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No “Boom,” No Systemic Inflation Instead, a Return to “Normal”

In many parts of the country, no more masks!  Businesses reopening.  And, it sure does look like the impact of the latest stimulus checks (helicopter money) faded fast. 

Despite the fact that the IRS continues to send out billions more in stimulus funds as they process 2020 tax returns, April Retail Sales fell -0.7% M/M.  Market expectations were for a rise of +1.0%.  In the retail sales world, this is a huge miss.  Worse, the “core” figure that is used in the GDP calculations fell -1.5% for April, the first month of Q2, not a good omen for GDP growth.  That likely means that the high single digit and some double-digit forecasts for Q2 GDP growth will soon come tumbling back to earth. 

The University of Michigan’s Consumer Sentiment Survey also threw cold water on the “boom” mentality.  The overall survey retreated from 88.3 in April to 82.8 in May.  The fall in sentiment was across every social stratum and through every age group.  Of concern is that auto buying plans fell hard to 102 from 118, the lowest level since October 2008.  But, the biggest fall in sentiment occurred in home buying plans which crashed to 95 in May from 114 in April and 127 in March.  The May reading was the lowest in 38 years!!!

Housing Data

As everyone who reads or watches the news knows, home prices have skyrocketed. The chart (through February) shows a 12% Y/Y growth.  The latest data, however, have accelerated and the M/M price increases are at a rate closer to 15% annualized.

Supply chain issues, due to the pandemic, have put building materials in short supply, and labor also appears to be in short supply (unemployment benefit disincentives?).  Those have caused upward price spikes.  In addition, in the existing housing space, the single-family unit is now the rage as work from home (WFH) put a premium on this form of housing.  In some markets, existing home for-sale listings last less than a day, and bidding wars result in prices paid being higher than the original asking price and the appraisal. 

The good news is that the supply chains are loosening.  As reported in our past blogs, Canada’s lumber industry has shifted into high gear.  We believe that much of the price frenzy has been caused by speculative fervor in the commodity pits as opposed to actual supply/demand.  Nevertheless, the speculation does have a large influence on commodity prices, like lumber.  We have recently witnessed some speculative retreats (Bitcoin!) and commodities have not been excluded.  The chart below shows the wild ride the price of lumber has taken in the CME commodity pits this year.  

                                                Lumber CME (Jul ’21)

On May 6, the price of lumber (per thousand board feet) reached $1,687.  As of 2:32 pm EDT on May 19, the price was $1,327, down 21% in two weeks.  Note that it was below $750 in January, so, the price is still sky high, but falling.  (Note: Continuing its volatility, Lumber on the CME closed at $1,390 on Thursday, May 20.)

Besides the price of lumber beginning to return to earth, other housing data lead us to believe that the housing frenzy may have peaked:

  • As alluded to above, the sub-index for home buying intentions in the University of Michigan’s recent survey hit a 38 year low in May;
  • Existing home sales have fallen in four of the last five months: Dec.: -2.6%; Jan.: -0.3%; Feb.:-2.8%; Mar.: -10.6%; Apr.: +1.9% (all data M/M changes);
  • Mortgage Purchase Applications fell -4.1% the week of May 14;
  • Housing Starts fell -9.5% in April with single family starts down -13.4% (the third decline in the past four months);
  • Building permits for single family homes also fell -3.8% in April.  Some blame this data on “shortages,” but, if that were the case, why did multi-family starts (+0.8%) and permits (+8.9%) rise?

Housing is now and always has been a major contributor to the economy.  So, moderation/weakness there is going to have a major impact on economic growth and inflation.

Labor Markets

Initial Unemployment Claims (ICs) continue to creep down, falling to +455K the week ended May 15 (Not Seasonally Adjusted – NSA) from +492K (revised up from 487K) the prior week, a fall of about -33K from the +487K number in the market just prior to the release.  We note the continued downtrend.  Let’s keep in mind that ICs are a proxy for layoffs, and +455K still represents a number we would only expect in a severe recession.

In the special Pandemic Unemployment Assistance (PUA) programs, ICs fell from +104K to +95K.  The people in these programs are owners of small businesses, and the number of new filings here are a proxy for small business closures.  Adding the two IC numbers together results in +550K new claimants (chart).  The pre-pandemic “normal” was +200K, so, the main excitement here is that ICs continue to fall.

As we have said in prior blogs, our biggest concern remains the level of Continuing Unemployment Claims (CCs) (those receiving benefits for more than a week).  These showed up as 16.0 million the week of May 1, down about -900K from the prior week.  Nearly all the fall was in the PUA programs which we interpret to mean that small businesses reopened with those business owners returning to work and falling off the unemployment roles.  However, the state numbers aren’t moving as fast.  Those on the state roles are former employees of an employer that paid into the state unemployment system.  That stubbornness tells us that the disincentive of the $300/week federal supplemental payment is still in play.  At this writing, 20 states are now considering a suspension of that federal supplement.

Our expectation is that the PUA claims will continue to fall as the economy reopens.  State claims will also fall, but the slope of that downtrend through most of the summer will be dependent on state actions regarding the current federal supplemental payment.  Although we think that a return to the full-employment economy is still far off (businesses have learned to get along with fewer employees), by the end of Q3, we expect much of the current dislocation in the labor market (labor shortages) to be largely resolved.

Inflation

We continue to see discussions of “non-transitory” (i.e., “systemic”) inflation in the business media, especially since the April CPI and PPI indexes showed outsized price increases on a Y/Y basis.  In our view, much of those increases were due to base effects.  Economist David Rosenberg observed that if the base period for the April CPI and PPI were two years ago instead of last year (thus eliminating the price plunges early in the pandemic), the annual rate of both headline and core inflation is 2.2% – not so scary.  Hence, it is logical to conclude that most of the outsized CPI and PPI results were caused by the “base effects.”

All the significant inflations in the Post-WWII era have been accompanied by rapid growth in consumer borrowing and rapid expansion in bank business loans.  Neither one of these is occurring today.  The chart shows that consumers have paid down debt during the pandemic.  And, the NY Fed has told us that one-third of the value of the latest batch of stimulus checks has gone or will go toward consumer debt reduction.

The next chart shows the initial borrowing spike during the first months of lockdown (in many cases, corporations borrowed the full amount of their bank lines of credit for fear that such lines would be pulled by the banks like they were in 2008).  Since then, bank loans outstanding have fallen and, today, are not much different than they were in mid-March 2020.  Without a general expansion of credit, “systemic” inflation just doesn’t happen.

Conclusions

Over the past months, we have asked several times in this blog what the pandemic has done to change the very slow growth/low inflation economy we had for the decade prior to COVID-19.  Once schools reopen, helicopter money stops, and the unemployment disincentives disappear (now 20 states are in the process of cancelling the federal $300/week subsidy), we don’t see any fundamental changes.  A slow growth and low inflation economy will return.  There is a caveat –  when the Fed starts to “taper” its monthly $120 billion asset purchase program (Treasury bonds and Mortgage-Backed securities), asset inflation will likely end (unless the Fed caves again to the market’s next “taper tantrum”)!

Robert Barone, Ph.D.

Joshua Barone

May 24, 2021

Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Four Star Wealth Advisors. www.fourstarwealth.com. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (the AAA brand) where he chairs the Finance and Investment Committee. Robert is the co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (FFIU)

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