Is Inflation about to Stir?

Inflation has been one of the major puzzles since the financial crisis.

Many people expected that after the Fed began its zero-interest-rate and quantitative-easing policies in 2009, inflation would rise to troublesome levels. That didn’t happen, and inflation has been stubbornly below average for years.

Inflation has increased the last few years, but it has only started to approach the 2% level. (See the latest numbers below.) That’s a far cry from the levels of the 1970s that many people expected would result from the Fed’s easy-money policies.

Even forecasts from the Fed have been off the mark and have left Fed officials and economists puzzled. Lower-than-expected inflation has put the Fed behind its preferred schedule of raising interest rates to more normal levels.

More recently, Fed officials have begun to admit that there might be some structural differences in the economy that are keeping inflation low. Let’s take a look at some of these structural issues.

Normally, when the unemployment rate is low, inflation is rising. Employers have to raise wages to keep employees, and the employees spend that money more freely. Only recently have we started to see wages exceeding 2% annual increases.

One reason why wages haven’t increased as much is that employees still remember the financial crisis. They’re afraid to ask for significant wage increases. They’re also not optimistic enough to look for new jobs.

There also are structural reasons for low wage growth.

Health care is a significant part of the economy, and it has been weaker than usual lately. That has restrained wage increases in that sector.

Also, growth in the global economy lagged until the last year or so. Many jobs in the United States are tied to global markets. Weakness in global markets means their employers aren’t doing as well and are less likely to increase pay. Only recently has global growth picked up.

Productivity also is weaker than usual. In the past, employers were able to pay workers more when the economy was strong because the workers were more productive. However, employers haven’t been investing in new plants, equipment and technology the way they used to. They’re conserving cash and limiting debt. So, worker productivity isn’t increasing the way they used to. That keeps a lid on wages, which keeps a lid on inflation.

Other factors are limiting inflation, too. Globalization generally forces more competition, and that limits price increases.

In various ways, technology is keeping inflation low. One way has become known as “the Amazon effect.” Businesses such as Amazon use the internet and technology to keep selling prices low. Even local businesses are forced to compete with Amazon and the other online retailers.

Then there were some one-time events that kept inflation low over the last few years.

When cellular phone companies changed their pricing earlier this year, that move had a significant downward effect on the overall Consumer Price Index (CPI). That effect has started to fade from the CPI.

The commodities bear market of 2014-2016 offset price increases in services and held down the overall CPI.

Many of these factors are fading, at least a bit. The inflation reading eased higher in 2015 and 2016, only to stall in 2017. I think the stall is over and that we’ll see inflation start to inch higher in 2018.

The Data

The Producer Price Index rose 0.4% for the month and 3.1% over 12 months. This marks the third month in a row of 0.4% monthly increases, and the 12-month increase is the highest in more than five years.

The Consumer Price Index also rose 0.4% for the month and is up 2.2% over 12 months. Higher gasoline prices were a big part of the increase. After excluding food and energy, however, the CPI rose only 0.1% for the month and 1.7% over 12 months. Medical care, which traditionally is higher than the headline CPI, was unchanged. Housing, which is the largest part of the index, increased only 0.2%.

Small business owners are increasingly optimistic, according to the Small Business Optimism Index from NFIB. The index surged to 107.5 from 103.8. That’s the highest level since November 2004. The survey respondents were more optimistic in almost all categories. They believe that this is a good time to expand and have increased the number of new workers they plan to hire. The NFIB emphasized that taxes were cited as the number one problem for small business owners, and their optimism probably hinges on tax reform being enacted.

The preliminary Consumer Sentiment reading from the University of Michigan showed a small decline to 96.8 from 98.5. The recent high was in October at 100.7. Despite the decline, the reading is very positive. According to the report, the decline was due primarily to self-identified Democrats saying tax reform gave them less confidence about the economy.

Consumer optimism is starting to show in retail sales. Retail sales jumped a whopping 0.8% in the last month, and the prior month’s gain was revised higher to 0.5% from 0.2%. Even after autos and gas are subtracted, the increase was 0.8% for the latest month and 0.4% for last month. It’s easy to see why small business owners are optimistic.

The economy still is perking along, according to the PMI Composite Flash Index, though there are some changes. The Services component of the index dropped to 52.4 from 54.7. That’s the lowest reading for services for 15 months. The manufacturing component increased to 55.0 from 53.8, an 11-month high.

The job market might be tightening, according to the JOLTS (Job Openings and Labor Turnover Survey) report. The report has been characterized for two years by many unfilled job openings as employers complained they couldn’t find qualified workers for the jobs they had. In the latest report, job openings declined 2% and hires increased 4.4%. The difference between openings and hires is the lowest since May.

Last week’s Employment Situation reports painted the same picture. The unemployment rate held steady at 4.1%, and the 228,000 new jobs exceeded expectations. Average hourly earnings increased a modest 0.2% and are up 2.5% over 12 months. That’s well below the rate of previous periods when unemployment was low, but well above the increases of a few years ago.

New unemployment claims in the last week dropped by a very high 11,000, bringing the total to 225,000, which is near the historic low.

The Markets

The S&P 500 rose 1.33% for the week ended with Wednesday’s close. The Dow Jones Industrial Average increased 1.94%. The Russell 2000 returned 1.04%. The All-Country World Index added 1.46%. Emerging market equities rose 2.50%.

Long-term treasuries fell 0.27% for the week. Investment-grade bonds gained 0.02%. Treasury Inflation-Protected Securities (TIPS) were unchanged. High-yield bonds rose 0.18%.

The dollar declined 0.16%.

Energy-based commodities rose 0.46% for the week. Broader-based commodities lost 0.69%. Gold declined 0.74%.

Bob’s News & Updates

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