Haver Analytics
Haver Analytics

Viewpoints: September 2022

  • State real GDP growth ranged widely in 2022: Q2. 40 states saw declines, with Wyoming’s -4.8 percent rate the lowest. However, there were also a number of increases, led by Tezas’s 1.8 percent. The diversity can be best illustrated by noting that Connecticut, a state will very little in common with Wyoming, saw a comparable decline (-4.7 percent). Moreover, West Virginia, like Wyoming heavily dependent on coal production, had a 1.4 percent growth rate. Some of the price increases were also interesting: North Dakota’s current-dollar GDP rose at a spectacular 30.5 percent rate, while its real output fell at a 0.7 percent rate, meaning that the state’s GDP deflator rose at a rate above 31 percent—obviously, a reflection of the spring surge in oil prices.

    Looking at industry contributions, major sources of declines were construction, nondurable goods manufacturing, and wholesale trade (all three down in every state). A large pickup in accommodations and food services was arithmetically responsible for Hawaii being one of the few states with a real GDP increase.

    State personal income and GDP are now reported in the same release. Q2 growth rates ranged from 10.9 percent in North Dakota (oil prices again at work) to Connecticut’s 2.2 percent.

    Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  • Consumer price inflation is at its highest rate in decades, yet some equity managers are screaming that deflation is the most significant risk. Is deflation a credible risk, or are these prognostications a spurious call for a Fed pivot? It's the latter.

    First, the US has never recorded one year of deflation in core consumer prices in the sixty-plus years that the Bureau of Labor Statistics has collected data. Think about that. There have been several years of high unemployment, with the jobless rate exceeding 8% and a few at 10%-plus. Also, the US experienced record wealth losses following sharp drops in equity and real estate prices, abrupt drops in commodity prices, and near-collapse in the banking system in 2008-09, and not one year of a decline in consumer prices. That does not mean the future risk is zero. Still, going from high to negative inflation in months has to be exceptionally low. Also, economic and financial conditions would have to get significantly worse, above and beyond what has happened in the past, for a prolonged period before deflation risks would be the dominant worry.

    Second, many equity managers form their opinion on inflation/deflation risks based on changes in commodity prices, especially energy. But, commodity prices are inputs into the production process and have a small weight in the overall cost of operations. Also, the US uses more commodities than it produces, so a fall in commodity prices is usually bullish for growth as it frees up cash flow and increases demand (and prices) in other areas.

    Third, it is surprising that some equity managers view deflation as bullish for equities. Price is what companies get for their goods and services. A broad decline in final goods and service prices equates to less revenue and slimmer margins for many companies as firms can't cover or offset the cost of labor and other things. Some of the lowest operating profit margins on record occurred during low consumer price readings. Those periods happened against relatively high unemployment, which is not the case nowadays. So it's hard to see how deflation is bullish for equities, especially in the current environment of job openings exceeding the number of jobless by a factor of two, pushing up the cost of labor.

    Fourth, the primary motivation of portfolio managers' deflation calls appears to be a campaign to pressure the fed to stop and eventually reverse the rise in official and market interest rates. Higher interest rates are a double whammy for equities as they hit growth and earnings and reduce the market multiple, or what people will be willing to pay for future profits.

    Suppose the Fed keeps on the current path of raising official rates to get consumer price inflation back to 2%. In that case, equity PMs might eventually get the policy reversal they are presenting with their spurious calls about deflation risks. But that path will be rocky, with sharp declines in operating earnings, corporate bankruptcies, and a rise in credit default rates. The risk of the latter occurring is much higher than the risk of deflation, which is not a friendly environment for risk assets.

    Deflation is not the magic wand to turn the equity market fortunes around, but that doesn't mean some PMs won't stop talking about it.

    Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  • The Federal Reserve Bank of Philadelphia's state coincident indexes in August were more dispersed, and generally softer, than in recent months, though the general pattern still shows substantive growth. A full 15 states recorded declines from July, with West Virginia down .84 percent. Four states, all in the South had increases above .5 percent, with South Carolina's .59 percent the highest. At the three-month horizon, four states declined, with West Virginia and Montana off by more than one percent. At the top, only North Dakota and Massachusetts had gains over 2 percent. Over the past 12 months, Massachusetts's index was up more than 10 percent, and 28 other states had increase of at least 5 percent. Mississippi was the only state with its index increasing less than 3 percent over this period.

    Yet again, the independently estimated national figures of growth over the last 3 (.85 percent) and 12 (5.14 percent) months look weaker than the state figures would imply.

    Connecticut and Hawaii remain the only states that have not yet passed their pre-pandemic peaks in this series.

  • State labor market results in August were somewhat less robust than in July, with less widespread monthly job growth and some increases in unemployment rates. Only 10 states saw statistically significant increases in payrolls, with Alaska and Kentucky both up 1.4 percent, while Mississippi saw a .7 percent drop. No state saw a numerical gain larger than Kentucky's 26,700. Over the last 12 months, every state (and DC) saw a gain in payrolls, though in 4 cases the increases were not deemed to be statistically significant. Texas's 5.7 increase was the largest, while Nevada's 5.0 percent was second, while 2 other very large states (Florida and New York) had gains above 4 1/2 percent , as did Georgia and New Jersey. Mississippi and New Hampshire were the only states with (not statistically significant) gains of less than 1 ½ percent.

