US Consumers Still Consuming (excerpt)

I have often said that betting against the US consumer is usually a bad bet. When we are happy, we spend money. When we are depressed, we spend even more to release the dopamine in our brains’ pleasure center. That helps us feel better. We were born to shop!

I have to admit that I was starting to doubt American shoppers earlier this year. Forgive me, please. Retail sales were anemic during the first four months of the year despite the windfall from lower gasoline prices. I reckoned that perhaps the savings from lower fuel costs was offset by higher out-of-pocket medical expenses attributable to Obamacare. In addition, rent inflation has been rising faster than overall CPI prices, reducing consumers’ spendable dollars for other goods and services.

Well, never mind: Retail sales jumped 1.2% during May, and the previous two months were revised higher. On Friday, we learned that personal consumption expenditures (PCE) jumped 0.9% during May, with upward revisions during April (0.1% from 0.0%) and March (0.6% from 0.5%). Real PCE rose 2.1% (saar) during Q1, and probably rose by about 3.0% during Q2.

On a year-over-year basis, real PCE rose 3.4% through May. Real disposable personal income rose 3.5%, with real wages and salaries rising 4.8%. Over the past three months through May, real consumer spending rose 2.8% (saar), led by solid gains in durable goods (9.8) and nondurable goods (2.9) but a middling increase in services (1.7).

Today's Morning Briefing: Standard of Living at Record High! (1) The last act of the Greek drama? (2) Dopamine and consumer spending. (3) Winter’s cabin fever set stage for spring spending splurge. (4) Real pay per worker at record high. (5) Real consumption per household is at record high. (6) Corporations prefer to buy back shares, pay dividends, acquire competitors, and cut expenses. (7) The logic of deals. (8) Not much inflation. (9) Why is PCED inflation lower than CPI version? (10) Yet another Chinese fire drill. (More for subscribers.)

Is Gold Just Another Commodity? (excerpt)

Gold is widely viewed as among the best hedges against inflation. It rose dramatically from $287 an ounce on September 11, 2001 to a record high of $1,895 during September 6, 2011. It’s down 37% since then. Gold bugs figured that the war on terror would widen government deficits and that central banks would help by keeping credit conditions loose. The financial crisis of 2008 unleashed the major central banks to experiment with various forms of ultra-easy monetary policy including NZIRP and QE.

Yet inflation remained subdued. The price of gold seemed to break when gold bugs were disappointed by the metal’s failure to rally on Abenomics, specifically the latest round of extremely easy money from the BOJ. So they started to sell.

I’ve observed that the price of gold tends to coincide with the underlying trend in the CRB raw industrials spot price index. If so, then the trend in both is more likely to be flat to down than to be up, in my opinion, given my outlook of secular stagnation for the global economy. That’s neither a boom nor a bust, just more of the same.

Today's Morning Briefing: Inflation Still MIA. (1) Diminishing inflation. (2) Un-COLA. (3) The forces of disinflation remain intact. (4) Lots of liquidity, yet not much inflation. (5) Unit labor cost inflation remains subdued. (6) Weak productivity growth doesn’t jibe with record profit margin. (7) Is Yellen waiting for Godot? (8) Fed study says cost-push inflation is a myth. (9) Inflationary expectations trending downwards with commodity prices. (10) Is gold really an inflation hedge or just another commodity? (11) Inflation is obviously key to bond and stock valuations. (More for subscribers.)

Yellen on the Wage Question (excerpt)

Fed Chair Janet Yellen has stressed the importance of wage inflation in influencing the FOMC’s decision to start raising interest rates. April’s average hourly earnings (AHE) for all workers rose just 0.1% m/m and 2.2% y/y. She has said that she would like to see 3%-4% wage gains, or be reasonably confident that they are heading in that direction. The three-month change in this measure of wages settled down to 1.8% (saar) during April from 3.6% during March. Nothing to get Yellen too excited, which seemed to get the stock market very excited on Friday.

However, Q1’s Employment Cost Index (ECI) for wages and salaries in the private sector--a more comprehensive measure of wages than the AHE rose 2.7% y/y, the highest since Q3-2008. The Phillips Curve, which posits an inverse relationship between wage inflation and the unemployment rate, is actually working much better with the ECI than the AHE measure of wages, especially compared to the short-term unemployment rate. (See Phillips Curve.)

