tool.  The funds rate should reach its so-called “neutral” level by early 2020.  Second, it will gradually return its balance sheet to a desired level.  The Fed says that should happen within five years.  But given the maturity schedule of the securities held in its portfolio that process may not be complete until 14 years from now.  Thus, the Fed has made it abundantly clear that it is unwilling to let its policy become the catalyst for the next recession – at least not in the near term.  If inflation heats up and the Fed needs to cool the economy, its policy approach will change, but that is not going to happen any time soon.

Stephen Slifer

NumberNomics

Charleston, S.C.


GDP Forecasts

June 16, 2017

First quarter GDP growth was revised upwards from an initially published growth rate of 0.7% to 1.2%.   A lot of the weakness came in inventories which rose by just $4.3 billion in the first quarter compared to $49.6 billion in the first quarter.  Thus, the inventory component subtracted 1.0% from GDP growth in the first quarter.  The other source of weakness was consumption spending which rose just 0.6% — the slowest rate of growth in this category since the recession.  However, consumer fundamentals remain strong.  The gains in employment are generating income which gives consumers the ability to spend.  Consumer debt is very low in relation to income.  The prospect of tax cuts later this year is boosting the stock market to a record high level.  The increase in stock prices is boosting household wealth.  Consumer confidence is at a multi-year high.  Gas prices remain low and are falling.  Interest rates remain low and are rising very slowly.  Consumer spending will not remain subdued for long.

We continue to expect a pickup in growth in the quarters ahead for a couple of other reasons as well.   First,  falling prices in 2014 and 2015 hit the manufacturing sector hard — the oil patch in particular — and negatively impacted GDP growth the past couple of years.  But with gasoline prices having risen, the earlier drag on GDP growth has disappeared as drillers are re-opening previously closed wells.

In addition, the 22% increase in the value of the dollar between October 2014 and the end of last year hit the trade sector hard — export firms in particular.  But the dollar has been relatively stable for the past six months so this drag on the economy has also disappeared.

Likely cuts in both individual and corporate income tax rates along with simplification of the tax codes, combined with repatriation of corporate earnings currently locked overseas and huge investments in spending on infrastructure  should help.  Expect GDP growth of 2.5% in the second quarter of this year with 2.8% and 2.7% growth in the final two quarters of the year.

Given that the economy is at full employment that faster pace of growth will probably boost the CPI  to 2.0% this year and the core CPI to 2.1%.  Higher inflation will push long-term interest rates higher with the 10-year hitting 2.65% by the end of 2017 and mortgage rates climbing to 4.4%.

With GDP expanding at a pace at roughly its potential and inflation only slightly above its target, the Fed will feel compelled to continue on a path towards gradually higher interest rates.  It needs to do so to get itself into position to lower rates when the time comes, but it appears to have the luxury of taking its time.  We expect one more rate hike in 2017 which would put the funds rate at 1.25% by the end of this year.

Stephen Slifer

NumberNomics

Charleston, SC

 


Consumer Sentiment

June 16, 2017

The final estimate of consumer sentiment for June fell 2.6 points from 97.1 to 94.5. The 98.5 reading for January was the highest level of confidence thus far in the business cycle.  But consumers’ political affiliation has created an interesting divide between Republicans and Democrats.

Richard Curtin, the chief economist for the Surveys of Consumers, said “The modest early June drop of 2.6 points in the Sentiment Index masks a much larger decline since June 8th. Prior to that date the Sentiment Index had averaged 97.7, but since June 8th, the Index fell to 86.7, a decline of 11.0 points. While this break corresponds with James Comey’s testimony, only a few consumers spontaneously referred to him or his testimony when asked to explain their views. Importantly, the decline was observed across all political parties, but the loss in confidence among self-identified Republicans since June 8th was larger than among Democrats.”

Based in part on the expectation of major changes in policy likely to be implemented by the end of the summer, we expect GDP growth for 2017 to be 2.4% and 2.8% in 2018.  We expect the economic speed limit to be raised from 1.8% to 2.8% within a few years.  That will accelerate growth in our standard of living.We expect worker compensation to increase 4.0% in 2017 vs. 3.0% last year. The core inflation rate should climb modestly in 2017 from 2.2% in 2016 to 2.4% this year and 2.7% in 2018.  Such a scenario would keep the Fed on track for the very gradual increases in interest rates that it has noted previously.  Specifically, we expect the funds rate to be 1.25% by the end of 2017 and 2.0% by the end of 2018.

