Monday, 25 of March of 2019

Economics. Explained.  

Category » NumberNomics Notes

Did the Fed Overreact?

March 22, 2019

In January Fed Chair Powell signaled that Fed policy would be on hold for a while.  Most economists thought that meant no rate hike through midyear, but with two rate hikes possible in the second half the funds rate would reach 2.9% by yearend.  On Wednesday the Fed said it expects the funds rate to remain at its current level of 2.4% through yearend.  What happened?

At the press conference Powell talked about slowing job growth, weaker than expected retail sales, investment falling short of last year’s pace, and sluggish growth in Europe and China.  The Fed seems to believe that the economic impact from these factors will be relatively long lasting.  As a consequence, it trimmed its 2019 GDP forecast from 2.3% to 2.1%.  Maybe the Fed is right, but we envision a more temporary slowdown.  Following 1.5% GDP growth in the first quarter, we expect growth of 3.0%, 2.8%, and 2.9% in the final three quarters of the year.  As a result, we anticipate growth of 2.6% in 2019 versus the Fed’s 2.1%.  While we may be too optimistic, it is just as likely that the Fed is too pessimistic.

We attribute most of the December and January drop-off to the precipitous 20% decline in the stock market, the Fed’s rate hike in December combined with an expectation of two additional rate increases in 2019, compounded by the negative impact on growth associated with the government shutdown.

But the stock market is now within 3.0% of erasing its fourth quarter drop and reaching a new record high level.

Consumer sentiment has bounced back sharply.  Job gains in the past three months have averaged 186 thousand which should boost income and permit consumers to spend at about a 2.5% pace this year.

The Institute for Supply Management indexes of activity for manufacturing and non-manufacturing firms have slipped from their previous lofty levels but are consistent with GDP growth in excess of 3.0%. Mortgage rates have fallen 0.5% since the end of last year to 4.4%.  And in April there is a good chance that the U.S. and China will come to some sort of a trade agreement which would remove yet another obstacle to both U.S. and global GDP growth.

Thus, we think there is a plausible case that as the year progresses GDP will register relatively vigorous 2.6% growth for the year and the core CPI inflation rate will climb to 2.3%.  The Fed expects core inflation of 2.0%.  Could this combination of faster-than-expected GDP growth and more-rapid-than-anticipated inflation cause the Fed to regroup and raise rates by yearend?  No.

Fed Chair Powell talked at some length about inflation having consistently fallen short of the Fed’s 2.0% target.   “That gives us the ability to be patient and not move until we see that our target goals are being achieved.”  That suggests that, if anything, the Fed may welcome a period of inflation that is somewhat above target.  Thus, it is very difficult to envision the funds rate above its current 2.4% pace by the end of this year regardless of who is right.  The Fed envisions one rate hike in 2020 which would boost the funds rate to 2.6% with no change in rates thereafter

No one knows exactly what constitutes a “neutral” funds rate.  For years the Fed believed it was about 3.0% because over the past 50 years, through numerous Fed tightening and easing cycles, the funds rate averaged 1.0% higher than the inflation rate.  For its policy to be “neutral” the Fed believed it should put the funds rate 1.0% above its 2.0% inflation target, or 3.0%.

But more recently estimates of the “neutral” rate have been falling.  In the last 30 years the “real” funds rate has averaged 0.5%, which could mean that for Fed policy to be “neutral” it should put the funds rate 0.5% above its 2.0% inflation target, or 2.5%.  The Fed currently believes the neutral rate is in a range from 2.5-3.0% with median estimate of 2.8%.

But consider the following.  At the end of 2021 the Fed expects the funds rate to be 2.6%.  This means that for the next 2-3/4 years the funds will remain below its estimated neutral level of 2.8%.  We have said many times in the past and will say once again — the U.S. economy has never, ever, gone into recession until such time as the funds rate has risen well above its neutral level.  The Fed’s action this past Wednesday lowered the trajectory of the funds rate by 0.5% for the next three years, and during that period of time it may never rise to its neutral level.  If previously one danger for the U.S. economy was that the Fed might tighten too much and put the economy in a tailspin, that fear is now completely off the table.   As we see it, the economy has clear sailing for years to come.

