A Healing Labor Market And Calming Inflation – What’s Not To Like? How About Slowing Growth…
Not much volatility in the equities market this past week, as the S&P slowly ground its way to four consecutive record highs on Tuesday, Wednesday, Thursday, and Friday.
Not true in the fixed income arena where the 10-Year benchmark Treasury began the week at 1.28% (having been as low as 1.17% just before the Payroll Report), rose to as high as 1.37% just prior to the CPI report, fell back to 1.32% as there was relief that CPI had stopped accelerating, but rose again to 1.37% to fund the huge new corporate and government supply on Thursday. Relief set in on Friday with yields closing at the 1.30% level.
Initial Unemployment Claims (ICs), a proxy for new layoffs, barely moved down (-5k) in the state programs to 321K (Not Seasonally Adjusted) the week of August 7. They rose +10K in the federal Pandemic Unemployment Assistance (PUA) programs. So, on net, only a small +5K rise, though this did end the downtrend that had been in place for several weeks. (Delta-Variant?)
The PUA programs, comprising about 25% of the IC total, end on September 4. If that occurs, weekly checks for more than 100K beneficiaries will abruptly end. While small in comparison to the number of consumers, this will have a negative impact, at the margin, for consumption at the end of Q3.
In June and July significant progress was made in the Continuing Unemployment Claims data (CCs) (those receiving benefits for more than one week). On June 12, there were 14.7 million such beneficiaries. The latest data (July 24) show a fall to 12.1 million, a -2.6 million reduction. Of the total, 9.0 million are in the PUA programs. As indicated, these programs end on September 4. No weekly check for this 9.0 million will have much more than a marginal impact on retail sales. This is one reason we continue to believe that Q3 and Q4 economic growth rates will disappoint.
Opt-Outs vs. Opt-Ins
Prior to the pandemic, there were no PUA programs. “Normal” ICs were 200K, and “normal” CCs were two million. On May 15, there were 3.545 million on state CC roles. The latest data (preliminary for July 31) shows a significant -20% fall here, to 2.817 million. Those who follow our blogs know that we have believed the federal $300/week supplement has been significantly responsible for holding back lower wage earners from reentering the labor market. The following table shows that since mid-May, unemployment has declined significantly faster for the opt-out states (-33.3%), those not paying the federal supplement, than for the opt-in states (-14.9%).
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The California (CA) data has shown inexplicable volatility, rising from 594K the week of June 26 to 833K (July 17), then down to 565K (July 24) and back to 651K (July 31). The bottom line of the table eliminates CA from the calculation, and, as we have forecast, shows the rising progress of the opt-in states as the end of the federal supplement approaches (September 6).
But it is the latest data (July 31) that reinforces our view that the federal supplement has been an impediment for a return to “normal” in the labor market. In the July 31 data, CCs fell by a total of -112.8K. Of this total, -104.9K, or 93%, came from the opt-out states. Note from the table that opt-out states only account for 25.5% of total CCs! Convinced yet?
CA, with its +55.6K rise the week of July 31 clearly skews the opt-in state data. Excluding CA, the total fall in CCs rises to -168.4K. The opt-outs now represent 32.8% of the total CCs (ex-CA), but still accounted for 67% of the CC reduction. For us, the data is conclusive: the federal supplement has been a hindrance to the reopening and a return to some semblance of “normal.” And, to reiterate, the supplement ends on September 6, and we can’t imagine that this won’t have a negative impact on September’s consumption. It will take many weeks for people not working because of the supplement to re-engage, and during that period, they will have $300/week less income.
Open any newspaper, especially a financial one, and an article on the inflation ravaged U.S. economy is sure to be prominently displayed. The July CPI headline number was +5.4% Y/Y (+0.5% M/M). Because June’s Y/Y tally was also 5.4%, and July’s number did not display acceleration, the credit markets gave a huge sigh of relief. Core CPI, which excludes food and energy, was even better: 4.3% Y/Y in July vs. 4.5% in June. This was the first inkling that, perhaps, we have seen “peak” inflation. For the month, Core CPI was +0.3%; ex-autos, +0.2%. Looking just at Core, 14% of its weight had an inflation rate of 20% Y/Y. The other 86%: just 1.1%! Sequentially, the monthly Core CPI data look like this: April: +0.9%; May: +0.7%; June: +0.9%, and now, July: +0.3%.
While one data point is not yet a trend, the incoming data continues to point to softer economic growth. And when demand is softening, inflation is too.
- Open Table: the week of August 10 showed restaurant reservations -8% lower than the pre-pandemic norm. They were higher than that norm in June, so, either the initial demand surge is over, or the Delta variant is having an impact. In either case, this conjures up a slower growth forecast.
- The headline on page B1 of the Thursday, August 12 edition of the Wall Street Journal read: “Southwest Warns of Slowdown.” The first sentence says it all: “Southwest Airlines Co. LUV said the recent surge in Covid-19 cases is causing bookings to slow and cancellations to rise, showing how quickly the Delta variant is denting economic activity.” Southwest lowered its 2021 guidance.
