Monday, 24 of September of 2018

Economics. Explained.  

Consumer Sentiment

September 14, 2018

The final estimate for consumer sentiment for September jumped 4.6 points to 100.8 after having declined 1.7 points in July.   The September level was 0.6 point lower than March’s level of 101.4 was the highest level of sentiment since January 2004.  Thus, sentiment remains at a very lofty level.

Richard Curtin, the chief economist for the Surveys of Consumers, said, “Consumer sentiment posted a robust rise in early September, reaching 100.8, the second highest level since 2004-only behind the March 2018 reading of 101.4. Importantly, the gains were widespread across all major socioeconomic subgroups. The Expectations Index reached its highest level since July 2004, largely due to more favorable prospects for jobs and incomes. Despite a lessening of expected gains in nominal incomes in September, inflation expectations also declined, acting to offset concerns about declining living standards. Consumers anticipated continued growth in the economy that would produce more jobs and an even lower unemployment rate during the year ahead. While consumers were somewhat more likely to anticipate that the economic expansion would continue uninterrupted over the next five years, nearly as many expected another downturn sometime in the next five years. The largest problem cited on the economic horizon involved the anticipated negative impact from tariffs.”

Given the tax cuts we expect GDP growth to climb from 2.5% in 2017 to 3.1% 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 3.5% in 2018 vs. 1.8% last year. The core inflation rate (excluding the volatile food and energy components) rose 1.8% in 2017 but should climb by 2.3% 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 2.2% by the end of 2018.

The August increase was attributable to both the expectations and current conditions components.

Consumer expectations for six months jumped 4.0 points from  87.1 to 91.1.

Consumers’ assessment of current conditions jumped 5.8 points from 110.3 to 116.1.

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 2018.

Stephen Slifer


Charleston, SC

Industrial Production

September 14, 2018

Industrial production rose 0.4% in both July and August.   During the past year industrial production has risen 4.9%.  A growth rate of that magnitude was last seen in early 2012.  So despite monthly wiggles, production continues to trend upwards.

Breaking industrial production down into its three major sub-components,  the Fed indicated that manufacturing production (which represents 75% of the index) rose 0.2% in August after having risen 0.3% in July.  During the past year  factory output has risen 3.1% (red line, right scale).    The factory sector is clearly gathering momentum.

Mining (14%) output rose 0.7% in both July and August.  Over the past year mining output has risen 14.1%.  Most of the recent upturn in mining has been concentrated in oil and gas drilling activity.  Oil and gas drilling fell 0.5% in August after having fallen 4.3% in July.     Over the course of the past year oil and gas well drilling has risen 12.2%.

Utilities output rose 1.2% in August after having risen 0.1% in July .  During the past year utility output has risen 4.8%.

Production of high tech equipment rose 0.4% in August after having declined 0.2% in July.  Over the past year high tech has risen 7.4  Thus, the high tech sector sector appears to be expanding nicely. This is an indication that the long slide in nonresidential investment has come to an end which would, in turn, signal an upturn in productivity growth.

Capacity utilization in the manufacturing sector rose 0.1% in August to 76.4%.  It remains below the 77.4% level that is generally regarded as effective peak capacity.  However, factory owners will soon have to spend more money on technology and re-furbishing or expanding their assembly lines to boost output.

Stephen Slifer


Charleston, SC

Retail Sales

September 14, 2018

Retail sales rose 0.1% in August after having risen 0.7% in July.  The trend rate seems to be edging upwards.  In the past year sales (the blue line) have risen 6.7% which is the fastest 12-month growth rate since February 2012.

Sometimes sales can be distorted by changes in autos and gasoline which tend to be quite volatile.  In this particular instance car sales declined 0.8% in August, but gasoline sales jumped 1.7%.  Higher gas prices boost the overall increase in sales, they typically do not reflect an actual increase in the volume of gasoline sold.

Perhaps the best indicator of the trend in sales is retail sales excluding the volatile motor vehicles and gasoline categories.  Such sales rose 0.2% in August after having jumped 0.9% in July.   In the last year retail sales excluding cars and gasoline have risen a solid 5.8% and are showing no signs of abating.

