Category Archives: Real Earnings

December Consumer Prices, Real Income and Industrial Production

KEY DATA: CPI: -0.4%; Excluding Energy: 0%; Food: +0.3%/ Real Earnings: +0.1%/ IP: -0.1%; Manufacturing: +0.3%

IN A NUTSHELL:   “Falling prices may worry some but households are ecstatic and manufacturers are gearing up to meet the growing demand.”

WHAT IT MEANS:  Horrors of horrors, energy prices are falling.  If you watch the business news, that is what you would think.  With another sharp drop in gasoline, the Consumer Price Index posted its largest decline in six years.  So, should we worry?  Not really.  Excluding energy, prices were flat and over the year, non-energy costs were up nearly 2%.  That is not deflation.  The December report was really odd.  There were a large number of components that posted outsized changes.  Apparel and used vehicle prices fell by over 1% while medical goods and energy services rose 1%.  Just about every major category was either up or down by 0.2% or more and that is not a normal pattern.   As for deflation, don’t tell that to people who have to spend a lot of their money on food and utilities.  Those costs were up solidly.  My suggestion: Stop looking at the headline number because when oil turns around, and it just might be starting to do that, the sign will simply change even if the magnitude doesn’t.

Real earnings rose modestly in December and that is distressing.  When prices fall sharply, if all you can get is a small rise in spending power, there are real problems out there.  This economy would be a lot better off with a little more money going to workers.

It will take additional quarters of strong growth to get to the point in the labor market where businesses will have to start raising wages faster and that growth is likely to occur.  Industrial production fell in December but a warm December (hoorah!) caused utility output to tank.  Meanwhile, manufacturing production rose solidly once again, despite a small pull back in vehicle assembly ratesThe University of Michigan’s mid-month reading of consumer sentiment rose to its highest level in eleven years.  It’s almost as if happy days are here again. The lower gas prices are going to wind up in the economy and better wage gains could trigger robust consumption.

MARKETS AND FED POLICY IMPLICATIONS: The economy is growing solidly and households are a happy bunch of campers once again, so it looks like 2015 should be a really good year.  Strong growth, coupled with oil price stability or even increases, will make people forget the idea of deflation and turn to the more important issue: When will the dam that is holding back wage gains break?  Normally, labor shortages lead to rising wages, which begin slowly once the inability to find workers starts appearing.  That is not happening this time.  Instead, we are creating the next “bubble”, which is the pent-up demand for higher wages.  The longer we go without slowly raising wages, the greater the surge will be.  The Fed may think it has time because labor compensation growth is largely non-existent.  But if my view is correct, when the capitulation occurs, wages will jump, catching the Fed with its rates down.

November Consumer Price Index and Real Earnings

KEY DATA: CPI: -0.3%; Energy: -3.8%; Excluding Energy: +0.1%/Real Hourly Earnings: +0.6%; Year-over-Year: 0.8%

IN A NUTSHELL:  “Falling energy costs is a gift that we hope keeps giving.”

WHAT IT MEANS:  The continued decline in oil prices may not be the greatest thing since sliced bread, but it is close.  Yes, some energy-related companies are being hurt and there are a few countries whose economies may slip into recession if prices remain low, but for consumers, it is nothing but great news.  Another sharp drop in energy prices caused the Consumer Price Index to fall in November.  Falling clothing costs helped as well.  And with new vehicle purchases jumping, it is not surprising that more used vehicles are available and their prices are declining.  Still, there were some places where prices seem to be firming.  Medical care expenses, both services and commodities, are beginning to accelerate.  Shelter costs are up, though not that rapidly.  We are also seeing a rise in transportation services and tuition, of course.  Food costs have become better behaved, especially for the critical cakes, cupcakes and cookies category.  One final point needs to be made: Services inflation is running at a moderately high pace, with costs up 2.5% over the year.  This component is over 60% of the index.  The only way inflation to remain contained is for commodity costs to stay low, or as it was in November, actually down.  Any rise in commodities would push consumer costs up above the Fed’s target.

The fall in consumer prices is helping household spending power.  Real hourly earnings jumped in November, but over the year the increase remains below one percent.  That pretty much explains the lethargic nature of consumer spending.

MARKETS AND FED POLICY IMPLICATIONS:  The Fed will be coming out with a statement today and this report should have little impact on the members’ thinking.  Inflation, excluding energy, is still just below the Fed’s 2% target, so there is room to maneuver.  But the Fed is not likely to focus on the restraining impact that declining oil prices has on inflation and instead consider the effects on consumer spending.  Barring a large rise in oil prices next year, households will have a lot more money left in their wallets and if there is any acceleration in wages, consumption could be very strong.  Conditions could be in place to raise rates during the first half of next year.  Whether the FOMC opts to do that is unclear, but the idea that the Fed should set monetary policy based on concerns about energy-impacted economies doesn’t sit well with me.  Indeed, the oil drop can only help Europe and Japan.  Regardless, we will know soon enough what the Committee is thinking so I will leave it at that.