Yellen is a big believer in the Phillips Curve. She said so in an important 3/27 speech: “A substantial body of theory, informed by considerable historical evidence, suggests that inflation will eventually begin to rise as resource utilization continues to tighten. It is largely for this reason that a significant pickup in incoming readings on core inflation will not [her emphasis] be a precondition for me to judge that an initial increase in the federal funds rate would be warranted. With respect to wages, I anticipate that real wage gains for American workers are likely to pick up to a rate more in line with trend labor productivity growth as employment settles in at its maximum sustainable level. We could see nominal wage growth eventually running notably higher than the current roughly 2 percent pace.” In a footnote, she cited four studies for “recent evidence on the relationship between labor market slack and wages.”

Today's Morning Briefing: Goldilocks' Godmother. (1) Janet & Hamlet: To lift or not to lift? That is the question. (2) Janet & Christine: High and mighty say stocks are mighty high. (3) Yellen’s dashboard shows labor market is cruising. (4) Phillips Curve may be starting to work, pointing to bigger wage gains. (5) April retail sales may settle soft-patch question. (6) Yellen’s latest assessment of stock valuation: It’s high. (7) Addictive fairy dust. (8) Another relief rally after latest feared outcomes turn out to be nonevents. (9) On the verge of a melt-up? (10) Energy, Materials, and Financials join the rally parade. (11) ECI vs. AHE. (More for subscribers.)

German Bond Selloff Spills Into US (excerpt)

In recent days, there have been lots of mixed and confusing signals coming out of the Eurozone and US economies, and investors have acted accordingly. On Friday, May Day was a happy day for stock investors as they merrily danced around the maypole. The day before, they all seemed to run for cover. The S&P 500 fell 1.1% on Thursday and rose 1.1% on Friday to 2108.29, just 0.4% below the record high of 2117.60 on April 24. It’s been range-bound since the start of the year.

For bond investors, it was “Mayday! Mayday! Mayday!” every day last week. The 10-year US Treasury yield rose to 2.12% on Friday from 1.93% the week before despite a weaker-than-expected GDP report and a relatively benign FOMC statement on Wednesday.

US yields rose in reaction to the rise in the German government’s 10-year bond yield from this year’s record low of 0.033% on April 17 to 0.37% on Thursday, just before much of continental Europe took Friday off for May Day. Germany’s economic indicators have been showing some strength, and deflationary fears seem to be subsiding. On Thursday, we learned that the Eurozone’s CPI was unchanged during April on a y/y basis as energy prices rebounded. It hit a recent low of -0.6% during January when oil prices were finding a bottom. No one seemed to care that the core CPI rose just 0.6% y/y during April, the same as the month before.

Furthermore, the euro has rebounded from the year’s low of $1.05 on March 13 to $1.12 on Friday, suggesting that Eurozone investors may be losing their interest in US bonds, even though US bonds still yield much more than German bonds. The stronger euro caused the EMU MSCI to sag by 2.8% last week, but rise 0.4% in dollar terms.

Today's Morning Briefing: Mixed Signals. (1) May Day vs. Mayday. (2) Dancing around the maypole. (3) German bond yield backup spills over into US bonds. (4) ECI showing first sign of rising wage pressures. (5) US business surveys were relatively weak in April. (6) CPI vs. PCED. (7) It all depends on FOMC’s interpretation of the data they depend on. (8) Oil exporters selling US Treasuries and other reserves. (9) First day of month often bullish for stocks. (10) Home in the range. (11) Stocks on verge of melt-up? (12) Bonds on verge of meltdown? (13) Signs of life in commodity pits. (14) “Ex Machina” (+). (More for subscribers.)

Will Robots Bend the Phillips Curve? (excerpt)

There’s an important debate about wage inflation. The inverse relationship between wage inflation and the unemployment rate is known as the "Phillips Curve." It makes sense that wage inflation would rise or fall depending on whether the unemployment rate was relatively low or high. However, I have been arguing that the Phillips Curve might not work as well given increasing globalization, innovation, and competition.

