Tuesday, 16 of July of 2019

Economics. Explained.  

Category » NumberNomics Notes

No Need for Lower Rates, but Rate Cuts Likely Anyway

July 12, 2019

Many Fed officials are itching to cut rates.  They keep saying that they see the potential for substantially slower GDP growth later this year.  But with each passing data release there is no evidence that is happening or is on the verge of happening. It is true that inflation is running below the Fed’s target and, while we expect it to climb almost to the 2.0% target level by yearend, the Fed could justify a rate cut by saying it wants to bring inflation back to or even slightly above, target quickly.  That would make sense, but to keep harping on some fear of future economic weakness seems implausible.

If the economy were truly teetering on the brink of a significant slowdown, wouldn’t stock market investors be getting a case of the jitters?  They are not.  The stock market is at a record high level.

Wouldn’t consumers be getting worried?  They are not.  Consumer sentiment remains close to a 19-year high.  Current sentiment levels were last seen on a consistent basis in 2000.

Wouldn’t small business owners be getting nervous?  That is not happening either.  Small business confidence has edged lower in the past six months, but it has backed off from a record high level in August of last year which was the highest level of optimism since July 1983.  Confidence remains at a lofty level.

Wouldn’t we begin to see smaller employment gains as business people become more reluctant to hire?  Monthly employment gains have shrunk from the 200+ thousand gains last year to about 180 thousand.  But what did you expect?  Employers simply cannot find enough qualified workers.   Labor shortages are widespread.  Most firms would love to see more qualified workers show up on their doorstep.

The only economic weakness we can find is in the manufacturing sector.  The purchasing managers index has slipped considerably despite the fact that it is still consistent with 2.6% GDP growth.  But the problem is not the level of interest rates.  If rate levels were truly too high, wouldn’t you expect to see both the manufacturing and service sectors showing signs of softening?  That is not happening.  The manufacturing sector has weakened but the non-manufacturing sector has not.  The non-manufacturing index remains at a relatively lofty level of 58.2 while service sector employment is robust and driving the economy.

We believe that manufacturing has been hit by the imposition of tariffs that began in the spring of last year and the ensuing trade war.   Foreign investors quickly recognized that in the event of a trade war the U.S. would fare better than any other country because trade is such a small part of the U.S. economy.  As the year progressed foreign funds poured into the U.S.  That boosted the level of the dollar which meant that U.S. exports became more expensive for foreigners to purchase and, as a result, exports growth slowed.  The solution is not to lower interest rates but, rather, reach trade agreements with China, the E.U., the U.K., Mexico and Canada.   Once that happens the manufacturing sector will quickly heal.

The other piece that people focus on is the yield curve which, with the funds rate at 2.38% and the 10-year at 2.12%, is slightly inverted.  While an inverted curve is typically a reliable indicator of an impending recession, it generally happens because the Fed has raised rates too quickly and Fed policy becomes “too tight”.  But with the funds rate today at 2.38% (by most estimates still below a “neutral” level), does anybody seriously believe that interest rates are too high and thereby impeding the pace of economic activity?  Sorry, don’t buy it!  The curve may be inverted, but for all the wrong reasons.  Long rates have fallen below short rates, rather than short rates rising above long rates.

It is true that upon occasions in the past the Fed has cut rates to provide a little “insurance” in case something bad were to happen.  But when it did so rate levels were much higher than they are today, and there was at least some hint that growth had begun to fade.  The absence of any evidence that the pace of economic activity is slipping is what makes the Fed’s recent laser-like focus on lower interest rates so hard to comprehend.

It is true that the core personal consumption expenditures deflator is at 1.6% compared to the Fed’s 2.0% target.  While we expect that rate to edge upwards as the year progresses and reach 1.9% by yearend, we could at least understand an argument by Fed officials that inflation has run below target for so long that it now wants it to climb above target for a while so that its average level for the cycle is 2.0%, and it needs lower rates now to make that happen quickly.  That is, at least, a logical argument.  This myth about slower growth ahead is not.

While we firmly believe lower rates are unnecessary, the reality is that Fed Chair Powell has done nothing to counter the widespread belief that it will cut rates at the end of this month.  He certainly had ample opportunity when he presented his semi-annual report to Congress.  If the Fed does NOT lower rates at month end when such action is so widely anticipated, it can anticipate a sizable negative reaction in both the stock and bond markets.  It does not want that to happen either.  Thus, the best bet now is that the Fed will cut the funds rate by 0.25% at its July 30-31 meeting.

