In meetings with our accounts, I am most frequently asked about the biggest risk to my optimistic outlook for the U.S. economy and financial markets. I believe a rebound in inflation is the biggest risk.
I’m not expecting it, but Debbie and I are monitoring the inflation indicators closely.
Here is a brief look at some of the latest data:
(1) Wage curve. At long last, the Phillips wage curve appears to be making a comeback. The unemployment rate fell to 3.7% during October. It is well below the Fed’s 4.5% estimate of NAIRU (the non-accelerating inflation rate of unemployment). The Employment Cost Index (ECI) for private-sector workers’ wages and salaries edged up to 3.0% y/y during Q3 (Fig. 6). That is the highest rate seen since Q2-2008 for this quarterly compensation measure. Average hourly earnings, a measure of wages, rose 3.2% y/y during October. That’s the highest reading since April 2009 (Fig. 7).
(2) Productivity. Productivity is one of the key factors that can mitigate so-called cost-push inflation, when rising labor costs are passed through into prices. The ratio of the yearly percent change in the ECI to nonfarm business productivity on the same basis has remained low at around 2.0% since the mid-1990s. This measure of unit labor costs pressure is highly correlated with the core PCED inflation rate, the Fed’s preferred measure of price inflation (Fig. 8).
(3) PPI finished goods. The Producer Price Index (PPI) for finished goods eased to 3.4% y/y during October from a recent peak of 4.2%. It hasn’t moved much above 4.0% since mid-2017. For historical comparison, the PPI for finished goods reached 9.9% and 7.2% during July 2008 and July 2011, respectively (Fig. 9). Excluding food and energy, the PPI for finished goods was 2.3% during October. That hasn’t moved above 3.0% since February 2012. So there isn’t any evidence that producers are rushing to raise their prices.
(4) Import prices. US import prices have remained subdued despite the aluminum, steel, Chinese import, and other tariffs recently imposed by the Trump administration. The US import price index was up 3.5% y/y during October, but only 0.8% excluding petroleum imports (Fig. 10).
Obviously, US import prices have less to do with domestic unemployment and more to do with the relative strength of the US dollar and the impact of recent tariffs (Fig. 11). Interestingly, US import prices from China have remained remarkably subdued, rising just 0.3% y/y last month (Fig. 12).
(5) Consumer prices. Despite higher wage growth, productivity and subdued producer prices as well as import prices among other factors have translated into moderate consumer price inflation. The headline CPI was up 2.5% y/y during October, but just 2.1% when food and energy are excluded.
As we’ve previously discussed, rent inflation has been looking toppy in the past couple of years and recently has started to come down. The CPI tenant rent inflation rate was down to 3.6% y/y during October from a recent peak of 3.9% at the start of 2017.
We have been watching for signs of a possible pickup in healthcare inflation, as we’ve discussed before. But so far, the CPI for medical care has remained remarkably low, up just 1.7% y/y during October (Fig. 13).
(6) Range-bound. Interestingly, the CPI excluding food and energy has remained range-bound above 0.5% and below 3.0% on a y/y basis all the way from the mid-1990s until now. The range became even tighter following the 2008 financial crisis, floating between about 1.5% and 2.5% (Fig. 14).
While the painful inflationary experience of the 1970s remains in the minds of many investors, inflation today poses no clear and present danger. Numerous disinflationary developments since then have contributed to the tight lid that’s on inflation now (Fig. 15).
Walmart went public during 1970. Fed Chairman Paul Volcker proved that monetary policy could bring inflation down rapidly by causing a severe recession. Private-sector unions lost their clout during the 1980s. The end of the Cold War at the end of that decade, and China’s entrance into the World Trade Organization during December 2001 unleashed the competitive forces of globalization. The high-tech revolution that started during the 1990s enabled Amazon to perfect online shopping.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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