Incoming PPI data marked the initial volley of the oncoming “siege” of inflation data.
Despite reopenings, state Initial Unemployment Claims spiked as March ended. Either the reopening lags are longer than we thought, or disincentives from overly generous benefit payments are at play.
If recent history is any guide, only part (25%) of the stimulus cash will be spent on consumption, the remainder saved or used to reduce debt. Business, consumer and real estate loans have fallen recently. These are normally rising when the economy is “roaring.”
Slow vaccine rollouts outside the U.S. and U.K. are negatively impacting U.S. exports and world tourism and may delay the recovery promised by today’s optimistic world GDP forecasts which appear to already be priced into world financial markets.
Incoming Inflation Data – PPI
As we have forecast, the first sign of what will amount to an “inflation” scare appeared in March’s Producer Price Index (PPI). It rose +1.0% M/M, well above the +0.5% consensus market view. That index is now up 4.2% Y/Y. That looks like a scary number and the start of something sinister, especially when compared to February’s +2.8% Y/Y reading and only +1.7% in January. But, as we have written in past blogs, the incoming price data are going to be skewed upward because of base effects. i.e., the downdraft in prices that occurred in March/April/May last year as the economy was shuttered. And, just as we didn’t have “systemic” deflation resulting from those price declines, there won’t be “systemic” inflation as a result of those base effects now being compounded by shortages due to disruptions of supply chains. Don’t misinterpret. We will see several months of mind numbing price index numbers which will continue to convince many market commentators that the return of 1970s style inflation is imminent. If our reading of the market sentiment is correct, there very well may be a temporary spike up in interest rates; perhaps the 10-Year Treasury Note yield will even touch 2%. But, such a spike up will be temporary, or to use Fed-speak, “transient.”
Deconstructing the PPI shows that the big price movers were energy (+5.9%) and transportation (+1.5%). Construction costs also rose +0.5% as did the costs of government procurement (+1.5%). These represent about 20% of the index. The other 80%? +0.4%!! Really not much underlying price pressures outside energy and transportation. Remember, when next month’s gargantuan PPI number comes across the tape, the price of crude oil was negative for a day or two last April. Oil prices today? They are about the same as they were pre-pandemic ($60/bbl). Not much underlying inflation here.
After a promising downtick of more than -90K in state Initial Unemployment Claims (ICs) to +651K the week ended March 20, we’ve had two weekly disappointments in a row, as state ICs ticked up to +722K (March 27), then up some more to +741K (April 3). These are a proxy for layoffs indicating that the economy is still bleeding. The pre-pandemic peak in state ICs was +665K during the Great Recession (March 28, 2009). Except for the recent +651K reading, we have been above that prior peak for over a year (53 of the past 54 weeks). In fact, the +651K was the only reading under +700K during that time span.
In our last few blogs, we indicated that there was some hope that the reopening of much of the economy would have a positive impact on the state ICs. We had been encouraged by the rapid downtrend of Initial Claims in the Pandemic Unemployment Assistance (PUA) data whose recipients represent small business owners and gig workers. The right hand side of the chart and the latest entries to the table of PUA ICs show a dramatic falloff in those claims since early March.
In the normal course of events, we thought that, with small businesses reopening, there would soon be a need to recall staff, and that we would have seen that by now in the state ICs, as state programs are for employees whose employers pay into the system. While there may be more explanations of why state ICs are rising while PUA ICs are falling, we can think of two:
- We may yet see a dramatic fall in state IC data, as, with no historical precedent, we just may not know the appropriate lag times between small business reopenings and the recall of laid off staff;
- The other possibility is the disincentive to work due to the more than generous unemployment benefits available via the ongoing stimulus programs. The biggest complaint of businesses in every recent business survey has been not only a lack of qualified applicants, but a lack of applicants altogether. “Help Wanted” signs pervade the landscape, but, few takers. And, while the University of Chicago published a recent study indicating that, on net, the exceptionally generous unemployment benefits (which will now last until early September) were not a negative for employment, we find it hard to reconcile more than 18 million on the unemployment roles with so many job openings.