While there has been a lot of disappointment about earnings in the traditional brick and mortar establishments (like Macy’s, Sears, K-Mart, and Limited) the reality is that they need to develop a better business model.  The action these days is in non-store sales which have been growing rapidly. Consumers like the ease of purchasing items on line.  While sales at traditional brick and mortar general merchandise stores have risen 3.6% in the past year, on-line sales have risen 10.4%.  As a result, their share of total sales has been rising steadily and now stands at a record 11.3% of all retail sales.

We believe that retail sales will continue to chug along at a 2.5% pace for some time to come.   First, all measures of consumer confidence are at their highest levels in a decade.

One of the reasons consumers are feeling so positive is that the stock market is at a record high.  That increase in stock prices boosts consumer net worth.

As long as the economy continues to crank out 200 thousand jobs a month, consumer income will continue to climb.

Real disposable income is currently climbing at a solid 2.9% pace which is somewhat higher than its 25-year average growth of 2.7%.

If the Fed keeps raising rates very slowly consumers will be able to continue to borrow at a reasonable rate.  At 4.5% mortgage rates are well below the 6.25% average over the past 25 years.


In addition, consumers have paid down a ton of debt and debt to income ratios are very low.  That means that consumers have the ability to spend more freely and boost their debt levels if they so choose.

Thus, the pace of consumer spending seems steady.  We continue to expect GDP growth to quicken from 2.5% last year to 3.1% this year.

Stephen Slifer


Charleston, SC

Consumer Price Index

September 13, 2018

The CPI rose 0.2% in both July and August.  During the past year the CPI has risen 2.2%.  However, that out-sized yearly increase was boosted by huge increases in energy prices in the second half of last year.  The year-over-year increase overall should drop back to about 2.4% by the end of 2018.

Food prices rose 0.1% in both July and August.  Food prices have risen 1.4% in the past twelve months.

Energy prices rose 1.9% in August after having fallen 0.5% in July 0.3% in June.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 10.3%.  However, as noted earlier, energy prices rose sharply in the second half of last year, so the energy component should rise only about 5.0% in 2018.

The recent run-up in energy prices seems to reflect three factors.  First, GDP growth around the world has picked up which is bolstering the demand for both crude oil and gasoline.  Second, oil production in Venezuela has dropped to a multi-decade low level given the chaotic political environment in that country.  And third, the supply situation from Iran is now highly  uncertain given the likely re-imposition of sanctions against that country later this year.  As a result, the International Energy Administration projects that demand will exceed supply by about 0.5 million barrels per day between now and yearend.  However, U.S. production is surging.  It will climb about 15% this year and another 10% in 2019 which will make the U.S. the world’s largest oil-producing country.  At the same time OPEC is talking about gradually increasing its pace of production. A s a result, crude oil prices have dropped from $74 to about $70 per barrel currently and should decline gradually between now and yearend.

Excluding food and energy the CPI rose  0.1% in August after having risen 0.2% in each of the past three months .  Over the past year this so-called core rate of inflation has risen 2.2%.  Clearly, inflation is on the upswing.  The question is still one of degree.  We expect the core CPI will rise 2.3% for the year as a whole.

The most interesting development in the CPI in recent years has been the dichotomy between the prices of goods (excluding the volatile food and energy components) and services.  For example, in the past year prices for goods have fallen 0.2% while prices for services have risen 3.0%.

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 for almost every major category in the past year.  New cars have risen 0.3%, televisions have declined 18.0%, audio equipment has dropped 14.1%,  toys have fallen 9.3%, information technology commodities (personal computers, software, and telephones) have declined 4.4%.  Prices for all of these items are widely available on the internet and can be used as bargaining chips with a traditional brick and mortar retailers.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 3.0% in the past year.  The increase in this  broad category has been led by shelter costs which have climbed 3.4%.  This undoubtedly reflects the shortages of both rental properties and homeowner occupied housing. Indeed, the vacancy rate for rental property is at a 30-year low. This steady rise in the cost of shelter  will continue for some time to come and, unlike monthly blips in food or energy, it is unlikely to reverse itself any time soon.

While the CPI, both overall and the core rate, will have an upward bias  in the months ahead because of what has been happening to shelter prices, gradually rising labor costs, and rising producer prices.  But on the flip side, the internet is keeping a lid on the prices of goods.  We look for an increase of 2.3% in 2018.

