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Popular Economics Weekly

When will inflation subside enough to bring down interest rates again? There are estimates that it takes from one year to 10 years to cure large inflation spikes such as occurred this year, based on what pundits and economists see as past history.

But that hasn’t stopped shoppers. Retail sales that account for some half of consumer spending jumped a huge 1.3 percent in October, 7.6 percent YoY.

FREDretailsales

Consumers are keeping up with inflation, in other words, because it’s the holidays and they want to celebrate their world returning to normal. Dining out at restaurants increased 1.3 percent in October, twice the current inflation rate.

And inflation is already cooling. The Fed has pumped up short-term rates from essentially zero to 4 percent in 2022, which has pummeled stock and bond prices. But financial markets rallied on Tuesday because the Producer Price Index (PPI) for wholesale goods and services continued to decline. Wholesale prices in October rose just 0.2 percent month-month and core inflation without food, energy and trade services declined from 5.6 to 5.4 percent YoY.

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My bet is that inflation will drop quickly during the coming winter as supply chains continue to improve, which ground to a halt during the worldwide pandemic lock downs.

For instance, the NY Federal Reserve’s Global Supply Chain Pressure Index (GSCPI) stated as much in its latest release. “The GSCPI’s year-to-date movements suggest that global supply chain pressures are falling back in line with historical levels,” it said.

It means that consumer prices will continue to decline as well, since the PPI measures the raw materials and data that go into retail products and services.

Alas, retail inflation is still too high, since the CPI declined to 7.7 percent in October compared to a year ago, down from 8.2 percent in September. Predictions are all over the map as to when the inflation rate will return to a more normal range. Treasury Secretary Janet Yellen has said in recent testimony it could take several years to return to the Federal Reserve’s two percent target.

Other pundits are predicting as much as 10 years, because they cite the 1970’s era of stagflation. Inflation soared to as high 14 percent in 1981 after 10 years of wage-price spirals. It was another 10 years before inflation returned to its more normal 2-3 percent range.

But this inflationary spiral has lasted just months, not years as in the 1970s, as Nobel Prize-winner and former Federal Reserve Chair Ben Bernanke has pointed out. So, there’s no reason for anyone to press the panic button, stock and bond traders included. Consumers are riding this inflation wave just fine to date.

Why shouldn’t they be upbeat, with Americans still fully employed?

The New York Fed also publishes a Survey of Consumer Expectations of inflation also shows inflation is a short-term problem. “Median one- and three-year-ahead inflation expectations increased to 5.9 percent and 3.1 percent from 5.4 percent and 2.9 percent, respectively. (But) The median five-year-ahead inflation expectations, meanwhile, rose by 0.2 percentage point to 2.4 percent.”

Wholesale prices are still high. The Producer Price Index for final demand in the U.S. rose 0.2 percent month-over-month in October of 2022, the same as a downwardly revised 0.2 percent increase in September. Goods cost went up 0.6 percent, the largest advance since a 2.2 percent rise in June, mainly pushed by a 5.7 percent jump in gasoline cost. Prices for diesel fuel, fresh and dry vegetables, residential electric power, chicken eggs, and oil field and gas field machinery also advanced. In contrast, the index for passenger cars declined 1.5 percent. Meanwhile, services cost fell 0.1 percent, the first decline since November of 2020.

So, the inflation outlook is muddled, but consumers’ inflation expectations give us a better picture of how consumers will behave in the future. It is another ingredient that helps to determine the Fed’s next move, and when shoppers buy or hold.

All this news backs my bet of inflation falling back to historical levels as soon as next summer.

Harlan Green © 2022

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

Financial FAQs

CPI inflation declined to 7.7 percent in October compared to a year ago, down from 8.2 percent in September, the government said Thursday. But it’s not making consumers any happier with the approach of the holidays. The University of Michigan’s survey of consumer sentiment also declined further to 54.7 from 59.9.

Food prices rose 10.9 percent year-over-year. Food at home — grocery store or supermarket purchases — increased by 12.4 percent, ticking down from 13 percent in September, and rose 0.4 percent on the month, the smallest monthly increase in the category since last December, said MarketWatch’s Jeffery Bartash.

But several categories rose far more than the overall rate of inflation. Egg prices rose 43% year-over-year in October, butter increased by 26.7%, and flour and prepared flour mixes were up 24.6%. Lettuce prices rose 17.7% year-over-year, while bread and milk prices rose by 14.8% and 14%, respectively.

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Such unpleasant news could continue due to a typical scarcity of these products in winter.

