Archive for January, 2015

Deflation Play

Friday, January 30th, 2015

Deflation has been in the headlines a lot lately.  Our Massachusetts based readers should understand this is not just a reference to football.  Much like Brady and Belichick, Atlas is shocked that the Patriots have allegedly been caught cheating by letting some of the air out of their game balls–again!   Of course, since underinflated balls seem to be both easier to catch and carry, the upcoming Super Bowl might be even more interesting if they are used by both teams.  We are sure Lynch and Sherman of the Seahawks would love a chance to demonstrate that on the field of play.

Football aside, deflation may not seem so scandalous.  After all, it is defined as a reduction in consumer and wholesale prices.  Why not make it easier for consumers to score the goods and services they desire?

Conventional economics contends that falling prices will grind an economy to a halt for several reasons.  First, some economist worry that consumers will begin postponing purchases because they are waiting for prices to fall further, thereby incentivizing savings at the expense of consumption.  Next, firms will defray capital expenditures until consumer demand increases.  In addition, as fewer consumers buy the goods and services provided by businesses, revenue and profitability falls.  When the topline figure drops, companies look for ways to compensate by lowering costs, and since employees are the largest expense to companies, layoff occur.  Higher unemployment means fewer taxes are collected which hurts the government’s situation.  It is tough to sell Super Bowl ads in this environment.

Since the Great Recession ended, the economic season has been tough, and every major global economy is looking for a winning advantage.  Our Federal Reserve gained yardage with a series of plays called quantitative easing (QE).  Now other central banks are following America’s game plan.  Take the European Central Bank; it just announced its very own money printing program.  Expectations are that the additional cash sloshing around in the European economy will cause demand to rise, thus combating falling inflation levels and thereby elevating the economy to the next round.

Before we declare economic victory for the home team, perhaps we should consider another nation which has been trying QE for awhile now.  Japan first started this offensive tactic in the early 2000s, and they have not made it to the end zone yet.  After a recent huddle, their central bank announced another round of similar plays last October.  While America has been the economic leader coming out of the Great Recession, even our claim to victory may be premature.  The Fed’s team, led by head coach Yellen, suggest they may stop running this aggressive offense soon.  If they do, will further deflation cause the ball to lose all of its bounce?  (by C. Cox & JR)

December 2014 Leading Economic Index

Thursday, January 29th, 2015

From the looks of the Conference Board’s Leading Economic Index (LEI), economic expansion will continue.  Improving for the fourth consecutive month, this forward-looking indicator increased 0.5 percent in December after November’s uptick of 0.4 percent (downwardly revised from 0.6 percent).

Constructive news was pervasive in the Board’s release of this report.  Initial claims for unemployment fell, adding to December’s total after climbing a month earlier.  New orders components contributed to the uptick and are signaling additional manufacturing in the months ahead.  Stock prices helped the LEI as well.  Interest rates and a proprietary index for credit contributed the most to December’s release; if there is a rub, the nature of these two components are it.  First, an intervening Federal Reserve is keeping its Fed Funds rate at virtually zero, so it is easy for debt maturing in 10-years to maintain a higher yield than the overnight rate even with near record low rates for bonds with longer maturities.  Secondly, the Leading Credit Index is a proprietary measure of lending, so it is tough to know how well it truly reflects the credit conditions in the economy, but we will have to take the Conference Board’s word.  The only negative contribution came from building permits which dropped for the second month in a row.  In all, nine out the ten components were positive.

From the perspective of this forward-looking indicator, there is not an end to America’s current economic expansion coming anytime soon.  On an annualized basis, this indicator grew by 3.0 percent in the first half of 2014 and accelerated to 3.3 percent in the final 6 months of the year.  Economic activity is growing and our central bank continues to be accommodative.   Atlas sees no reason to expect a recession in the next several months.           (by C. Cox)

December 2014 Existing Home Sales

Wednesday, January 28th, 2015

Sales of existing homes increased 2.4 percent in December according to the National Association of Realtors.  The uptick follows November’s downwardly revised decline of 6.3 percent (originally 6.1 percent).  On an annualized basis, the sales rate increased to 5.04 million from 4.92 million a month earlier.  Sales of single-family homes increased by 3.5 percent, and condos fell 5.0 percent.  For all of 2014, there were 4.93 million homes sold, 3.1 percent less than 2013’s count.