We have a hard time seeing how lower interest rates will boost the pace of economic activity.  Clearly, lower rates will reduce the cost of corporate borrowing which will, in turn, reduce costs and increase profits.  Thus, the stock market will benefit.  But even if firms have a desire to boost production, they will need more workers to make that happen and it will not be any easier to find qualified workers in the months ahead than it is today.  Thus, it is not clear to us that GDP growth will quicken in the quarters ahead even with lower interest rates.  If the rate cuts stimulate demand, we could envision a slightly higher inflation rate as firms, perhaps, raise wages to attract additional workers, and then test the waters to see if they can get away with slightly higher prices.  But keep in mind that productivity gains thus far have countered all of the increase in wages so that unit labor costs are actually declining.  Also, the internet allows U.S. consumers to easily find the cheapest available price.  That means that goods producing firms will continue to have little pricing power and any increase in inflation is likely to be small.

Could lower rates actually make things worse?  Probably not.  Our biggest argument against a rate cut is that it provides the Fed with less ammo to use when the next downturn arrives – whenever that may be.  While the end of the expansion has never been in sight for us, a rate cut – if it actually occurs – would push rates to levels that are even farther below a level that could bite and, therefore, extend the life of the expansion even farther.

The Fed’s story is confusing to us.  Not only do we think lower rates are unnecessary, they are unlikely to help the Fed achieve its goals.  Instead, Trump should focus on trade agreements around the world.  Nonetheless, the Fed seems to have widely advertised its intention to lower rate.  Let’s see what it does at the July 30-31 meeting and re-evaluate afterwards.

Stephen Slifer


Charleston, S.C.

GDP, Inflation, and Interest Rate Forecasts

July 12, 2019

The final estimate of first quarter GDP growth came in at 3.1% which was exactly the same as the revised estimate, and compares to an initial estimate of 3.2%.  The stock market selloff late last year and the government shutdown early this year almost certainly pulled down both consumer spending and investment spending in the first quarter.  Both of these categories should rebound in the second quarter given that the the stock market is at a record high level and the government shutdown now over, but the bloated level of inventories will shrink considerably in Q2.  As a result, we expect GDP growth in the second quarter of 1.5% after having risen 3.1% in the first.  For the year as a whole we anticipate 2.6% GDP growth after having risen 3.0% in 2018.

Consumer spending slipped to 0.9% in the first quarter because of the stock market drop combined with the government shutdown.  However, stock price are now close to a new record high level and the shutdown is over.  Thus, we expect consumer spending to jump 3.3% in the second quarter.  Over the longer term 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 through the end of this year.  For 2019 we anticipate growth in consumer spending of 2.3%.

Investment spending slowed in the first quarter to 4.4% after having risen 5.4% in the fourth quarter of last year.  Growth in this category slowed in the first quarter for the same reasons that consumer spending slowed — the stock market drop and the shutdown.  We expect nonresidential investment to jump 6.0% in the second quarter and increase 5.8% for the year.  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 narrowed by $50.7 billion in the first quarter to $905.0 billion.  This means that the trade component added 1.0% to  GDP growth in the first quarter.  We expect trade to add 0.2% to GDP growth in 2019.

Non-farm inventories jumped by $122.8 billion in the first quarter and added 0.5% to GDP growth in that quarter.  Going forward we expect inventories to rise $55.0 billion in the second quarter and climb by about $70 billion per quarter thereafter.

Expect GDP growth of 2.6% in 2019 versus 3.0% 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.  Also, higher prices from China in the wake of the newly-imposed tariffs will boost inflation.  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 increase 2.3% in 2019 versus 2.2% last year..

With GDP growth at 2.6% and core inflation inching upwards to 2.3%, we do not believe that the Fed needs lower interest rates.  However, Fed officials in recent weeks have expressed a fear of substantially slower growth in the quarters ahead, and noted that inflation remains stubbornly below its 2.0% target.  It has also telegraphed a desire for lower rates perhaps starting at the FOMC’s next meeting on July 30-31.

With a 0.25% cut in the funds rate later year and core CPI inflation edging upwards to 2.3%, long-term interest rates should rise slightly in 2019, the 10-year note yield could climb from  2.0% currently to 2.35% by the end of this year.  Mortgage rates should edge upwards from 3.8% currently to 4.0% by the end of 2019.