In his Barron’s column this week, Gene Epstein argues that wage growth is about to take off. He bases this forecast on a version of the Phillips Curve model devised by Jason Benderly of Applied Global Macro Research. In addition to the level of the unemployment rate, this model includes the change in the jobless rate, labor productivity, and the after-tax profit margin.

I note that the unemployment rate remained at 5.5% during March, the lowest since May 2008, yet wage inflation remained subdued for all workers at 2.1%, while falling recently to 1.8% for production and nonsupervisory workers. On the other hand, as we noted last week, wage inflation over the past three months through March for all workers jumped to 3.9% (saar), the highest since December 2008. That might have reflected the one-shot impact of the widespread hike in the minimum wage at the start of the year. Or else, the Phillips Curve is starting to work, finally.

If it’s different this time, then robots might be one of the reasons. The 4/23 WSJ reported that in Oxnard, California, “A 14-arm, automated harvester recently wheeled through rows of strawberry plants here, illustrating an emerging solution to one of the produce industry’s most pressing problems: a shortfall of farmhands.” The 4/24 NYT reported, “Faced with an acute and worsening shortage of blue-collar workers, China is rushing to develop and deploy a wide variety of robots for use in thousands of factories.”

Today's Morning Briefing: Great Debates. (1) The link between easy money and secular stagnation. (2) Summers vs Rogoff. (3) Debt super-cycle. (4) Time heals all wounds. (5) Asia’s debt binge. (6) Glut of gluts. (7) Will China solve its debt problem with a stock bubble? (8) Lots of burdensome debt burdens in Japan, Eurozone, and China. (9) US corporations borrowing for financial engineering. (10) A cold spring following an icy winter. (11) Dallas slipping on oil. (12) Are robots bending the Phillips Curve? (13) Lots of debatable subjects including Fed, oil, dollar, Grexit, MENA, and the meaning of life. (More for subscribers.)

Inflation Warning (excerpt)

Last week, the 4/16 WSJ reported: “U.S. wages may be starting to pick up, a development that could help policy makers at the Federal Reserve feel more confident that sluggish U.S. inflation also will gain traction, Fed Vice Chairman Stanley Fischer said Thursday.” He said so on a panel discussion in Washington. That same morning, in a CNBC interview, he said the Fed knows the markets “look ahead somewhat, so I think--I hope--that they are taking into account that the Fed, at some point, is likely to raise the interest rate.” On timing, he said markets “can’t depend on the current situation continuing forever--or even probably--beyond the end of this year.”

He reiterated that “there are more signs every day” of mild wage increases. What is he looking at? Let’s have a look:

(1) Minimum wage. Anecdotally, the minimum wage was raised in 21 states at the start of the year. However, during March, average hourly earnings rose only 2.1% and 1.8% for all workers and for production and nonsupervisory workers.

(2) McDonald’s. On 4/15, fast-food cooks and cashiers demanding a $15 minimum wage walked off the job in 236 cities in what organizers called the largest mobilization of low-wage workers ever. On April 1, McDonald’s announced plans to give employees a 10% pay bump and some extra benefits. The raise will affect about 90,000 workers at a small fraction of McDonald’s stores. Employees at franchises, which make up the majority of the burger chain's locations, won't be affected.

(3) Walmart. At the start of April, Walmart raised its minimum starting wage to $9 an hour, 24% higher than the federal minimum. A 4/10 story on PBS NewsHour noted, “The company says that its wage increases will impact 500,000 workers, but the number who will see their wages rise from the federal minimum of $7.25 to $9 is much smaller. Only 5,000 of its 1.4 million workers actually make the minimum wage. And the minimum in most of the country, 29 states, is already considerably higher than the federal minimum. Seven states and the District of Columbia have minimums of $9 or higher. So the average pay raise for the affected Walmart workers will be far less than the 24% raise for the very small number currently earning the federal minimum.”

(4) Quit rate. The quit rate in retailing tends to be relatively high, especially among low-paid workers. Retailers are raising their wages to reduce their labor turnover costs.

(5) Q1 wages and prices. Average hourly earnings for all workers rose 3.9% (saar) during the first three months of the year, the highest since December 2008. That’s the kind of y/y increase that Fed officials have said would allow them to normalize monetary policy sooner and at a faster clip.

