Robert Brusca

The trend to spend took a hit in March but the quarter was still strong for the consumer, as we already say in the GDP report. Three-month trends show us that spending is cooling to a 2.2% pace led by a slowdown in nondurable goods [...]

US Consumer Spending Flounders in March but Trend Still Mostly Firm

Carol Stone, CBE

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070427c.jpg" width="353">
Japan&#39;s economy appears in an uncertain position, according to a collection of data released this morning in Tokyo. What seem to be favorable trends turn out to be unsustainable, so evidence of growth is fleeting.
Industrial production perhaps surprised the most, falling 0.6% in March from February and slowing on a year-to-year basis to just 1.6% above March 2006, after gaining 3.1% in February and 4.8% for last year as a whole. Forecasters had looked for industry to raise production in March by an amount about equal to the decline that occurred. The losses in March were widespread across equipment and materials. <img align="right" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070427d.jpg" width="353">
Similarly, household living expenditures had perked up following a late summer decline, but they could not hold the newfound gains, and sank by 1.4% in March. They are now essentially flat with March a year ago. This is not, however, because there is significant weakness in labor markets. March employment was up only 10,000, but that followed a 420,000 increase in February; the numbers of persons employed are up 0.7% from March 2006, stronger than the 0.4% rises in each of the last three years. The unemployment rate has been steady at 4.0% for five consecutive months; a rate lower than this was last seen in the winter of 1998.
Perhaps most exasperating for Japanese government officials, the CPI has started to weaken again. We, as they, were excited over a turn toward rising prices just ahead of the Bank of Japan&#39;s rate increase last July. The year-on-year change in the CPI excluding fresh food -- the preferred &quot;core rate&quot; -- there, shifted to positive in March 2006, then after hesitating, it set a consistent trend of 0.2%-0.3% gains over much of the rest of 2006. This is not rapid, of course, but it gives business some badly needed pricing flexibility. Clothing prices, for instance, picked up, but then moderated in the most recent months. Furniture prices are falling more slowly than they were. But so far this year, the &quot;ex fresh food&quot; core has started to tilt lower. In February, it was down 0.1% on the year earlier and in March, 0.3%. Interpreting this is tough, considering it&#39;s one of the BoJ&#39;s main policy targets. The weakest categories this month are housing, which has declined all along, and transportation, particularly public transportation. Part of the adverse year-on-year comparison is also due to the acceleration of energy prices a year ago. Some of these items are administered prices and energy costs are, of course, burdensome, like a tax. <img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070427e.jpg" width="353">
So all of these things together: a sudden and unexpected drop in industrial activity, weaker household expenditures and skittish consumer prices facing a firm employment conditions -- make it hard to characterize the strength of Japanese markets and hard for policymakers to key their decision-making. A semiannual outlook released today (available <a href="http://www.boj.or.jp/en/type/release/teiki/tenbo/gor0704.htm">here</a>) featured a reduction in the consumer price forecast for the current fiscal year (ending March 2008) and suggested to many observers that it will be hard to raise interest rates anytime soon. 

<table border="0" cellspacing="0" width="100%">
<colgroup><col><col><col><col><col></colgroup>
<thead>
<tr>
<th scope="col" class="firstcol">JAPAN&nbsp; (Seas. Adj., % Change, ex as noted)</th>
Mar 2007
Feb 2007
<th scope="col">2006</th>
<th scope="col">2005</th>
<th scope="col">2004</th>
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">Mo/Mo</td>
<td>Yr/Yr</td>
<td>Mo/Mo</td>
<td>Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">CPI: General</td>
<td>0.0</td>
<td>-0.1</td>
<td>-0.3</td>
<td>-0.2</td>
<td>0.2</td>
<td>-0.3</td>
<td>-0.0</td>
</tr>
<tr>
<td class="firstcol">&nbsp; ex Fresh Food</td>
<td>-0.1</td>
<td>-0.3</td>
<td>-0.2</td>
<td>-0.1</td>
<td>0.1</td>
<td>-0.1</td>
<td>-0.1</td>
</tr>
<tr>
<td class="firstcol">&nbsp; ex Food &amp; Energy</td>
<td>-0.2</td>
<td>-0.4</td>
<td>0.0</td>
<td>-0.3</td>
<td>-0.4</td>
<td>-0.4</td>
<td>-0.6</td>
</tr>
<tr>
<td class="firstcol">&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td class="firstcol">Industrial Production</td>
<td>-0.6</td>
<td>1.6</td>
<td>0.7</td>
<td>3.1</td>
<td>4.8</td>
<td>1.1</td>
<td>5.5</td>
</tr>
<tr>
<td class="firstcol">&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td class="firstcol">Employment</td>
<td>+10K</td>
<td>0.7</td>
<td>+420K</td>
<td>0.5</td>
<td>0.4</td>
<td>0.4</td>
<td>0.4</td>
</tr>
<tr>
<td class="firstcol">Unemployment Rate</td>
<td>4.0</td>
<td>--</td>
<td>4.0</td>
<td>--</td>
<td>4.1</td>
<td>4.4</td>
<td>4.7</td>
</tr>
<tr>
<td class="firstcol">&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td class="firstcol">Household Living Expenditures*</td>
<td>98.4</td>
<td>0.1</td>
<td>99.8</td>
<td>1.1</td>
<td>98.1</td>
<td>100.0</td>
<td>100.8</td>
</tr>
</tbody>
</table>
</body>
</html>

Japan's economy appears in an uncertain position, according to a collection of data released this morning in Tokyo. What seem to be favorable trends turn out to be unsustainable, so evidence of growth is fleeting. Industrial [...]

Japan's Economy Hits Some Air Pockets; CPI Starts To Fall Again

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070427b.jpg" width="353">
The Employment Cost Index or ECI is a major US inflation survey. The quarterly index came packaged with a surprise: This quarter benefit costs rose by a very thin 0.1% as wages surged ahead by 1.1%. As a result total compensation was held to a gain of 0.8%, less than expected. But as surely as some are worried about that wage rise they are also curious about the small gain in benefits costs. 
The story for benefits seems to be due to one particular technical issue related to pension contributions. Firms with defined benefit plans have fiduciary responsibility to keep their pensions funded according to some set rules. Since stocks were so strong, the BLS surmises that many firms simply took the run up in prices as their &#145;contribution&#146; and did not inject new funds into the pension plans. This saving results in lower benefit costs to the firm but does not imply any reduction in benefits given to workers. In that sense it is bogus decline if we think in terms of labor costs. We have seen surging stock prices do this on other occasions in the past. On balance we can throw out the benefit number as a one anomaly. 
The problems in this report remain as the rise in wages. And despite the hiatus in benefit costs this quarter we expect the Fed to take the wage component as an authentic a signal of tightening labor markets. The chart above shows quite clearly that the pressures are escalating rapidly and that they are strong in both goods ands services, but strongest in services where international competition plays the smallest role. 
Services wages are rising at an extremely rapid pace. There are still being outpaced by the employment reports average hourly earnings measure (a poorer index) but that only serves to show there is another, albeit less pure wage measure that is showing the same effect. The Fed has been getting the same feed back in its regional Beige Book canvas. How long can the Fed ignore these signals? On balance I think this report will be sort of chilling from the Fed&#146;s perspective. 
The Fed will not be happy over the low growth print for Q1 2007. But there is no denying that wages are rising rapidly and that consumer incomes are growing solidly and the consumer spending is strong and price pressures are still in play. Despite the weak Q1 GDP print I think the Friday reports ( GDP, ECI and U of M final (revised)) put the Fed a half step closer to a rate hike ( yes, HIKE). It will take more information to do it but the Fed must be increasingly nervous about inflation and not so worried about growth after seeing the composition of GDP. Wage pressures, remember, tend to be sticky and longer lasting. These pressures are indeed getting out hand. 
Moreover, although hours worked (in the monthly employment report) only rose at a 1.5% pace in Q1 2007 weak GDP will not allow that to become good news for productivity. With GDP advancing by 1.3% there is not much room for productivity growth and that will put the Fed even more on edge about wage pressures becoming cost pressures and leading to price hikes.

<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
Employment Cost Index Overview of Key Components
</tr>
</thead>
<tbody>
<tr class="even">
<td class="firstcol">ECI Trends</td>
<td>07:Q1</td>
<td>06:Q4</td>
<td>07:Q1</td>
<td>06:Q4</td>
<td>06:Q1</td>
</tr>
<tr class="odd">
<td class="firstcol">Civilian</td>
<td colspan="2">% Q/Q</td>
<td colspan="2">% Yr/Yr</td>
<td>% Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Compensations</td>
<td>0.8</td>
<td>0.9</td>
<td>3.5</td>
<td>3.3</td>
<td>2.8</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Benefits</td>
<td>0.1</td>
<td>1.1</td>
<td>3.1</td>
<td>3.6</td>
<td>3.4</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Wages</td>
<td>1.1</td>
<td>0.7</td>
<td>3.6</td>
<td>3.2</td>
<td>2.5</td>
</tr>
<tr class="odd">
<td class="firstcol">Private</td>
<td colspan="2">% Q/Q</td>
<td colspan="2">% Yr/Yr</td>
<td>% Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Compensations</td>
<td>0.6</td>
<td>0.8</td>
<td>3.1</td>
<td>3.2</td>
<td>2.6</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Benefits</td>
<td>-0.3</td>
<td>0.9</td>
<td>2.3</td>
<td>3.1</td>
<td>2.9</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Wages</td>
<td>1.1</td>
<td>0.8</td>
<td>3.5</td>
<td>3.1</td>
<td>2.5</td>
</tr>
<tr class="odd">
<td class="firstcol">Memo:</td>
<td colspan="2">% Q/Q</td>
<td colspan="2">% Yr/Yr</td>
<td>% Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">Average Hourly Earnings</td>
<td>0.9</td>
<td>1.0</td>
<td>4.1</td>
<td>4.1</td>
<td>3.5</td>
</tr>
</tbody>
</table>
</body>
</html>

The Employment Cost Index or ECI is a major US inflation survey. The quarterly index came packaged with a surprise: This quarter benefit costs rose by a very thin 0.1% as wages surged ahead by 1.1%. As a result total compensation was [...]