“Declines in sentiment were observed across the distribution of age, education, income, geography, and political affiliation, showing that the recent improvements in sentiment were tentative,” wrote Joanne Hsu, director of the survey, in a statement. “Instability in sentiment is likely to continue, a reflection of uncertainty over both global factors and the eventual outcomes of the election.”

UMichigan

How fast will prices continue to decline that might improve sentiment? I noted recently that market strategist Jim Paulsen of the Leuthold Group has done research on the history of such inflationary spikes, and they seem to behave similarly, regardless of monetary policies.

CPI inflation generally taken 12 months to return to more normal levels from its high point, he said. Since this inflation spike peaked in March-April 2022 he maintains we should see inflation returning to a normal range of 2-3 percent by next March-April 2023.

And consumer surveys already show consumers becoming more confident about the future with longer-term inflation expectations holding at 3 percent over the next five years.

Thursday’s 1,000 + point surge of the DOW following news of the latest CPI report may have been prompted by Paulsen’s remarks last Tuesday in a recent CNBC interview that “we may by heading for a new recovery rather than a recession.”

That is to say, if we see inflation continuing to decline into the new year, as Paulsen predicts.

Harlan Green © 2022

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

Financial FAQs

FREDdurablegoods

After four consecutive 0.75 percent rate hikes, the Fed should slow down its rate increases, say at least three Federal Reserve Governors. That is good news as we try to assess the likelihood of another recession.

It’s good news because there are already signs of a possible soft landing in 2003, if the Fed will take their foot off the economic brakes until there is more certainty of its tightening efforts down the road.

Reuters quotes the Chicago Fed’s Charles Evens (San Francisco and Richmond Fed Presidents also advocate slowing) that it is time for the Federal Reserve to shift to smaller interest rate hikes to avoid tightening monetary policy more than needed and slow the pace further once risks become more “two-sided,” (i.e., a possible recession) Chicago Fed President Charles Evans said on Friday.

“From here on out, I don’t think it’s front-loading anymore, I think it’s looking for the right level of restrictiveness,” Evans told Reuters in an interview, referring to the U.S. central bank’s string of supersized rate hikes.

If the Fed did nothing more this year, we could have a ‘soft landing’ since growth is already slowing in both the manufacturing and service sectors of our economy.

New orders for factory goods are down, for instance (see top line in above FRED graph from 2/92) and holding at a lower level of activity. Orders for manufactured goods rose 0.3 percent in September, the Commerce Department said last Thursday, and orders have risen eleven months of the past year. The factory sector led the economy’s recovery from the pandemic because of huge pent-up demand for things like automobiles and other durable goods after the pandemic.

The ISM’s manufacturing index is now close to breakeven. The S&P global U.S. manufacturing PMI inched up to 50.4 in its “final” reading in October from the “flash” reading of 49.9. This is down from a reading of 52 in September.

“The U.S. manufacturing sector continues to expand,” said ISM Chair Timothy Fiore, “but at the lowest rate since the coronavirus pandemic recovery began. With panelists reporting softening new order rates over the previous five months, the October index reading reflects companies’ preparing for potential future lower demand.”

The Institute for Supply Management (ISM) serviced sector (non-manufacturing) Index that measures conditions at companies such as retailers and restaurants fell to 54.4 percent in October and touched the lowest level since the U.S. lockdowns in 2020, pointing to a slowing U.S. economy. A number above 50 signals expansion; but settling in a more normal range typical of a slower growing economy.

Granted this is before the Fed’s latest rate hikes take hold that could reduce the demand for goods and services even further. Consumer borrowing that is reported by the Fed is a better indicator of consumer wherewithal, since they wouldn’t be shopping as much if they fear an imminent recession.

Consumercredit

Consumer credit has been declining slowly, but again it is back to more normal pre-pandemic levels (see above Fed chart from 1/04). Revolving credit, like credit cards, rose 8.7 percent in September, less than half of the 18.1 percent gain in the prior month. Nonrevolving credit, typically auto and student loans, rose 5.7 percent, up from a 4.5 percent growth rate in the prior month. This category of credit is much less volatile.

The growing danger is to continue to tighten while there are still shortages of food and energy supplies, while demand is already shrinking in the rest of the world.

China’s economic woes are one example. Reuters reports “China’s exports and imports unexpectedly contracted in October, the first simultaneous slump since May 2020, as a perfect storm of COVID curbs at home and global recession risks dented demand and further darkened the outlook for a struggling economy.”