Stephen Slifer


Charleston, SC


Producer Price Index

July 12, 2019

The Producer Price Index for final demand – intermediate demand  includes producer prices for goods, as well as prices for construction, services, government purchases, and exports and covers over 75% of domestic production.

Producer prices for final demand rose 0.1% in both May and June after having risen 0.2% in April.  During the past year this inflation measure (the red line) has risen 1.6%.

Excluding food and energy producer final demand prices rose 0.3% in June after having risen 0.2% in May and 0.1% in April.  They have risen 2.3% in the past year (the pink line).  This series was steadily accelerating for a couple of years, but it has begun to drift lower in the past 12 months or so.

This overall index can be split apart between goods prices and prices for services.

The PPI for final demand of goods fell 0.4% in June after having declined 0.2% in May after having increased 0.3% in April. These prices have now risen 0.1% in the past year (left scale).   Excluding the volatile food and energy categories the PPI for goods was unchanged in April, May, and June.  During the past year the core PPI for goods (the light green line) has risen 1.4% (right scale).

Food prices rose 0.6% in June after having fallen 0.3% in May and 0.2% in April.  Food prices are always volatile.  They can fall sharply for a few months, but then reverse direction quickly.  Over the past year food prices have risen 2.2%.

Energy prices fell 3.1% in June after having declined 1.0% in May after having risen 1.8% in April.  Energy prices have fallen 7.0% in the past year.   Output in Venezuela and Iran has been falling steadily and Saudi Arabia recently cut its oil output in an effort to boost prices, but U.S. production has continued to surge to a new record high level of 12.4 million barrels per day and that increase in output has more than countered the OPEC shortfall.  As a result, oil prices declined to about $53 per barrel.  However, the recent attack by Iran on an oil tanker in the Persian Gulf has lifted crude prices to $58.  That increase will be reflected in the data for next month.

The PPI for final demand of services rose 0.4% in June after having risen 0.3% in May and 0.1% in April.  This series has risen 2.5% over the course of the past year (left scale).   The PPI for final demand of services excluding trade and transportation (the light blue line) was unchanged in June after having jumped 0.5% in May after having increased 0.3% in April.  It has climbed 2.2% in the past year.

Because the PPI measures the cost of materials for manufacturers, it is frequently believed to be a leading indicator of what might happen to consumer prices at a somewhat later date.   However, that connection is very loose.

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 3.6% the labor market is well beyond full employment.  As a result, wages pressures have begun to climb, but the resulting upward pressure on inflation has been countered by an increase in productivity.  Unit labor costs, labor costs adjusted for the increase in productivity, have fallen 0.8% in the past year.  Compensation climbed 1.5% during that period of time but that increase was almost entirely offset by a 2.4% increase in productivity.  No wonder the seemingly tight labor market is not putting upward pressure on inflation — the increase is being entirely offset by an increase in productivity.  That means that firms have no real incentive to raise prices — workers have earned their fatter paychecks.

We expect the core CPI to increase  2.3% in 2019 after having risen 2.2% in 2018.

Stephen Slifer


Charleston, SC

Consumer Price Index

July 11, 2019

The CPI rose 0.1% in both May and June after having risen 0.3% in April and having risen 0.4% in March.  During the past year the CPI has risen 1.7%.  The overall index levels for May and June were held in check by a decline in energy prices.

Food prices rose 0.1% in June after having risen 0.3% in May.  Food prices have risen 1.9% in the past twelve months.  These prices tend to be lumpy with increases reported for a few months followed by several months of declining prices.

Energy prices declined 2.3% in June after having fallen 0.6% in May.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have fallen 3.4%.

The drop in crude oil prices in the past couple of months reflected a huge jump in U.S. oil production.  Oil output has fallen sharply in both Venezuela and Iran and the Saudis have also curtailed output.  However, a huge pickup in U.S. output has caused prices to decline. But the recent attack by Iran on an oil tanker in the Persian Gulf has ratcheted crude prices higher which will get reflected in the July data.

Excluding food and energy the CPI rose 0.3% in June after having climbed 0.1% in each of the previous four months.  Over the past year this core rate of inflation has risen 2.1%.  We expect the core CPI will increase 2.3% in 2019 as higher prices on goods imported from China will push this index higher in the months ahead.