Inventory is tight after the strong month of sales.  Around the nation, there are only 1.85 million homes on the market, down from 2.08 million in November.  At the current rate of sales, the entire stock of homes would be gone in just 4.4 months.

Prices firmed in the period.  The average price of a home improved $2,100.00 to $255,800 and is 4.4 percent higher than a year earlier.  The median price ticked higher to $209,500 from $207,200 in November and has increased by 6.0 percent since December 2013.  Interest rates helped make homes more affordable.  According to Freddie Mac, the average commitment rate for a 30-year conventional, fixed-rate mortgage in December fell to 3.86 percent, its lowest level since May 2013.

One possible fly in the ointment came from a separate National Association of Realtors survey mentioned in the release.  The annual share of first-time home buyers fell to its lowest level in nearly three decades.  These new buyers are an important segment of the marketplace because they allow current homeowners to trade up.  Fewer first-time buyers might provide clues into developing secular trends for home sales.  Perhaps younger purchasers may be having a tougher time qualifying for loans.  Equally plausible is a changing mindset where they don’t feel as compelled to own a home as did previous generations.  Atlas is not convinced the shadow of crisis has passed.         (by C. Cox)

December 2014 Consumer Price Index

Tuesday, January 27th, 2015

Energy prices caused the Bureau of Labor Statistics’ headline Consumer Price Index (CPI) to deflate in December.  Falling 0.4 percent in the final month of the year, 2014 ended with two consecutive months of declines for CPI, and this price measure has only been positive once in the last five.  On a year-over-year basis, CPI is up just 0.7 percent, down from 1.3 percent in November.

Energy may have garnered all of the attention for the headline figure, but core inflation deserves a look as well.  Excluding food and energy, the core measure of CPI was flat for the month after gaining just 0.1 percent in the prior period.  Also, disinflation was evident in the core statistics’ year-over-year tally, falling to 1.6 percent from 1.7 percent in November.  Several components within the core figure (apparel, airline fares, used cars and trucks, household furnishings, and new vehicles) were lower in the period.  Shelter, however, ticked up 0.2 percent and medical care posted its largest increase since August 2013, up 0.5 percent.

Falling energy prices are making a significant impact on the various measures of inflation in America at a time when our nation’s central bank appears to be preparing itself to exit more fully its experimental monetary policy.  Overnight lending rates have been at virtually zero since December 2008, and there are hints coming from the beltway that this will need to end in 2015.  The Federal Reserve put rates at zero hoping to stimulate the economy and, as an intended consequence, increase inflation to a level that would cause consumers to take rational actions (i.e. consume more before prices rose further), thereby allowing the economy to become self-propelling.  However, our economy has consistently fallen short of the inflation level for which the central planners are looking, and the economy has been unable to sustain ample growth levels as well.  Making matters worse, economies outside of the U.S. are not healthy and will likely have a marginally negative impact on America’s output.  All of these circumstances contribute to Atlas’ sense that higher overnight lending rates in 2015 should not be considered a forgone conclusion.  In fact, an additional round of Quantitative Easing (a.k.a. money printing) remains plausible in our view.     (by C. Cox)

December 2014 Industrial Production

Monday, January 26th, 2015

Industrial production slowed in December according to the Federal Reserve.  Falling 0.1 percent after being 1.3 percent higher in November, the slowdown was mostly a function of weather.  Capacity utilization was a few ticks lower, dropping to 79.7 percent from 80.0 percent but still remaining near its long-term average of 80.1 percent.

Warmer-than-usual temperatures reduced the demand for heating, so collapsing utilities use put this indicator into negative territory.  While utility output plummeted 7.3 percent in the period, overall industrial production expanded 0.7 percent when they are excluded.  In part this is due to manufacturing’s follow through on November’s jump of 1.3 percent; it increased 0.3 percent in December.  This category is the largest component in the indicator, so its continued improvement is constructive for the economy overall.  Mining also boosted the monthly total as it jumped 2.2 percent after falling in the two prior periods.  Much of mining’s gain is attributed to an increase in oil and gas extraction.  A drop in drilling and fewer well servicing-activities kept the gains from being even greater and are likely a response to falling energy prices as firms shut down expensive attempts to access previously untapped petroleum reserves.