ECI Wages Jump; Benefits Whimper

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070427a.jpg" width="353">
GDP growth &#145;surprised&#146; on the slow side for 2007Q1 coming in at a pace of 1.3%. The Yr/yr pace slowed, too, to 2.1% a sharp slowdown from 3.1% Y/Y just last quarter. 
Despite the low growth print of the headline, GDP was anything but weak. Consumer spending came in with a gain of 3.8% quite strong and in the 25th%-tile of all its contributions to GDP growth since 1980. With consumer spending running hard at 3.8% it would be difficult to believe that to boost GDP the Fed would want to cut rates and spur even stronger spending. As it is, the rate of unemployment is falling. Now the issue for GDP is that, for the moment, there are some special subtractions in play that are keeping real spending growth in the various GDP sectors from hitting the bottom line. It is these subtractions we need to turn our attention to.
The subtractions from GDP in Q1 were not a surprise. Residential structures took nearly one percentage point from GDP growth by itself. As large as this is for such a small sector of the economy (only 4.5% of GDP) it was its smallest subtraction by this beleaguered sector in three quarters. It is obviously too small to continue to have this sort of outsized impact on GDP. Since the sector is only 4.5% of GDP it could only subtract a percentage point from GDP growth for four years in a row before it would be reduced itself to only 0.5% of GDP itself. Housing cannot and will not continue to be such a negative. 
While housings weakness could spill over to in other ways it seems that people&#146;s tendency to rely on home equity increases to support spending have been exaggerated, this according to a new study Alan Greenspan had a hand in. With the upward revisions to U of M Consumer sentiment on Friday (4/27/07) the erosion in consumer attitudes seems to have been stabilized as well. Spill over form housing no longer seems to be such a risk. 
Also subtracting from GDP are inventories. They have subtracted from growth in five of the past eight quarters. But this is their weakest rise in six quarters. Inventories have already done a lot of their adjusting or so it seems especially With consumption so strong, surely this sort of inventory paring won&#146;t go on for long. 
The ongoing subtraction from GDP is GDP net exports. They have contributed positively to growth in only six quarters (out of 29 quarters) since the end of 1999. The net export drain is a persistent drain on US product and on US incomes. The other drains are temporary or cyclical in nature. For this reason and more the net export drain is particularly troublesome. Despite a very weak dollar (read &#145;a highly competitive dollar&#146;) and reported strong growth in Europe and in China US exports FELL in 2007-Q1. Generally what happens to the trade account is that US imports are strong due to strong US growth and they outpace exports. But this quarter US imports are weak due to weak US growth and exports fell pushing the deficit up. It does not make sense for US exports to be so weak and to me, at least, this is the most troubling aspect of this GDP report. 
The chart above shows several measures of US domestic activity in GDP. We show real consumer spending (PCE) and the consumer income that support such spending (real disposable personal income). We also plot final sales of domestic products. As an overlay on this mapping we chart the unemployment rate that continues to fall. Very clearly US activity- however you define it- is strong enough to drive the rate of unemployment lower. This is the main reason why despite evidence of a slowing in GDP the Fed will not want to touch stimulus with a ten foot pole.
We have been through the accounting of GDP and see the measures that account for most of the GDP slippage. We can tell that there are certain leakages that relate to certain problems or issues in the economy. We can even assess some of them to be temporary. But we cannot deny the impact they had on GDP in the quarter. Despite the slowdown in GDP we find there is growing wage pressure and dropping unemployment. While the Fed is not comfortable with GDP growth slowing and certainly is quite uncomfortable with GDP at 1.3% (annualized) &#150; even for one quarter - it can see that the economy, despite its weak headline, is growing quite fast enough. This GDP report helps to explain the Fed&#146;s dilemma like nothing else could. Despite the slowing in GDP and the low growth rate, inflation pressures are worsening and the rate of unemployment is dropping. What is the Fed supposed to do about all that? It&#146;s not supposed to happen that way. <a name="A"></a>Note: Stagflation 
This GDP report has prompted some to raise of the specter of stagflation. Is this what stagflation is? Stagflation may be a difficult topic to wrap your brain around, but we can answer this question with some degree of clarity.
NO! and on the other hand&#133;NO! &#150;that&#146;s just be clear about it.
People who are calling this stagflation are confused.
While it may seem like stagflation with the GDP growth rate falling and inflation rising stagflation is not really about rising inflation and slowing growth (even though the name says Stag-flation). Instead stagflation is about stubbornly high inflation and insufficient growth.
For stagflation, inflation need not be accelerating; it just needs to be &#145;high.&#146; Growth need not be decelerating; it simply needs to be insufficient&#146;.
The US economy may be losing steam and it may have slowed but growth is NOT insufficient. Corporate profits are doing well and DJIA has just made a series of all-time record highs. Other market indices are on 6-yr highs plus the RATE OF UNEMPLOYMENT is low and has been falling. 
When unemployment starts to rise and inflation is stubbornly high or rising we can open this question of stagflation. But let me say this: I have seen stagflation and this is not stagflation. 
As for inflation, inflation may be rising, and it may be above the Fed&#146;s comfort zone, but it is hardly high.
The problem with branding this as stagflation is that we have NO &#145;stag&#146; at all and very little &#145;flation&#146;.

<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
Contributions to GDP Growth
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">&nbsp;</td>
<td>PCE</td>
<td>Services</td>
<td>Goods</td>
<td>Non Residential Structure</td>
<td>Residential Structure</td>
<td>Equipment % Software</td>
<td>Inventory</td>
<td>Net Exports</td>
<td>Government</td>
</tr>
<tr>
<td class="firstcol">Q1-07</td>
<td>2.66</td>
<td>1.51</td>
<td>1.15</td>
<td>0.07</td>
<td>-0.97</td>
<td>0.14</td>
<td>-0.30</td>
<td>-0.52</td>
<td>0.18</td>
</tr>
</tbody>
</table>
<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
US GDP Summary
</tr>
</thead>
<tbody>
<tr class="even">
<td class="firstcol">GDP Growth</td>
<td>2006 Q1</td>
<td>2006 Q2</td>
<td>2006 Q3</td>
<td>2006 Q4</td>
<td>2007 Q1</td>
<td>Current</td>
</tr>
<tr class="odd">
<td class="firstcol">Actual/A,P,F</td>
<td>Actual</td>
<td>Actual</td>
<td>Actual</td>
<td>Actual</td>
<td>Advance</td>
<td>Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">Real GDP</td>
<td>5.6%</td>
<td>2.6%</td>
<td>2.0%</td>
<td>2.5%</td>
<td>1.3%</td>
<td>2.1%</td>
</tr>
<tr>
<td class="firstcol">PCE</td>
<td>4.8%</td>
<td>2.6%</td>
<td>2.8%</td>
<td>4.2%</td>
<td>3.8%</td>
<td>3.4%</td>
</tr>
<tr>
<td class="firstcol">Durables</td>
<td>19.8%</td>
<td>-0.1%</td>
<td>6.4%</td>
<td>4.4%</td>
<td>7.3%</td>
<td>4.5%</td>
</tr>
<tr>
<td class="firstcol">Nondurables</td>
<td>5.9%</td>
<td>1.4%</td>
<td>1.5%</td>
<td>5.9%</td>
<td>2.9%</td>
<td>2.9%</td>
</tr>
<tr>
<td class="firstcol">Services</td>
<td>1.6%</td>
<td>3.7%</td>
<td>2.8%</td>
<td>3.4%</td>
<td>3.7%</td>
<td>3.4%</td>
</tr>
<tr>
<td class="firstcol">Business Invst.</td>
<td>13.7%</td>
<td>4.4%</td>
<td>10.0%</td>
<td>-3.1%</td>
<td>2.0%</td>
<td>3.2%</td>
</tr>
<tr>
<td class="firstcol">Structures</td>
<td>8.8%</td>
<td>20.3%</td>
<td>15.7%</td>
<td>0.9%</td>
<td>2.1%</td>
<td>9.4%</td>
</tr>
<tr>
<td class="firstcol">Equipment</td>
<td>15.6%</td>
<td>-1.4%</td>
<td>7.7%</td>
<td>-4.8%</td>
<td>1.9%</td>
<td>0.8%</td>
</tr>
<tr>
<td class="firstcol">Housing</td>
<td>-0.3%</td>
<td>-11.1%</td>
<td>-18.6%</td>
<td>-19.8%</td>
<td>-17.0%</td>
<td>-16.7%</td>
</tr>
<tr>
<td class="firstcol">Inventories ($B)*</td>
<td>$41.2</td>
<td>$53.7</td>
<td>$55.4</td>
<td>$22.4</td>
<td>$14.8</td>
<td>$31.8</td>
</tr>
<tr>
<td class="firstcol">Farm</td>
<td>$4.3</td>
<td>$1.9</td>
<td>$2.5</td>
<td>$2.4</td>
<td>$3.0</td>
<td>$1.2</td>
</tr>
<tr>
<td class="firstcol">Nonfarm</td>
<td>$36.8</td>
<td>$52.2</td>
<td>$53.3</td>
<td>$20.0</td>
<td>$11.3</td>
<td>($45.2)</td>
</tr>
<tr>
<td class="firstcol">Net Exports ($B)**</td>
<td>($636.6)</td>
<td>($624.2)</td>
<td>($628.8)</td>
<td>($582.6)</td>
<td>($597.8)</td>
<td>$38.8</td>
</tr>
<tr>
<td class="firstcol">Exports</td>
<td>14.0%</td>
<td>6.2%</td>
<td>6.8%</td>
<td>10.6%</td>
<td>-1.2%</td>
<td>5.5%</td>
</tr>
<tr>
<td class="firstcol">Imports</td>
<td>9.1%</td>
<td>1.4%</td>
<td>5.6%</td>
<td>-2.6%</td>
<td>2.3%</td>
<td>1.6%</td>
</tr>
<tr>
<td class="firstcol">Government</td>
<td>4.9%</td>
<td>0.8%</td>
<td>1.7%</td>
<td>3.4%</td>
<td>0.9%</td>
<td>1.7%</td>
</tr>
<tr>
<td class="firstcol">Real Final Sales</td>
<td>5.6%</td>
<td>2.1%</td>
<td>1.9%</td>
<td>3.7%</td>
<td>1.6%</td>
<td>2.3%</td>
</tr>
<tr>
<td colspan="7">For Yr/Yr: * average, ** Change from Yr ago Qtr</td>
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GDP growth surprised on the slow side for 2007Q1 coming in at a pace of 1.3%. The Yr/yr pace slowed, too, to 2.1% a sharp slowdown from 3.1% Y/Y just last quarter. Despite the low growth print of the headline, GDP was anything but [...]

