Paul L. Kasriel

"Core" this and that is all the rage these days. Soon to be retiring Chicago Fed President Charlie Evans is now talking about a supercore CPI. What is that? A CPI that excludes all items that have increased in price? But I digress. The headline of the media reports of the Bureau of Economic Analysis (BEA) release of its first guesstimate of the annualized percent change in real GDP for Q1:2022 was "economy contracts by 1.4%". Oh my. Call off Fed interest rate hikes because the economy has one foot in the recession grave? I referred to this advance estimate of GDP as a guesstimate because the BEA does not yet have complete first-quarter data for net exports, inventories and residential investment. So, cool your jets. I will argue that the part of the economy that the Fed has the most influence on, real private domestic sales excluding inventories (or real private domestic final sales), apparently picked up in Q1:2022.

The advance estimate of first-quarter real GDP was held back primarily by real net exports and the change in real inventories for which, again, March data still have not been released. Real net exports held back first-quarter real GDP by 3.20 percentage points; the real change in private inventories by 0.84 percentage points. And for good measure, real government, combined federal, state and local, retarded first-quarter real GDP by 0.48 percentage points. With defense expenditures likely to be increasing and infrastructure spending gearing up, how much longer will government expenditures on goods and services be a drag on real GDP?

But if we look at real private expenditures for goods and services, excluding inventories, the spending most influenced by monetary policy, we find a different picture. This is just a fancy name for combined real personal consumption expenditures, real private fixed-investment expenditures, including business and residential investment. As shown in Chart 1, this measure of real aggregate spending grew at an annualized pace of 3.66% in the first quarter, up from the annualized pace of 2.57% in Q4:2021. The 2017 through 2019 median quarter-to-quarter annualized growth in real private domestic final sales has been 2.72 % (the thin blue horizontal line in the chart). So real private final demand grew in Q1:2022 faster than it grew during those pre-Covid glorious years when the US economy was great again.

**Chart 1**

d2f6b92d-6962-47a4-9834-afd76bb6b583_1220502z1.jpg

So far, the discussion has been in real terms. Now, let’s get nominal. Real expenditures measure what you received in units of the good or service. Nominal expenditures measure the dollars you paid to get the units. So, let’s look at the behavior of nominal core GDP or nominal final sales to private domestic purchasers in Q1:2022. Plotted in Chart 2 are the annualized growth rates for quarterly nominal final sales to private domestic purchasers (the blue line) and real final sales to private domestic purchasers (the red bars). In Q1:2022, the nominal spending aggregate grew at an annualized rate of 11.50% compared to growth in the real purchases aggregate of 3.66%. The difference between nominal spending and real purchases approximates the inflation rate.

**Chart 2**

31a1d092-c15c-4cb3-afa1-ca269a3adc94_1220502z2.jpg

Where did the US private sector get the funds to purchase final goods and services at the annualized rate of 11.50% in the first quarter. Corporate profits data have not yet been released. But personal income data have been released. After-taxes, nominal personal income increased at an annualized pace of 4.85% in the first quarter. Nominal personal consumption expenditures plus nominal residential investment expenditures increased at an annualized rate of 10.58%. If your nominal expenditures are growing faster than your nominal after-tax income you either have to borrow more, save less or sell assets. We’ll have to wait until the middle of June for the Fed’s release of the Q1:2022 Financial Accounts (Flow of Funds) data to get a handle on this. But we know that the private sector has built up massive amounts of cash holdings since the federal government, effectively, started crediting households’ bank accounts with Covid-relief payments, financed by the Fed and the banking system. It is conceivable and, in fact, I predicted it (see "Households’ Extraordinary Cash Holdings Will Thwart Fed Tightening", March 14, 2022, at "Viewpoints" on Haver.com or on my LinkedIn page) that households would start to put this cash to work in order to try to maintain their purchases in the face of inflation outpacing their income growth. This is effectively households selling their cash assets.

Economists refer to the ratio of some aggregate spending measure to some money supply measure as the velocity of money. An increase in spending relative to money is referred to as an increase in the velocity of money. What this means is that the given money supply is turning over more rapidly to support the higher relative spending. Let’s see what happened to velocity of money in Q1:2022 with nominal final sales to private domestic purchasers in the numerator and the M2 money supply in the denominator. The blue bars in Chart 3 are the quarterly observations of this version of M2 velocity. The red line is the quarter-to-quarter annualized percent changes in this version of M2 velocity. Sure enough this version of M2 velocity increased in Q1:2022 , increased at an annualized rate of 3.19%.

**Chart 3**

bd776722-7208-4579-9d01-1763c38eca8e_1220502z3.jpg

In sum, contrary to the headlines accompanying the release of the advance estimate of Q1:2022 GDP, the US economy still has legs and can tolerate some Fed interest rate hikes before slipping into recession. How high the Fed can raise the federal funds rate before inducing a recession is a question I am not equipped to answer. There used to be a PBS show called "Wall Street Week" hosted by Louis Rukeyser. One of his regular guests was Martin Zweig, a money manger. Lou used to ask Marty at what level the stock market would top out. Marty used to reply by saying he didn’t know the numerical level right then, but when his indicators pointed to a top, he would tell Lou. Similar to Marty, I’ll tell you when a recession is imminent when my indicators suggest such.

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

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Joseph G. Carson

The widely followed employment cost index (ECI) jumped 1.2% in Q1 2024, faster than the 0.9% increase in Q4 2023, raising fears that labor costs are re-accelerating. As big as the jump in the ECI was in Q1, another labor cost measure (ECEC) shows employee costs are rising even faster.