The San Francisco Fed has also flagged the danger with its own published research that suggests we have already tightened too much. U.S. monetary policy is tighter than the Federal Reserve’s policy rate suggests, according to research published Monday by the San Francisco Fed, with financial conditions by September 2022 reflecting the equivalent of a 5.25 percent policy rate, which it the top boundary of Chairman Powell’s own prediction.

“Accounting for the broader stance of policy and comparing the proxy rate to simple rules suggests U.S. monetary policy tightened sooner and more sharply than has been generally recognized,” the Letter said.

Given what could be a brutal economic winter for much of the world, and demand maybe reaching parity with supply so that risks become more “two-sided” in Chicago Fed President Charles Evans words, we may now see a more benevolent Federal Reserve and enjoy the possibility of a soft landing.

Harlan Green © 2022

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

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Roosevelt Institute

Paul Krugman has forwarded an excellent blog piece by Roosevelt Institute Fellow Justin Bloesch on why we can maintain near-full employment while inflation is returning to the rate that prevailed prior to the pandemic.

Bloesch maintains that full employment and 2 percent inflation rates are possible because there is no longer a higher “natural rate” of unemployment that the Fed must maintain to bring down inflation.

The Fed believes that the best way to bring down inflation is to slow economic growth by inducing lower consumer spending and capital investment by continuing to boost their short-term interest rate target to somewhere between 4.5 to 5 percent.

But the current 3.5-3.6 percent unemployment rate has prevailed since March 2022 even while wage growth and consumer spending have been slowing that are the major ingredients of inflation.

Top that off with supply-side bottlenecks already easing and commodity prices falling, leading us to believe that inflation will return to more historical levels by the spring of 2023.

The probability of such a return to more historical inflation levels of 2-3 percent that prevailed since the 1990s is further increased should the Ukraine War quiet down and China get its post-pandemic COVID problems resolved.

Justin Bloesch’s graph shows that COVID’s shock to the employment system was uniform across all sectors, and the post-pandemic recovery has been uniform across all job sectors as well. This suggests that the COVID pandemic was the main cause of the inflationary surge, and as infection rates continue to decline, more people will want to return to work, keeping unemployment low, and lowering the pressure for employers to raise wages further.

“The better explanation for a temporarily high V/U ratio (i.e., job vacancy to unemployment), and the overall high level of churn in the economy, is just that the economy was rapidly emerging from the pandemic. Many workers did lose their jobs and took jobs in new sectors, and demand for labor was both high and growing rapidly,” said Bloesch. However, as the economy shifts to a slower pace of growth, it is likely that recruiting activity can fall without triggering layoffs.”

This is while the Fed seems to believe that we can’t maintain full employment and a tight labor market without pushing wages even higher as employers compete for scarce workers.

We have had lower inflation during the last few decades, an era labeled the “great moderation” by economists, because of modern technologies like faster just in time supply chains and improved production facilities jn many Asian and third world countries that created an excess of goods and services worldwide.

Harvard Professor Jeffery Frankel, a member of President Clinton’s Council of Economic Advisors, sees commodity prices in particular continuing downward in a recent Project Syndicate article because of the current economic malaise.

“There are two macroeconomic reasons to think that commodity prices in general will fall further. The (slowing) level of economic activity is a self-evidently important determinant of demand for commodities and therefore of their prices. Less obviously, the real interest rate is another key factor. And the current outlook for both global growth and real interest rates suggests a downward path for commodity prices.”

There doesn’t have to be such a draconian tradeoff between what has been called a “natural rate” of unemployment and inflation. In fact, the relationship between employment and inflation seems to have created a lower “natural rate” than the Fed and many forecasters are using to determine what is the ideal interest rate target the Fed should be shooting for.

This is important and might prevent the large number of layoffs the Fed is expecting because of their current policies, given today’s market conditions in a fast-changing world.

Tomorrow’s release of the government’s first estimate of Q3 GDP growth may give us a hint of what kind of slowdown we are already experiencing.

Harlan Green © 2022

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

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Conference Board

One economic growth measure acknowledged by market professionals but few else is the Conference Board’s Index of Leading Economic Indicators (LEI) that attempts to forecast future economic activity. And it is signaling an upcoming recession, according to its director.

“The US LEI fell again in September and its persistent downward trajectory in recent months suggests a recession is increasingly likely before yearend,” said Ataman Ozyildirim, Senior Director, Economics, at The Conference Board. “The six-month growth rate of the LEI fell deeper into negative territory in September, and weaknesses among the leading indicators were widespread. Amid high inflation, slowing labor markets, rising interest rates, and tighter credit conditions, The Conference Board forecasts real GDP growth will be 1.5 percent year-over-year in 2022, before slowing further in the first half of next year.”