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 2.0% rate but is  likely to head higher.  The Fed has a 2.0% inflation target.  However, going forward we have to watch out for the steady increases in shelter which, as noted above, is being pushed higher by the shortage of both rental properties and homeowner-occupied housing.   Shelter is a long-lasting problem and given its 33% weighting in the CPI it will introduce an upward bias to inflation for some time to come.  We also have to watch rising medical costs(prescription drug prices in particular) and the impact of higher wages triggered by the shortages of available workers in the labor market.

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

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

As we see it, inflation is a measure of price change (the CPI).  It is not a mixture of price changes and changes in consumer behavior (the PCE deflator).  The core CPI currently is at 2.2%. We expect it to continue to climb at a 2.3% rate through yearend.  The core PCE should increase about 2.2% in 2018.  Both rates are beginning to trend higher.

Keep in mind that real short-term interest rates are negative.  With the funds rate today at 1.9% and the year-over-year increase in the CPI at 2.7% the “real” or inflation-adjusted funds rate is negative 0.7%.  Over the past 57 years that “real” rate has averaged about plus 1.0% which should be regarded as a “neutral” real rate.  Given a likely pickup in GDP growth this year and next and a gradual increase in the inflation rate, we regard a negative real interest rate inappropriate in today’s world.  The Fed should continue to push rates higher and gradually run off some of its longer term securities.

Stephen Slifer


Charleston, SC

Producer Price Index

September 12, 2018

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

Producer prices for final demand declined 0.1% in August after having been unchanged in July.  During the past year this inflation measure (the red line) has risen 2.8%.  The PPI has been moving steadily higher for some time but took a breather in August..

Excluding food and energy producer final demand prices also declined 0.1% in August after having risen 0.1% in July.  They have risen 2.4% since August of last year (the pink line).  This series has been steadily accelerating for the past two years.  Inflationary pressures are gradually re-surfacing.

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

The PPI for final demand of goods was unchanged in August after having risen 0.1% in  July. These prices have now risen 3.9% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods was unchanged in August after having risen 0.3% in each of the past five months.  During the past year the core PPI for goods (the light green line) has risen 2.6% (right scale).

Food prices fell 0.6% in August after having declined 0.1% in July after having declined 1.1% in June.  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 declined 0.9%.

Energy prices rose 0.4% in August after having dropped by 0.5% in July.  Energy prices have risen 13.7% in the past year.  These prices are also very volatile but the recent upswing seems to reflect a significant quickening of GDP growth around the globe, the cutback in global supply by OPEC, and a state of complete chaos for oil production in Venezuela.  However, U.S. oil output is now surging and OPEC has increased its crude oil output.  The Department of Energy believes that the recent surge in energy prices will be at least be partially reversed between now and yearend.

The PPI for final demand of services declined 0.1% in both July and August after having risen 0.4% in June.  This series has risen 2.3% over the course of the past year (left scale).   The August drop was partly caused by a 0.9% decline in the trade services category which largely reflects the change in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular). In addition, the trade, transportation and warehousing component declined 0.6%.  The PPI for final demand of services excluding trade and transportation (the light blue line) increased 0.3% in June, July and August.  It has climbed 2.7% during the past year.  This series, like the overall index, has been gradually accelerating for some time.

The recent increases in producer prices were foreshadowed by the results of the Institute for Supply Management’s series on prices paid by manufacturing firms.  In the case of manufacturing firms the chart looks like the one below.  Price pressure were steadily building for six consecutive months.  Specifically, the price component rose steadily from 64.8 in November of last year to 79.5 in May.  The fact that every month was above 50.0 meant that prices producers were paying increased every single month.  Given that the level of the index steadily rose during that period of time indicates that price pressures were intensifying every single month.  However, from June through August this series actually declined to 72.1.  This means that prices continued to climb in those three months, but the rate of increase was less than in other recent months.  Hopefully, this means that the steady upward pressure on the PPI is beginning to abate.

We believe this escalation in the prices that producers are having to pay reflects stronger GDP growth around the globe.