Can’t Tell a Book - or GDP – by its Cover, or Headline

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070427a.jpg" width="353">
GDP growth &#145;surprised&#146; on the slow side for 2007Q1 coming in at a pace of 1.3%. The Yr/yr pace slowed, too, to 2.1% a sharp slowdown from 3.1% Y/Y just last quarter. 
Despite the low growth print of the headline, GDP was anything but weak. Consumer spending came in with a gain of 3.8% quite strong and in the 25th%-tile of all its contributions to GDP growth since 1980. With consumer spending running hard at 3.8% it would be difficult to believe that to boost GDP the Fed would want to cut rates and spur even stronger spending. As it is, the rate of unemployment is falling. Now the issue for GDP is that, for the moment, there are some special subtractions in play that are keeping real spending growth in the various GDP sectors from hitting the bottom line. It is these subtractions we need to turn our attention to.
The subtractions from GDP in Q1 were not a surprise. Residential structures took nearly one percentage point from GDP growth by itself. As large as this is for such a small sector of the economy (only 4.5% of GDP) it was its smallest subtraction by this beleaguered sector in three quarters. It is obviously too small to continue to have this sort of outsized impact on GDP. Since the sector is only 4.5% of GDP it could only subtract a percentage point from GDP growth for four years in a row before it would be reduced itself to only 0.5% of GDP itself. Housing cannot and will not continue to be such a negative. 
While housings weakness could spill over to in other ways it seems that people&#146;s tendency to rely on home equity increases to support spending have been exaggerated, this according to a new study Alan Greenspan had a hand in. With the upward revisions to U of M Consumer sentiment on Friday (4/27/07) the erosion in consumer attitudes seems to have been stabilized as well. Spill over form housing no longer seems to be such a risk. 
Also subtracting from GDP are inventories. They have subtracted from growth in five of the past eight quarters. But this is their weakest rise in six quarters. Inventories have already done a lot of their adjusting or so it seems especially With consumption so strong, surely this sort of inventory paring won&#146;t go on for long. 
The ongoing subtraction from GDP is GDP net exports. They have contributed positively to growth in only six quarters (out of 29 quarters) since the end of 1999. The net export drain is a persistent drain on US product and on US incomes. The other drains are temporary or cyclical in nature. For this reason and more the net export drain is particularly troublesome. Despite a very weak dollar (read &#145;a highly competitive dollar&#146;) and reported strong growth in Europe and in China US exports FELL in 2007-Q1. Generally what happens to the trade account is that US imports are strong due to strong US growth and they outpace exports. But this quarter US imports are weak due to weak US growth and exports fell pushing the deficit up. It does not make sense for US exports to be so weak and to me, at least, this is the most troubling aspect of this GDP report. 
The chart above shows several measures of US domestic activity in GDP. We show real consumer spending (PCE) and the consumer income that support such spending (real disposable personal income). We also plot final sales of domestic products. As an overlay on this mapping we chart the unemployment rate that continues to fall. Very clearly US activity- however you define it- is strong enough to drive the rate of unemployment lower. This is the main reason why despite evidence of a slowing in GDP the Fed will not want to touch stimulus with a ten foot pole.
We have been through the accounting of GDP and see the measures that account for most of the GDP slippage. We can tell that there are certain leakages that relate to certain problems or issues in the economy. We can even assess some of them to be temporary. But we cannot deny the impact they had on GDP in the quarter. Despite the slowdown in GDP we find there is growing wage pressure and dropping unemployment. While the Fed is not comfortable with GDP growth slowing and certainly is quite uncomfortable with GDP at 1.3% (annualized) &#150; even for one quarter - it can see that the economy, despite its weak headline, is growing quite fast enough. This GDP report helps to explain the Fed&#146;s dilemma like nothing else could. Despite the slowing in GDP and the low growth rate, inflation pressures are worsening and the rate of unemployment is dropping. What is the Fed supposed to do about all that? It&#146;s not supposed to happen that way. Note: Stagflation 
This GDP report has prompted some to raise of the specter of stagflation. Is this what stagflation is? Stagflation may be a difficult topic to wrap your brain around, but we can answer this question with some degree of clarity.
NO! and on the other hand&#133;NO! &#150;that&#146;s just be clear about it.
People who are calling this stagflation are confused.
While it may seem like stagflation with the GDP growth rate falling and inflation rising stagflation is not really about rising inflation and slowing growth (even though the name says Stag-flation). Instead stagflation is about stubbornly high inflation and insufficient growth.
For stagflation, inflation need not be accelerating; it just needs to be &#145;high.&#146; Growth need not be decelerating; it simply needs to be insufficient&#146;.
The US economy may be losing steam and it may have slowed but growth is NOT insufficient. Corporate profits are doing well and DJIA has just made a series of all-time record highs. Other market indices are on 6-yr highs plus the RATE OF UNEMPLOYMENT is low and has been falling. 
When unemployment starts to rise and inflation is stubbornly high or rising we can open this question of stagflation. But let me say this: I have seen stagflation and this is not stagflation. 
As for inflation, inflation may be rising, and it may be above the Fed&#146;s comfort zone, but it is hardly high.
The problem with branding this as stagflation is that we have NO &#145;stag&#146; at all and very little &#145;flation&#146;.

<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
Contributions to GDP Growth
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">&nbsp;</td>
<td>PCE</td>
<td>Services</td>
<td>Goods</td>
<td>Non Residential Structure</td>
<td>Residential Structure</td>
<td>Equipment % Software</td>
<td>Inventory</td>
<td>Net Exports</td>
<td>Government</td>
</tr>
<tr>
<td class="firstcol">Q1-07</td>
<td>2.66</td>
<td>1.51</td>
<td>1.15</td>
<td>0.07</td>
<td>-0.97</td>
<td>0.14</td>
<td>-0.30</td>
<td>-0.52</td>
<td>0.18</td>
</tr>
</tbody>
</table>
<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
US GDP Summary
</tr>
</thead>
<tbody>
<tr class="even">
<td class="firstcol">GDP Growth</td>
<td>2006 Q1</td>
<td>2006 Q2</td>
<td>2006 Q3</td>
<td>2006 Q4</td>
<td>2007 Q1</td>
<td>Current</td>
</tr>
<tr class="odd">
<td class="firstcol">Actual/A,P,F</td>
<td>Actual</td>
<td>Actual</td>
<td>Actual</td>
<td>Actual</td>
<td>Advance</td>
<td>Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">Real GDP</td>
<td>5.6%</td>
<td>2.6%</td>
<td>2.0%</td>
<td>2.5%</td>
<td>1.3%</td>
<td>2.1%</td>
</tr>
<tr>
<td class="firstcol">PCE</td>
<td>4.8%</td>
<td>2.6%</td>
<td>2.8%</td>
<td>4.2%</td>
<td>3.8%</td>
<td>3.4%</td>
</tr>
<tr>
<td class="firstcol">Durables</td>
<td>19.8%</td>
<td>-0.1%</td>
<td>6.4%</td>
<td>4.4%</td>
<td>7.3%</td>
<td>4.5%</td>
</tr>
<tr>
<td class="firstcol">Nondurables</td>
<td>5.9%</td>
<td>1.4%</td>
<td>1.5%</td>
<td>5.9%</td>
<td>2.9%</td>
<td>2.9%</td>
</tr>
<tr>
<td class="firstcol">Services</td>
<td>1.6%</td>
<td>3.7%</td>
<td>2.8%</td>
<td>3.4%</td>
<td>3.7%</td>
<td>3.4%</td>
</tr>
<tr>
<td class="firstcol">Business Invst.</td>
<td>13.7%</td>
<td>4.4%</td>
<td>10.0%</td>
<td>-3.1%</td>
<td>2.0%</td>
<td>3.2%</td>
</tr>
<tr>
<td class="firstcol">Structures</td>
<td>8.8%</td>
<td>20.3%</td>
<td>15.7%</td>
<td>0.9%</td>
<td>2.1%</td>
<td>9.4%</td>
</tr>
<tr>
<td class="firstcol">Equipment</td>
<td>15.6%</td>
<td>-1.4%</td>
<td>7.7%</td>
<td>-4.8%</td>
<td>1.9%</td>
<td>0.8%</td>
</tr>
<tr>
<td class="firstcol">Housing</td>
<td>-0.3%</td>
<td>-11.1%</td>
<td>-18.6%</td>
<td>-19.8%</td>
<td>-17.0%</td>
<td>-16.7%</td>
</tr>
<tr>
<td class="firstcol">Inventories ($B)*</td>
<td>$41.2</td>
<td>$53.7</td>
<td>$55.4</td>
<td>$22.4</td>
<td>$14.8</td>
<td>$31.8</td>
</tr>
<tr>
<td class="firstcol">Farm</td>
<td>$4.3</td>
<td>$1.9</td>
<td>$2.5</td>
<td>$2.4</td>
<td>$3.0</td>
<td>$1.2</td>
</tr>
<tr>
<td class="firstcol">Nonfarm</td>
<td>$36.8</td>
<td>$52.2</td>
<td>$53.3</td>
<td>$20.0</td>
<td>$11.3</td>
<td>($45.2)</td>
</tr>
<tr>
<td class="firstcol">Net Exports ($B)**</td>
<td>($636.6)</td>
<td>($624.2)</td>
<td>($628.8)</td>
<td>($582.6)</td>
<td>($597.8)</td>
<td>$38.8</td>
</tr>
<tr>
<td class="firstcol">Exports</td>
<td>14.0%</td>
<td>6.2%</td>
<td>6.8%</td>
<td>10.6%</td>
<td>-1.2%</td>
<td>5.5%</td>
</tr>
<tr>
<td class="firstcol">Imports</td>
<td>9.1%</td>
<td>1.4%</td>
<td>5.6%</td>
<td>-2.6%</td>
<td>2.3%</td>
<td>1.6%</td>
</tr>
<tr>
<td class="firstcol">Government</td>
<td>4.9%</td>
<td>0.8%</td>
<td>1.7%</td>
<td>3.4%</td>
<td>0.9%</td>
<td>1.7%</td>
</tr>
<tr>
<td class="firstcol">Real Final Sales</td>
<td>5.6%</td>
<td>2.1%</td>
<td>1.9%</td>
<td>3.7%</td>
<td>1.6%</td>
<td>2.3%</td>
</tr>
<tr>
<td colspan="7">For Yr/Yr: * average, ** Change from Yr ago Qtr</td>
</tr>
</tbody>
</table>
ECI Wages Jump; Benefits Whimper 
by <a href="/comment/Brusca.html">Robert Brusca</a> April 27, 2007