The most interesting development in the CPI in recent years has been the dichotomy between the prices of goods (excluding the volatile food and energy components) and services.  For example, in the past year prices for goods have risen 0.2% while prices for services have risen 2.8%.

With respect to goods prices, it appears that the internet has played a big role in reducing the prices of many goods.  Shoppers can instantly check the price of any particular item across a wide array of online and brick and mortar stores.  If merchants do not match the lowest price available, they risk losing the sale.  Thus, they are constantly competing with the lowest price available on the internet.  Looking at specific items in the CPI we find that prices have been unchanged or fallen for almost every major category in the past year.  Apparel prices have declined 2.9%, new cars have risen 0.9%, airfares have risen 0.9%, televisions have declined 18.6%, audio equipment has  risen 0.9%, toys have fallen 8.4%, information technology commodities (personal computers, software, and telephones) have declined 6.7%.  Prices for all of these items are widely available on the internet and can be used as bargaining chips with traditional brick and mortar retailers.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 2.8% in the past year.  The increase in this  broad category has been led by shelter costs which have climbed 3.5%.  This undoubtedly reflects the shortages of both rental properties and homeowner occupied housing. Indeed, the vacancy rate for rental property is at a 30-year low. This steady rise in the cost of shelter  will continue for some time to come and, unlike monthly blips in food or energy, it is unlikely to reverse itself any time soon.

The CPI, both overall and the core rate, will be relatively steady  in the months ahead.  Steadily rising shelter prices, gradually rising labor costs, and higher prices on goods being imported from China will tend to boost the CPI.  But on the flip side, productivity gains are countering all of the increase in labor costs, and the internet is keeping a lid on the prices of goods.  We look for an increase in the core CPI of 2.3% in 2019.

The Fed’s preferred measure of inflation is not the CPI, but rather the personal consumption expenditures deflator, specifically the PCE deflator excluding the volatile food and energy components which is currently expanding at a 1.6% rate.  We expect it to climb 1.9% in 2019.  The Fed has a 2.0% inflation target.

Why the difference between the CPI and the personal consumption expenditures deflator?  The CPI is a pure measure of inflation.  It measures changes in prices of a fixed basket of goods and services each month.

The personal consumption expenditures deflator is a weighted measure of inflation.  If consumers feel less wealthy in some month and decide to purchase inexpensive margarine instead of pricey butter, a weighted measure of inflation will give more weight to the lower priced good and, all other things being unchanged, will actually register a decline in that month.  Thus, what the deflator measures is a combination of both changes in prices and changes in consumer behavior.

As we see it, inflation is a measure of price change (the CPI).  It is not a mixture of price changes and changes in consumer behavior (the PCE deflator).  The core CPI should increase 2.3% in 2019 while the core PCE climbs 1.9%.  That compares to the Fed’s targeted rate of 2.0%.

Given sustained growth in GDP growth this year and the inflation rate being close to target, there is no need for the Fed to alter the level of the funds rate.  However, recent rhetoric from Fed officials suggest that they could choose to lower rates slightly — beginning perhaps at the end of this month — by the end of the year.

Stephen Slifer


Charleston, SC

Initial Unemployment Claims

July 10, 2019

Initial unemployment claims fell 13 thousand in the week ending July 6 to 209 thousand.  The four-week average of claims declined 4 thousand to 219 thousand.  The 4-week average for the week of April 13 of 202 thousand was the lowest for the current business cycle and  the lowest 4-week average level of claims since November, 1969 when it was 200 thousand.  The current low level of claims indicates clearly that the trend rate of increase in employment of about 180 thousand remains intact.

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 219 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 180 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 rose 6 thousand  in the week ending June 29 to 1,723 thousand.  The 4-week moving average rose 6 thousand to 1,695 thousand.  This series hit a low of 1,654 thousand in late October of last year.

The only way the unemployment rate can decline is if actual GDP growth exceeds potential.  Right now the economy is climbing by about 2.7%; potential growth has probably picked up from 1.8% a couple of years ago to perhaps 2.5% today given faster growth in productivity.  Thus, going forward  the unemployment rate should continue to decline slowly.

Stephen Slifer


Charleston, SC

Gasoline Prices

July 10, 2019

Gasoline prices at the retail level rose $0.03 in the week ending July 8 to $2.74 per gallon.  Gas prices declined for seven consecutive weeks by a total of $0.25 before rising $0.09 in the past two weeks.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.49. The Department of Energy expects national gasoline prices to average $2.64 in 2019, slightly lower than where they are currently.  