BLS’ JOLTS (Job Openings and Labor Turnover Survey) showed a jump of +268K in the number of job openings in February (latest data) to a 7.4 million level. Of the increase in job openings, +357K were in the lower paying leisure/hospitality and education/health sectors. These two sectors represent about 25% of the total employment pie. That means that the other 75% of employment sectors saw a contraction of -89K of job openings! This tells us that, because of the composition of the sectors in need of employees, there won’t be rapid aggregate income increases or upward wage pressures as the economy fully reopens. That means no “systemic” inflation! Adding further to this thought, total Continuing Unemployment Claims (those receiving benefits for more than one week) in the state and PUA programs combined have been above 18 million for 47 of the last 49 weeks (18.4 million the week of March 20). The pre-pandemic normal was 2-3 million. With so many unemployed, it is hard to see “systemic” upward pressure on wages which was the major issue in the inflation of the 1970s.
We expect spikes in retail sales in March/April as a result of the Biden stimulus. In February, prior to the money drop, consumer spending was $14.79 trillion (annual rate), similar to October’s $14.63 trillion (after the initial CARES Act stimulus had run its course) and still below the $14.88 trillion level a year earlier (February, 2020, pre-pandemic).
The Chart shows Real Personal Income excluding transfer payments.
February’s (2021) $13.97 trillion was still -2.5% lower than that of a year earlier ($14.33 trillion). According to Milton Friedman’s “Permanent Income Hypothesis,” people tend to spend “bonus” money once (on a vacation or big ticket item), but adjust their “normal” spending to their “permanent” income. We saw this during and after last year’s CARES Act money drop. By autumn, retail sales had turned negative M/M. In addition, all of the surveys (the NY Fed in particular) show that only about 25% of the stimulus checks will be spent on consumption. The remainder either goes to pay off debt (e.g., the -11% reduction in credit card debt outstanding) or is saved (e.g., the rise in the savings rate from 7% to 14%).
A good barometer of the health of the economy is borrowing, either on credit cards (daily purchases) or via financial institution loans (used for big ticket items by consumers or for business expansion). Look at the following two charts: Percentage Change in Bank Loans and Leases, and Residential Real Estate Loans. Do these look like the beginning of a “Roaring Twenties” expansion to you?
With regard to real estate, mortgage applications have fallen five weeks in a row and are at a 14 month low; the purchase sub-index is down -15% since the last week of January, and the refi sub-index, also down five weeks in a row, is off -35% from that last January week.
The Great Vaccine Hope
The vaccine rollout in much of the rest of the world is lagging. Canada, for example, is considering shutting down again! When economies restrict movement or shut down, the result for the U.S. is a lower demand for exports, an economic sector that accounts for $2.5 trillion, double the value of the heavily pandemic stricken sectors (airlines, restaurants, hotels…). Over the past year, the U.S. trade deficit has risen +87%. Exports have fallen -10% Y/Y and imports have risen +5%. The trade deficit is a subtraction from GDP!
- There is a huge pool of idle labor, and the sectors where there is job growth are all low wage. This will serve to keep down wage growth, the primary cause of the 1970s “systemic” inflation.
- Initially, there will be the appearance of a “strong” economic cycle with the upcoming March/April/May stimulus induced numbers. But, like earlier helicopter money, the recent drop, too, will be one and done. By late summer, we are likely to see flat/falling consumer data.
- Similarly, we already saw the first of the price index spikes in March’s PPI. The Wall Street “inflation narrative” will live on through the spring and early summer as Y/Y comps spike due to base effects in the comparable months last year and due to current supply chain (transportation) issues. But, these are “transient” and, barring more helicopter money, will pass in Q3.
- With an unemployment hangover of 18+ million and permanent income (real personal income less transfers) -2.5% below pre-pandemic levels, it is hard to see robust economic growth post-stimulus.
- Vaccine issues in the rest of the world will continue to impair U.S. exports, and the recent appreciation of the dollar’s value won’t help. Besides issues with U.S. exports, this will continue to impair global tourism (about 10% of Global GDP).
- If this analysis is correct, the valuation metrics priced into world financial markets appear to be overly optimistic.
Robert Barone, Ph.D.
April 12, 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)