<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070427b.jpg" width="353">
The Employment Cost Index or ECI is a major US inflation survey. The quarterly index came packaged with a surprise: This quarter benefit costs rose by a very thin 0.1% as wages surged ahead by 1.1%. As a result total compensation was held to a gain of 0.8%, less than expected. But as surely as some are worried about that wage rise they are also curious about the small gain in benefits costs. 
The story for benefits seems to be due to one particular technical issue related to pension contributions. Firms with defined benefit plans have fiduciary responsibility to keep their pensions funded according to some set rules. Since stocks were so strong, the BLS surmises that many firms simply took the run up in prices as their &#145;contribution&#146; and did not inject new funds into the pension plans. This saving results in lower benefit costs to the firm but does not imply any reduction in benefits given to workers. In that sense it is bogus decline if we think in terms of labor costs. We have seen surging stock prices do this on other occasions in the past. On balance we can throw out the benefit number as a one anomaly. 
The problems in this report remain as the rise in wages. And despite the hiatus in benefit costs this quarter we expect the Fed to take the wage component as an authentic a signal of tightening labor markets. The chart above shows quite clearly that the pressures are escalating rapidly and that they are strong in both goods ands services, but strongest in services where international competition plays the smallest role. 
Services wages are rising at an extremely rapid pace. There are still being outpaced by the employment reports average hourly earnings measure (a poorer index) but that only serves to show there is another, albeit less pure wage measure that is showing the same effect. The Fed has been getting the same feed back in its regional Beige Book canvas. How long can the Fed ignore these signals? On balance I think this report will be sort of chilling from the Fed&#146;s perspective. 
The Fed will not be happy over the low growth print for Q1 2007. But there is no denying that wages are rising rapidly and that consumer incomes are growing solidly and the consumer spending is strong and price pressures are still in play. Despite the weak Q1 GDP print I think the Friday reports ( GDP, ECI and U of M final (revised)) put the Fed a half step closer to a rate hike ( yes, HIKE). It will take more information to do it but the Fed must be increasingly nervous about inflation and not so worried about growth after seeing the composition of GDP. Wage pressures, remember, tend to be sticky and longer lasting. These pressures are indeed getting out hand. 
Moreover, although hours worked (in the monthly employment report) only rose at a 1.5% pace in Q1 2007 weak GDP will not allow that to become good news for productivity. With GDP advancing by 1.3% there is not much room for productivity growth and that will put the Fed even more on edge about wage pressures becoming cost pressures and leading to price hikes.

<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
Employment Cost Index Overview of Key Components
</tr>
</thead>
<tbody>
<tr class="even">
<td class="firstcol">ECI Trends</td>
<td>07:Q1</td>
<td>06:Q4</td>
<td>07:Q1</td>
<td>06:Q4</td>
<td>06:Q1</td>
</tr>
<tr class="odd">
<td class="firstcol">Civilian</td>
<td colspan="2">% Q/Q</td>
<td colspan="2">% Yr/Yr</td>
<td>% Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Compensations</td>
<td>0.8</td>
<td>0.9</td>
<td>3.5</td>
<td>3.3</td>
<td>2.8</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Benefits</td>
<td>0.1</td>
<td>1.1</td>
<td>3.1</td>
<td>3.6</td>
<td>3.4</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Wages</td>
<td>1.1</td>
<td>0.7</td>
<td>3.6</td>
<td>3.2</td>
<td>2.5</td>
</tr>
<tr class="odd">
<td class="firstcol">Private</td>
<td colspan="2">% Q/Q</td>
<td colspan="2">% Yr/Yr</td>
<td>% Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Compensations</td>
<td>0.6</td>
<td>0.8</td>
<td>3.1</td>
<td>3.2</td>
<td>2.6</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Benefits</td>
<td>-0.3</td>
<td>0.9</td>
<td>2.3</td>
<td>3.1</td>
<td>2.9</td>
</tr>
<tr>
<td class="firstcol">&nbsp; Wages</td>
<td>1.1</td>
<td>0.8</td>
<td>3.5</td>
<td>3.1</td>
<td>2.5</td>
</tr>
<tr class="odd">
<td class="firstcol">Memo:</td>
<td colspan="2">% Q/Q</td>
<td colspan="2">% Yr/Yr</td>
<td>% Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">Average Hourly Earnings</td>
<td>0.9</td>
<td>1.0</td>
<td>4.1</td>
<td>4.1</td>
<td>3.5</td>
</tr>
</tbody>
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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070426c.jpg" width="353">
French industry perceives its business climate as the best in over six years, according to the monthly survey by the French government statistics office INSEE. The &quot;business climate index&quot; stands at 111 this month, that is, 11% above companies&#39; long-run average. It rose 2 points from March and is 4 points ahead of 2006 as a whole. Among major factors, the trend in industrial production swung from a net balance of -2 in February and March to +9 this month, the first positive reading since last November. That is, the proportion of companies seeing an uptrend in production outnumbered those seeing a decline by 9 percentage points. Order books in particular are seen at +5 this month, a third consecutive positive count and the highest since April 2001. Foreign orders have had a positive balance for over a year, but until recently that has been more than offset by domestic weakness. So finally, domestic markets are improving enough to permit overall growth, rather than completely offsetting the foreign component.<img align="right" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070426d.jpg" width="353">
Apparently growth in output is not expected to produce an acceleration in sales prices. Instead, perhaps, companies view stronger output as accompanying restraint in price increases. The &quot;likely sales price development&quot; among manufacturers moderated back to +4 for April from +10 in March. In Q1, this measure averaged +10, the highest quarterly figure since Q2 1995, but if April&#39;s reading is sustained, it would suggest a recognition by business that the generally tenuous environment necessitates holding the line on price increases.
Among French service industries, the business climate has eased a bit this month to 108 from 110 in March. This sector has experienced a remarkably steady climate for just about three years, with a tight range of 104 to 111. Similarly, the companion measure of the &quot;overall outlook&quot; has ranged from -2 to +7 in the same time span, although the last 15 months or so give a hint of uptrend. This is reflected in &quot;sales expected over next 3 months&quot;, which has averaged +14 in February, March and April, up from 12 in 2006 and 11 in 2005.<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070426b.jpg" width="353">
These firms do not generally expect to raise their prices. Their expectations for sales price increases have a balance of -2 for this month, and while there have not been any large negative readings, the only positive reading in the last year-and-a-half was a +1 in December. This mildly negative trend results from a mildly increasing trend for consumers and a declining path for business services. There is certainly little thought that demand will be strong enough to allow rising cost increases to be blithely passed on to customers.
&quot;Services&quot; in this survey have a more restricted definition than in most other data collections; here, they include real estate activities, business operations services and services for individuals. This last consists of travel agencies, hotels, restaurants, recreation, domestic services and the like. Notably, the category excludes transportation, finance and wholesale and retail trade.

