It's the Pandemic, Stupid!

 Popular Economics Weekly

Economists are beginning to say enough is enough. The Fed might continue to pause from another rate hike in their November FOMC meeting because the latest inflation data show a continued decline, but not in December.

“Although inflation has come down from the peak reached last year, it is still too high,” New York Fed President John Williams said in a prepared speech. “We still have a ways to go to fully restore price stability.”

To borrow from some economists who fear the Fed is getting the causes of inflation wrong and thereby keeping interest rates too high, the current inflation surge was caused by the pandemic, stupid!

Major economists such as former White House Chief Economist Jason Furman and Nobel laureate Paul Krugman have spoken about the dangers of prolonging higher interest rates, despite the rapid inflation decline.

“The question now is whether we’ll get a recession anyway — basically, whether Fed tightening will produce an unnecessary recession,” says Krugman. “And the picture there is very muddy. Milton Friedman’s famous line about “long and variable lags” has come in for a lot of questioning lately, with some suggestions that the lags may have gotten a lot shorter. If the lags are long, we may stumble into a recession; if not, not.”

@JasonFurman

Furman’s assertion is that wage growth can’t be a major determinate of inflation as it was in the 1970s, since it is still below the longer-term trend line.

“How are real wages doing? Most measures show they are up since prior to the pandemic but are still 3-5% below their immediate pre-pandemic trajectory.”

Yet listening to Fed Chair Powell, you would think most of the Fed Governors believe it was caused by higher wages, since Econ 101 postulates that wages comprise some two-thirds of product costs, therefore costs will rise or fall in line with wages.

That has been an economic truism since the 1970s, even though there was an Arab oil embargo in 1973 that brought shortages and sky-high gas prices leading to the so-called wage-price spiral that has traumatized the Fed since then.

The real question should be why are so many meetings necessary to make the point that inflation should come down further?

The Federal Reserve Governors convene eight official vote-taking meetings per year after which they broadcast their intentions for policy—whether to raise, lower rates, or stand pat. This is really interfering with Wall Street’s own internal processes and the actual time lag needed for policy actions to take effect that determine the direction of inflation, causing the wild price fluctuations we see today.

Would the markets behave differently with fewer Fed pronouncements? Fed officials have been acting preemptively before seeing the results of their policies for decades, which let us not forget includes maximizing employment as well as price stability.

Yet today we have the COVID pandemic causing the product shortages that led to the current inflation spike, followed by the Ukraine-Russian war causing further shortages. But inflation has been declining anyway, much more so than in the 1970s.

FREDpce

The favored measure of inflation, the Personal Consumption Expenditure Index (PCE) that measures a broad spectrum of products and services, has been declining fast. From the same month one year ago, the latest PCE price index for August increased 3.5 percent, per the FRED (St. Lous Fed) graph, down from its 7.1 percent peak in June 2022.

The danger with comparing it to the only analogy the Fed seems to come up with, the 1970s and the Arab oil embargo, is the damage it causes to wage and salary earners which comprise almost 80 percent of the adult work force.

Could the fear of not being taken seriously be the reason for so much Federal Reserve jawboning and unnecessarily high interest rates? Raising interest rates too high for too long has precipitated at least eight of the ten recessions since 1960, harming economic growth as well as household incomes.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

What is Normal Inflation?

 Financial FAQs

I have found support for my contention that the Fed should be done with raising interest rates and in fact drop them sooner rather than later, or we will see a full-blown recession.

Campbell Harvey, a Duke University finance professor best known for developing the yield-curve recession indicator in an interview on MarketWatch, says the Federal Reserve’s read on inflation is out of whack. And, as a result, the likelihood that the U.S. slips into a recession is increasing.

FREDcpi

Why? Because, “Harvey said that if shelter inflation were normalized at around 1% or 1.5% (It’s longer term average), overall core inflation would measure closer to 1.5% or 2%. In other words, at — or substantially below — the Fed’s 2% target,” said MarketWatch’s Mark DeCambre.