As a result of production declines in Venezuela, Iran, and Saudi Arabia, oil prices climbed to $63 a couple of weeks ago before retreating to $52.  But Iran’s firing on oil tankers and escalating tensions in the Mideast have sharply boosted crude prices to $58.00.  The Department of Energy expects crude prices to average $59.58 this year.

Crude oil output in both Venezuela and Iran has declined markedly.  Venezuela’s oil output has been falling steadily for the past couple of years and is showing no sign of recovering.   The Iranian sanctions went into effect in early November.  Iranian production has since fallen sharply.  The U.S.’s  goal is to reduce exports (and, hence, production) close to zero.

Meanwhile, U.S. production  has surged from 10,900 thousand barrels to 12,300 thousand barrels per day.  The cut in oil production by the Saudi’s combined with reduced production in Venezuela and Iran have boosted the  price of oil to about $58.  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 quickly boost production.  At the moment the impressive increase in U.S. production is countering the cutbacks from Venezuela and Iran.  The Saudi’s share of global production has been falling steadily for the past couple of years.  However, the Saudis cannot allow its market share to continue to slide.

The Department of Energy expects U.S. production to climb 13% from 11.0 million barrels last year to 12.4 million barrels this year and  to 13.3 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 combined with reduced production in Venezuela and Iran  appears to have  gotten supply and demand back into better balance.    At 1,104 million barrels crude inventories are  in line with the 5-year average of 1,116 million barrels.

Stephen Slifer


Charleston, SC

Unemployment vs. Job Openings

July 9, 2019

The  Labor Department reported that job openings fell 0.7% in May to 7,323 thousand after declining 1.4% in April, but those back-to-back declines follow an increase of 4.6% in March.  As we see it, job openings seem to be bouncing around from month to month at a very elevated level.  Indeed, there are far more job openings today than there were prior to the recession (4,123 thousand in December 2007).   There were 5.9 million people unemployed in May.

As shown in the chart below, there are currently 0.8 unemployed workers for every available job.   Think of that — there are more job openings today than there are unemployed workers.  Prior to the recession this ratio stood at 1.7 so the labor market is clearly in far better shape now than it was prior to the recession.  Further, at the end of the recession there were 6.6 times as many unemployed workers as there were job offers so, clearly, the job market has come a long ways in the past 10 years.

In  this same report the Labor Department indicated that the quit rate in April was  at 2.3 which is the highest level since January 2001.   It has been at that level since June of last year.  This is a measure of the number of people that voluntarily quit their jobs in that  month.  During the height of the recession very few people were voluntarily quitting because jobs were scarce.  So the more this series rises, the more comfortable workers are in leaving their current job to seek another one.  The quit rate today is 2.3.  At the beginning of the recession it was at 2.0 and the record high level for this series was 2.6 back in January 2001.

There is one other point that should be made about this report.  Janet Yellen used to  claim that there were a large number of unemployed workers just waiting for jobs if only the economy were to grow fast enough.  She is assuming that these people have the skills and are qualified for employment.  We tend to disagree.  There are plenty of job openings out there.  What is not happening as quickly is hiring.  Take a look at the chart below.  Job openings (the green line) have been rising rapidly (and are far higher now than they were prior to the recession); hires (the red line) have been rising less rapidly.

Indeed, if one looks at the ratio of openings to hires the reality is that this ratio  has not been higher at any point in time since this series began in 2000.  There are plenty of jobs out there, but employers are having a hard time filling them.  Why is that?

A couple of thoughts come to mind.  First and foremost, many unemployed workers simply do not have the skills required for the jobs available.  If they did, why aren’t they being hired?  Why aren’t some current part time workers stepping into the void for those full time positions? Why haven’t discouraged workers begun to seek employment with so many jobs available?  Why haven’t long-term unemployed workers bothered to go back to school and acquire the skills that are necessary to land a  job?

Or perhaps many of these people flunk the drug tests.  They might not be qualified for employment for a variety of possible reasons.

Perhaps also some people in this group find the combination of unemployment benefits and/or welfare benefits sufficiently attractive that there is little incentive to take a full time job when you can sit at home do nothing and make almost as much.