But what about the yield curve? It has flattened considerably and could be in danger of “inverting” with short rates becoming higher than long rates.  An inverted yield curve is, in fact, a good harbinger of recession.  With the yield on the 10-year note currently at 2.55% and the funds rate at 2.4%, the yield curve has a positive slope of just 0.15%.  It is close to inverting.  But in the past three business cycles the curve inverted by 0.7-1.0%.  Today it still has a positive slope of 0.15%.  That is a long way above the levels of inversion that occurred prior to the previous three business cycles.  Furthermore, once inverted a recession did not occur for at least another year.  So do not fret about the flatness of the yield curve.  It is not flashing a warning signal.  If the economy grows as quickly as we expect for the balance of this year and inflation edges upwards, our sense is that the yield curve will steepen somewhat to perhaps 0.3% by yearend.

Some have suggested that by taking two rate hikes off the table the Fed sees a substantial growth slowdown or perhaps even a recession next year.  Rubbish.  The Fed still envisions 2.1% GDP growth this year, 1.9% in 2020, and 1.8% in 2021.  It also believes potential GDP growth is 1.8%.  Thus, the Fed sees healthy growth for as far as it can see.  We agree.  Our forecast is for even more robust growth.  Rest easy. All is well.

Stephen Slifer


Charleston, S.C.

GDP, Inflation, and Interest Rate Forecasts

March 22, 2019

GDP growth rose 2.6% in the fourth quarter versus  3.4%growth  in the third quarter.  The stock market selloff in that quarter and the first few days of the government shutdown did not have a significant impact on growth in that quarter.  However, we expect a bigger impact from the stock market selloff and government shutdown in Q1 where we anticipate GDP growth of 1.5%.  But with the stock market having recovered most of its fourth quarter drop and the government shutdown now over, we expect a growth rebound in the second quarter to 3.0%.  For the year as a whole we anticipate 2.6% GDP growth after having risen 3.1% in 2018.

Consumer spending rose 2.8% in the fourth quarter despite the stock market selloff.   After a moderate drop in consumer confidence during the stock debacle, confidence has rebounded sharply.  Stock prices have rebounded and are now within about 5.0% of their previous high level..  The gains in employment are generating income which gives consumers the ability to spend.  Consumer debt is very low in relation to income.  Interest rates  should be steady at least through midyear.  For 2019 we anticipate growth in consumer spending of 2.5%.

Investment spending rebounded and climbed 6.2% in the fourth quarter after having taken a bit of a breather with a 2.5% growth rate in the third quarter..  Investment spending was essentially unchanged for 2014-2016.  It appears that the corporate tax cuts, repatriation of earnings at a favorable tax rate, and a reduction in the regulatory burden are giving business leaders confidence to open their wallets and spend on new equipment and technology.  Not only will this boost GDP growth in the short term, if investment continues to climb it will boost productivity growth which will, in turn, raise the economic speed limit from about 1.8% previously to 2.8% or so by the end of this decade.

The trade gap widened by $13.5 billion in the fourth quarter to $963.2 billion  after having widened by $108.7 billion in the third quarter.  This means that the trade component subtracted 0.1% from  GDP growth in the fourth quarter and 0.2% from the GDP growth rate for last year.  We expect trade to have little impact on GDP growth in 2019.

Non-farm inventories climbed by $97.1 billion in the fourth quarter after having risen $89.8 billion in the third quarter. Going forward we expect inventories to climb by about $85 billion per quarter.

Expect GDP growth of 2.6% in 2019 versus 3.1% last year.

The inflation rate should be fairly steady in 2019.  There is a shortage of available homes and apartments in the housing sector which is raising rents.  That will put upward pressure on the inflation rate.  However, the pickup in inflation will be limited as internet price shopping will keep goods prices steady in 2019.  At the same time, rising productivity growth will offset much of the increase in wages.  As a result, we expect the core CPI to edge upwards from  2.2% last year to 2.3% in 2019.