Shelter costs are a lagging indicator; rental costs lag other costs because rental contracts typically change annually.

That is why there isn’t an accurate measure of today’s retail CPI inflation in particular, which is still positive.

The inflation rate is declining but still positive, which is called disinflation in economists’ terms. Yet if prices actually begin to drift into negative territory, it means we are in a recession. And prices have fallen precipitously since June 2022 when it reach 7 percent (see CPI graph above), though rising from its low of 3 percent to 3.7 percent over the past two months.

This is a huge plunge that signaled supply chains wasted little time in catching up to demand. Consumer prices ex-shelter were up +1.9 percent on a year-over-year basis in August, up from +1 percent in July, according to the Labor Department.

That is a verly low inflation rate, and skirting an outright deflationary spiral if the trend continues, as prices are wont to behave during business cycles.

Professor Harvey says he was right in predicting eight of the last recessions when the yield curve inverted. That is a time when the yield curves of the 10-year and 3-month fixed rates are inverted from their normal relationship. The 10-year yield is normally higher than the 3-month yield because it is for a longer term (i.e., 10 years).

But when reversed, banks cannot profit when they must lend money at a lower rate (many lone rates are based on 10-yr yield) than they borrow (e.g., at 1-3 mos.) when inverted, hence credit conditions are tightened, if it is prolonged.

And adding to the possibility of recession are the Fed’s credit-tightening rate hikes lasting more than one year.

It’s a dicey time when Fed officials seem to believe prolonged inflation is right around the corner. They just lowered their rate-reduction schedule from four to two times next year at last week’s FOMC meeting.

@paulkrugman

Nobel Laureate Paul Krugman has been saying this for months. His ‘supercore’ CPI with consumer prices excluding more volatile food, energy, used cars and shelter is at 2 percent.

Yet we know what can happen when rate hikes are prolonged for too long. When former Fed Chair Greenspan and his Governors raised interest rates from 1 percent to 5.25 percent with 16 consecutive rate hikes from May 2004 to June 2006—the Great Recession followed.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

When a Return to Normal Growth?

 Financial FAQs

FREDfedfunds

There is so much confusion in the financial markets, as well as with consumers, over what comes next and little history to compare because we are recovering from a world-wide pandemic, the first one since the Spanish flu pandemic of the 1920s.

So, it is useful to look at interest rates as an indicator of what is normal, namely the Fed Funds rate that the Fed has jacked up to 5.25 percent (per above graph) and the Bank Prime Loan rate—which controls consumer spending and therefore economic growth and job formation—to determine what the U.S. economy might look like over next few years.

The Bank Prime Loan Rate which moves in tandem to the Fed Funds rate (see below FRED graph), is used by most banks to set both short-term credit card as well as longer-term installment loan interest rates for such as autos and appliances. And a high Prime Rate really puts a damper on consumers’ pocketbooks.

It is currently 8.50 percent in the second graph dating from the 1950s, up from its pandemic low of 3.25 percent, which ignited so much consumer spending and the mortgage refinance binge in 2020-21.

FREDprimerate

That is too high for any sustained growth. The Bank Prime Loan Rate fluctuated from 7.5 to 10 percent in the 1970s to 2000, as did a higher unemployment rate, before unemployment descended to its current 3 percent lows after the Great Recession (2009), and which is causing the current growth spurt.

Economic growth is accelerating again but the Fed must begin to lower their rates sooner rather than later for growth to continue.

Avoiding another recession will be the miracle of miracles if they don’t lower interest rates soon, since every recession since the 1950s (10 at last count per gray bars in graphs) was mainly caused by the Fed jacking up their Fed Funds rate and hence the Bank Prime Loan Rate to ‘tame’ inflation, which drastically slowed both spending and lending, as I said.

GDP growth expanded 2.1 percent in Q2. And just last week S&P Global Market Intelligence raised its third-quarter GDP estimate by nearly two percentage points to an annualized rate of 4 percent, citing strong retail sales data. It moved its annual estimate up slightly to a historically strong 2.3 percent.

