Viewpoints: 2022

Personal incomes growth again varied widely across the states in 2022:Q1, with large differences in both the growth of transfer payments (reflecting idiosyncratic impacts of the wide-down of COVID relief) and net earnings The fastest rate of growth was South Dakota’s 8.5 percent, while the lowest was Hawaii’s 1.3 percent. Growth was fastest in the Great Plains and New England; slowest in the Southwest. The distribution of net earnings was somewhat different. The Plains—aided by sharp increases in farm income--and New England remain the strongest regions there, but the weakest was the Mideast. In the Mideast overall personal income grew at the national average of 4.8 percent. The drop in transfers was less marked than the national average, and the growth of property income was larger. In the Southwest, net earnings growth was greater than the national average, but property income rose less rapidly and transfers fell more.

In other industry detail, the boom in incomes generated in leisure and hospitality was over in the first quarter, with Nevada the only state seeing especially marked gains.

State payrolls were not as strong in May as in recent months. Only 7 states had statistically significant increases, while 3 report declines. Texas had the largest gain (74,200) while West Virginia jobs rose 1.3 percent. On the other side, Alaska shed 4,400 jo15 bs (1.4 percent), Wyoming lost 2,800 (1.0 percent) and Michigan payrolls fell 14,600. Over the last year, Alaska and Wyoming were the only localities that did not show statistically significant job growth (Alaska's point estimate edged down). Both California and Texas had job growth exceeding three-quarters of a million in that period, and Nevada had a 7.1 percent increase. Aside from Alaska and Wyoming, Wisconsin was the only state with job growth under 2 percent.

16 states saw statistically significant drops in their unemployment rate in their unemployment rates in May, with a number (California, Iowa, Missouri, and Rhode Island) reporting declines of .3 percentage points. The range of unemployment rates across the nation continues to narrow. Nebraska continues to have a 1.9 percent rate; the highs continue to be DC (5.7 percent) and New Mexico (5.1 percent), but in both cases May's number was lower than April's.

Puerto Rico's recovery is ongoing, with a small (likely statistically insignificant) increase in payrolls, and the unemployment rate moving down to 6.2 percent.

The latest June survey of Blue Chip professional forecasters is an uncomfortable read. Further downward revisions to growth expectations for 2022 have been accompanied by further upward revisions to inflation forecasts. That’s an unpleasant combination, suggesting stagflation risks are high and rising. That many policymakers moreover are now more actively engineering a tighter monetary policy in order to check inflation leaves global growth forecasts subject to further downward revision. The still-large - and growing - disconnect between forecasts for consumer spending growth and real household income growth in the meantime offers a stark reminder that the growth portion of the stagflation equation are subject to intense downward pressure at present. In other words, global recession risks are rising sharply.

These conclusions are reinforced in the charts below.

The evolution of consensus GDP growth forecasts for 2022 is shown in figure 1 below. These have been revised sharply lower over the last several months and most notably in large economies such as China, the US and the Euro Area. Their synchronized nature moreover hints that these revisions can be traced to global, not domestic, factors.

Figure 1: The evolution of Blue Chip forecasts for GDP growth in 2022

Peak inflation is not a meaningful statistic. In some ways, it is similar to peak growth or peak earnings. Indeed, it provides no context to the reduction in speed or the duration of the cycle. It is hollow. The Fed made a mistake in thinking that the spike in inflation was supply-side driven and, therefore, temporary. It would be equally wrong to conclude that peak inflation signals a quick end to the inflation cycle.

There is a lot of talk of peak inflation as it somehow creates the impression that with inflation coming off its highs, the Federal Reserve has less need to tighten. Yet, peak inflation implies inherent linearity to inflation, which is not the case. Inflation cycles are non-linear. To be sure, inflation cycles rotate, move up and down, and broaden over time.