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<th scope="col" class="firstcol"><a href="http://www.haverselect.com/dlx/FRANCE/@F09/@F09.HTM">FRANCE</a><a href="http://www.haverselect.com/dlx/FRANCE/@F09/@F09.HTM">, </a> SA, %-Balance,&nbsp; except as noted*</th>
<th scope="col">Apr 2007</th>
<th scope="col">Mar 2007</th>
<th scope="col">Feb 2007</th>
<th scope="col">Year Ago</th>
<th scope="col">2006</th>
<th scope="col">2005</th>
<th scope="col">2004</th>
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">Industry Business Climate Indicator*</td>
<td>111</td>
<td>109</td>
<td>108</td>
<td>109</td>
<td>107</td>
<td>101</td>
<td>104</td>
</tr>
<tr>
<td class="firstcol">Industrial Production Trend Outlook</td>
<td>9</td>
<td>-2</td>
<td>-2</td>
<td>3</td>
<td>5</td>
<td>-12</td>
<td>5</td>
</tr>
<tr class="odd">
<td class="firstcol">Order Books</td>
<td>5</td>
<td>4</td>
<td>1</td>
<td>-5</td>
<td>-6</td>
<td>-17</td>
<td>-14</td>
</tr>
<tr>
<td class="firstcol">Sales Prices Next 3 Mos.</td>
<td>4</td>
<td>10</td>
<td>8</td>
<td>1</td>
<td>6</td>
<td>0</td>
<td>1</td>
</tr>
<tr class="odd">
<td class="firstcol">Services Business Climate Indicator*</td>
<td>108</td>
<td>110</td>
<td>108</td>
<td>105</td>
<td>108</td>
<td>106</td>
<td>105</td>
</tr>
<tr>
<td class="firstcol">Overall Outlook</td>
<td>7</td>
<td>6</td>
<td>6</td>
<td>2</td>
<td>4</td>
<td>-0</td>
<td>-0</td>
</tr>
<tr class="odd">
<td class="firstcol">Sales Next 3 Mos.</td>
<td>14</td>
<td>15</td>
<td>13</td>
<td>12</td>
<td>12</td>
<td>11</td>
<td>8</td>
</tr>
<tr>
<td class="firstcol">Prices Next 3 Mos.</td>
<td>-2</td>
<td>-1</td>
<td>-1</td>
<td>-3</td>
<td>-2</td>
<td>1</td>
<td>2</td>
</tr>
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French industry perceives its business climate as the best in over six years, according to the monthly survey by the French government statistics office INSEE. The "business climate index" stands at 111 this month, that is, 11% above [...]

French Business Climate Improves for Manufacturers this Month; Service Companies Experience Slight Updrift

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070426e.jpg" width="353">
Germany has long been a bastion of inflation fighting. Ever since the post war hyperinflation raged, sapping German spending power, Germans have been alert and vigilant against the rise of inflation. The Bundesbank long was charged with that job. But when the monetary union was formed in Europe a central bank of central banks was to take control and the question was raised as to who would run it...and how. 
Early conflict on the issue was decided by the two largest Euro members. The Germans, wanting to root the ECB and the euro in the same stability as the Bundesbank and the Deutschemark, pushed for an ECB located in Frankfurt with a research head drawn from the staff of the Bundesbank. France wanted the honor of having the first central bank head. But France&#146;s pick, Jean-Claude Trichet, was embroiled in a controversy stemming from his tenure as head of the Bank of France and was still under investigation at the time the ECB was formed. Europeans were adamant that someone under a cloud like that could not head the ECB. So it fell to a Dutchman, Wim Duisenberg, to head the first European Central bank. Eventually Trichet was cleared and he took his place as the ECB&#146;s second head. 
It is important to bear in mind the nationalistic themes that underlay everything in Europe. It is not a united states of Europe. It is a federation of independent nations with a common currency and some common trade rules amid some varied domestic regulations that conflict with the confederation rules from time to time. While the EU makes some political decisions, each nation runs its own foreign policy. The rules in Europe, at least to this American, seem sometimes to be a smorgasbord where they pick and choose which will apply and when. 
So it is against this back ground that we wonder about European inflation trends. 
Germany is typically is not the country with a burgeoning inflation problem inside the e-zone. The table below identifies those that are persistent violators of the supposed 2% cap imposed by the ECB on inflation. Note that the cap is a zone-wide cap &#150; not country by country- but it still is interesting to see where inflation is stubborn- even in a common currency area. 

<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
E-zone &amp; Friends: Core Inflation Yr/Yr
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">Core HICP</td>
<td>Mar-07</td>
<td>Feb-07</td>
<td>Jan-07</td>
<td>Dec-06</td>
<td>Nov-06</td>
<td>Oct-06</td>
<td>Sep-06</td>
</tr>
<tr>
<td class="firstcol">Austria</td>
<td>1.8%</td>
<td>1.7%</td>
<td>1.6%</td>
<td>1.5%</td>
<td>1.5%</td>
<td>1.5%</td>
<td>1.3%</td>
</tr>
<tr>
<td class="firstcol">Belgium</td>
<td>2.0%</td>
<td>1.7%</td>
<td>1.6%</td>
<td>1.6%</td>
<td>1.5%</td>
<td>1.6%</td>
<td>1.9%</td>
</tr>
<tr>
<td class="firstcol">Finland</td>
<td>1.4%</td>
<td>1.3%</td>
<td>1.2%</td>
<td>1.0%</td>
<td>1.0%</td>
<td>1.2%</td>
<td>0.9%</td>
</tr>
<tr>
<td class="firstcol">France</td>
<td>1.3%</td>
<td>1.4%</td>
<td>1.4%</td>
<td>1.5%</td>
<td>1.4%</td>
<td>1.3%</td>
<td>1.2%</td>
</tr>
<tr>
<td class="firstcol">Germany</td>
<td>1.7%</td>
<td>1.8%</td>
<td>1.7%</td>
<td>1.0%</td>
<td>1.1%</td>
<td>0.9%</td>
<td>0.8%</td>
</tr>
<tr>
<td class="firstcol">Greece</td>
<td>3.5%</td>
<td>4.0%</td>
<td>3.6%</td>
<td>3.4%</td>
<td>3.3%</td>
<td>3.3%</td>
<td>3.0%</td>
</tr>
<tr>
<td class="firstcol">Ireland</td>
<td>3.0%</td>
<td>2.9%</td>
<td>2.5%</td>
<td>2.8%</td>
<td>2.4%</td>
<td>2.5%</td>
<td>2.3%</td>
</tr>
<tr>
<td class="firstcol">Italy</td>
<td>2.0%</td>
<td>2.1%</td>
<td>1.7%</td>
<td>1.9%</td>
<td>1.8%</td>
<td>2.0%</td>
<td>2.0%</td>
</tr>
<tr>
<td class="firstcol">Luxembourg</td>
<td>2.4%</td>
<td>2.4%</td>
<td>2.4%</td>
<td>2.3%</td>
<td>2.2%</td>
<td>2.2%</td>
<td>2.3%</td>
</tr>
<tr>
<td class="firstcol">The Netherlands</td>
<td>1.6%</td>
<td>1.0%</td>
<td>1.0%</td>
<td>1.1%</td>
<td>1.0%</td>
<td>1.0%</td>
<td>1.1%</td>
</tr>
<tr>
<td class="firstcol">Portugal</td>
<td>2.0%</td>
<td>2.0%</td>
<td>2.0%</td>
<td>2.1%</td>
<td>2.2%</td>
<td>2.7%</td>
<td>2.7%</td>
</tr>
<tr>
<td class="firstcol">Spain</td>
<td>2.5%</td>
<td>2.8%</td>
<td>2.8%</td>
<td>2.5%</td>
<td>2.7%</td>
<td>2.8%</td>
<td>3.0%</td>
</tr>
<tr class="odd">
<td class="firstcol">Core HICP/CPI</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td class="firstcol">UK (HICP)</td>
<td>#N/A</td>
<td>1.9%</td>
<td>1.8%</td>
<td>1.9%</td>
<td>1.7%</td>
<td>1.6%</td>
<td>1.6%</td>
</tr>
<tr>
<td class="firstcol">US</td>
<td>2.5%</td>
<td>2.7%</td>
<td>2.7%</td>
<td>2.6%</td>
<td>2.6%</td>
<td>2.8%</td>
<td>2.9%</td>
</tr>
<tr>
<td class="firstcol">Japan</td>
<td>#N/A</td>
<td>-0.3%</td>
<td>-0.2%</td>
<td>-0.3%</td>
<td>-0.2%</td>
<td>-0.4%</td>
<td>-0.5%</td>
</tr>
</tbody>
</table>
<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
<th scope="col" class="firstcol"> &middot; With energy prices having jumped and with Germany doing a good deal of trade with these high inflation countries inside the E-zone it is useful to look at German export and import prices to see if Germany is importing any of this inflation . &middot; German trends typically are an example of the best of the best&#133;But are they good enough? German domestic price and export and import trends &middot; Trends in German inflation show that Ex petrol and mineral imports, prices surged last year around September, as knock-on effects from high energy prices were passed on. Non Petroleum and non-mineral export prices also were elevated at that time and have since receded but by less than import prices. Producer non-energy prices went up in Germany around midyear and have continued to hover at a 3% pace Yr/Yr. The German CPI excluding energy has also ratcheted up but on a minor scale. The index hit its local low below 1% early in 2006 and has steadily risen moving &#145;sharply higher&#146; in early 2007 to a Yr/yr pace that peaked at 1.9%. Since then it has deflated slightly, moving lower with a current pace of 1.7%. &nbsp; &nbsp; &middot; While Germany is not a problem inflation country, it is one of those countries that tends to have a low rate of inflation and provides a counter-weight to e-zone high inflation countries. So the concern going ahead is that with EIGHT of TWLEVE (excluding Slovenia for this discussion) E-zone members having inflation at or above 2% are there enough countries or enough LARGE countries with inflation low enough below 2% to keep EMU inflation in check? More broadly, there is the question of whether the trend rise we see in German ex-petroleum inflation is still in force, if inflation has played out its bubble already, or if the push in prices has more to come. This next time will it come from wage inflation and tight domestic labor markets? &middot; The perusal of Germany&#146;s trends and those from the E-zone members give us reason to be wary. Not only have recent European data particularly from Germany and France looked firm-to-strong but we do have this inflation effect percolating in the background. &nbsp;With eight EMU countries on inflation levels that are too strong or with borderline trends there are still the low but rising inflation countries to worry about&#133; and that includes about everyone else. &middot; For the ECB, 2% inflation is a ceiling rate, not a target rate. The ECB surely wants to stop inflation short of that mark. The trend from exported inflation, based on German data, is going in the &#145;right direction.&#146; But the pace of even German export and import price inflation while &#145;locked&#146; in a downtrend (excl petrol) is still near to or over the ECB&#146;s preferred pace for overall inflation. It will take some time &#150; and only if that down-trend continues -- before export and import prices will be of some help to fighting inflation.&nbsp; In these circumstances it would be a surprise to see the ECB hold off on a rate hike, although the strength in the Euro is one thing that could make it somewhat gun shy when it comes to pulling the policy tightening trigger. All we can say so far is that if the high euro is an adverse issue for Euro-growth it has not made its mark yet on activity trends nor has it made its mark on restraining export and import prices in Germany. &middot; European growth is not so strong nor is inflation so wrong that ECB action is called for at this very moment. But this, we know, is how inflation often starts. &middot; There can be little doubt that if these trends stemmed from Germany alone and were the Bundesbank making policy what it would do. Will the ECB find its backbone or will it play the same waiting game that the Fed seems to have lost with inflation? &nbsp; &middot; I am reminded of a old Three Stooges comedy routine in which one of the &#145;Stooges&#146; dares a bully to step over this line, then he draws another and dares him to step over the next and the next&#133;before he turns tail to run. Better to act than to draw meaningless lines in the sand. The ECB has drawn a line. The Fed has created a zone of discomfort. The Fed has decided to reside in its discomfort zone instead of taking steps to exit it. Only time can tell what is next. But waiting doesn&#146;t always make it better. What choice will the ECB make? Will it take the policy course of discomfort or like the Fed tolerate inflation discomfort? &nbsp; &nbsp;</th>
</tr>
</thead>