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

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 3.9 the labor market is beyond full employment.  As a result, wages pressures have begun to climb, but much of the upward pressure on inflation should be countered by an increase in productivity.  Nevertheless, the tighter labor market should exert at least moderate upward pressure on the inflation rate.

Some upward pressure on labor costs, rents, and the cost of materials will put upward pressure on inflation.  We expect the core CPI to increase 2.2% in 2018 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

Car and Truck Sales

September 11, 2018

Unit car and truck sales fell 0.6% in August to 16.6 million units after having fallen 3.1% in July.  A 16.6 million pace is 0.9% higher than  it was at this time last year.  Car sales have leveled off in the past year or so and auto industry experts think this  modest pace will continue for the rest of this year.  They talk about the fact that the period of ultra-low interest rates has ended.  The Fed is raising short-term interest rates and is expected to boost rates two more times later this year.  They talk about how automobile quality has improved so that consumers are holding onto their vehicles for longer periods of time.  And now they talk about higher prices for gasoline which could dampen growth.  All of those are fair points.  However, we expect car sales to continue to climb slowly for some time to come for a couple of reasons.

First, all measures of consumer confidence are close to their highest levels thus far in the business cycle.

Second, real, disposable consumer income (what is left after taxes and inflation) is rising at a solid pace as jobs growth continues apace, and as the tax cuts began to boost after tax income

Third, the S&P 500 index,  the Russell 2000 and the NASDAQ are all at record high levels.  That is an indicator of investor sentiment.  In addition, a rising stock market also boosts consumer net worth.  With corporations destined to benefits from tax cuts this year, interest rates still low, and the consumer spending at a solid 2.5% pace, corporate earnings should continue to rise.  We anticipate a 10% increase in earnings in 2018 which should put the stock market at an even higher record level by yearend.

Fourth home sales remain at s solid pace.  Because car and home sales are the two biggest ticket items in a consumers budget, it is not surprising that a change in trend will be evident in these two categories first.  If home sales seem pretty solid it would be surprising if car sales did not follow suit.

It is true that gasoline prices have risen, but the Energy Information Institute believes that gasoline prices peaked at about $2.95 per gallon at the end of June and should decline slowly in the second half of the year.

Finally, keep in mind that consumers have paid down tons of debt and are now in a position to spend.  Jobs are climbing at a pace of 190 thousand per month.  The unemployment rate has fallen to a level that is far below the full employment mark.  Consumers are benefiting from stable and still low gasoline prices. For all of these reasons we look for  3.1% GDP growth in 2018 and car sales to remain healthy.

Stephen Slifer


Charleston, SC

Unemployment vs. Job Openings

September 11, 2018

The  Labor Department reported that job openings rose 1.7% in July to a record high level of 6,939 thousand.   It is worth noting that there are more job openings today than there were prior to the recession (4,123 thousand in December 2007).   There were 6.3 million people unemployed in June.

As shown in the chart below, there are currently 0.9 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 9-1/2 years.

In  this same report the Labor Department indicated that the quit rate in July was  at 2.4 which is the highest level since January 2001.   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 2.4.  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.

Whatever the case, it appears that the decline in the unemployment rate in the past couple of years is not simply a reflection of workers dropping out of the labor force.  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

September 11, 2018

Small business optimism rose 0.8  point in August to 108.0 which .which broke the previous record high level of 108.0 set 35 years ago back in July 1983.

NFIB President Juanita Duggan said,  ““Today’s groundbreaking numbers are demonstrative of what I’m hearing everyday from small business owners – that business is booming. As the tax and regulatory landscape changed, so did small business expectations and plans. We’re now seeing the tangible results of those plans as small businesses report historically high, some record breaking, levels of increased sales, investment, earnings, and hiring.”

NFIB Chief Economist added that, “At the beginning of this historic run, Index gains were dominated by expectations: good time to expand, expected real sales, inventory satisfaction, expected credit conditions, and expected business conditions.  Now the Index is dominated by real business activity that makes GDP grow: job creation plans, job openings, strong capital spending plans, record inventory investment plans, and earnings. Small business is clearly helping to drive that four percent growth in the domestic economy.”

In our opinion the economy is expected to expand at a rapid clip in coming months in response to a number of significant policy changes.  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.