Jobs are plentiful and the only reason the unemployment rate is not falling faster is because the remaining unemployed/discouraged/part time workers do not have the skills required by employers today, flunk the drug tests, or are unwilling to take the jobs that are available.

Stephen Slifer


Charleston, SC

Small Business Optimism

July 9, 2019

Small business optimism edged lower by 1.7 points in June to 103.3 after having climbed 1.5 points in May.  The August level of 108.8  broke the previous record high level of 108.0 set 35 years ago back in July 1983.  So while confidence slipped slightly in the early part of this year it has fallen from a record high level and still remains very lofty.

Chief Economist William Dunkelberg said,  “As expectations for sales gains and the general business environment faded, uncertainty levels increased.  Still, job openings and plans to create jobs remain historically very strong, and while it’s not as ‘hot’ as May, Main Street is still running strong.”

In our opinion the economy is expected to expand at a reasonably robust 2.6% pace this year.  Specifically, we believe that the cut in the corporate income tax rate, legislation that will allow firms to repatriate corporate earnings currently locked overseas back to the U.S. at a favorable 15.5% rate, and the steady elimination of unnecessary, confusing and overlapping federal regulations will boost investment.  That, in turn, should boost our economic speed limit should from 1.8% or so today to 2.8% within a few years.

After falling 20% late last year the stock market recovered all of the earlier loss and established a new record high level.   Jobs are being created at a brisk pace.  The unemployment rate is well below the full employment threshold.  Mortgage rates have fallen in the past couple of months from 4.9% to 3.8%.  And investment spending remains solid.  We expect GDP growth to be 2.6% this year after having risen 3.0% in 2018.  The core inflation should be relatively stable at 2.3% in 2019 after rising 2.2% in 2018.  The Fed will has pledged to keep rates steady through the end of the year and may even lower them.  Moderate GDP growth, low inflation, and low interest rates should continue to bolster the stock market in the months ahead.

Stephen Slifer


Charleston, SC

The Case for Lower Rates is Vanishing

July 5, 2019

The markets continue to look for a 0.5% cut in the federal funds rate by yearend.  No doubt some members of the Fed’s Open Market Committee continue to lean in that direction. While there remains an expectation that the economy is going to soften noticeably between now and yearend, there is virtually no evidence that a slowdown is underway.  Having said that, a number of Fed officials suggest that the Fed could lower rates in a determined effort to nudge inflation to or above its 2.0% target rate.  Our sense is that the economy is continuing to chug along at about a 2.5% pace, and that by yearend the inflation rate will rise on its own close to the 2.0% pace the Fed would like to see.  Thus, we anticipate no need for a rate reduction any time soon.

Two weeks ago we outlined half a dozen events/economic indicators that would influence Fed policy makers at their July 30-31 gathering.  Thus far, four of those six pieces of information have become available and the odds of a rate cut at the July meeting seem remote.

One of the primary reasons for expecting slower GDP growth in the second half of the year would be an escalation of the trade conflict with China.  But at the conclusion of the recent G-20 meeting Trump and Chinese President Xi Jinping agreed to restart trade talks between the two countries.  This clearly represents a truce in the trade war.  While serious obstacles remain, we remain convinced that an agreement of some sort will be reached in the second half of this year.  It is in the interest of both countries to make that happen.  If it does, the need for lower rates to support GDP growth that some argue is teetering on the brink of recession would largely disappear.

At the end of last month we received May data on the Fed’s preferred inflation gauge, the personal consumption expenditures deflator excluding the volatile food and energy components.  It rose 0.2% in May after a similar-sized increase in April.  While the year-over-year increase remains below target at 1.6%, this inflation measure has risen at a 2.0% pace in the past three months.  We expect monthly increases in the second half of the year to continue at a 0.2% pace which would lift the increase for 2019 as a whole to 1.9% and imply a 2.4% increase in 2020.   If so, there is no reason for the Fed to cut rates to bring inflation back to its 2.0% target.  It will get there on its own without any assistance from the Fed.

The Institute for Supply Management’s index of conditions in the manufacturing sector continued to slide in June.   It edged lower by 0.4 point to 51.7.  After reaching a peak of 60.8 in August of last year, this series has been steadily falling.  However, the ISM indicates that at its current level the index is consistent with 2.6% GDP growth, a pace that should not generate cause for alarm.  The index levels of roughly 60.0 late last year were the highest in a decade and were consistent with GDP growth of between 4.0-4.5%.  While the murky trade situation has softened the manufacturing sector it has not pushed it over a cliff.  Furthermore, the solution is not lower interest rates but a solution to the trade difficulties with China in particular.