</table>
<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
German International and Domestic Inflation Trends
</tr>
</thead>
<tbody>
<tr class="even">
<td class="firstcol">&nbsp;</td>
<td colspan="3">% m/m</td>
<td colspan="4">% SAAR</td>
</tr>
<tr class="odd">
<td class="firstcol">SA</td>
<td>Mar-07</td>
<td>Feb-07</td>
<td>Jan-07</td>
<td>3-Mo</td>
<td>6-Mo</td>
<td>12-Mo</td>
<td>Yr-Ago</td>
</tr>
<tr>
<td class="firstcol">Export Products</td>
<td>0.0%</td>
<td>0.1%</td>
<td>0.2%</td>
<td>1.1%</td>
<td>1.9%</td>
<td>2.1%</td>
<td>1.9%</td>
</tr>
<tr>
<td class="firstcol">Import Products</td>
<td>-0.1%</td>
<td>0.4%</td>
<td>-0.9%</td>
<td>-2.6%</td>
<td>-1.1%</td>
<td>0.8%</td>
<td>5.4%</td>
</tr>
<tr class="odd">
<td class="firstcol">NSA</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td class="firstcol">Exports excl Petroleum</td>
<td>0.1%</td>
<td>0.1%</td>
<td>0.4%</td>
<td>2.3%</td>
<td>1.9%</td>
<td>2.2%</td>
<td>1.6%</td>
</tr>
<tr>
<td class="firstcol">Imports excl Petroleum</td>
<td>0.1%</td>
<td>0.0%</td>
<td>0.3%</td>
<td>1.6%</td>
<td>0.4%</td>
<td>1.9%</td>
<td>3.2%</td>
</tr>
<tr class="odd">
<td class="firstcol">Memo: SA</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td class="firstcol">CPI</td>
<td>0.3%</td>
<td>0.1%</td>
<td>0.5%</td>
<td>3.3%</td>
<td>2.0%</td>
<td>1.9%</td>
<td>1.8%</td>
</tr>
<tr>
<td class="firstcol">CPI excl Energy</td>
<td>0.1%</td>
<td>0.0%</td>
<td>0.4%</td>
<td>1.9%</td>
<td>1.7%</td>
<td>1.7%</td>
<td>0.8%</td>
</tr>
<tr>
<td class="firstcol">PPI</td>
<td>0.2%</td>
<td>0.2%</td>
<td>0.1%</td>
<td>1.7%</td>
<td>1.4%</td>
<td>2.5%</td>
<td>5.9%</td>
</tr>
<tr>
<td class="firstcol">PPI excl Energy</td>
<td>0.1%</td>
<td>0.2%</td>
<td>0.2%</td>
<td>1.8%</td>
<td>2.2%</td>
<td>3.0%</td>
<td>1.2%</td>
</tr>
</tbody>
</table>
</body>
</html>

Germany has long been a bastion of inflation fighting. Ever since the post war hyperinflation raged, sapping German spending power, Germans have been alert and vigilant against the rise of inflation. The Bundesbank long was charged [...]

German Export and Import Prices Show Relief

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/070426a.jpg" width="353">
The tunnel chart on KC production says it all in a nutshell. The index has been weak. In July 2006 the production index sank below its 12-mont moving average and has more or less stayed there. It has been fluctuating sharply in early 2007 but in April it has made a sharp break higher. The production reading that has jumped to +25 for production is in the top 25 percentile of all readings for production for this index and that is a fairly strong showing. The jump is out of character with the small rises we saw in NY and in Philadelphia and weaker reading in Richmond. But as the regional Consumer Confidence readings showed us, the strength in the economy is really OUT WEST. So KC is strong and getting stronger. This is one time I hope to root for the West Coast&#133; or at least things the other side of the Continental Divide (which the KC district bridges). 
Unfortunately, one message in the chart above is that spikes in the production index tend to give way - to back off -- so while we can be encouraged by the KC reading it is only one month, after all.
The KC Fed has three different sorts of surveys. We reported at the top on the m/m survey. That is akin to most MFG surveys we see. It also has a more unusual year/year diffusion survey and a somewhat more common 6-month outlook survey. We have combined all these results into one table across the various components, provided the raw months scores as well as a second panel that expresses them as a percentile in their own respective ranges of values so they can be more directly compared. On that basis we find a number of high 60-percentiles and 70 percentiles, a few that are higher, and not many that are lower. 
As to those that are lower, they are mostly good news. The recent price showing is only in about the 50Th percentile of values, a position that is neutral with respect to inflation pressures. The two inventory components show some weak readings indicating that stocks have been cut - a good thing for future production prospects. Export orders are and have been strong but prospects (oddly, given the weak dollar) are somewhat lower as a percentile reading&#133; 
As for the key readings&#133;we find production is strong in the current month in the 77th percentile - a bit higher than its outlook, which is only in the 60th percentile. Shipments are firm in the high 70th percentile across categories. The volume of news orders is only in the mid 60th percentile as are new and past order trends &#150; that&#146;s only 10 percentage points above what has been average. Order backlogs are moderate, in their mid 60th percentile. 
ON BALANCE&#133; The KC survey looks much better than those from &#145;out East.&#146; The various readings look firm to strong with most key readings above their respective mid point readings. The outlook index is quite solid. The one thing I wonder about is the weaker export readings. The world economy is supposed to be doing better. Why is the export outlook below the 50Th percentile? 

<table border="0" cellspacing="0" width="100%">
<colgroup></colgroup>
<thead>
<tr>
Kansas City Fed Diffusion Components and their Properties
</tr>
</thead>
<tbody>
<tr class="even">
<td class="firstcol">&nbsp;</td>
<td colspan="3">Current Readings</td>
<td colspan="3">Percent of Own Range</td>
</tr>
<tr class="odd">
<td class="firstcol">Kansas City Component</td>
<td>M/M</td>
<td>6-Mo Outlook</td>
<td>Yr/Yr</td>
<td>M/M</td>
<td>6-Mo Outlook</td>
<td>Yr/Yr</td>
</tr>
<tr>
<td class="firstcol">FAO Indices for Kansas City</td>
<td>15</td>
<td>29</td>
<td>27</td>
<td>79.6%</td>
<td>71.5%</td>
<td>81.5%</td>
</tr>
<tr>
<td class="firstcol">Production</td>
<td>26</td>
<td>41</td>
<td>28</td>
<td>77.1%</td>
<td>60.5%</td>
<td>70.3%</td>
</tr>
<tr>
<td class="firstcol">Volume of shipments</td>
<td>25</td>
<td>42</td>
<td>33</td>
<td>78.1%</td>
<td>78.1%</td>
<td>76.7%</td>
</tr>
<tr>
<td class="firstcol">Volume of new orders</td>
<td>23</td>
<td>40</td>
<td>33</td>
<td>59.5%</td>
<td>77.5%</td>
<td>76.4%</td>
</tr>
<tr>
<td class="firstcol">Backlog of orders</td>
<td>10</td>
<td>19</td>
<td>16</td>
<td>65.9%</td>
<td>63.3%</td>
<td>65.6%</td>
</tr>
<tr>
<td class="firstcol">Number of employees</td>
<td>11</td>
<td>22</td>
<td>27</td>
<td>70.5%</td>
<td>66.7%</td>
<td>90.0%</td>
</tr>
<tr>
<td class="firstcol">Average employee workweek</td>
<td>3</td>
<td>13</td>
<td>14</td>
<td>36.7%</td>
<td>68.4%</td>
<td>67.6%</td>
</tr>
<tr class="odd">
<td class="firstcol">Prices received</td>
<td>6</td>
<td>33</td>
<td>60</td>
<td>50.0%</td>
<td>84.4%</td>
<td>93.1%</td>
</tr>
<tr class="odd">
<td class="firstcol">Prices paid for raw goods</td>
<td>36</td>
<td>54</td>
<td>81</td>
<td>51.7%</td>
<td>72.2%</td>
<td>94.7%</td>
</tr>
<tr>
<td class="firstcol">Capital expenditures</td>
<td>--</td>
<td>22</td>
<td>27</td>
<td>--</td>
<td>68.6%</td>
<td>89.0%</td>
</tr>
<tr>
<td class="firstcol">New orders for exports</td>
<td>6</td>
<td>7</td>
<td>13</td>
<td>80.0%</td>
<td>40.9%</td>
<td>85.2%</td>
</tr>
<tr>
<td class="firstcol">Supplier delivery time</td>
<td>5</td>
<td>2</td>
<td>5</td>
<td>25.0%</td>
<td>29.2%</td>
<td>33.3%</td>
</tr>
<tr>
<td class="firstcol">Inventories: Materials</td>
<td>3</td>
<td>-15</td>
<td>4</td>
<td>68.1%</td>
<td>3.2%</td>
<td>50.8%</td>
</tr>
<tr>
<td class="firstcol">Inventories: Finished goods</td>
<td>-1</td>
<td>-5</td>
<td>0</td>
<td>39.3%</td>
<td>32.0%</td>
<td>40.0%</td>
</tr>
</tbody>
</table>
</body>
</html>

The tunnel chart on KC production says it all in a nutshell. The index has been weak. In July 2006 the production index sank below its 12-mont moving average and has more or less stayed there. It has been fluctuating sharply in early [...]