The stock market is at a record high level.    Jobs are being created at a brisk pace.  The unemployment rate is well below the full employment threshold.  The housing sector is continuing to climb slowly.  And now investment spending has picked up after essentially no growth in the past three years.  We expect GDP growth to climb from 2.5% in 2017 to 3.1% in 2018.  The core inflation will  climb from 1.8% in 2017 to 2.4% in 2018.  The Fed will continue to raise short-term interest rates very slowly.  Accelerating GDP growth, low inflation, and low interest rates should propel the stock market to new record high levels.

Stephen Slifer


Charleston, SC

The Yield Curve Will Not Invert — Do You Care?

September 7, 2018

The markets fear many things one of which is the shape of the yield curve.  The yield curve is simply the difference between long-term interest rates and short rates.  That sounds like something that only an economist could love.  But it matters – to economists and to you.  Why?  Because if it inverts it could be a sign that a recession is rapidly approaching.  Why that is the case?  Is it likely to happen any time soon?  Rest easy.  That long-awaited recession will not be on our doorstep until 2022 at the earliest.

Today the yield on the 10-year bond is 2.9%.  The overnight federal funds rate is 1.9%.  Subtracting one from the other, long rates are 1.0% higher than short rates.  That means that the yield curve has a positive slope which is the case about 99% of the time.  Some economists use different short-term interest rates to make the comparison.  Some like to look at the difference between the 10-year bond and the 2-year note.  Others think that it is better to use the 10-year bond and the 3-month bill rate.  Pick whatever short-term interest rate you want.  They all tell the same story.

Why does the yield curve typically have a positive slope?  Because long-term securities are riskier than short-term ones.  The long-term bond holder must wait longer for the repayment of principal,   If the bond holder must sell a bond  prior to maturity they might have to sell it at a reduced price.  To compensate for this risk, long-term bonds almost always pay higher interest rates than short-term instruments.

Why does the yield curve invert?  Typically, it  happens because the Fed has tightened too much.  Perhaps the economy is overheating.  Perhaps inflation is picking up rapidly.  If the Fed falls behind the curve it must raise rates quickly to catch up.  But the economy does not respond to higher interest rates for at least a year.  As a result, the Fed often goes too far, and the economy slips into recession.  Historically, the yield curve inverts about one year prior to the onset of recession.  That is why economists attach so much significance to an inverted yield curve.

What has been happening lately?  The yield curve has been flattening for the past nine years.  In June 2009 when the recession ended long rates were 3.5% higher than short rates.  Today the difference has shrunk to 1.0%.  Most economists fear that additional Fed tightening later this year and next will raise short rates by 1.5% and cause the yield curve to invert.  They conclude that a recession is brewing by 2021.  Sorry.  We don’t buy it.

In our world there are two necessary conditions for a recession.

  1. The Fed raises the funds rate to 5.0% or higher.
  2. The yield curve inverts.

Most economists believe that Fed policy is neutral – it is neither stimulating the economy nor trying to slow it down – when the funds rate is about 3.0%.    Today it is 1.9%.  If the Fed tightens six more times between now and the end of next year in 0.25% increments, the funds rate will have risen to 3.4% which makes it just slightly higher than neutral.

But the economy does not swoon just because the funds rate reaches neutral.  In the past 50 years the U.S. economy has never gone into recession until the funds rate is above 5.0%.  For example, going into the last recession the Fed raised the funds rate to 5.25% before the economy succumbed.  The funds rate was even higher going into earlier recessions.  Thus,  5.0% is a pretty good place for us to begin a recession watch.  If at the end of  2019 the funds rate is 3.4%, we are not even close to the 5.0% danger point.

What about the yield curve?  Won’t it invert if the Fed tightens raised short rates by another 1.5%?  Probably not.  Think of the 10-year note as the average of a series of ten 1-year notes purchased back-to-back.  Thus, it becomes clear that if the Fed raises short-term interest rates, long-term interest rates will rise as well.  Second, bond holders are sensitive to the inflation rate.  If inflation rises, the amount they will get paid at maturity will be worth less than if inflation had not risen.  If the inflation rate rises between now and the end of next year, the yield on the 10-year note should rise as well.

