Inflation Specifics
Inflation has been increasing modestly this year. Since the inflation most often focused on is the year over year data, it’s important to recognize that there are base effects helping the rate look better than it is. It’s easy to grow on top of the disappointing growth numbers in 2017. The base effects will be supportive of year over year inflation until October. If you remember, Janet Yellen blamed the decline in inflation on the decrease in wireless telephone costs.
As you can see in the chart below, there was a sharp down turn in wireless telephone prices in the middle of 2017. That being said, if one industry can bring down inflation, it isn’t that strong to begin with. The blue line shows internet services are currently seeing a decline in prices. There’s a new excuse as to why inflation isn’t increasing as much as some expected. Internet speeds have increased so much over the years, a flat price is great for consumers. 5G access, which should start being implemented in 2020, will be transforming both the internet and wireless phone businesses. The services are merging into one as the telecom firms grow their tentacles.
Higher Gas Prices
The Bloomberg Consumer comfort index shows there was a slight decline in consumer optimism as the index fell from 56.5 to 55.8. The height of this index was mid-April when it was at 58.1 As you can see, there hasn’t been much of a decline, but you wouldn’t expect one with the tax cuts putting more money in the consumers’ pockets. One catalyst for consumer optimism to fade is higher gas prices. Gas is a relatively small amount of a typical person’s budget, but when prices hit psychologically important levels like $3 or $4 consumers start driving less. This is pivotal because the consumer spends less at retail outlets when they drive less. More spending is done online than ever before, but the majority of money is still spent in person. Rising oil prices could push consumers to shop more online and make some more people subscribe to Amazon Prime as if consumers needed more of a reason to get it.
The chart below shows the price of gas in the past 12 months compared to the previous 12 months. The price per gallon has almost risen to $3 which will hurt the consumer. As you can see, the chart’s sub-heading shows 1/3rd of the tax withholding benefit will be eliminated if oil prices stay at these levels. The big catalysts which can push them higher is accelerated economic growth in America and destabilization in the Middle East caused by the negotiations with Iran.
GDP Estimates
The GDP estimates in the regional Fed models don’t have much data to go by for their Q2 predictions, but it’s worth setting the stage for the expectations for Q2 as the economic data comes in. The Atlanta Fed model is expecting 4% growth which is much higher than the blue chip average estimate of 3.1%. The Atlanta Fed model gets a lot of criticism because it generally comes out with very high estimates before falling. This quarter it started at 4.1% growth. Usually, the initial estimate is really high because of the positive ISM reports. The ISM reports for April were less positive than they have been in the past few months, yet the Atlanta fed model is still optimistic.
I’m expecting above 3% growth, so this time there may not be a sharp drawdown. It all depends on the May and June economic data. The St. Louis Fed forecast is 3.86% which is very close to the Atlanta Fed model. Last quarter the St. Louis Fed model was way too optimistic. It still didn’t face the level of criticism the Atlanta Fed model did. The NY Fed Nowcast is the least optimistic as it expects 2.97% growth. I take this one the most seriously early in the quarter because it comes out the earliest, meaning it includes the most data. It has been modeling Q2 growth since March 2nd.
Tight Labor Market
The latest jobless claims report showed 211,000 claims which is flat from last year and 9,000 below the consensus. It brought the 4 week average down 5,500 to a new 49 year low of 216,000. The chart below seems to indicate the labor market is just as tight as the jobless claims data suggests. As you can see, there are 2.55 people who are actively looking for work, want a job, or are involuntarily working part time per job opening. That is the lowest point since December 2000. I have been delivering the thesis that the labor market isn’t tight because the employment to population ratio and labor force participation ratio for prime aged workers haven’t recovered to the levels seen in the previous two cycles.
Another potential explanation for why there hasn’t been big gains in wage growth even though the jobless claims to population ratio is at a record low and the unemployment rate is 3.9% is that the labor market is tight, but it just won’t ever deliver huge wage growth gains. Weak wage growth with a tight labor market defies the logic of supply and demand, but that’s exactly what we’ve seen in Japan as it has a higher labor participation rate and a 2.5% unemployment rate, yet economists are only expecting 1% wage growth in 2018. This second thesis is much more negative because the first one suggests delayed gains, while this one suggests the gains aren’t coming at all.
Conclusion
Consumers will need to deal with higher gas prices if oil stays in the low $70 range. When consumers see gas hitting a new round number, they drive less. That means the summer driving season will be impacted. The labor market is very tight yet wage growth is lower than previous cycles. That leads me to wonder if America is becoming Japan which has a 2.5% unemployment rate along with only 1% wage growth.
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