- Airfares in July were flat (-0.1%) and while that only moved the Y/Y rate from +24% in June to +19% in July, it is the first sign of a topping. Same for used cars. Prices rose +0.2%, lowering the Y/Y increases to +41.7% from +45.2%. Much bigger falls are likely going forward. (There is a similar pattern for furniture.)
- In July, IT service prices rose 0.2%; same for education and telecom. Medical rose +0.3% (but prescription prices fell -0.1% – imagine that!).
Much of what we are calling “inflation” seems to be coming from the significant fall in prices in the summer of 2020 (i.e., the “base effect”). Hotel prices, for example, are up 24% Y/Y in July, but back in July 2020, that same metric was -15%!
The inflation story, however, does have some legs.
· Rents rose +0.2%, and OER (Owners’ Equivalent Rent – the “rent’ BLS attributes to an owner-occupied home) rose 0.3%. As we commented in last week’s blog, we do expect some persistency in rent inflation due to rising home prices and the continuing moratorium on evictions.
· Last week, China shut down the world’s third busiest container port due to a single case of Covid-19. Some see this as part and parcel of the developing political duel between the U.S. and China, but, whatever the reason, this is going to have a negative impact on world-wide supply chains, will lengthen the “transitory” inflation period, and shows just how fragile the world’s economies have become. To add to the supply chain issue, there appears to be a significant shortage of container ships now that many must park outside of ports and wait days/weeks to be unloaded. Again, this may serve to lengthen the “transient” time frame for inflation. And the longer “transient” period may eventually exert an influence on world central banks, including the Fed, regarding some reversal of their ultra-easy monetary policies.
- Reshoring of supply chains and abandonment of “just-in-time” inventory policies (in favor of “just-in-case”) is likely the ultimate result. Realize, however, that not all supply chains can be local, as there are raw material concentrations in certain parts of the world. Rare earths, used extensively in battery technology, come to mind. Many of these are concentrated in China.
Gouging at the Pump
Gasoline prices appear to have skyrocketed, up +2.4% in July, +2.5% in June, and a whopping +42% Y/Y. The Biden Administration has voiced concerns and has publicly asked OPEC to up its production targets.
Here is our analysis:
- The price of a barrel of oil has hovered between $60 and $70 for most of the year. In the past, it has been higher than $100/bbl.
- Inventories of oil do not appear to be out of sorts as seen from the accompanying chart showing two years of weekly inventory data. The August 2021 data, while falling, appear to be in the normal seasonal pattern (summer driving season).
- U.S refineries get about 41 gallons of yield per barrel (19 gasoline, 10 diesel, 4 jet fuel, and 9 other including resins). Thus, the cost of the raw material is about $1.65/gallon, and this has historically been 45%-55% of overall costs. Let’s use 48%. Reasonable estimates for refining costs (including profits) are 23%, marketing and distribution 9% and taxes 20%. Doing the math using these inputs results in a price per gallon of $3.45.
- As of August 13, the national average per gallon of regular grade is $3.19 (sorry CA: you’re at $4.40!). So, while the cost is up 42% from $2.25 a year ago (anyone remember that one week-end last summer when the price per barrel was negative?), it is clear that the large percentage change is due to base effects, not to price gouging.
We began this blog with a discussion of equity and fixed income markets, and so we will also end there. After some indigestion due to headline employment data, lower than feared CPI and the successful placement of a near-record amount of corporate and government debt in the middle of last week caused a substantial pullback in interest rates on Friday, August 13. The 10-Year Treasury benchmark fell to 1.28% from 1.36% on Thursday. Our forecast for slower than expected economic growth in Q3 and Q4 should continue to put downward pressure on the yield curve. (Of course, this is not the standard rate forecast being pushed by the financial media!)
There has been some positive movement in the labor markets. It does appear that there will still be millions on the CC roles when the programs terminate in early September, and that spells a significant slowdown in consumption and economic growth. This is not the consensus view.
Inflation continues to be “transitory,” with most of the spike due to base effects. While we do continue to forecast downward inflation prints going forward, the Delta variant appears to be lengthening the “transitory” period, with the dearth of container ships and the major port closure in China as key reasons. In addition, as we blogged last week, rent increases may prove to be more persistent due to the continued eviction moratorium, and especially if home prices are stickier to the upside than we originally thought.
Our study of gasoline prices indicates that we have returned to a more “normal” set of prices, on average, in the country. Some hot spots still exist (CA, HI, NV), but inventories appear to be normal from an historical perspective, as does the historical cost/profit structure. The 42% Y/Y price spike appears to be entirely due to the base effects of depressed prices in the summer of 2020.
After some indigestion from the headline employment report and a spike in the supply of new debt, interest resumed their downward bias as the week ended.
(Joshua Barone contributed to blog)