In addition, the core CPI inflation rate edged back up to 1.8% during March, closer to the Fed’s 2% target--which is really for the core PCED, which was 1.4% during February. The three-month annualized change in the core CPI through March was 2.3%, suggesting that the core PCED, which was 0.9% through February, might show a higher increase when March data are released on Thursday, April 30.

Today's Morning Briefing: The Twilight Zone. (1) Valuations on the border of the Irrational Zone. (2) Three fears hit market: Greek exit, China bubble, and inflation uptick. (3) Recapping stretched valuations. (4) Institutional investors remain skeptical. (5) Outperforming SMidCaps less exposed to dollar. (6) Shortage of bargains. (7) Buybacks = Corporate QE. (8) Corporate execs comparing earnings yield to borrowing rate when buying back shares. (9) Warning: Inflation may be warming. (More for subscribers.)

Inflation Remains Below Target (excerpt)

So what is inflation doing? February’s inflation data released in yesterday’s personal income report show that the core PCED remains stuck about half a point below the Fed’s 2% target for this variable. It was up 1.4% y/y during February, and has been hovering around 1.5% for the past 10 months. However, over the past three months through February, the core PCED increased 0.9% (saar), the third consecutive reading below 1.0%. It may be hard for Fed officials to be reasonably confident that inflation is heading higher given the trend of the recent three-month inflation rates.

The persistence of the core inflation rate below 2% despite ultra-easy monetary policy in the US and elsewhere over the past six years is certainly puzzling Fed officials. Nevertheless, rather than reassessing their models of inflation, they continue to expect that a tightening labor market will boost wage inflation soon, which then will boost price inflation. In other words, they continue to bet on the Phillips Curve model.

I have argued on many occasions over the past couple of years that there may be structural forces at work (such as globalization, competition, and innovation) keeping a lid on inflation. If so, then maintaining ultra-easy monetary policy to boost wage and price inflation may instead boost asset inflation. Indeed, easy money actually may be deflationary by boosting supplies of goods and services more than the demand for them, as I’ve discussed before. Let’s have a closer look at the latest price inflation data:

(1) Inflating, disinflation, & deflating. The PCED is based on prices in the CPI, but with different weights that are more reflective of actual consumer spending. The core CPI inflation rate tends to exceed the core PCED inflation rate. The former was 1.7% y/y during February, while the latter was 1.4%.

The services components of the CPI and PCED rose 2.4% and 2.1% during February. Both have disinflated by about 50bps since early 2014. Nondurable goods prices including energy are deflating--down by about 4% y/y. Durable goods prices are also deflating--down 1.6% in the CPI and down 2.6% in the PCED.

(2) Devil in the details. One of the main reasons why services inflation is lower in the PCED than in the CPI is because medical care services inflation is lower in the former (currently 0.8%) than in the latter (currently 1.8%). Both have been disinflating in recent years. It’s not obvious to us why the Fed would want to see this component of inflation rise to achieve its 2% target.

On the other hand, rents have been rapidly inflating in recent years based on the CPI (3.5%) and PCED (3.4%), with both at the highest readings since November 2008. Again, would Fed officials cheer if they achieved their 2% inflation target by driving rent inflation still higher?

It’s not obvious how ultra-easy monetary policy is supposed to stop consumer durables prices from deflating. They’ve been doing so mostly as a result of globalization, which has lowered labor costs in manufacturing. Now automation and robotics is increasingly replacing labor in durable goods manufacturing. If the Fed’s policies succeed in boosting wage costs, manufacturers may simply replace labor with technology. This all begs the question: Why are higher durable goods prices a good thing anyway?

Today's Morning Briefing: Days of Wine & Rosés. (1) Les Misérables. (2) Rosé a day. (3) Setback for Socialists in France. (4) Six cylinders firing in Eurozone. (5) Slicing and dicing Yellen’s latest speech. (6) FOMC lowers new normal unemployment rate. (7) Waiting for Godot and Phillips? (8) From ZIRP to LIRP. (9) Liftoff coming, though it might be postponed, but will be gradual until further notice. (10) Fed puzzled by persistence of low inflation. (11) Slicing and dicing the inflation data. (12) Three-month annualized core PCED inflation rate falling below 1.0% rather than rising to 2.0%! (More for subscribers.)