Inflation should continue to decline overall because of the Fed’s past rate hikes, though consumer prices rose again in August to reach a 3.7% yearly rate, based on last week’s release of the monthly consumer-price index. That marked its biggest jump in 14 months, up from 3.2 percent in July and a 27-month low of 3 percent in June.

If we want to avoid a recession then history tells us th e Fed needs to drop its shorter-term rates, so that the Bank Prime Loan Rate returns to its historic norm of 5-7 percent, and its Fed Funds rate in the neighborhood of 3.75 percent, which history says consumers and businesses can tolerate for sustained growth.

But that also depends on supply chains remaining healthy. What about the Ukraine-Russian war? It doesn’t seem to be affecting food and energy prices anymore, since food prices are back to normal and even OPEC had to reduce oil production to boost the price of crude oil which means oil supplies are plentiful.

Returning to a more normally functioning economy also means the Fed must return to a more normal Fed Funds rate to avoid another recession, which hasn’t been the case in the past.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

No More Rate Hikes?

 Popular Economics Weekly

NBER.org

The latest inflation data make it almost unanimous: Chairman Powell, leading economists and even his Fed Governors are saying the Federal Reserve Governors may not raise interest rates again this year, or maybe into next year as well.

Why? Inflation has been tamed; except for gas prices, which have soared of late due to more positive economic growth and OPEC cutting oil production.

Second quarter GDP growth was 2.1 percent, and there are estimates of 4 percent or higher Q3 growth. It is a picture of the U.S. economy returning to a more normal growth pattern.

This is while the headlines are screaming that U.S. retail and wholesale prices have suddenly spiked. Wholesale PPI prices jumped 0.7 percent in August to mark the largest increase in 14 months, as did retail CPI prices the day before.

“The Producer Price Index for final demand increased 0.7 percent in August, seasonally adjusted, after rising 0.4 percent in July, the U.S. Bureau of Labor Statistics reported today. The August advance is the largest increase in final demand prices since moving up 0.9 percent in June 2022.

But note that on an unadjusted basis, the index for final demand rose (just) 1.6 percent for the 12 months ended in August.

So why isn’t retail CPI inflation following suit with its overall inflation rate rising to 3.7 percent?

An NBER working paper by noted economists Olivier Blanchard and former Fed Chair Ben Bernanke, accompanied by the above NBER graph, maintain rising wages are the culprit.

“Rising commodity prices and supply chain disruptions were the principal triggers of the recent burst of inflation. But, as these factors have faded, tight labor markets and wage pressures are becoming the main drivers of the lower, but still elevated, rate of price increase.”

But the above NBER graph shows that is not yet the case. The blue portion of the bar portraying energy prices has shrunk the most. The red and yellow portions portraying wage pressure and product shortages have shrunk the same amount bringing actual inflation (black line) below 4 percent. The gray portion is a pre-pandemic historical compendium of contributions to inflation (Don’t ask what that means, read the paper for further clarity).

So once again the fear of persistent wage inflation is driving their analysis, as many blamed for the 1970s era of stagflation. Yet they almost totally ignore the role of persistent supply shortages in the inflation equation, (oil shortages in the 1970s, Ukraine-Russian war shortages and trade sanctions today), as well as the profit-taking role of producers and distributers that padded their profits because of supply bottlenecks.

The recent spike in retail CPI and wholesale Producer Price Index was also because the financial markets believe recession dangers are over and therefore the demand for gas and oil use will only increase, another indication that markets are functioning normally.

That is why Goldman Sachs chief economist Jan Hatzius is predicting no looming recession and better economic growth ahead, as I said last week.

We can also thank Bidenomics, the boost to growth that the infusion of $billions into renewal of the US economy in infrastructure, CHIPs manufacturing, and the conversion to more climate friendly policies has jump started.

