The stock market may very well be helped by international developments and key US economic data this week. The Treasury market will likely give back of some of last week's oil-related gains.
The ups and downs of Trump's international efforts risk helping stocks in the next week or two, as the summit with Kim Jong Un appears to be almost back on course. The press will probably focus on the extent to which Trump gets the North Koreans to give up their nuclear weapons. Just as important for the markets will be the positive implication of the summit for a resolution of the US/Chinese trade dispute. Since China is North Korea's main backer, a summit would suggest China stood back from stopping it, hoping in exchange for the US to bend somewhat in its trade demands.
The implications of a US/Chinese trade agreement may not be positive for stocks longer term, however. A negotiated reduction in the US/China deficit, even by having China buy more US exports, would serve to boost the US dollar's exchange rate. This would hurt US exports. And, ironically, if the negotiated boost in US exports is in agricultural goods, other exports -- e.g., manufactured goods -- would be hurt the most. It also would hurt the dollar value of US corporate profits earned abroad. A stronger dollar should serve to depress commodity prices, such as oil, as well.
Aside from these international developments, this week's key US economic data should underscore a strong economy with little inflationary pressures. Consensus looks for no revision in the 2nd estimate of Q118 Real GDP Growth, due Wednesday. But, I would not be surprised if it is revised up from the 2.3% first print. On Thursday, the consensus estimate of +0.1% m/m in the April Core PCE Deflator has more downside than upside risk based on composition differences between the Deflator and the CPI. On Friday, there is probably downside risk to the +185k m/m consensus estimate for May Nonfarm Payrolls, after having climbed 164k in April. March-April Payrolls have followed a similar path to last year's. Last year, May Payrolls slowed from April's pace. The consensus estimate of a steady 3.9% Unemployment Rate looks reasonable, but history has a lot of examples when a large m/m decline, as in April, is followed by a further decline the subsequent month. The consensus estimate of a 0.2% m/m increase in Average Hourly Earnings risks being too high. Calendar considerations point to a 0.1% print -- lowering the y/y to 2.5% from 2.6%. The consensus expectation of an increase in the May Mfg ISM to 58.0 from 57.3 looks reasonable, based on the increase in the Richmond Fed Mfg Index. The two moved in the same direction each month this year, although in only 7 of 12 months in 2017.
Sunday, May 27, 2018
Sunday, May 20, 2018
Inflationary Fear of Higher Oil Prices Overdone?
The markets are paying close attention to oil prices now that they've broken above $70/bbl. Some analysts expect the price to climb as high as $80 in coming months. The fear that this will spur higher inflation is probably overdone, however. At some point, the Treasury market should realize it has overreacted.
The run-up in oil prices, like the imposition of tariffs, is a relative price change. To be sure, it will show up in a wide range of price increases as this cost gets passed through to the consumer. But, even these pass-throughs will end eventually. If natural gas prices get pulled up in the process, there actually could be an offset in the Core CPI -- they could hold down the important Owners' Equivalent Rent, since they are subtracted out of rent in the calculation of OER. Also, retailers could cut other prices (taking a hit on margins) in response to a softening in consumer spending on non-oil goods and services.
The rise in oil prices would be inflationary only if it leads to faster wage inflation, which would be the case if labor is successful in regaining its lost purchasing power. The relationship between oil prices and wage inflation is tenuous, however, now that cost of living adjustments in labor contracts are rare.
The increase in oil prices is a net negative for the real economy. On the negative side, consumption will be hurt. With the US consuming 7.2 Bn barrels of petroleum products a year and oil prices up over $13/bbl this year, the increase is equivalent to a tax increase of about $100 Bn (about 0.5% of GDP). On the positive side, slightly less than half of this amount is "collected" by domestic oil producers. Their increased revenue should lead to increases in oil production, investment in oil wells, and dividends. On balance, the run-up in oil prices could subtract 0.2-0.3% pt from GDP Growth.
The run-up in oil prices, like the imposition of tariffs, is a relative price change. To be sure, it will show up in a wide range of price increases as this cost gets passed through to the consumer. But, even these pass-throughs will end eventually. If natural gas prices get pulled up in the process, there actually could be an offset in the Core CPI -- they could hold down the important Owners' Equivalent Rent, since they are subtracted out of rent in the calculation of OER. Also, retailers could cut other prices (taking a hit on margins) in response to a softening in consumer spending on non-oil goods and services.