With GDP growth at 2.6% and inflation steady at 2.3%, the Fed will leave rates unchanged at 2.4% through the end of the year.

With no further increase in the funds rate this year and inflation quickening slightly to 2.3%, long-term interest rates should rise slightly in 2019 with the 10-year climbing from  2.5% currently to 2.75% by the end of this year.  Mortgage rates should edge upwards from 4.4% currently to 4.5% by the end of 2019.

Stephen Slifer


Charleston, SC


Existing Home Sales

March 22, 2019

Existing home sales came roaring back to life with an 11.8% increase in February to an annual rate of 5,510 thousand after having fallen 1.4% in January.  Sales currently are now just 1.8% below where they were at this time last year.

Lawrence Yun, NAR chief economist said,   “A powerful combination of lower mortgage rates, more inventory, rising income and higher consumer confidence is driving the sales rebound.”

With sales surging in February and a small increase in the available inventory, the month’s supply of available homes fell from 3.9 to 3.5 months.  Realtors consider a 6.0 month supply as  the point at which demand for and supply of homes are roughly in balance.  Thus, housing remains in very short supply.

If one looks at the actual number of homes available for sale, it has been steadily declining for a decade.  Realtors cannot sell what is not available for sale.  If sales were not being constrained by the limited supply they would almost certainly be at a 5,800 thousand pace rather than the current 5,500 thousand and we would not be talking about weakness in home sales.

Meanwhile, properties stayed on the market for just 44 days in February.  More than 41% of homes that sold in February were on the market less than a month.  The 44-day length of time between listing and sale is still a very short period of time.  Back in 2011 homes remained on the market for 100 days.  Thus, the demand for housing still seems to be quite solid.

The National Association of Realtors series on affordability now stands at about 155.  At that level  it means that a household earning the median income has 55.0% 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 and should continue to remain affordable throughout 2019 because sizable job gains are boosting income almost as fast as mortgage rates and home prices have been rising.

Existing home prices rose 0.1% in February to $249,500 after have fallen 2.1% in January.  Because this is a relatively volatile series we tend to focus on the 3-month average of prices which now stands at $251,200.  Over the course of the past year existing home prices have risen 3.6% which is lower than the 4.0-5.% range that we saw throughout 2018 .  However, in the past six months prices have actually declined at a 12.2% annual rate.  Thus, the slower pace of sales seems to be pushing prices lower.
At the same time mortgage rates are declining.  they reached a peak of 4.9% a couple of months ago, but with global GDP growth slowing, a slower pace of tightening by the Fed, and some softness in the housing sector, mortgage races have dropped to 4.4%.
 The housing sector will rebound in the quarters ahead.   Jobs growth is expected to remain solid which should boost  income. Home prices have begun to fall.  And mortgage rates have worked their way lower to 4.4%.
 Stephen Slifer


Charleston, SC

Homeownership Rates

March 22, 2019

Home ownership continued to climb in the fourth quarter.  It rose 0.4% in that quarter after having  climbed 0.1% in the third quarter.  It hit a low of 62.9% in the second quarter of 2016 but has been climbing steadily for the past 2-1/2 years.

The upswing in home ownership in the past two years  has been most pronounced amongst younger borrowers, i.e., those under the age of 45.  That is where most of the earlier decline occurred.  These younger people are now getting somewhat older and raising families.  As this occurs, they find home ownership increasingly attractive.  Thus, demographics now seems to be working in favor of a significant rebound in housing in the quarters ahead.

Home prices had been rising by 6.0-6.5%, but the softness in sales last year has caused home prices to slow.  They have now risen 3.7% in the past year.

Meanwhile, mortgage rates have fallen 0.5% in the past several months from 4.9% to 4.4%.