Above all, we see consumers feeling prosperous enough to continue to shop and enjoy more leisure activities even with higher interest rates. The Fed has signaled they won’t be in any hurry to drop their interest rate. But that’s also a sign of interest rates returning to more normal levels that prevailed before the COVID pandemic.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Why the Inflation Confusion--Part II

 Financial FAQs

FREDcpi

Americans want to blame someone for the post-pandemic inflation surge, according to most polls. Yet when in our history has it been a real problem affecting serious economic growth?

Consumer prices rose again in August to reach a 3.7% yearly rate, based on Wednesday’s release of the monthly consumer-price index. That marked its biggest jump in 14 months and a higher reading than the recent 3% low set in June (see chart) as the toll of the Fed’s rate hikes kicked in.

Horrors, according to some pundits! But it hasn’t affected economic growth which is again surging after the pandemic—up 2.1 percent in Q2. And just last week S&P Global Market Intelligence raised its third-quarter GDP estimate by nearly two percentage points to an annualized rate of 4%, citing strong retail sales data. It moved its annual estimate up slightly to a historically strong 2.3 percent.

What makes the above FRED consumer price index (CPI) chart more interesting is that I have dated it to World War I; yes, pre-1920 and World War I; to give inflation the proper historical perspective. It shows that inflation, in fact, has rarely been a problem in our up-and-down consumer-driven capitalist economy.

Why? We have seldom had a supply problem—i.e., not enough goods and services to balance out and keep inflation in check—because the US economy is very productive and able to quickly meet surging demand.

The 1970’s stagflation era when the CPI topped out at 14 percent in 1980 was an exception because we didn’t yet have the means to produce enough oil, and OPEC did, so they embargoed the supply to US because of our support of the Arab-Israeli War, which sent oil prices skyrocketing that we depended on.

The other major peak was 1947 when post-WWII consumers demanded more while our WWII economy was just beginning to shift out of war-mode and produce autos instead of tanks.

(The earlier 1917 to 1920 spikes were for the same reason—a WWI economy shifting back to a peacetime economy.)

Looking at the graph again, moderate inflation has been the norm—averaging around 2.5 percent and never more than 5 percent since 1980—until the post-pandemic spike, which again was mainly caused by another war, the war against the COVID-19 pandemic that paralyzed the world economy for a time, until supply chains began to catch up.

It is difficult to imagine another time when wild animals wandered in the empty streets of major cities under lockdown.

In the words of CNN senior business reporter Alison Morrow, “Demand went from zero to 100, but supplies couldn’t bounce back so easily. Factories were on lockdown or navigating Covid-19 restrictions, and raw materials were harder to get because of the sudden swell in demand. Shortages of just about everything cropped up, especially workers to unload goods and drive them to their destination. We’re still untangling the mess at ports around the world.”

And there is another war going on, the Ukraine-Russia war, which is affecting the current spike in energy prices, and is the main reason for this month’s uptick in inflation.

West Texas Intermediate Crude, the U.S. benchmark, was near $88.58 a barrel on Wednesday, with traders focused on supply concerns following decisions by Saudi Arabia and Russia to cut crude supplies through year-end. WTI was trading at a low for the year below $65 a barrel in May.

So we shouldn’t forget such historical events do occur, but also that they have never lasted for long.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Consumer Services Show Growth Rebound

 Popular Economics Weekly

TradingEconomics

Why are the likes of Goldman Sachs chief economist Jan Hatzius predicting no looming recession and better economic growth ahead?

It’s partly because of Bidenomics, the boost to growth that the infusion of $billions into renewal of the US economy in infrastructure, CHIPs manufacturing, and the conversion to more climate friendly policies has jump started.

But it is also because consumers feel prosperous enough to continue to shop and enjoy more leisure activities such as dining out and travel.

The latest indicator of said prosperity is the Institute of Supply Management’s monthly survey of service sector industries that show a continuing expansion rather than contraction of these services, with any number above 50 in its index indicating expansion.

The ISM non-manufacturing Services PMI unexpectedly jumped to 54.5 in August 2023, pointing to the strongest growth in the services sector in six months, compared to 52.7 in July and forecasts of 52.5.