The market jumped on the minuscule 75 thousand increase in payroll employment for May as clear evidence that a slowdown was underway.  Unfortunately for the lower rates crowd, June produced a solid increase of 224 thousand.  The three month moving average increase in payroll employment now stands at 171 thousand.  While clearly less than the 235 thousand average increase last year, with the economy at full employment it is exactly what one would expect.  There simply are not enough workers for employers to hire.  It is not a sign of weakness.  Rather, it is a sign of strength that the economy is growing as quickly as it possibly can.  Lower rates will not help.

Looking ahead we should see an increase in the core CPI index for June of 0.2%.  The year-over-year increase should remain at 2.0%.  With somewhat larger increases in recent months we expect the core CPI to rise 2.2% this year and 2.4% in 2020.

Finally, on Friday, July 26 we will get our first look at second quarter GDP growth.  We expect to see a growth rate of 1.5% following a 3.1% increase in the first quarter.  While second quarter growth did slip, that is hardly a surprise given the steamier-than-expected first quarter pace.  In the first half of the year as a whole the economy will have risen 2.3% which is roughly in line with what economists had anticipated and presumably faster than potential growth.

While many FOMC members believe that rates will be 0.5% lower by yearend, there is a slightly larger number of members who believe that no rate cuts are required.  The jury remains out, but what we have seen in the past month suggests that the no-rate-cut crowd may be supported in July by one or more of their previously dovish colleagues.

Stephen Slifer


Charleston, SC

Private Employment

July 5, 2019

Private employment for June rose 191 thousand after having climbed a modest 83 thousand in May.   A better reading of what is truly going on is typically represented by the  3-month moving average of private employment which is now 156 thousand.  To us, the pace of hiring has slowed from 215 thousand per month last year, to about 160 in the first  half of this year.  Thus, we are  now seeing employment gains of 160 thousand.  That is exactly what one would expect if the economy is truly at full employment.  There are simply not enough adequately trained workers available to hire.  Labor force growth rose 100 thousand in the past year.  With employment gains continuing to exceed growth in the labor force, the unemployment rate should continue to decline slowly.

Amongst the various employment categories construction employment rose 21 thousand in June after having risen 5 thousand in May.  The trend increase in construction employment appears to be about 20 thousand per month.

Manufacturing employment climbed by 17 thousand in June after having risen 3 thousand in May .    Factory employment is now rising by about 15 thousand per month.  It is struggling as the recently imposed tariffs take a toll on growth in the goods sector.

Elsewhere, health care  climbed by 35 thousand.  Professional and business services increased 51 thousand in June.   Transportation and warehousing employment rose 24 thousand.  Employment in leisure and hospitality establishments climbed 8 thousand.  Financial services gained 2 thousand workers.  Retail jobs declined 6 thousand.

In any given month employers can boost output by either additional hiring or by lengthening the number of  hours that their employees work.  The nonfarm workweek was unchanged in both May and June at 34.4 hours.  It has been bouncing around between 34.4 and 34.5 hours for the past year.  The  elevated level of the workweek  implies that employers are in need of workers and will continue to hire at a meaningful pace in the months ahead.

The increases in  employment and hours worked are reflected in the aggregate hours index which rose 0.2% in June.  This index climbed by 1.8% in the first quarter and now 0.6% in the second quarter, which when combined with a 0.9% projected increase in productivity would produce our projected 1.5% GDP growth rate in that quarter (which follows 3.1% GDP growth in the first quarter).

There is no doubt that the consumer sector of the economy is expanding at roughly a 2.5% pace.   The stock market had a tough couple of months late last year but has completely recovered and stands at a record  high level.    Consumer confidence fell in the fourth quarter but it, too, has recovered and now stands at a 15-year high.

The sectors of the economy that remains under pressure are the various production industries.  That is climbing but very slowly.  As noted earlier, factory employment is barely increasing.  Construction employment has been rising slowly but steadily.  Mining employment has been rising by about 5 thousand per month.  The service sector, however, is booming.

Looking ahead, steady consumer spending and continued rapid growth rate in investment should cause  GDP to grow 2.6% this year.

Stephen Slifer


Charleston, SC