The high level of  confidence was evident in both the current conditions and expectations components.

Consumer expectations for six months from now climbed from 87.7 to 84.7.

Consumers’ assessment of current conditions declined  in May from 111.7 to 109.6.

Trends in the Conference Board measure of consumer confidence and the University of Michigan series on sentiment move in tandem, but there are often month-to-month fluctuations.  Both series remain at levels that are consistent with steady growth in consumer spending at a reasonable clip of  about 2.5% in the quarters ahead.

Stephen Slifer

NumberNomics

Charleston, SC


Housing Starts

June 16, 2017

Housing starts declined 5.5% in May to 1,092 thousand after having fallen 2.8% in April and 7.7% in March. This is the third consecutive decline in starts and the fourth in the past five months.  Because these data are particularly volatile on a month-to-month basis, it is best to look at a 3-month moving average of starts (which is the series shown in blue above).   That 3-month average now stands at 1,146 thousand which has fallen off from the 1,264 thousand peak pace in the cycle which was registered back in February.    So what is happening?  Is it a drop in demand?  Or a constraint on the part of builders?  We  believe it is the latter.

Both new and existing home sales continue to climb.   Thus, the demand for housing remains robust.

Builders remain enthusiastic in part because they see traffic through the model homes accelerating.

Mortgage rates are at 4.0% which is quite low by any historical standard.

At the same time employment gains are about 170 thousand per month which is boosting income.  As a result, real disposable income (what is left after inflation and taxes) is growing at a 2.0% pace.

H housing remains affordable for the median-price home buyer.  Mortgage rates may have risen, but income has been rising at almost as quickly, hence affordability has not dropped much.  At 158.2 the index  indicates that a median-income buyer has 58.2% more income than is necessary to purchase a median-priced house.

The problem in housing is not a lack of demand.  Rather it is a constraint on the production side.  Builders have had difficulty finding an adequate supply of skilled labor.

As one might expect there is a tight correlation between home builder confidence and the starts data which probably makes a great deal of sense.   Judging by the homebuilder confidence data we should expect starts to eventually climb to 1.5 million or so from about 1.1 million currently.  However,  as noted above, many home builders  report an inability to get the skilled workers they require.   Overcoming the labor shortage on a long-term basis will be challenging.  Employment in the construction industry will continue to climb, but slowly, which will limit the speed with which starts rise in the months ahead.

The other thing worth noting is that about 1.3 million new households are being formed every year.  Those families all need a place to live, either a single-family home or an apartment.  Thus, we need to see housing starts rise by 1.3 million just to keep pace with growth in households.  And because housing starts were substantially below the growth in households for so long, there is pent-up demand.  We expect starts to reach 1.3 million by the end of 2017 and 1.5 million in 2018.

Building permits declined 4.9% in April to 1,168 thousand after having fallen 2.5% in April.  Because  permits are another volatile  indicator it is best to look at a 3-month average (which is shown below).  That 3-month moving average now stands at 1,219 thousand which continues to point towards slow but steady improvement in housing.   The reason people look at permits is because a builder must first attain a permit before beginning construction.  Thus, it is a leading indicator of what is likely to happen to starts several months down the road.  If permits are currently at 1,219 thousand, housing starts will gradually approach the 1.35 million mark.

Stephen Slifer

NumberNomics
Charleston, SC


Homebuilder Confidence

June 15, 2017

Homebuilder confidence declined 2 points in June to 67 after having risen 1 point in May.  Confidence is bouncing around from month to month at a very high level.    Clearly, builders believe that the housing market will perform well in 2017.

Robert Dietz, Chief Economist for the home builders association said, “As the housing market strengthens and more buyers enter the market, builders continue to express their frustration over an ongoing shortage of skilled labor and build-able lots that is impeding stronger growth in the single-family sector,”

“Builder confidence levels have remained consistently sound this year, reflecting the ongoing gradual recovery of the housing market”  said NAHB Chairman Granger MacDonald.

Traffic through the model homes edged lower by 2 points in June to 49.  The March reading of 53 was the highest reading thus far in the business cycle.

Not surprisingly there is a close correlation between builder confidence and housing starts.  Right now starts are lagging considerably because builders are having some difficulty finding financing, building materials, an adequate supply of finished lots, and skilled labor.  Starts  currently are at a 1.3 million pace.  They should continue to climb gradually in the months ahead and reach 1.4 million by the end of 2017.

Stephen Slifer

NumberNomics

Charleston, SC