The rise in oil prices would be inflationary only if it leads to faster wage inflation, which would be the case if labor is successful in regaining its lost purchasing power. The relationship between oil prices and wage inflation is tenuous, however, now that cost of living adjustments in labor contracts are rare.
The increase in oil prices is a net negative for the real economy. On the negative side, consumption will be hurt. With the US consuming 7.2 Bn barrels of petroleum products a year and oil prices up over $13/bbl this year, the increase is equivalent to a tax increase of about $100 Bn (about 0.5% of GDP). On the positive side, slightly less than half of this amount is "collected" by domestic oil producers. Their increased revenue should lead to increases in oil production, investment in oil wells, and dividends. On balance, the run-up in oil prices could subtract 0.2-0.3% pt from GDP Growth.
Sunday, May 13, 2018
Macroeconomic Background Remains Good -- And A Critique of the Critics
The macroeconomic background remains positive for stocks and neutral to negative for Treasuries. Real GDP Growth should speed up in Q218 -- and US economic data over the next two weeks should support this expectation. While Payrolls still risk printing sub-200k in May, they are climbing above trend -- as seen in the decline in the Unemployment Rate to 3.9% in April. Meanwhile, underlying inflation is subdued.
This background has puzzled a number of prominent economists, including Larry Summers, Paul Krugman and Alan Blinder. They recognize that conventional models do not predict this scenario of above-trend growth, low unemployment and stable inflation. In my view, these models don't adequately capture, if at all, the impact of the globalization of output and labor markets. In addition, the models don't capture the effects of regulatory clampdown on bank lending after the 2008 financial crisis. These considerations support a gradual tightening approach by the Fed and possibly a lower end point than Fed officials project.
Secular Stagnation
Summers defends his secular stagnation thesis, arguing the above-trend growth resulted from temporarily stimulative fiscal policy. He also argues the stimulative monetary policy of the past several years, with its negative real interest rates, is unsustainable in the long run, as it likely leads to rising "financial risk, unsound lending and asset bubbles with potentially serious implications for medium-term stability."
I would argue the need for policy-induced excessive spending by the federal or private sector is required to maintain GDP in the face of China and other countries keeping their currencies low for the purpose of grabbing market share in the US. So, what seems to be temporary may have to be a permanent fixture of the US economy -- unless Trump is successful in getting China to change its ways.
The stimulative fiscal and monetary policies offset the drag from higher imports on US GDP Growth. In other words, some sector of the US economy -- public or private -- needs to spend more than normally to make up for the output lost to China. And, in a growing economy, with an ever-increasing drain of spending abroad, this "deficit" spending (in dollar terms) has to increase over time. The secular stagnation observed by Summers is likely in part a result of the excessive spending not being enough to fully offset the drag from the Chinese grab.
The other likely cause of the sub-par growth in the past few years was an overly aggressive clamping down of bank lending practices (as well as other regulations with anti-growth implications). Tighter bank lending standards worked against low interest rates in their attempts to spur economic growth. It is probably an important reason why the "neutral" funds rate is below levels seen prior to the Great Recession, as Fed officials keep mentioning.
Phillips Curve Doesn't Work
Krugman and Blinder point out that the failure of wage inflation to rise significantly when the Unemployment Rate fell sharply to low levels runs counter to the Phillips Curve. (The Phillips Curve relates wage inflation to labor market conditions and inflation expectations.) Estimated models of the Phillips Curve do not contain a variable representing competition from low-paid workers in other countries. And, my guess is that this competition or the fear of it has kept wage inflation at bay. So, while some pickup in wage inflation is likely, given the tightening US labor market, the pickup will probably be more muted than standard models predict.
Recent and Upcoming Inflation Data
The April Core PPI and Core CPI were noteworthy since their low 0.1% m/m prints reflected widespread softness. In particular, the decline in Household Appliances in the Core PPI supported the idea that the impact of tariffs (remember the tariff on washing machines in January) would be temporary -- a relative price change rather than a pickup in underlying inflation. While airfares dropped 2.7% m/m in the April CPI, they subtracted a tiny 0.02% pt from the Core CPI. So, even if they rebound in May -- which is likely given the jump in oil prices and the increase in airfares seen in the PPI over the past few months -- they may not give a noticeable lift to the Core CPI.