Kansas City Fed Index Jumps

Inflationary impact of surge in oil prices larger in Europe than in the US

Futures market thinks the price of oil will recede significantly over the next six months

Recent pickup in US defense orders could help support overall growth ahead

Cost of transporting crude oil has soared to series high

Market-based inflation expectations have not yet reflected recent surge in oil prices

Global equity markets are fearing a major economic disruption from soaring oil prices

Is recent drop in sentiment signaling softer growth ahead?

With the Iran conflict, geopolitical risk has soared to alarming levels

Soaring AI-related investment in US underpinning strong contribution of business spending to overall growth

AI-related outperformance of IP in Advanced Asia ex Japan

Resilient US economy pushing up Blue Chip 2026 outlook

US and China big leaders in adoption of AI models

Robust US demand for advanced technology products

China's export growth rotating away from the US

More pronounced upward revisions in countries more exposed to AI investment

Stable job openings and hiring rates point to cautious hiring

Global freight costs are on the rise while supply chain pressures are contained

Accelerating positive economic surprises in the G10 are boosting the global economy

Considerably more monetary ease expected from US and UK as Japan tightens

Tighter US immigration enforcement adversely impacting labor force

Economic policy uncertainty, while still elevated, is declining

Gradual disinflation and easier monetary policies across advanced economies

Largest October layoffs since 2003, led by technology

Subdued global shipping costs not yet pointing to supply chain problems

PMIs show still-elevated but slowing US inflation

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Mortgage applications fell 1.6% w/w (+33.4% y/y) in the week ending April 24, after rising 7.9% w/w (29.9% y/y) in the week ending April 17, according to the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey. Applications for loans to purchase a house rose 1.2% w/w (21.2% y/y) in the April 24 week, following a jump of 10.1% w/w (14.5% y/y) in the April 17 week.  Applications for loan refinancing declined 4.4% w/w (+50.7% y/y) after rising 5.8% w/w (51.9% y/y) in the week of April 17. 

The effective interest rate on a 30-year fixed-rate loan rose 1bps to 6.54% in the week ending April 24 from 6.53% in the week ending April 17. The rate on 15-year fixed-rate mortgages was unchanged at 5.92% in the latest week from the prior week. The 30-year Jumbo rate was also unchanged at 6.56% in the April 24 week from the April 17 week, while the rate on a 5-year ARM jumped 21bps to 6.02% in the latest week from 5.81% in the week ending April 17.

The share of applications for refinancing an existing loan declined to 42.5% of total applications in the week of April 24, from 44.2% in the April 17 week. The adjustable-rate mortgage (ARM) share of activity rose to 8.3% in the week ending April 24 from 8.0% in the week ending April 17.

The average size of a mortgage loan rose 2.0% w/w (6.2% y/y) to $407,900 in the week ending April 24, after rising 1.2% w/w (3.4% y/y) to $399,900 in the week ending April 17. The average size of a purchase loan rose 1.0% w/w (4.6% y/y) to $460,200 in the latest week, after edging down 0.1% w/w (+3.6% y/y) to $455,600 in the April 17 week. The average size of a loan to refinance a mortgage rose 2.3% w/w (16.3% y/y) to $337,100 in the April 24 week, after rising 2.4% w/w (10.7% y/y) to $329,500 in the April 17 week.

The Mortgage Bankers Association Survey covers 75% of all U.S. retail residential mortgage applications and has been conducted weekly since 1990. Respondents include mortgage bankers, commercial banks and thrifts. The base period and value for all indexes is March 16, 1990=100. The figures for weekly mortgage applications and interest rates are available in Haver’s **SURVEYS** database.

- Applications for loans to purchase rose, while applications for loan refinancing declined in the latest week.
- Interest rate on 30-year fixed-rate loans rose 1bps to 6.54%. 
- Average loan size edged up.

U.S. Mortgage Applications Edged Down in the April 24 Week

Michael J. Moran

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The Conference Board’s index of Consumer Confidence inched higher in April from an upwardly revised reading in March. The combined changes left the measure 1.1% higher than the preliminary tally in March. Despite the improvement, the index remained in the low end of the range for the current expansion. The index in April totaled 92.8, down from an average of 96.1 in 2025 and an annual cyclical high of 105.4 in 2023.

The Improvement in April reflected a pickup in the expectations component, which rose 1.7%. The current conditions component inched 0.2% lower. Overall views on current conditions slipped despite more favorable assessments of the labor market. The so-called measure of the jobs gap (share of respondents indicating that jobs are plentiful less the share saying that jobs are hard to get) rose 1.4 percentage points higher to 7.5%. The pickup reflected a drop in the share indicating that jobs are hard to get (down 1.5 percentage points to 19.8%). The share indicating that jobs are plentiful eased 0.1 percentage point to 27.3%.

Although expectations improved in April, from a long-term perspective they could be viewed as the more important factor restraining the headline measure of confidence. As shown in the left chart below, the expectations component of confidence shows considerably less volatility than the current conditions component does. The contrasting patterns suggest that individuals realize that the economy will undergo possibly sharp cyclical swings, but they expect conditions at some point to return to an underlying norm.

The current conditions index in the current cycle has indeed dropped noticeably, but it is still above the long run average (123.8 in April versus the average of approximately 108 from 1990 to 2025). The expectations component, as usual, has eased less than the current conditions component, but its shift has pushed the measure to the low end of its long-run range (72.2 in April versus an average of approximately 88).

Interestingly, concern about the labor market seems to be a factor affecting expectations. While current views on the labor market are favorable (plentiful less hard to get jobs gap of 7.5%), Individual are concerned about the future. The survey asks respondents if they expect more jobs or fewer jobs six months hence. The share indicating fewer jobs has moved well into the upper end of the historical range. Such observations in the past were typically seen only during recession (chart, below right). An unfavorable view on interest rates also seems to be playing a role in depressing the expectations component. More than 60% of respondents to the current survey expect higher interest rates 12 months from now.

The results from the Conference Board survey of consumers differ markedly from those of the University of Michigan Survey Research Center. The Michigan results show consumer sentiment at a record low, while the Conference Board index is only slightly below its long-run average. The difference most likely reflects the nature of the questions in the surveys. The Conference Board focuses on business and employment conditions, while Michigan emphasizes personal finances. The focus on finances, along with questions on inflation, probably picks up concerns about affordability.

The Consumer Confidence data are available in Haver’s **CBDB** database. The total indexes, which are indexed to 1985=100, appear in **USECON**, and market expectations are in **AS1REPNA**.

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- Expectations improved slightly in April, but are still subdued relative to norms.
- Moderately favorable view of current conditions.

Consumer Confidence: Modest Change in April

Winnie Tapasanun

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U.S. house prices were essentially unchanged m/m in February after rises of 0.2% in January (+0.1% initially) and 0.3% in December (unrevised), according to the Federal Housing Finance Agency (FHFA) House Price Index. February marked the first flat reading since September following four consecutive m/m increases. The HPI was at 441.43 in February, up 14.8% from its August 2022 low of 384.59. The year-on-year growth rate eased to 1.7% in February—the lowest since March 2012—from 1.8% in January (+4.1% in February 2025), down from a high of 6.9% in February 2024 and well below a peak of 18.5% in February 2022.

By region, February FHFA house prices showed a mixed performance. House prices fell m/m in February (vs. January) in four of the nine census divisions. Declines were led by Mountain (-1.1% vs. +0.4%), followed by Pacific (-0.5% vs. +0.6%), West North Central (-0.4% vs. +0.3%), and Middle Atlantic (-0.1% vs. +0.3%). To the upside, house prices rose m/m in four census divisions in February (vs. January): South Atlantic (+0.6% vs. -0.2%), East South Central (+0.2% vs. +1.2%), New England (+0.2% vs. +0.6%), and West South Central (+0.2% vs. -0.3%). Meanwhile, house prices in East North Central were virtually unchanged m/m for the second successive month in February following seven straight m/m gains.

Year-on-year house prices continued to rise in February in most regions, except Mountain, Pacific, and West South Central. The y/y growth rate accelerated in February (vs. January) in only two of the nine census divisions: East South Central (+4.0% vs. +3.2%) and South Atlantic (+0.9% vs. +0.4%). Meanwhile, house price growth decelerated y/y in February (vs. January) in four regions: New England (+3.1% vs. +3.9%), West North Central (+3.1% vs. +3.6%), East North Central (+3.8% vs. +4.5%), and Middle Atlantic (+4.2% vs. +4.5%). To the downside, Mountain (-0.7% vs. 0.0%), Pacific (-0.4% vs. -0.3%), and West South Central (-0.1% vs. -0.4%) posted y/y declines in February.