The thinking behind peak inflation is similar to the supply-side driven view of the current inflation cycle. Supply-driven inflation, according to some, is temporary as it will fall on its own accord once the unique factors disappear or dissipate in intensity. Yet, the error in that analysis is that it overlooks or ignores the spreading effect of inflation. In other words, as certain costs rise, it forces different prices up over time.

For example, in the 1970s, supply shocks (food and energy) played a massive role in starting the inflation cycle. After that, however, the inflation process spread, and for more than a year, inflation measures without food and energy costs were rising faster than those that included them.

A similar script is starting to play out today. For example, consumer price inflation has accelerated by 400 basis points in the past twelve months. Unique factors, such as energy +30%, used cars +23%, and food +9%, accounted for a lot of the spike. Yet, prices other than food, energy, shelter, and used cars accelerated by 330 basis points, rising 5.8%, the most significant acceleration and fastest increase in this broad price index in over 40 years.

Prices paid indexes are relatively high (low to mid 80%) for manufacturers and non-manufacturers in the May survey from the Institute of Supply Management, and wage costs for the rank and file posted their most significant monthly increase (0.6%) of 2022 in May. So as long as companies are saying costs for materials are increasing and workers' pay is as well, the Fed must conclude the inflation cycle lives on and ignore talk of peak inflation.

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

Bank of England policymakers have been slammed by UK newspapers in recent days for 'being asleep at the wheel'. Spiralling inflation, a 'cost-of-living crisis', a borrowing binge and an overheating labour market are being specifically pinned on lax UK monetary policy. And last week's UK data flow showing a further big jump in inflation, a steeper than expected drop in the unemployment rate and a record high for job vacancies have added more grease to the media's wheels.

But are these criticisms really justified? Well the answer is not quite, and for a number of reasons. The most straightforward reason being that these criticisms are not just being levelled at the BoE. They're also directed at the Fed, the BoC, RBA, ECB, and at many other central banks besides. In other words, many of these issues are globally-rooted and don't have their origins in lax domestic monetary policy.

Global roots

On the other hand, perhaps all of these central banks have been similarly asleep at the wheel during this period? Global monetary policy settings may have been far too loose for too long, particularly during the pandemic period. This could have generated too much money, excessive private sector leverage, and soaring demand. This could have now yielded outsized price pressures, wage price spirals thanks to overheating labour markets and dislodged inflation expectations to boot. If this isn't a wake-up call for policymakers to tighten monetary policy swiftly and aggressively and squeeze these excesses out of the system, then what is?

However, this global narrative and policy prescription doesn't quite hit the nail on the head either. There's no evidence – at the global level – for rampant money supply growth, for excess private sector leverage, or for economic activity more generally that's overheating. Price pressures have been, and still are, emerging due to acute supply side shortages that can mostly be traced to the pandemic or, more recently, to the conflict in Ukraine and China's zero COVID policy. And while a recovery in global demand has admittedly amplified these pressures, it has been fiscal policy – not monetary policy – that's been playing the supporting role.

All things considered, if that analysis is accurate, shouldn't monetary policy now play a bigger role in ameliorating these price pressures and, at the very least, preventing a bad situation from getting worse? This scribe is dubious. If loose and unorthodox monetary policies throughout the post-financial-crisis era failed to generate any consumer price inflation, and isn't really responsible for high inflation levels at present, why on earth should we expect tighter monetary policy to play a restraining role now?

More appropriate policy tools

Fighting the current combination of weak growth and high inflation with higher interest rates will not restore the supply fabric of the world economy not least now that most governments are tightening their fiscal stance at the same time. Surely a far more apt policy response (which admittedly the UK government is leaning toward) would be to use the levers of fiscal policy to alleviate supply-side shortages (e.g. in energy markets), increase an economy's production capacity and shore up the purchasing power of households and companies. By raising the cost of borrowing, tighter monetary policy will impede a supply side investment drive and further derail private sector purchasing power. As such, central banks may well make a bad situation even worse if they were to more actively respond to the pressures facing them from so many opinion formers in the media.