Looking ahead, May Average Hourly Earnings risk printing a low 0.1% m/m -- as they did in April, based on calendar considerations as well as the fundamental factors mentioned above. The y/y would edge down to 2.5% from 2.6%.
This background has puzzled a number of prominent economists, including Larry Summers, Paul Krugman and Alan Blinder. They recognize that conventional models do not predict this scenario of above-trend growth, low unemployment and stable inflation. In my view, these models don't adequately capture, if at all, the impact of the globalization of output and labor markets. In addition, the models don't capture the effects of regulatory clampdown on bank lending after the 2008 financial crisis. These considerations support a gradual tightening approach by the Fed and possibly a lower end point than Fed officials project.
Secular Stagnation
Summers defends his secular stagnation thesis, arguing the above-trend growth resulted from temporarily stimulative fiscal policy. He also argues the stimulative monetary policy of the past several years, with its negative real interest rates, is unsustainable in the long run, as it likely leads to rising "financial risk, unsound lending and asset bubbles with potentially serious implications for medium-term stability."
I would argue the need for policy-induced excessive spending by the federal or private sector is required to maintain GDP in the face of China and other countries keeping their currencies low for the purpose of grabbing market share in the US. So, what seems to be temporary may have to be a permanent fixture of the US economy -- unless Trump is successful in getting China to change its ways.
The stimulative fiscal and monetary policies offset the drag from higher imports on US GDP Growth. In other words, some sector of the US economy -- public or private -- needs to spend more than normally to make up for the output lost to China. And, in a growing economy, with an ever-increasing drain of spending abroad, this "deficit" spending (in dollar terms) has to increase over time. The secular stagnation observed by Summers is likely in part a result of the excessive spending not being enough to fully offset the drag from the Chinese grab.
The other likely cause of the sub-par growth in the past few years was an overly aggressive clamping down of bank lending practices (as well as other regulations with anti-growth implications). Tighter bank lending standards worked against low interest rates in their attempts to spur economic growth. It is probably an important reason why the "neutral" funds rate is below levels seen prior to the Great Recession, as Fed officials keep mentioning.
Phillips Curve Doesn't Work
Krugman and Blinder point out that the failure of wage inflation to rise significantly when the Unemployment Rate fell sharply to low levels runs counter to the Phillips Curve. (The Phillips Curve relates wage inflation to labor market conditions and inflation expectations.) Estimated models of the Phillips Curve do not contain a variable representing competition from low-paid workers in other countries. And, my guess is that this competition or the fear of it has kept wage inflation at bay. So, while some pickup in wage inflation is likely, given the tightening US labor market, the pickup will probably be more muted than standard models predict.
Recent and Upcoming Inflation Data
The April Core PPI and Core CPI were noteworthy since their low 0.1% m/m prints reflected widespread softness. In particular, the decline in Household Appliances in the Core PPI supported the idea that the impact of tariffs (remember the tariff on washing machines in January) would be temporary -- a relative price change rather than a pickup in underlying inflation. While airfares dropped 2.7% m/m in the April CPI, they subtracted a tiny 0.02% pt from the Core CPI. So, even if they rebound in May -- which is likely given the jump in oil prices and the increase in airfares seen in the PPI over the past few months -- they may not give a noticeable lift to the Core CPI.
Looking ahead, May Average Hourly Earnings risk printing a low 0.1% m/m -- as they did in April, based on calendar considerations as well as the fundamental factors mentioned above. The y/y would edge down to 2.5% from 2.6%.
Sunday, May 6, 2018
Inflation Risks At Center Stage This Week
Inflation risks will likely be a major focus for the markets as this week progresses. Rumors or leaks ahead of Trump's May 12th decision regarding the Iran nuclear deal risk roiling oil prices. And, the April CPI is due Thursday, May 10. A near-consensus print is likely. Stocks and Treasuries should rally if some relaxation in Trump's hard stance against Iran is leaked (a negative for oil prices) and the Core CPI prints at or below consensus. They should sell off if the opposite happens.