“Thirteen industries reported growth in August’” said Anthony Nieves, Chair of the Institute for Supply Management^® (ISM^®) Services Business Survey Committee.. “The Services PMI^®, by being above 50 percent for the eighth month after a single month of contraction and a prior 30-month period of expansion, continues to indicate sustained growth for the sector. The composite index has indicated expansion for all but three of the previous 162 months.”

The service sector comprises more than 60 percent of economic activity, and overall consumer spending now almost 70 percent; even more important because of the shrinking industrial sector that Bidenomics is attempting to revive.

And surprise, surprise, Real Estate, Rental & Leasing were the leading service activities, with Accommodation & Food Services next in line. Does it mean the real estate sector (and housing) is recovering and could lead US out of the current malaise?

The construction sector, for instance, continues to expand with a total of 67,000 new construction jobs added in just the past three months.

Bidennomics is also helping decrease the growing income inequality, which has poisoned our politics as well as increased drug use and suicide rates among the working age population.

It’s become so bad that the top 1 percent of income earners corralled 19 percent of incomes earned in 2021, per the NYTimes graph, vs. its low of some 10 percent in the 1970s.

NYTimes

In the words of NYTimes David Leonhardt, “He (Biden) has signed laws (sometimes with bipartisan support) spending billions of dollars on semiconductor factories, roads, bridges and clean energy. He has tried to crack down on monopolies. He has encouraged workers to join unions.”

The ISM non-manufacturing survey reported faster increases were seen in business activity (57.3 vs 57.1), new orders (57.5 vs 55), employment (54.7 vs 50.7) and inventories (57.7 vs 50.4). Also, supplier deliveries increased (48.5 vs 48.1). In the last six months, the average reading of 47.7 percent reflects the fastest supplier delivery performance since June 2009.

This all is a sign that the service sector, comprising more than 60 percent of US economic activity is picking up speed, not slowing down.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Here's to a Return of Normal - Part II

 Popular Economics Weekly

MarketWatch

Another unemployment report confirms the US economy is returning to normal, and Americans can breathe easier about the danger of a recession.

By that I mean adding a more normal 187,000 new jobs in July is a sign the economy is cooling enough to drive inflation lower and maybe keep the Fed from further interest rate increases.

Employment growth has fallen below 200,000 two months in a row for the first time since the onset of the pandemic in 2020, although the unemployment rate rose to 3.8 percent from 3.5 percent, the government said Friday.

June and July payroll hires were revised down 110,000 jobs as well in the report and the number of unemployed persons increased by 514,000 to 6.4 million.

Wall Street jumped on the news, as the financial markets had been fretting for most of August that Fed officials would remain hawkish if businesses kept up their hiring pace.

But there aren’t enough available workers to produce more, so both industrial and service sector growth has slowed. The Transportation/warehousing and Information sectors lost jobs, Education & health added the most jobs (+102,000).

Interest rates are still too high for sectors such as manufacturing and real estate that are the holdouts in this recovery. Longer term bond prices have fallen sharply (ergo, yields rising) in tandem with inflation because bonds with fixed rates lose value with rising inflation.

Mortgage rates are putting 30-year conforming fixed rate mortgages above 7 percent, which is keeping many home buyers on the sidelines and holding down a key part of economic activity. Though construction is booming because of the rise in new home starts.

This is important because housing has almost always been a leading indicator that signals expansion or decline of the overall economy even though it is a small part of overall GDP.

FRED30yrfixed

The 30-year fixed rate mortgage average is currently 7.18 percent per FRED in the graph below. It was last this high in March 2002 at the start of the housing bubble that ultimately led to the Great Recession.

However, US pending home sales ticked up again in July by 0.9 percent, rising for the second month in a row despite elevated prices and rising mortgage rates, according to a report released Wednesday by the National Association of Realtors.

“Jobs are being added, thereby enlarging the pool of prospective home buyers,” NAR chief economist Lawrence Yun said. “However, rising mortgage rates and limited inventory have temporarily hindered the possibility of buying for many.”

So, a healthy housing market, as well as steady job creation, is an important part of our return to more normal times.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen