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Learning how to love an overshoot
Simply Economics - May 4, 2018
By Mark Pender, Senior Editor



It was a week filled with signs and with no signs at all, of inflation that is. Core inflation is taking off and the Fed is acknowledging it, but wage inflation is still going nowhere. The mix is an offset keeping in place expectations for moderate growth in inflation and with it moderate rate hikes from the Fed. Yet wages aside, the economic discussion has now been opened to include the risk of accelerating inflation.


The economy

One of the biggest headlines of the week isn't about inflation at all though it is inflationary. The unemployment rate fell 2 tenths in April to 3.9 percent for the lowest rate since 2000 and well under the 4.4 percent low at the height of the last expansion in 2007. The number of unemployed looking for work is down 239,000 to 6.346 million which is the lowest level since 2001 at a time when the civilian workforce numbered 143 million vs the much larger 161.5 million total right now. Is the well of available labor drying up or is the well much deeper than anybody thought? Judging by the labor participation rate, which at 62.8 percent has been hovering at 40-year lows, it should be no surprise if the available supply of labor isn't able to keep up with demand for labor.


Judging by wages, however, there's still plenty of labor available, or at least employers aren't yet having to bid up wages despite drawing from an ever dwindling pool. Annual growth in average hourly earnings has been hovering just above the 2.5 percent line and has not been showing any pickup. Rates in the middle of last year, as seen on the chart, look like easy comparisons for the year-on-year rates this year but they haven't helped, at least yet. Average hourly earnings were expected to approach the 3 percent line two years ago when the unemployment rate first started to move below 5 percent, let alone the sub 4 percent rate where it is now.


But wages are only one part of the inflation picture. One of the week's other big headlines was a giant spike in the core PCE price index, 3 tenths higher to 1.9 percent and just below the Federal Reserve's 2 percent price target. The spike suddenly raises a very unpleasant question for everybody: Is this the first hint that the Fed is getting behind the curve? Costs are rising for housing and medical care and look to rise for imports as well due to the decline in the dollar not to mention tariffs. These costs are still tame but the pressure may be enough to drive core inflation even higher, especially given how easy the year-ago comparisons are from 2017. Note how last year's comparisons will become even easier going into mid-year and the summer.


But would a several month run of rising annual inflation rates be enough to trigger a hawkish strike from the Federal Reserve? Maybe not given that month-to-month rates of growth have remained subdued, at only 0.15 percent whether for average hourly earnings in April or the core PCE in March. For an inflation scare to have any bite, monthly rates are going to have accelerate like the yearly rates. Still the Fed, in its May policy statement and what was the very biggest news of the week, acknowledged the risk of higher yearly rates by emphasizing the two words "symmetric objective" in its inflation goal. This emphasis signals that the Fed will protect an unwanted rise in inflation over 2 percent (by raising rates faster) as much as it would try to boost inflation when under 2 percent (by raising rates slower). Rarely have two such stale words ever let in so much fresh air.


Average hourly earnings are only one key measure of wage pressures. Another is inflation-adjusted disposable income, a measure that usefully includes tax effects. The tax cut gave a boost to this reading early in the year though the strength since has been edging off, to only a 1.7 percent year-on-year growth rate in March. Still this is favorable compared to the last couple of years though hourly earnings in the April employment report don't hint at any upcoming acceleration for disposable income. Real consumer spending, the green line, has been much more consistent holding just under the 3 percent though, like income, it too has been tailing off this year.


The lack of consumer spending punch has been another of the year's puzzles. Yes, wage growth is subdued but job growth has been solid, housing prices are going up, and though the stock market has been volatile, its losses this year have been limited and follow very robust gains last year. Yet an indication on  consumer spending starting the second quarter, following a very flat first quarter, isn't pointing to strength. Vehicles represent about 1/5 of the retail sales report and an early signal of what to expect for April is on the flat side. Unit vehicle sales slipped in the month to a 17.2 million annualized rate vs 17.5 million in March. But not all unit sales are to consumers and when converted to dollars, the two series don't always match up. Yet the results, at the very least, do point to healthy vehicle totals in the April report though perhaps to lower totals.


A rundown of the week's data wouldn't be complete without the latest on the effects of the steel and aluminum import tariffs imposed in March. This was the talk of the ISM business surveys where respondents are warning of related price pressures, disruptions to business planning, and the risk of unforeseen consequences. So far, however, tariff effects aren't really visible in the hard economic data. Amid reports of pre-buying and stockpiling, new orders and inventories for primary metals did rise strongly in March but really not much greater than trend. New orders for primary metals totaled $22.3 million in March for a 3.3 percent year-on-year gain with inventories at $35 billion and up 5.9 percent. In other data, steel imports, which presumably will begin to slow because of the tariffs, rose in March to $2.8 billion compared to $2.2 billion in February.


Markets: Big news, little reaction

It was back in January when the FOMC first upgraded inflation -- an assessment that was followed by a big selloff in the stock market. But stocks this time around hardly showed any reaction at all following the core rate spike or the latest FOMC warning. If the core rate, with or without a boost from wages, begins to move over 2 percent, then the FOMC's updated wording clearly implies a proactive adjustment to policy. Or will they, not wanting to slow the economy, allow inflation to run over for an extended period as they patiently allowed it to run under for so long? After all the news, markets were little changed in the week with the Dow, at 24,262, down 0.2 percent and Treasury yields at 2.51 percent for the 2-year, up 2 basis points, and at 2.95 percent for the 10-year, down 1 basis point. One market that wasn't little changed was oil where West Texas Intermediate, ending at $69.78, rose 2.5 percent in the week and is knocking at the $70 door which, if broken, would add an increasing twist to the inflation picture.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 27-Apr-18 4-May-18 Change Change
DJIA 24,719.22 24,311.19 24,262.51 -1.8% -0.2%
S&P 500 2,673.61 2,669.91 2,663.42 -0.4% -0.2%
Nasdaq Composite 6,903.39 7,119.80 7,209.62 4.4% 1.3%
Crude Oil, WTI ($/barrel) $60.15 $68.06 $69.78 16.0% 2.5%
Gold (COMEX) ($/ounce) $1,305.50 $1,324.90 $1,314.80 0.7% -0.8%
Fed Funds Target 1.25 to 1.50% 1.50 to 1.75% 1.50 to 1.75% 25 bp 25 bp
2-Year Treasury Yield 1.89% 2.49% 2.51% 60 bp 2 bp
10-Year Treasury Yield 2.41% 2.96% 2.95% 54 bp –1 bp
Dollar Index 92.29 91.51 92.61 0.3% 1.2%


The bottom line

Signs of inflation are taking the notice of FOMC members who can't afford to get behind the inflation curve and risk a runaway acceleration in rate hikes. With core inflation suddenly very near the 2 percent goal, the FOMC is now emphasizing the symmetry of its target, implying that an overshoot beyond 2 percent would be met by a policy reaction, that is an acceleration in rate hikes. The risk of a policy bungle, however low of a risk that may be given wages, is nevertheless in the cards for the Fed. And it's not just the effects that are or are not appearing, its the background against which these effects are awaited: full employment.


Week of May 7 to May 11

Average hourly earnings kicked off April's inflation data and will be followed in the coming week by a full run: producer prices on Wednesday, consumer prices on Thursday, and import & export prices on Friday. Only moderate pressures are expected with limited gains seen for year-on-year CPI rates. Adding a final note to the inflation news will be the consumer sentiment report on Friday where, however, inflation expectations have been decidedly subdued. Employment will also be a focus of the week starting Tuesday with the JOLTS report, where job openings have been on the rise, and jobless claims data on Thursday where all the data are pointing to unusually strong demand for labor.