As a result, housing affordability has one again begun to rise..  The National Association of Realtors index of housing affordability stands at about 155.   At a level of 155 it means that consumers have 555 more income than is required to purchase a median-priced home.  Back at the peak of the housing boom in 2007  consumers had just 14% more income than required.  Thus, despite higher home prices and rising mortgage rates, housing remains affordable for most because of the steady growth in consumer income.

Also, the very limited supply of homes available to purchase means that some potential home buyers simply cannot find a suitable property to purchase.

Many former homeowners and some younger people have turned to renting, but vacancy rates for rental properties have been falling fast and at 7.1% are the lowest they have been since the mid-1980’s.  There continues to be a significant housing shortage in the United States.  This implies that home sales and prices will continue to climb.

Stephen Slifer


Charleston, SC

Initial Unemployment Claims

March 21, 2019

Initial unemployment claims declined 9 thousand in the week of March 16 to 221 thousand.  The January 19 level of 200 thousand was the lowest since November 15, 1969.  The four-week average of claims rose 1 thousand to 225 thousand.

As one might expect there is a fairly close inverse relationship between initial unemployment claims and payroll employment.  With initial claims (the red line on the chart below, using the inverted scale on the right) at 225 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 200 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 might choose to offer some of their part time workers full time positions.  But this series is close to where it was going into the recession so they will have limited success in finding necessary workers from this source.

They will also have to think about hiring  some of our youth (ages 16-24 years) .  But the youth unemployment rate today is close to the lowest on record (for a series that goes back to 1970) 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 — it is essentially where it was going into the recession.

The number of people receiving unemployment benefits fell 27 thousand  in the week ending March 9 to 1,750  thousand.  The 4-week moving average rose 6 thousand to 1,773 thousand.  This series hit a low of 1,635 thousand in late October.

The only way the unemployment rate can decline is if actual GDP growth exceeds potential.  Right now the economy is climbing by about 2.6%; potential growth has probably picked up from 1.8% previously to perhaps 2.3% today given faster growth in productivity.  Thus, going forward  the unemployment rate should continue to decline slowly.

Stephen Slifer


Charleston, SC

Gasoline Prices

March 20, 2019

Gasoline prices at the retail level rose $0.08 in the week ending March 18 to $2.55 per gallon.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.30. The Department of Energy expects national gasoline prices to average $2.50 in 2019, not far from where they are currently.

The selloff in the stock market that began in October pushed oil prices lower as investors believed that global GDP growth would slow and, hence, reduce the demand for oil.  Oil prices fell to a low of about $45 per barrel.  But Saudi Arabia has cut production twice this year and, as a result, oil prices have rebounded to about $58.  The Department of Energy expects crude prices to average $56.13 this year.

Meanwhile, U.S. production  has surged from 10,900 thousand barrels to 12,100 thousand barrels per day.  As noted above, the cut in oil production by the Saudi’s has boosted the  price of oil to about $55.  The Saudi’s would like it to climb to $90, or at least $85, per barrel to ensure that their budget deficit remains in balance.  That is not going to happen.  As prices rise U.S. drillers will boost production.  The Saudi’s will not permit the U.S. to increase its market share of the global markets.

The Department of Energy expects U.S. production to climb 11% from 10.9 million barrels last year to 12.3 million barrels this year and 13.0 million barrels per day in 2020.  The U.S. became the world’s largest oil producer in March of last year and the gap between U.S. production and that of Russia, and Saudi Arabia will widen in 2019 and 2020.

The cut in Saudi production appears to have arrested the recent decline in crude stocks and gotten supply and demand back into better balance..    At 1,098 million barrels crude inventories are  roughly in line with the 5-year average of 1,116 million barrels.

The wild cards right now are production levels for Venezuela and Iran.  Venezuela’s oil output has been falling steadily for the past couple of years and is showing no sign of recovering.  Iran is different.  The Iran sanctions went into effect in early November.  Iranian production has not fallen too sharply yet, but the U.S.’s  goal is to reduce exports (and, hence, production) close to zero.  Thus, as we go forward Iranian output could fall sharply and push crude prices higher.