Excluding the collapse in utilities, the physical portion of our economy remains in an uptrend.  Manufacturing is sensitive to the business cycle, so it higher pattern is promising.  Increases in this segment of output suggest the economy should continue expanding in the immediate future.  Producers of items like computers and apparel only make more of their wares when they expect consumers to buy them.  For now, improvements to the labor market seem to be supporting greater consumption at the margin, helping to create a virtuous cycle between consumers and producers.  (by C. Cox)

December 2014 Producer Price Index

Friday, January 23rd, 2015

Headline prices fell for producers and wholesalers as 2014 came to an end according to the Bureau of Labor Statics’ Producer Price Index (PPI).  Finished goods costs fell at an accelerating rate, dropping 0.3 percent versus a decline of 0.2 percent in November.  Excluding the volatile food and energy components however, the core measure accelerated to 0.3 percent after being unchanged a month earlier.  Year-over-year, the headline and core measures have increased by 1.1 percent and 2.1 percent respectively.

Prices at the final stage of production were mixed.  Goods deflated at a faster pace, falling 1.2 percent versus being 0.7 percent lower a month earlier.  Goods were 1.2 percent cheaper from a year ago as well.  Final stage services were up 0.2 percent after climbing 0.1 percent in November and have increased by 2.2 percent in the last twelve months.

Earlier stages of production are not indicating growing inflation pressures in America.  Intermediate demand services were unchanged overall.  However, prices for intermediate demand goods deflated.  Processed goods fell 1.7 percent to end 2014 and are 2.2 percent cheaper than a year earlier; energy led the monthly decline, but even the core measure fell 0.6 percent.  Goods which have not been processed suffered an even steeper decline, collapsing 5.0 percent in the month and plummeting 8.1 percent from a year ago.

PPI indications suggest benign cost pressures.  Falling petroleum prices help the typical American because it allows a smaller portion of the household budget to be spent at the local filling station.  So what are Americans doing with the extra money?  According to the latest retail sales report, it appears they are pocketing the difference and not putting it to work in other areas of the economy.  If this behavior continues, the Federal Reserve may feel the need to extend the time its overnight interest rate remains virtually at zero.         (by C. Cox)

December 2014 Retail Sales

Thursday, January 22nd, 2015

Retail sales disappointed right in the middle of the most wonderful time of the year.  According to the Census Bureau, the figure fell 0.9 percent during December following November’s downwardly revised uptick of 0.4 percent (originally 0.7 percent).  From a year-ago, retail sales increased 3.2 percent after being 4.7 percent higher in the prior period.

Falling gasoline prices were the primary cause of the decline. Spending at gasoline stations dropped 6.5 percent in the final month of 2014, accounting for over half of the monthly decline.  But there was additional weakness in the report as auto dealers experienced slower sales in December even though 2014 was their best year in nearly a decade.  Even after excluding gasoline and auto sales, the indicator fell 0.3 percent, suggesting retail weakness was pervasive in the period.  There was one silver lining to this dark cloud of a report: American restaurateurs’ revenue grew by 0.8 percent in December, an acceleration over the 0.3 percent uptick seen in November.  Eating out is at the core of discretionary spending, a sign of consumer confidence.

Retail sales represent a significant portion or our economy (roughly one-fifth of our nation’s GDP), so its slowdown cannot be taken lightly.  The Federal Reserve may have some concern regarding this report because it does not appear that consumers spent much of the money they saved at the pump.  If demand for other goods does not grow when gasoline prices are collapsing, headline deflation becomes a greater risk and may give the central bank additional justification to keep overnight interest rates low into 2016.  However, one month of data, in fact, even two months of data do not constitute a trend.  Atlas will be following this indicator in the months ahead to see if a pattern is developing.   (by C. Cox)