Viewpoints

State labor market results in June were again somewhat mixed. 13 states had statistically significant increases in payrolls, but only 2 were striking in percentage terms (Montana's .9 percent and Tennessee's 1.0 percent). Texas's 82,500 gain was a smaller .6 percent. Two states (Alaska and West Virginia) had statistically significant declines. All states had at least point increases in payrolls over the last year, but the increases in Vermont, Ohio, Alabama, Louisiana, Wisconsin, and Kansas were less than 2 percent. On the other hand, California added more than 850,000 jobs (a 5.1 percent increase) and Texas nearly 780,000 (a 6.1 percent gain), while Nevada's increase was 6.6 percent.

Unemployment rates were little-changed. Missouri was the only state to see a .3 percentage point decline. Interstate variation in unemployment is now fairly narrow. Minnesota's 1.8 percent was the lowest in June, while no state was at or above 5 percent (DC, though, had a 5.5 percent rate).

Puerto Rico's improvement ebbed in June. Nonfarm payrolls fell, apparently reflecting a drop in government employment. The island's unemployment rate fell to 6.1 percent, but both the labor force and resident employment declined.

Before the academic arbiters debate whether the economy is in a recession, the Bureau of Economic Analysis (BEA) must first examine and hopefully find answers to the unprecedented and growing gap between income and output in the GDP accounts.

In Q1, Gross Nominal Income (GDI) exceeded Gross National Product (GDP) by a record $836 billion annualized. The gap widened by roughly $220 billion from the fourth quarter of 2021. That increase was sufficiently significant to produce two different outcomes--- GDI, adjusted for inflation, posted a small gain, while GDP, adjusted for inflation, recorded a decline.

In theory, the two series measure the same thing (the economy). But, in practice, there are substantial differences, but nothing on the scale of the past few years.

GDP measures the final output of goods and services, which involves many different series of sales, shipments (domestically and overseas), construction, inventories, and a wide range of private and public services. GDI measures the income associated with the output side, with employee compensation and operating profits accounting for 80% of the total and interest income and investment the remaining portion.

The income side of the accounts is not as timely as the product side. For example, BEA offers a preliminary estimate on the output side less than 30 days after a quarter ends. But, details on the income side are delayed 60 to 90 days due to companies reporting on operating profits.

Still, I have always felt that the income side is neater, as it has far fewer series and revisions than inputs in the output figures. And support for that view comes from a Fed staffer. He argued that GDI is probably a better indicator since his research found the initial estimates of GDI are much closer to the final numbers of both series.

The consensus expects Q2 GDP to show a slight decline when reported on July 28. Back-to-back declines will surely increase talk of recession, but it would be wrong to jump to that conclusion when the gap between income and output has quadrupled in the past two years, and GDI is still increasing in real terms.

BEA is investigating this issue. But it will take months before they issue any report.

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

The strength of the US dollar and by extension the weakness of other major currencies in recent weeks has generated a great deal of comment. Heightened global risk aversion and an investor preference for the relative safety of US assets is one reason for the dollar's ascent. But relative growth and inflation fundamentals and their implications for interest rate differentials have also been key.

The outsized degree to which the dollar has climbed based on relative growth fundamentals alone, however, is noteworthy. As figure 1 below suggests, the US dollar has advanced by much more than the incoming US data-flow would suggest. This could be because US inflation has been more broadly-based compared with other major economies (where higher food and energy prices have been principal drivers). And this has caused the Fed - in the face of a weakening economy – to signal a more active inflation-fighting monetary policy campaign relative to, say, the BoJ or the ECB.

Figure 1: The US dollar is decoupling from relative growth fundamentals

This is a transcript of a brief webinar that we have posted on stagflation risks.

As a reminder we have been recommending that a neat way to keep tabs on those risks would be to look at the spread between global growth surprises and global inflation surprises. If that spread has been in negative territory for some time it would suggest that growth expectations have been ebbing or that inflation expectations have climbing and possibly both and with attendant increased risk of a stagflation combination

So where are we now? As the charts in figures 1 and 2 below suggest we have seen a higher risk of a global stagflation scenario emerge of late insofar as our indicator as plunged into deeper negative territory in the past few weeks. And that in turn can mostly be traced to a steady drumbeat of downbeat news on the global growth front.