This week's key US economic report is the April Core CPI. Another decline in apparel prices is likely, based on their bi-monthly sampling and further payback for their huge increases in January-February. But, this may just keep the Core CPI at the consensus 0.2% m/m, as it did in March.
Recent history shows no significant tendency for the April Core CPI to diverge from the January-February average, barring unusual factors such as the drop in telephone service prices pulled down the Core CPI in both March and April 2017. The tendency to rise near the January-February pace hints at a high April 2018 Core CPI. But, the January-February 2018 pace would have been 0.2% m/m without the unusual jumps in apparel prices, which is probably more realistic for comparison purposes.
Core CPI (m/m % change)
April March Jan-Feb Average
2018 na 0.18 0.27
2017 0.09 -0.07 0.22
2016 0.20 0.13 0.22
2015 0.25 0.26 0.25
Recent history also shows the Core CPI rising over Q2 similarly to how much it rose over Q1.
Core CPI (quarterly average of m/m % change)
Q2 Q1
2018 na 0.24
2017 0.10 0.17
2016 0.19 0.19
2015 0.18 0.16
The macroeconomic background is playing out as I had expected: The strong data in Q118 are giving back some of their oversized gains, while the weak data are picking up. Payrolls have slowed in the past two months, after large gains in January-February. There is still room in terms of payback for a below-trend increase in May Payrolls. In contrast, early data point to a speedup in Q218 Real GDP Growth. The NY Fed and Atlanta Fed models' estimates are now 3.0% and 4.0% (q/q, saar) for Q218 Real GDP Growth versus the 2.3% advance print for Q118.
The 2.3% Q118 Real GDP Growth Rate has been termed weak by many market commentators. But, this is a misrepresentation. Growth was above trend (1.8%) in a quarter that tends to be relatively weak. And, the underlying component -- Nonfarm Business Output -- rose 2.8% (q/q, saar), close to the Administration's 3.0% target and slightly above the 2.7% average of the past two years. Moreover, I would not be surprised if Q118 Real GDP is revised up as more data come in.
This week's key US economic report is the April Core CPI. Another decline in apparel prices is likely, based on their bi-monthly sampling and further payback for their huge increases in January-February. But, this may just keep the Core CPI at the consensus 0.2% m/m, as it did in March.
Recent history shows no significant tendency for the April Core CPI to diverge from the January-February average, barring unusual factors such as the drop in telephone service prices pulled down the Core CPI in both March and April 2017. The tendency to rise near the January-February pace hints at a high April 2018 Core CPI. But, the January-February 2018 pace would have been 0.2% m/m without the unusual jumps in apparel prices, which is probably more realistic for comparison purposes.
Core CPI (m/m % change)
April March Jan-Feb Average
2018 na 0.18 0.27
2017 0.09 -0.07 0.22
2016 0.20 0.13 0.22
2015 0.25 0.26 0.25
Recent history also shows the Core CPI rising over Q2 similarly to how much it rose over Q1.
Core CPI (quarterly average of m/m % change)
Q2 Q1
2018 na 0.24
2017 0.10 0.17
2016 0.19 0.19
2015 0.18 0.16
The macroeconomic background is playing out as I had expected: The strong data in Q118 are giving back some of their oversized gains, while the weak data are picking up. Payrolls have slowed in the past two months, after large gains in January-February. There is still room in terms of payback for a below-trend increase in May Payrolls. In contrast, early data point to a speedup in Q218 Real GDP Growth. The NY Fed and Atlanta Fed models' estimates are now 3.0% and 4.0% (q/q, saar) for Q218 Real GDP Growth versus the 2.3% advance print for Q118.
The 2.3% Q118 Real GDP Growth Rate has been termed weak by many market commentators. But, this is a misrepresentation. Growth was above trend (1.8%) in a quarter that tends to be relatively weak. And, the underlying component -- Nonfarm Business Output -- rose 2.8% (q/q, saar), close to the Administration's 3.0% target and slightly above the 2.7% average of the past two years. Moreover, I would not be surprised if Q118 Real GDP is revised up as more data come in.
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