Consumer Credit for March

Consensus Forecast: $16.0 billion

Consensus Range: $11.0 to $19.1 billion


A stronger increase in consumer credit is the call for March, at a consensus $16.0 billion vs $10.6 billion in February. Growth in revolving credit has slowed sharply this year and is one of the factors that has held down consumer spending.




Small Business Optimism Index for April

Consensus Forecast: 105.0

Consensus Range: 104.0 to 106.7


Forecasters are calling for only a small bounce back in the small business optimism index which missed Econoday's low forecast in March on a step back in expectations. Econoday's call for April is 105.0 vs March's 104.7.


JOLTS: Job Openings for March

Consensus Forecast: 6.100 million

Consensus Range: 6.000 to 6.200 million


Job openings are expected to rise slightly in March to 6.100 million vs February's 6.052 million. Openings in this report have been well ahead of hirings suggesting that there are more jobs than workers.




PPI-FD for April

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.2% to 0.5%


PPI-FD Less Food & Energy

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.3%


PPI-FD Less Food, Energy, & Trade Services

Consensus Forecast, Month-to-Month Change: 0.4%

Consensus Range: 0.2% to 0.4%


Moderate inflation has been the trend for producer prices and moderate increases are the forecasts for April: at 0.3 percent for headline PPI-FD, at 0.2 percent excluding food and energy, and at 0.4 percent when excluding food, energy and trade services. Steel prices did show tariff effects in this report in March and further pressure would be closely noted.


Wholesale Inventories for March

Consensus Forecast, Month-to-Month Change: 0.5%

Consensus Range: 0.5% to 0.6%


Wholesale trade inventories are expected to rise a sizable 0.5 percent in March in line with previously released advance data for the month. This would follow very strong builds of 1.0 and 0.9 percent in the two prior months.




Initial Jobless Claims for May 5 week

Consensus Forecast: 220,000

Consensus Range: 218,000 to 229,000


Initial claims are expected to come in at 220,000 in the May 5 week in what would be a 9,000 increase from the prior week which was just above a 49-year low. Low readings in this report are consistent with strong demand for labor.


Consumer Price Index for April

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.1% to 0.5%


Consumer Price Index

Consensus Forecast, Year-on-Year Change: 2.5%

Consensus Range: 2.4% to 2.6%


CPI Core, Less Food & Energy

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.2% to 0.3%


CPI Core, Less Food & Energy

Consensus Forecast, Year-on-Year Change: 2.2%

Consensus Range: 2.0% to 2.3%


Forecasters are calling for modest-to-moderate pressures in the April consumer price report, at a headline monthly gain of 0.3 percent but a core rate gain of only 0.2 percent. Year-on-year rates are both expected to rise but only 1 tenth each, to 2.5 percent overall and 2.2 percent for the core.


Treasury Budget for April

Consensus Forecast: $88.0 billion

Consensus Range: -$5.0 billion to $130.0 billion


Corporate tax receipts have falling at the same time that spending has been going up. Six months into the 2018 fiscal year, the government's deficit through March was 13.8 percent deeper than the prior year. For April, a big tax month, forecasters see the Treasury budget coming in at a surplus of $88.0 billion.




Import Prices for April

Consensus Forecast, Month-to-Month Change: 0.5%

Consensus Range: 0.3% to 0.7%


Export Prices

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.2% to 0.3%


Inflationary effects of the lower dollar and metal tariffs are the risks for import prices which forecasters see rising a less-than-moderate 0.5 percent in April. Export prices are seen up a moderate 0.3 percent.


Consumer Sentiment Index, Preliminary May

Consensus Forecast: 99.0

Consensus Range: 98.0 to 100.0


The consumer sentiment is expected to move higher in the preliminary reading for May, to 99.0 vs April's final reading of 98.8 and well above April's mid-month reading of 97.8. This index has been edging off unusually strong readings earlier in the year, gains triggered by this year's tax cut. Inflation expectations in this report, which are closely watched, have been very soft.


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