So it is predicting contraction later this year: “The negative contributors—beginning with the largest negative contributor—were stock prices, average consumer expectations for business conditions, the ISM® New Orders Index, the Leading Credit Index™ (inverted), and manufacturers’ new orders for nondefense capital goods excluding aircraft,” said the LEI.

The labor market is slowing but it is still tight with initial jobless claims ultra-low, and inflation beginning to decline, which makes it less likely the U.S. slides into recession this year.

Prices are already plunging is many areas not covered by the standard inflation indexes. The New York Federal Reserve has said its September Survey of Consumer Expectations found that respondents projected their spending will rise by 6 percent over the next year, a sharp drop from the 7.8 percent rise predicted in the August survey. The bank noted that decline in spending expectations was the biggest since the survey began in 2013, while inflation expectations are holding steady, even declining slightly in the near term.

This will be a Federal Reserve induced recession if it materializes. Stock prices and consumer spending are down because of the higher interest rates, with the housing market, another leading indicator, already in recession.

The COVID pandemic and war in Ukraine have thrown a monkey wrench into economic policymaking because inflation reared up so quickly after the worldwide shutdown of economic activity, while governments and Central Banks spent $trillions in various COVID rescue packages in the face of worldwide shortages of goods and services—especially food and energy.

I quoted Adam Tooze, a well-regarded economic historian, last week as sounding the alarm in a recent NYTimes Opinion.

“We now find ourselves in the midst of the most comprehensive tightening of monetary policy the world has seen. And raising interest rates is not going to bring more gas or microchips to market, but rather the contrary. Reducing investment will limit capacity and thus reduce future supply”

Yet the Conference Board’s confidence index signals consumers are still upbeat, at least through the holidays, which makes it also less likely we see a downturn this year.

“…purchasing intentions were mixed, with intentions to buy automobiles and big-ticket appliances up, while home purchasing intentions fell,” said the Conference Board. The latter no doubt reflects rising mortgage rates and a cooling housing market. Looking ahead, the improvement in confidence may bode well for consumer spending in the final months of 2022, but inflation and interest-rate hikes remain strong headwinds to growth in the short term.”

In fact, Gross Domestic Product is predicted to grow more than 2 percent in Q3 and slightly less in the fourth quarter. So, no recession is yet in the works—at least this year.

Harlan Green © 2022

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

Popular Economics Weekly

FREDretailsales

Another part of the inflation puzzle is retail sales; probably the most important picture of consumer demand since consumers power some 70 percent of economic activity. Any decline in retail sales helps the Federal Reserve decide when consumer demand for goods and services cools enough to slow rising inflation, and hence interest rates.

So, its good news to see that retail sales dropped sharply in one month—from 15.5 percent in March 2022 to just 5 percent in April 2022 YoY.

That’s also when Putin began his invasion of Ukraine and food and energy prices began to surge. It’s a sign that consumers pay attention to inflation and are cutting back on spending of their own accord.

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What the headlines don’t yet grasp is that retail sales flattened out in April, as did the 40-year spike in the Consumer Price Index, which has risen just 2 percent over the past three months.

Retail sales are now rising at 7.7 percent YoY and are barely keeping up the with the 8 percent inflation rate. Total sales were flat rather than up 0.2% in September as we had expected, said Reuters:

“Retail sales are slowing as spending shifts back to services. Sales at auto dealerships slipped 0.4% last month, while receipts at service stations dropped 1.4%. Furniture store sales fell 0.7%, while those at building material and garden equipment retailers decreased 0.4%.”

A survey from the University of Michigan on Friday showed consumer sentiment improved further in October, but inflation expectations deteriorated a bit as average national gasoline prices moved towards $4 per gallon after falling over the summer.

“Continued uncertainty over the future trajectory of prices, economies, and financial. markets around the world indicate a bumpy road ahead for consumers,” said survey director Joanne Hsu. “The median expected year-ahead inflation rate rose to 5.1%, with increases reported across age, income, and education. Last month, long run inflation expectations fell below the narrow 2.9-3.1% range for the first time since July 2021, but since then expectations have returned to that range at 2.9%.”

It looks like consumers via their spending habits will know and be the first to tell the Fed when the inflation dragon has been tamed.

Harlan Green © 2022

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