“Flation” remains one of the key debates of the day.
Some expect huge inflation. Others expect stagflation (a rediscovered
buzzword) and still others hyperinflation (yes, some still hang their hats on
that one), or even deflation.
Meanwhile, the Fed and other economists have a spotlight on inflation
expectations (as if they matter, but they really don’t).
Let’s take a look at “flation”, where it shows up, and where it doesn’t.
Perfect Storm?
Gad Levanon, vice president, The Conference Board, emailed me yesterday
stating “some of my blogs will be posted on the CNBC website.”
His new blog is “The US Faces a Perfect Economic Storm”
Levanon invited questions.
I had questions. I usually do. First let’s see what the “perfect storm” is
all about.
In the weeks after the Federal Reserve raised interest rates in December,
global financial markets trembled and inflation expectations, as measured by
the bond market, declined significantly. On Feb. 9, market-based inflation
expectation over the next five years fell to just 0.93 percent, the lowest
level since the Great Recession.
This drop in inflation expectations fueled calls for halting the rate
hikes, with a growing cohort of economists and market participants
questioning the wisdom of raising rates in the first place.
Thus far, however, actual inflation numbers have refused to cooperate with
the winter’s bleak expectations. Both major core inflation measures — core
consumer price index (CPI) and core deflator of personal consumption
expenditure (PCE), the measure favored by the Fed — have accelerated
significantly in recent months; the 12-month growth rates of core CPI and
core PCE now stand at 2.3 and 1.7 percent, respectively.
But is it really surprising that inflation is not remaining at its subdued
rates of well below 2 percent? We don’t think so. The main story in the U.S.
economy right now is that it is gradually running into supply constraints,
which by definition implies price pressures in the labor market and later on
in goods and services.
However, we should not be complacent about inflation risk, simply because
there wasn’t much of it in recent years. In fact even later this year and in
2017 it could be a different story. If, as The Conference Board projects, the
U.S. economy is still growing at around 2 percent in 2017, accelerating labor
costs will start being passed on to the consumer. Meanwhile, the
inflation-limiting effects of a strengthened dollar and lower oil prices will
have mostly evaporated.
Many doubt that we should be worried about inflation with GDP growing at
just 2 percent. But we argue that, when planning for 2017, it is completely
justified to be more concerned. As we have been warning since 2014, the U.S.
faces a perfect economic storm: Baby-boomer retirement is a generational
tidal wave that combines with very weak gains in labor productivity to set up
a situation of historically low growth on the supply side of the economy.
In Search of Supply Constraints
“The main story in the U.S. economy right now is that it is gradually
running into supply constraints” said Levanon.
Do these charts represent supply constraint?
Merchant Wholesalers: Inventories to Sales Ratio
Total Business Sales Percent Change From Year Ago
Total Business Sales Detail
Harper Petersen Shipping Index
Supply Constraint or Oversupplied?
Somehow it seems we are massively oversupplied.
Retail sales were dismal (see Retail Sales -0.3%; Autos Down 4th Month, Plunge -2.1%)
Also note that Used Car Inventory Hits Record Level.
For more charts and commentary, please see Inventories and Sales: How Bad Are They? Study in Pictures
Questions and Comments for Levanon
- What about stock market and junk bond market bubbles? I
seriously cannot understand the Fed and other economists never taking
asset bubbles into consideration.
- Then what happens when those bubbles pop? Recession?
- And what about GDPNow at 0.1% and Auto sales dropping?
- Retail spending looks weak. Manufacturing is in a
recession.
- Yep – oil prices going up – so will import prices.
- Exports? In a weakening global economy?
- It will not take much to tip this economy into a
recession (assuming we are not already in recession – and I think we
are).
- Fed prepared to hike with GDP at 0.1% and falling like a
rock?
- Then again – these guys have never seen a recession in
advance, and likely never will.
Those were my unanswered comments and questions to Levanon.
Perhaps those questions and comments hint at a “perfect storm” but for
different reasons than inflation.
Regardless, there are few if any supply constraints.
Yield Curve
The 30-year long bond is a mere 33 basis points from a record low. The
10-year note is under 30 basis points away from a new low. Meanwhile, the
short end of the curve has been rising since 2013 or 1014.
Had rates been higher, an inversion would have been likely.
The US treasury yield curve looks and acts like the concern is recession
or deflation, not inflation. Why?
Three Possibilities
- Recession is here or on the horizon
- Central bank manipulations and negative yields make US
treasuries attractive at what would otherwise be unattractive rates
- Both of the above
I sympathize with reasons one and three, but not two in isolation.
Price Inflation
For sure, there is decent-sized price inflation in healthcare, education,
gasoline since the low earlier this year, housing, and rent.
We also see significant wage inflation in a number of states.
If wages and prices do rise, and the Fed hikes into recession, we have the
dreaded stagflation scenario, albeit at much lower levels of concern.
Many promoting a stock market crash believe in hyperinflation.
We can sort this all out in a moment. First, I have a musical tribute.
Whole Lotta Flation Going On
Asset Bubble Inflation/Deflation
The key to where this is all headed depends on the answer to the question
“Did the Fed sponsor more asset bubbles?”
If the answer is yes (and I believe it is), then another asset bust is
coming up.
Asset bubble busts lead to asset level deflation, falling profits, rising
unemployment, and likely falling prices.
Mike “Mish” Shedlock