Stephen Slifer


Charleston, SC

Homebuilder Confidence

March 18, 2019

Homebuilder confidence was unchanged in March at 62 after having risen 4 points in February.  Most economists had expected a slightly higher number so a level of 62 was slightly disappointing.  However, a level of 62 is indicative of a solid level of confidence going forward although, admittedly, it is below readings of 70-75  at this time last  year.

NAHB Chairman Greg Ugalde said that, “Builders report the market is stabilizing following the slowdown at the end of 2018 and they anticipate a solid spring home buying season.”

NAHB Chief Economist Robert Dietz said  “In a healthy sign for the housing market, more builders are saying that lower price points are selling well, and this was reflected in the government’s new home sales report released last week.  Increased inventory of affordably priced homes – in markets where government policies support such construction – will enable more entry-level buyers to enter the market.”

The NAHB report also indicated that affordability still remains a key concern for builders. The skilled worker shortage, lack of buildable lots and stiff zoning restrictions in many major metro markets are among the challenges builders face as they strive to construct homes that can sell at affordable price points.

Traffic through the model homes fell 4 points in March after having risen 4 points in February.  However, the combination of falling home prices and lower mortgage rates should boost traffic in the months ahead.

Reflecting optimism about the future the homebuilders expectations index jumped 3 points in March to a solid 71.

Not surprisingly there is a fairly close correlation between builder confidence and housing starts.  Given the rebound in the expectations component it is likely that housing starts will pick up further in the months ahead.  But builders continue to have difficulty finding labor so the upswing in starts will probably be muted.

However, builders have many units that have been authorized but not yet started.  In fact, the authorized but not yet started units are the highest they have been in a decade.  Our sense is that as labor slowly becomes available builders will continue building new homes.  Thus, we look for starts to climb about 4% this year.

Stephen Slifer


Charleston, SC

Second Half Rate Hikes Harder to Justify

March 15, 2019

It is clear that first quarter GDP growth will be relatively anemic.  We have reduced our forecast from 1.8% to 1.5%.  Some economists anticipate even softer growth of perhaps 0.5%.  However, the stock market selloff and the government shutdown have taken a toll on first quarter growth and it will certainly rebound. January was clearly a weak month and we are all guessing about February and March.  Nobody knows exactly how vigorous the upswing will be.

As an example of the current confusion consider retail sales which fell 1.6% in December amidst the stock market debacle.  That was perhaps no great surprise.  Economists expected a relatively significant rebound in January but, instead, sales rose just 0.2% in that month.  However, the January sales data were in the midst of the protracted federal government shutdown and followed the earlier sharp stock market decline which clearly biased the data downwards.  Sales will continue to climb, but by exactly how much?

Home sales fell 6.2% in January.  But, at the same time, Census revised upwards sharply the pace of sales for November and December.  As a result, the 3-month average for sales appears to have hit bottom in October.  Is the housing sector now on an upward trajectory?

Payroll employment for February rose by an anemic-looking 20 thousand.  But sales in the previous two months were surprisingly robust with gains of 227 thousand and 311 thousand, respectively.   The 3-month average increase of 186 thousand is very much in line with the other recent months.

As we look at these data, we conclude that the trend rate has not changed a lot.  However, the economic tea leaves indicate clearly that first quarter growth will be soft.  Is our 1.5% projected growth rate accurate?  Or could it be more like 0.5%.  As additional data are received, we will get a better sense of what that growth rate will be.  The combination of the stock market drop and the government shutdown have muddied the waters sufficiently that nobody can be certain exactly what the trend rate of GDP growth is at the moment.

Meanwhile, both actual inflation readings and inflation expectations have been inching their way lower.  For example, the core CPI for January rose 0.1% after having risen 0.2% in each of the previous five months.  As a measure of inflation expectations, we look at the spread between the nominal yield on the 10-year note and the comparable inflation-adjusted yield.  It has fallen in recent months from 2.1% to 1.9%.  As a result, the Fed’s intent to raise rates twice in the second half of the year seems unlikely.  It all depends on the magnitude of the rebound in growth, and whether that pushes inflation and inflation expectations higher.  We will have to see.