Figure 1: An updated stagflation stress indicator

Almost all states saw their real GDP fall in 2022:Q1. The exceptions were New Hampshire, Vermont, Massachusetts, and Michigan (New Hampshire was first with a modest 1.2 percent growth rate.) .

The GDP declines were generally most notable in energy and mining-intensive states, with Wyoming’s output plunging at a 9.7% annual rate, Alaska down 8.2%, North Dakota ,6.3%, West Virginia, 6.1%, New Mexico, 4.7%, Louisiana, 4.3%, Montana, 3.8%, and Oklahoma, 3.7%. Wisconsin, Maryland, and Connecticut had rates of decline very near zero. Elsewhere, only the declines in Hawaii (-3.5%) and Washington (-3.3%) look notably out of like with the nation’s 1.6% rate of decline.

The Federal Reserve Bank of Philadelphia's state coincident indexes in May showed some dispersion. Five states had no gains, or losses, in May (Michigan, Arizona, Hawaii, Montana, and Arkansas), while West Virginia, Rhode Island, Massachusetts, and Maryland were all up by more than 1 percent. The relative strength of the Northeast was also evident at the 3-month horizon, with Massachusetts, Maryland, West Virginia, and Rhode Island rising more than 3 percent. While 12 states—none in the Northeast—had increased of less than 1 percent. Over the last 12 months, every state had gains of at least 3 percent, but 6 (including California and New York) were up more than 10 percent, with West Virginia's 15.2 percent far and away the highest.

As is chronically the case, the independently estimated national figures of growth over the last 3 (1.3 percent) and 6 (6.0 percent) months look substantively weaker than the state figures.

It remains the case that Connecticut, Hawaii, Louisiana, and Michigan are the only states that have not yet matched their pre-pandemic highs in this series.

Recession risks are high, in my view, because of the "income" consequences of the Fed's inflation fight. The math is very straightforward: A significant reduction in price inflation means less nominal revenue or sales, weak or negative operating profits, and less labor income. Consequently, the subsequent drop in national income growth would be sharp, rivaling some of the most significant declines on record.

The Fed aims to bring consumer price inflation back to 2%, down from the current rate of over 8%, a drop of 600 basis points. Slicing 600 basis points off the headline and roughly 400 basis points from the current reading of the core index would cause an uneven distribution of price changes, with prices for many consumer goods posting significant declines.

Commodities or consumer goods prices rose 10% in 2021. Given the stickiness in service sector prices, inflation for consumer goods would have to show no change or decline a few hundred basis points if the Fed successfully gets overall core prices back to a 2% rate. That would result in a sharp fall in revenue growth for a vast part of the retail sector.

Yet, the consumer price inflation fall would extend much further. Producer prices for finished goods and intermediate materials are cyclically aligned with consumer prices but are much more volatile. In 2021, producer prices for core materials and supplies rose 23%, 4x the core consumer price index and the most significant increase since the mid-1970s. If the Fed kills consumer price inflation, a record deceleration in prices for materials and supplies is in store.

The most significant reversal in materials prices occurred during the Great Financial Recession. In mid-2008, these prices were up 12% and one year later off 8%. If material price inflation drops to zero by early next year, it will exceed the price deceleration of 2008-09. As a result, the revenue drop for the materials producers would be substantial, crushing profits.

In 2021, with significant and broad consumer and producer inflation along with large wage gains, national income, 80% of which is accounted for by operating profits and employee compensation, rose 12%, 200 basis points faster than GDP.

If the Fed takes three-fourths of consumer price inflation out of the economy and all of the producer price inflation, the drop in nominal income would be sharp, especially when the hit to labor occurs.

Aggregate income would rise marginally, no more than 4%, and down from the current rate of 11%. That 700 basis points deceleration of nominal income growth would match the drop during the Great Financial Recession. Yet, in this case, it would still be marginally positive. Depending on how quickly firms cut back on labor and other costs, the fall in operating profits would be sharp, off at least 20%.

The Fed's inflation fight is in its early innings, and the biggest hit to company revenues, profits, and margins is months or even quarters away. Still, the process has started with reports of cuts in advertising and hiring freezes.

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