At the end  of next year, we believe the funds rate will be 3.4%.  The yield on the 10-year note will have risen from 2.9% today to 4.0%.  Hence, the yield curve will have a positive slope of 0.6% (compared to a positive slope of 1.0% today).  The yield curve will be flatter, but it will not invert.  Thus, neither condition necessary for a recession will have been achieved.  The funds rate will be at 3.4%, still way below the 5.0% danger point.  And the yield curve will still have a positive slope of 0.6%.  A recession will not happen in that world.

Let’s go out one more year to the end of 2020.  What might that world look like?  Let’s assume that the Fed raises short rates four more times in that year and boosts the funds rate to 4.4%, still below the 5.0% danger point.  We expect the yield on the 10-year note to be 4.8%.  The yield curve will have a positive slope of 0.4%.  Still no danger of recession.

Make no mistake.  The yield curve matters.  A lot.  And when it inverts because Fed policy has become too tight, we will be warning about an imminent recession.  But if the yield curve inverts later this year it will be inverted for the wrong reason.  With the funds rate at 3.3% Fed policy will not be too tight.  Rather, the curve will be inverted because bond holders have pushed long rates below short rates.  Right now, foreign investors are piling into the United States because of dueling tariffs.  They believe that the U.S. will weather a trade war better than anybody else.  That makes dollar-denominated assets – both stocks and bonds – extremely attractive.  Historically, the yield on the 10-year note averages 2.2% higher than the inflation rate.  Over the next 10 years market participants expect the inflation rate to average 2.1%.  So, based on history, we would expect the yield on the 10-year note to be 4.3%.  It isn’t.  It is 2.9%.  If the yield curve inverts any time soon, it will be because long rates are too low, not too high.  That does not sound like a warning shot to us.  Rest easy.  Clear sailing until 2022.

Stephen Slifer


Charleston, S.C.

Private Employment

September 7, 2018

Private sector employment for August rose 204 thousand after having risen 153 thousand in July.   While the August increase of 204 thousand was slightly more than the 190 thousand jobs that had been expected, employment gains for June and July were revised downwards,  Thus, the outlook for employment has not changed much in the wake of this report.

A better reading of what is truly going on is represented by the  3-month moving average of private employment which is now 183 thousand.  That compares to an average increase of 180 thousand in 2017.  Thus, employment continues to chug along.  The labor force is growing by about 100 thousand per month.  For employment gains to be consistently larger than the increase in the labor force implies some people not previously in the labor force are choosing to return (like discouraged workers).

Amongst the various employment categories construction employment rose 23 thousand in August after climbing 18 thousand in July.    The trend increase in construction employment appears to be about 25 thousand per month.

Manufacturing employment fell 3 thousand in August after having risen by 18 thousand in July.    Factory employment is now rising by about 20 thousand per month.

Mining rose 6 thousand in August after having fallen 1 thousand in July.  After a long period of steady declines mining employment is now rising about 5 thousand per month as rising oil prices are boosting hiring in that  sector.

Elsewhere, health care climbed by 33 thousand.  Professional and business services increased 53 thousand in August.  Wholesale trade jobs increased 22 thousand.  Transportation and warehousing climbed by 20 thousand.  Employment in leisure and hospitality establishments increased 17 thousand in August.  Retail jobs declined by 6 thousand in August.

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 for August was unchanged at 34.5 hours  That is  about as long as it gets.  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 August to 109.9 after having fallen 0.2% in July.  Thus, it rose 2.7% in for the second quarter as a whole and is on track to rise about 1.5% in Q3.

There is no doubt that the consumer sector of the economy is expanding at roughly a 2.5% pace.  Individual  income tax cuts should slightly boost spending in 2018.  The stock market is at a record high level.  Consumer confidence is holding up well.  Remember that consumer spending represents two-thirds of total GDP.

The sector of the economy that had previously been weak was the various production industries.  But that seems to be changing.  As noted earlier, factory employment is rising modestly.  Construction employment has been rising steadily.  And even mining has been rising somewhat after a steady series of declines associated with the drop in oil prices.

Looking ahead the prospect of both individual and corporate income cuts and the repatriation of some overseas earnings currently locked overseas should boost GDP growth from 2.5% in 2017 to 3.1% in 2018.

Stephen Slifer


Charleston, SC