While two second half rate hikes seem unlikely at the moment, the second half of the year is still months away.  If the economy bounces back vigorously, actual inflation might inch its way higher and expectations might also climb.  Given that scenario one or even two rate hikes could still be in the cards.

But if the rebound falls a bit short of what we are expecting and inflation expectations remain stable, the yield on the 10-year note might remain at its current level of 2.6%.  If that is the case, there is absolutely no way the Fed would consider a rate hike at midyear.  That is because the yield curve – the different between long-term and short-term interest rates — would be likely to invert.  If the yield on the 10-year remains at 2.6% and the funds rate is 2.4% the yield curve would be 0.2%.  A a rate hike or two by the Fed would push short rates higher, lift them above long rates, and cause the yield curve to invert.  An inverted curve is a harbinger of an impending recession.  The Fed will not do anything that could knowingly jeopardize the expansion.  So, depending on the combination of GDP growth and inflation in the months ahead, it is possible that the Fed keeps rates on hold through yearend and perhaps beyond.  We will have to wait and see how all this falls out.

Stephen Slifer


Charleston, S.C.

S&P 500 Stock Prices

March 15, 2019

The S&P fell 20% in the fourth quarter of last year.   The market appeared to be concerned about a variety of factors.  The expansion is approaching its tenth anniversary which is geriatric, so some economists fear that,for that reason alone, the end of the expansion must be close.  It was seeing growth weakening overseas, particularly in China which is the world’s second largest economy.  It feared a trade war could weaken growth further.  The Fed indicated that intended to raise rates twice in 2019.  And it saw the housing market fall steadily for most of last year.

But heading into 2019 growth the view has changed.  Growth overseas appears to have stabilized.  The Fed has said that it intends to leave rates unchanged for the foreseeable future.  Mortgage rates have fallen 0.5% since the end of last year and  home prices are declining.  These two factors should re-invigorate the housing sector in the months ahead.  Thus, the economic fundamentals in our view remain solid.  That change in outlook has allowed the stock market to rebound and erase nearly all of the fourth quarter drop.  Indeed, it is currently within 3.5% of an all-time record high level.

Given the positive combination of moderate GDP growth, low and still stable inflation, and the likelihood of no further rate hikes, we fully expect the stock market to reach another record high level, probably by midyear.


Stephen Slifer


Charleston, SC

Consumer Sentiment

March 15, 2019

The final estimate of consumer sentiment for March jumped 4.0 points to 97.8 after having risen 2.6 points in February.  The peak for sentiment was in September of last year which came in at 100.1.  The March level is clearly close.

Richard Curtin, the chief economist for the Surveys of Consumers, said, “All income groups voiced more positive prospects for growth in the overall economy during the year ahead.”   He added that, “The data indicate that real consumption will grow by 2.6% in 2019 and that the expansion will set a new record length by mid year.”

Our sense is confidence will continue to climb . in the months ahead.  Since the beginning of the year the stock market has recovered almost all of what it lost in the fourth quarter.  The Fed has said it intends to leave rates unchanged for the foreseeable future.   The government shutdown has ended.  And mortgage rates have fallen from 4.9% to 4.4%.

We expect GDP growth of 2.6% in 2019 versus 3.1% last year.  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 3.7% in 2019 vs. 2.6% last year. The core inflation rate (excluding the volatile food and energy components) should climb from 2.2% in 2018 to 2.3% in 2019.  Such a scenario would keep the Fed on track for no rate hikes at least through the middle of year and perhaps longer.

The February rebound was attributable to a moderate increase in both the current conditions and expectations components.

Consumer expectations for six months from now rose from 84.4 to 89.2.

Consumers’ assessment of current conditions climbed from 108.5 to 111.2.

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 2019.

Stephen Slifer


Charleston, SC