In what follows, we take a look at a few charts accompanied with (mostly) brief commentary reinforcing these messages.

The first chart in figure 1 below shows the strong link between commodity prices and consumer price inflation in the advanced economies over recent years. In short, consumer prices have been rising because input cost pressures have been rising.

Figure 1: Higher commodity costs have pushed up consumer price inflation

The Federal Reserve Bank of Philadelphia's state coincident indexes in April were again almost uniformly strong, with every state seeing gains over the one-, three-, and twelve-month horizons. Over the three months since January Maryland's index rose more than 4 percent, and only 4 had growth less than 1 percent (Oklahoma, Louisiana, Arizona, and Mississippi). The independently estimated national figure of 1.1 percent growth over this period was, yet again inconsistent with the state numbers.

Over the last 12 months 6 states registered gains higher than 10 percent, led by West Virginia's 14.3 percent. Yet again, New York and California were in this group, and the 5.7 percent national figure was not representative of the individual state outcomes.

Maryland's 1.5 percent gain was the highest between March and April, and 5 other states saw increases above 1 percent. On the other side, 7 had gains less than .25 percent.

Nearly all the states set new record highs in April. However, Connecticut, Hawaii, Louisiana, and Michigan (the latter just barely) have yet to match their pre-pandemic highs.

State payrolls were positive in April, with gains comparable to those in March. 11 states saw statistically significant increases from March, with New Hampshire’s 1.0 percent gain the largest. In absolute numbers Texas’s 62,800 increase was the largest. As was the case in the initial March estimates, over the last 12 months 49 states and the District Columbia had statistically significant increases in payroll employment. Delaware was the odd-man out, even though the April 2022 point estimate was more than 1 percent higher than the April 2021 figure). Aside from Delaware, Alabama, Kansas, and Wisconsin were the only states with gains less than 2 percent over that period. Nevada has seen an 8 percent rise, and the aggregate job increase in California was 925,000.

13 states and DC saw statistically significant drops in their unemployment rate in their unemployment rates in April, with Maryland’s .4 percentage point decline being the largest. The range of unemployment rates across the nation is no longer pronounced. Nebraska and Utah both have 1.9 percent rates; the highs are DC’s 5.8 and New Mexico’s 5.3.

Puerto Rico had another solid month, with a 4,700 gain in jobs and the unemployment rate ticking down to 6.4 percent.

Based on the preliminary data from the GDP report, operating profits fell roughly 10% in Q1 relative to Q4. A decline of that magnitude would drop aggregate company profits back to the Q1 2021 level, or nearly $300 billion below the record level of Q4 2021.

The plunge in operating profits reflects a sharp drop in margins. Real operating profit margins for Non-Financial Companies hit a record high of 15.9% in Q2 2021, dropped to 15.2% in Q4, and probably fell 100 to 150 basis points in Q1 2022. To be sure, Q1 earnings reports from large companies such as Amazon, Wal-Mart, and Target confirm a sharp contraction in operating margins due to rising input costs.

More margin contraction lies ahead, especially if the Fed successfully squeezes inflation to 2%, down from 8%, and limits any significant fallout in the labor markets. For reported consumer price inflation to drop 600 basis points over the next year or so, producer prices for many companies involved in production and distribution would drop twice as much, if not more. And if overall labor costs are unchanged, the hit to profit margins, or the ratio of profits from sales after all expenses, will be significant.

Past cyclical slowdowns offer some perspective on significant margin contraction when monetary policy simultaneously slows demand and price inflation. For example, in 2000, consumer price inflation dropped 200 basis points, but producer prices for finished goods and intermediate materials fell between 600 and 1000 basis points. That dropped triggered the most significant cyclical contraction in real profit margins (700 basis points).

The potential disruption to business operations in 2022 is more significant than in 2000 because the Fed faces a bigger inflation problem. That means a substantial decline in operating margins is the most considerable risk to the equity market. Investors forewarned.

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