The FHFA house price index is a weighted purchase-only index that measures average price changes in repeat sales of the same property. An associated quarterly index includes refinancing the same kind of properties. The indexes are based on transactions involving conforming conventional mortgages purchased or securitized by Fannie Mae or Freddie Mac. Only mortgage transactions on single-family properties are included.

The FHFA data are available in Haver’s **USECON** database.

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- February FHFA HPI 0.0% m/m; +1.7% y/y, lowest since Mar. ’12.
- House prices down m/m in four of nine census divisions, led by Mountain (-1.1%); up in four, driven by South Atlantic (+0.6%); flat in East North Central.
- House prices up y/y in six of nine regions, led by Middle Atlantic (+4.2%), but down in Mountain (-0.7%), Pacific (-0.4%), and West South Central (-0.1%).

U.S. FHFA House Prices Flat in February After Four Straight M/M Gains

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Early PPI reports in the monetary union show collective pressures building over the past year, with newly emergent pressures popping up strongly in March.

The sequence of monthly inflation observations for these five early reporters in March shows that inflation pressure has not been clearly building but did jump up suddenly in March. In February, before the Iran war, the median monthly PPI gain was -0.5%. In March, that jumped to +3.9% (median month-to-month gain). Monthly pressure does not show steady gains anywhere except moderately in Germany. Finland shows deceleration in progress (!) even through—especially through—March, as its PPI in March fell by 5.3%. But the whole Finish pattern is somewhat upside down, with prices up month-to-month by 6.2% in January and 2.9% in February. It is not a trend that is easy to understand.

However, the March monthly gains are strong enough to drive sequential inflation higher from 12-months, to 6-months, to 3-months across all early-reporting countries. Even the German ex-energy index shows acceleration on that profile.

On a year-on-year basis, two of the early reporters have PPI inflation below 2%. Finland has 12-month PPI inflation at 2.1%, but Italy and Spain have inflation much higher, up by 3.4% over 12 months in Spain and by 5.6% in Italy.

The PPI has been very well-behaved in the last few years. Looking at 12-month changes for the year ended in March, the median change for this group in 2025 was -0.1%, compared to -4.6% in 2024.

The chart shows the PPI flared sharply in 2021 and 2022, then fell quickly into line in 2023. Clearly, the inflation tune now is being called by oil prices, the same as for that spike prices in 2022 and 2023.

The hope is that the oil price bump up will not be as long-lived, that the war will end soon, with the Strait of Hormuz reopened, and that oil prices—and other inflation pressures—will sink back to prerevision norms relatively quickly. That could happen, but so could other outcomes so markets remain wary. One problem this time is the destruction of oil facilities and the shutting of oil fields that could cause high prices to linger longer.

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**A new dynamic**
However, there is now a new dynamic with the UAE leaving OPEC. OPEC has been a vehicle to harness common behavior to control oil prices mostly to keep them higher. While undermining OPEC (UAE pumps about 13% of OPEC capacity) at a time the U.S. oil prowess has risen, this defection will make it much harder for OPEC to control prices. When countries are not bound together, the incentive is for countries to cheat on their production quota. In a cartel arrangement, when many cheat, the output reduction does not hold, and oil prices fall. A cartel arrangement allows for supply control and reduction which raises prices. But once prices are up, each member has an individual incentive to cheat—to sell more than his quota share of oil at the higher price. But that undermines the cartel. So, this move, this exit of UAE from the cartel, will create instability in the OPEC by moving more production outside the OPEC framework, beyond its control. Unless the Saudis are willing to be the ‘swing man’ and cut back their output to keep prices on target—something the Saudis have been increasingly unwilling to do—OPEC will be in less control.

EMU PPIs Show Instant Pressure

Tian Yong Woon

In this week’s Letter, we cover the latest developments and implications of the Middle East conflict for Asia, while also making space for other important themes, including artificial intelligence (AI). The Middle East conflict remains in a no deal state coming out of the weekend, though some early Monday optimism emerged in Asian markets following Iran’s reported offer to reopen the Strait of Hormuz (chart 1). Nonetheless, as the Strait closure drags on, so too do the fiscal costs of domestic fossil fuel subsidies across Asia, which have been shown to move closely with crude oil prices (chart 2). While such measures offer direct relief by cushioning household energy costs, they remain difficult to sustain over the long haul.

Over the week, we also saw a further fraying in regional monetary policy trends, with the Philippines hiking its policy rate for the first time in about two years amid inflation concerns, while Indonesia stood pat on rates (chart 3). Investor attention is likely to remain fixed on monetary policy this week, with the Bank of Japan due to decide on policy. Expectations for an April hike have faded amid the persistent Middle East conflict, though yen weakness continues to present a source of concern (chart 4). The week also brings China’s latest PMI readings (chart 5), adding to the recent run of hard data accompanying the Q1 GDP release.

Beyond the Middle East conflict, the evolution of AI continues to demand close attention. Before geopolitical tensions took centre stage, AI was the dominant market narrative — and that enthusiasm has hardly faded. If anything, recent developments suggest the story is broadening: use cases are expanding, scalability is improving, and access is widening beyond large corporates to the mass market — increasingly spilling into the realm of physical AI. It may well be this persistent wave of optimism that is helping to underpin equity valuations, even as the geopolitical backdrop darkens (chart 6).

**The Middle East conflict**
About two months in, we remain stuck in the limbo of the US-Iran conflict, which has left the Strait of Hormuz largely closed and much of the world starved of the critical oil flows needed to power the global economy. The back and forth between the US and Iran has persisted in recent weeks, with both sides again failing to reach a peace deal over the weekend, though Monday’s news of Iran offering to reopen the Strait has revived some hope in markets. In truth, commodity and market valuations do not hinge so much on a peace deal itself, but rather on the resumption of oil flows through the Strait, something that could materialise even in the absence of a formal deal, though any agreement that includes and credibly delivers such a reopening would likely be warmly received by markets. Until then, market gyrations are likely to persist, with prices fluctuating in response to each new snippet of news. And until then, the world will continue both to be starved of, while gradually adapting to, the drip feed of oil flows emerging from the Strait.

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**The fiscal costs of the Middle East conflict**
As the Middle East conflict drags on, so too does the strain on fiscal resources across parts of Asia, as the costs of energy-related subsidy programmes continue to mount. While such programmes have an immediate, direct, and tangible impact in shielding households from surging energy costs, they are far from sustainable, particularly if oil prices remain well above targeted levels or stay elevated for an extended period. As chart 2 illustrates, the costs of these explicit subsidy programmes tend to rise closely with crude oil prices, as seen in India and Indonesia. Other measures adopted elsewhere, such as drawing down oil reserves, may be less fiscally costly, but are similarly difficult to sustain indefinitely. In both respects, the clock is ticking, and the world continues to hold its breath as the conflict drags on.

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**The latest central bank responses to the conflict**
Over the past week, Asia saw two central bank decisions. The Philippines’ (BSP) opted to deliver its first rate hike in about two years, while Indonesia’s (BI) chose to stand pat on policy rates and instead committed to stepped up FX intervention (chart 3). This latest round of decisions points to a further fraying of what had been a broad regional monetary policy consensus, namely that central banks would delay additional easing while maintaining a high bar for outright tightening. Domestic considerations, however, remain paramount. In the Philippines’ case, the central bank has moved to rein in inflation, which is already showing notable signs of price pass through stemming from disruptions linked to the Strait of Hormuz. That said, BSP is not the first in the region to buck the reluctance to tighten. Singapore’s central bank had already tightened policy in mid-April, albeit through its own distinct framework, given its use of the exchange rate rather than policy rates as the primary channel for monetary policy.

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**The week ahead**
Looking to the week ahead, a major central bank decision looms in Japan. Market expectations for the Bank of Japan to deliver a rate hike at its April meeting have ebbed amid the persistence of the Middle East conflict, to which Japan remains particularly vulnerable given its reliance on oil imports flowing through the Strait of Hormuz. At the same time, inflation in Japan has yet to become a major concern, with recent readings having picked up but not yet entering troubling territory. One potential source of concern, however, lies with the Japanese yen, which has remained on a weakening trend since early last year (chart 4). That depreciation has been one of the key arguments underpinning calls for further rate hikes.

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The week also brings China’s latest PMIs into focus. March saw a divergence between China’s official PMI readings, which improved, and the unofficial readings from RatingDog, which instead pulled back. Nonetheless, both official and unofficial gauges remained in expansionary territory (chart 5), with investors now watching closely to see whether that resilience can be sustained amid ongoing stresses from the Middle East, or whether offsetting drivers can continue to keep Chinese business sentiment and prospects buoyant.

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**Beyond the strait**
Moving beyond the Middle East conflict, a whole host of developments continue to unfold globally, many of which have in fact helped offset some of the pessimism wrought by the Strait’s chokehold. One such development is artificial intelligence (AI), which had dominated headlines before the outbreak of the conflict and continues to advance at breakneck pace. AI capabilities are still rapidly evolving, while practical applications, such as physical AI embodied in humanoid robots, are beginning to show broader and stronger use cases. Production of such robots is also becoming increasingly scalable and within reach not just for industrial complexes and healthcare, but for the mass market as well. It is perhaps growing optimism around these prospects that has helped keep equity valuations buoyant, even in the face of the festering conflict in the Middle East. Moreover, while concerns over AI-driven job displacement persist, new opportunities are emerging as well, particularly for AI adopters, with a growing share of job postings in Western economies increasingly referencing AI-related skills, as shown in chart 6.

Economy in Brief

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