Inflation scare? I’m sorry, I seem to have missed something. Didn’t the recession end five years ago? How long does it take for inflation to take hold? Do I need to go looking for it? Okay, I’ll give it a shot.
We have heard intermittently over the past five years that inflation will rear up on us, following our trek out “The Great Recession” wilderness. Treasury Inflation Protection securities became so popular that to receive a positive return, you had to depend on inflation. Three years ago central banks around the world embraced ZIRP (Zero Interest Rate Policy) and quantitative easing. The general feeling again was that we were on the path back into the face of a big-time inflationary scare.
Today, in most OECD countries outside of Japan, the pace of consumer price rises continues to grind lower. China and Germany have recently registering producer price deflation. Normally, this is a something we’d expect immediately following a recession, not five years into a recovery. Okay, Europe is less than one year out of a mild recession but they are well past the bottom five years ago.
In the US, it is much the same. Weak inflation data persists. Only a few marginal threats via a recent uptick in wage growth (remember inflation in simple terms is Unit Labor Costs plus CPI) and a potential minimum wage increase have surfaced. Sure, energy is a bit high and U.S. food prices might be up a bit but the drought will probably end and temperatures will rise, so these temporary pressures should subside. Energy, longer term should provide deflationary pressure as the cost to produce goods should drop if/when energy prices drop here in the U.S. as expected. Albeit, cheaper energy would put more in our pockets to spend but prices on the downside are sticky.
What about the almighty U.S. dollar? Is there a reason for it to depreciate? As the Fed removes stimulus, tapering bond purchases and as we continue to absorb sequestration cuts to heal the U.S economy and budget deficits, the dollar should appreciate. Yes, there will likely be bumps.
Oh, did someone forecast strong growth (demand pull inflation)? I missed that one, too. At this point, it would be the forecast of strong growth and typically we would need to a period of strong growth before inflation would become a factor as it is more aligned with a trailing indicator. For now, everything I see shows slow growth. China continues to decelerate. Yes, eventually they may become consumer driven nation but this is not anytime soon. Here in the states, as the boomers age, are they going to consume more or less? Statistically, retirees spend the most immediately following their retirement and then the level of spending drops significantly every eight years or so. The Boomers I know are more interested in distributing their assets rather than increasing them but these are the ones more toward the front of the curve (Plenty more to follow!). By the way, those retirees are helping improve the employment numbers as they are removed from the statistics.
No worries so far. So, let’s have a deeper look! Is the pace of improvement in the labor market a concern for inflation? Over the past two years, we have consistently averaged around 180k/mo in non-farm payroll gains. If this number were to increase, it would certainly be something to monitor closely. What about people job hopping? We monitor this in the quit rate, which is currently at 1.7%. It was 2% prior to 2008 and it is up slightly from the low in 2008 of 1.3%. Apparently, we still love to hold onto the jobs we have. Another measure is the Job Opening Labor Turnover Survey (JOLTS) which is currently at 3.3%. This is half a percent below five year period prior to the recession. It represents job churn which correlates with an improving economy. It still has room for improvement. GDP growth improvement would be nice, too. From 1980 forward, the average annual GDP through 2013 has been around 5.5%. Today we are struggling in the 2’s. The Business Roundtable CEO Economic Outlook Index survey’s expectation for 2014 GDP growth was 2.4 percent, representing below-normal growth compared to past economic recoveries. This is up from the Q4 reading of 2.2% and at an eight quarter high. I’m glad CEO’s are at least marginally more optimistic than in the recent past!
All of this is something we believe the Fed will be watching closely to determine when to tighten policy. For now, these numbers simply don’t show anything indicating inflationary trends or strong growth for that matter. Perhaps that is why the Fed has dropped the 6.5% employment target. I’ve heard several firms stating an inflation scare is possible. Maybe it is the Ukraine/Russia issue which is fueling the fire. Europe is dependent on Russian energy. The U.S. currently restricts export of energy. My issue is the $4 per gallon effect. If it is energy leading the scare, we have seen that gas above $4 per gallon has a negative impact on the economy, slowing consumption as it removes consumers spending from other areas. In effect, we seem to be locked into slow growth with correspondingly low inflation.
As a contrasting viewpoint, one might point to CapEx. It is expected to increase and Q4 2013 did show some increase. We’ve heard this for some time but it is worth watching. Capacity utilization rates have been increasing and corporate profits have been strong. Some of the past uncertainties seem to have been removed. CEO’s are becoming generally more optimistic. I’ll give the inflation bugs that one understanding that the recovery cycle normally pins this to mid to late-cycle economic driver. It fits. Again, it is the pace I’d watch and this I’m thinking will match the speed we’ve seen in other areas, slow, slow, and slow.
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