The Bureau of Labor Statistics, the government agency in charge of reporting labor market data, provides two crucial measures of employee costs: the employment cost index (ECI) and employer costs for employee compensation (ECEC). Both measures, with a similar scope covering 5500 to 5600 private industry establishments and 23000 occupational observations, play a pivotal role in labor cost analysis. However, it's important to note that the ECI excludes employment shifts among occupations and industries, while the ECEC does not, making the ECEC an equally important comprehensive measure of total current employment costs.

The two measures are simple to understand: the starting point for both measures is the change in wages, but if people move to higher-paying jobs or shift occupations because of the promise of higher pay, the ECEC measures will grow faster than the ECI. In contrast, if the opposite is true, when the jobless rate is high, job openings are low, and people have to accept lower-paying jobs, the ECI would increase faster than the ECEC.

In the last several years, the labor market has been characterized by a record number of job openings, which have encouraged people to shift industries and occupations in search of higher pay. The labor cost data confirms this did happen. Private industry wage costs in the ECEC have outpaced the increases in the ECI every year, and the increase in 2023 of 6.9% was the largest on record and 270 basis points over the increase in the ECI.

The Q1 2024 report for ECEC is due on June 18. Based on the still high number of job openings and low jobless rate, the Q1 rise in the ECEC index should exceed the ECI increase, adding to current fears of higher labor costs feeding into inflation numbers.

How Fast Are Labor Costs Rising?  Faster Than You Think

Ken Matheny

**The US economy is stronger than suggested by the “soft” 1.6% increase in GDP in the first quarter, while a sharp upturn of inflation puts Fed rate cuts on hold for at least several months.**

**Look to final sales to private domestic purchasers, not GDP, for a better indication of the economy’s underlying strength.**
The initial (“advance”) report of the national accounts for the first quarter of 2024 should be interpreted carefully.  Looking beyond the headline figures, the economy’s underlying growth momentum was notably stronger than the disappointing figure of 1.6% quarterly GDP growth in the first quarter.  GDP growth was held down by declines in components that tend to be more volatile  --- inventories and net exports --- in contrast to solid growth in other components, including consumer spending and private investment.  Personal consumption expenditures (PCE) posted solid growth (of 2.9%).  Business fixed investment also rose 2.9%, while residential investment jumped 13.9%, continuing a recovery that began in the second half of 2024.

A more telling indicator of the US economy’s underlying strength is final sales to private domestic purchasers, which rose at a solid 3.1% annual rate in the first quarter, virtually identical to increases in the third and fourth quarters of 2023 of 3.0% and 3.3%, respectively.  This is a clear if preliminary indication that the economy retains solid momentum for growth.

Together, declines in inventory investment and net exports subtracted 1.2 percentage points from GDP growth in the first quarter, but those components are not likely to continue to subtract large amounts from GDP growth on an ongoing basis, even though quarterly swings could be significant (in either direction) from time to time.  The level of inventory investment ($35 billion in the first quarter) is broadly sustainable, suggesting that repeated large declines are not the most likely outcome.  Net exports have been in a sideways waffle since the second half of 2022.  Future large declines are possible if foreign demand were to collapse or the dollar were to appreciate sharply, but neither of those outcomes appear to be highly likely at this juncture.  In short, the 3.1% growth in final sales to domestic purchasers is a better indicator of underlying strength in demand than the smaller 1.6% increase in GDP in the first quarter.

Of course, GDP and other estimates are subject to revision, so the picture of first-quarter growth could be altered in coming months.

**Inflation surged in the first quarter, nearly eliminating any prospect for a Fed rate cut prior to this fall.**
Another major component in today’s report on the national accounts was a disturbing increase in consumer inflation.  The price index for personal consumption expenditures (PCE) rose at a 3.4% annual rate in the first quarter, the largest increase since the first quarter of 2023.  Meanwhile, the core PCE price index rose at an even higher 3.7% annual rate in the first quarter, far above the increase of 2.0% in the final two quarters of last year.  This is a direct challenge to any hope that the Federal Reserve will begin to lower interest rates in coming months.  As of the first quarter, the annual (four-quarter) increase in the core PCE price index was 2.9%.  It is likely that tomorrow’s report on monthly PCE will show annual (12-month) inflation at or slightly above February’s 2.8% reading.

The Federal Open Market Committee (FOMC) will almost certainly not begin to seriously contemplate rate cuts without clear indications that inflation is easing and well on track to fall to 2% over time.  The latest inflation figures suggest that progress on bringing inflation down has stalled.  It will take more than one or two “good” monthly inflation reports to convince policymakers that it is appropriate to begin cutting interest rates.  This makes any rate cut prior to this fall a low probability outcome and adds to the risk that there might not be any Fed rate cut in 2024.

240425KM.jpg

First-Quarter 2024 National Accounts

Charles Steindel

The Federal Reserve Bank of Philadelphia’s state coincident indexes in March showed some moderate variance. Four states were down slightly from February. The largest increase was Arizona’s .8 percent; three other states (Iowa, Delaware, and Vermont) had gains of at least .5 percent. Over the three months since December, Massachusetts was up 1.9 percent, while 8 other states (scattered across the nation) rose more than 1 percent. Over the last 12 months, Massachusetts again led, with an increase of 4.9 percent, while New York’s 3.6 percent was a fairly distant second. 5 states were down over the period, with Montana’s slump continuing, with a loss of 3 percent.

The independently estimated national figures of growth over the last 3 months (.75 percent) may be a touch higher than the state estimates would have suggested, but the 12-month figure (2.9) percent) looks to be roughly in line with the state numbers.

State Coincident Indexes in March 2024

Viewpoints: May 2022

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"Core" GDP Suggests Economy Gained Momentum in Q1:2022