October Consumer Prices, Earnings and Jobless Claims

KEY DATA: CPI: 0.0%; Excluding Food and Energy: +0.2%; Real Hourly Earnings (Year-over-Year): +0.4%/Jobless Claims: 291,000 (down 2000)

IN A NUTSHELL:  “Stable inflation is keeping spending power up as wages continue to go nowhere.”

WHAT IT MEANS:  The Fed’s focus of attention appears to be turning to inflation and labor compensation as the members are indicating that the labor market is tightening.  At least that is what it seems.  It is hard to really know what the policy indicator du jour is at the Fed.  I guess if you keep changing the target, your aim is irrelevant.  Enough of my poking fun at the Fed.  Consumer prices went nowhere in October, which was actually a surprise.  It was expected that the decline in energy costs, which were off sharply, would lead to a fall in the Consumer Price Index.  It didn’t, even though food costs were more restrained than they had been.  There was a sharp drop in meat and poultry prices and that helped since most other components continued on their inexorable rise.  While clothing and used vehicle costs fell, new vehicle and especially services prices rose.  Meanwhile, medical costs, both services and goods, are about as well contained as we have seen them in decades. 

With inflation flat, a small rise in hourly wages allowed inflation-adjusted earnings to increase over the month.  If you want to see why consumption remains muted and so many people think we are still in recession, look at the hourly earnings numbers: They have grown by only 0.4% over the past year.

Will wage gains improve?  Eventually, as the labor market keeps firming.  Jobless claims have settled in the 290,000 a week range, which is consistent with solid to strong payroll increases.

MARKETS AND FED POLICY IMPLICATIONS: The talk is all about deflation, but the data provide little support for that view.  Excluding food and energy, the 1.8% rise over the year is not that far from the Fed’s desired 2% range.  The deceleration that occurred in the late spring and summer has turned around.  Why?  While few were watching, services inflation has rebounded, settling into a 2.5% annual range.  That is above the Fed’s target.  Services, excluding energy, is the key component in the index, making up over 57% of the total and 75% of the core.  If 2.5% is the base for services inflation, the prospects for deflation seem slim.  Meanwhile, commodities less food and energy, has been falling for over a year.  If this component starts rising even slowly, the core will exceed 2%.  My expectation is that core inflation will move above the target level early next year, keeping the Fed on course for raising rates this spring.  As for investors, the headline should be encouraging, though my analysis argues it should be a warning that inflation is not all it is not cracked up to be.

September Consumer Prices and Real Earnings

KEY DATA: CPI: +0.1%; Excluding Food and Energy: +0.1%; Real Hourly Earnings: -0.2%; Year-over-Year: +0.3%

IN A NUTSHELL:   “Despite minimal inflation, worker compensation continues to go nowhere.”

WHAT IT MEANS:  The missing link remains a missing link.  The lack of any gain in household spending power has restrained growth during the recovery and there are still no signs of this changing, even as inflation remains in check.  Consumer prices inched up in September, which was a bit of a surprise given the sharp decline in gasoline costs.  Since energy costs are viewed more as an issue of consumer spending than underlying inflation, I think the index that excludes energy is a better measure to watch.  Here, prices moved up at a more moderate pace but still nothing threatening.  Food costs continue to rise more rapidly than general inflation, a trend that is likely to continue for a long time as growing incomes around the world pressure prices.  Medical costs are beginning to rise sharply once again and that includes commodities and hospital services.  There were also solid increases in rent and vehicle maintenance and insurance costs, as well as utility piped gas, which was odd.  Otherwise, prices remained well restrained.  Over the year, just about any measure you can use rose by less than the Fed’s 2% target.

Despite the minimal increase in prices, earnings, adjusted for inflation, fell.  An increase in hours worked offset the decline in wages and led to a gain in weekly earnings.  But the reality is that over the past year, both hourly and weekly earnings, adjusted for inflation, rose by only about 0.5%.  It is hard to have strong growth when spending power is largely flat.

MARKETS AND FED POLICY IMPLICATIONS: Inflation is not a major issue for the Fed as long as wage gains remain muted.  That has been Chair Yellen’s talking point since she has taken over and there is little reason to think that will not be the message in next week’s FOMC statement.  But there was a sign that labor shortages are on the horizon.  The September state unemployment numbers were released yesterday and fifteen states now have a rate below 5%.  With full employment around 5.5%, there are a growing number of markets where labor shortages have to be appearing and wage pressures building.  In addition, another eight states have rates between 5% and 5.9% and they are nearing the point of no return.  Since wages are not falling in above-average unemployment areas, the inevitable increases in the labor shortage locations will drive the numbers up.  Compensation gains are a lagging indicator and they are trailing even more now as firms cling to the belief that they don’t have to raise wages any more than minimally.  Good luck with that over the next year.  As for investors, it is off to the races again as either irrational exuberance has returned or there is a growing belief that strong growth is on the horizon.  I think GDP will rise well in excess of 3% next year and could exceed the 3.3% posted in 2005, making it the strongest gain in a decade, but that is not the consensus in the investing community.