    A full 16 states experienced statistically significant increases in their unemployment rates in August, with the rates in Maryland, Connecticut, and New York all up .4 percentage point (New Jersey's rose .3 percent). Minnesota had the lowest unemployment rate (1.9 percent) and Alaska the highest (4.6 percent) among states—DC's rate was 5.1 percent. There appears to be substantial divergence between state and national seasonal adjustments.in the household survey. New Jersey was the sole state to report labor force growth, seasonally adjusted, higher than the brisk national gain of .48 percent.

    Due to a drop in its labor force, Puerto Rico's unemployment rate edged down to 5.8 percent, setting another new record low. The island did gain 5,500 jobs to reach a nine-year high.

    Puerto Rico's labor market also showed some improvement. The island gained 7,500 jobs (.8 percent) in July, and the unemployment rate fell to 5.9 percent—another record low for this series, which starts in 1976, and the first time the rate has been under 6 percent. However, the drop in the unemployment rate from June to July was an artifact of a decline in the labor force, as resident employment declined.

  • The August report on consumer prices should end the discussion of peak inflation, deflation risks, and the quick end to the Fed tightening cycle. But it won't. The happy prophecy of this inflation cycle ending without a lousy outcome fails to learn from past episodes.

    Lessons from past cycles show that inflation cycles are not static or linear; they rotate and broaden. Some items post significant increases in any given month, others smaller ones, and a few none at all. Months later, the composition of inflation could be completely reversed, with items that were not rising at the outset beginning to run faster than others.

    Earlier this year, rapid price increases in a few items were mainly responsible for the acceleration in inflation. For example, at the end of Q1, gasoline prices increased 48% from a year ago, used cars 35%, airline fares 24%, and new cars 13%. These price spikes reflected supply shortages and the rebound in demand from the idle days of the pandemic. Much of that inflation has reversed, but the more significant broad inflation cycle lives on.

    The Bureau of Labor Statistics (BLS) provides special aggregate price series that remove the noise from these factors, the spike in food prices, and the controversial shelter index. In August, BLS estimated that CPI less food, energy, shelter, and used car and truck prices rose 0.5% in the month and now stands at a new cycle high of 6.3% in the past year. The annual increase is the largest since 1982.

    Inflation cycles are complex, with many interconnected parts. Consequently, taming or reversing the inflation cycle is not as simply slowing or ending the price increases for those items that spiked early on. The drop in consumer goods or commodities, especially energy, is good, but inflation in the service sector is much more difficult to eradicate with monetary policy. That's because it is linked directly to labor costs, and labor nowadays is in short supply.

    Investors are waking up to the view that the Fed has much more tightening before it can confidently conclude the inflation cycle is over. Policy rates of 4% or higher are possible, given the changing nature of the inflation cycle. And because of that, I am reminded of what a former colleague and Wall Street strategist, Bob Farell, claimed bear markets have three stages, "sharp down, reflexive rebound and drawn-out fundamental downtrend." The last stage can last a while and be ugly.

    Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  • At the start of the third quarter, there were 10 million job openings in the private sector, and seventy-five percent were in the service sector. The imbalance in the labor markets, especially for service workers, creates a nightmare scenario for the Federal Reserve. That's because as it attempts to slow demand, dampen wage growth, and cool inflation, its monetary tools are much less effective in dealing with the less interest-rate sensitive service sector.

    Up to now, the hottest inflation issue was commodities, even excluding food and energy prices. But the composition of the inflation cycle is quickly shifting towards consumer services, making it more difficult to reverse without a dramatic drop in demand due to a prolonged period of higher interest rates.

    Core inflation in consumer commodities stands at 6.8%, well off its double-digit highs from earlier than in the year. Yet, prices for core consumer services at 5.6%, the fast annual gain in roughly 25 years, are still accelerating. And core consumer services have nearly three times the weight of core consumer commodities.

    Thus, solving the inflation problem requires a fundamental change in service sector growth dynamics. And that cannot occur without a dramatic shift in the demand and price of service sector labor.

    Before the pandemic, the private sector service job growth was 1.5 to 2 million per year. So reducing the 7.5 million job openings in the service sector by half would take two years. But that would not mitigate wage pressures, the most significant source of service sector inflation.

    The average wages for the private sector non-supervisory service sector workers are up 6.2% in the past year. Excluding the spike in wages in the early months after the pandemic, service sector wages are running at their fastest pace since the early 1980s. And, they are running roughly 100 basis points above the gains in the goods-producing industries.

    Private service sector labor and price dynamics are the Fed's most significant hurdles in its inflation fight. Creating slack in the labor market for service workers will require a much official rate and in place for an extended period than it would if inflation was only a goods sector phenomenon.

    So Fed Powell's warning that "a lengthy period of very restrictive monetary policy" will be needed to stem the inflation cycle is something investors should not ignore, as it signals a volatile market environment.

    Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.