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Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; GSU - EFC = Georgia State University, Economic Forecasting Center, Atlanta, Georgia; ICIMS=Holmdel, New Jersey; Moody's Economy = Moody's Economy.com, Westchester, Pennsylvania; Mortgage = Mortgage Bankers Association, Washington, D.C.; NAM = National Association of Manufacturers, Washington, D.C.; Perryman Gp = The Perryman Group, Waco, Texas; Royal Bank of Canada, Toronto, Ontario, Canada; S&P = Standard & Poor's, New York, New York; US Chamber = U.S. Chamber of Commerce, Washington, D.C.; Wells Fargo = Wells Fargo Bank, San Francisco, California. At last, the average annual hourly earnings is reflecting the labor market conditions with a 2.8 percent growth for manufacturing and non-supervisory workers by the end of the second quarter. The Downward Pressure On Labor Participation, Aging population, and Need for More Innovation As A Source of Growth Baby boomers who have postponed retirement after the great recession are now retiring due to increased home and equity evaluation and the fact that some had remained in the labor market to support their unemployed family members. The supply-side policies in investment in technology, human capital, and infrastructure is the responsibility of the legislative and executive branches of government and cannot be managed through monetary policy choices.
PARTICIPANTS I Conf. Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; GSU - EFC = Georgia State University, Economic Forecasting Center, Atlanta, Georgia; ICIMS=Holmdel, New Jersey; Moody's Economy = Moody's Economy.com, Westchester, Pennsylvania; Mortgage = Mortgage Bankers Association, Washington, D.C.; NAM = National Association of Manufacturers, Washington, D.C.; Perryman Gp = The Perryman Group, Waco, Texas; Royal Bank of Canada, Toronto, Ontario, Canada; S&P = Standard & Poor's, New York, New York; US Chamber = U.S. Chamber of Commerce, Washington, D.C.; Wells Fargo = Wells Fargo Bank, San Francisco, California.
The U. S. economy has surpassed the Fed's 4.5 percent natural rate of unemployment since March of 2017 and stands at 3.9 percent in August with a modest rise in inflation expectations. The labor productivity from second quarter 2017 to second quarter 2018 is double the average at 2.9 percent. The unit labor cost has decreased by 1 percent, the difference between 2.9 percent productivity growth and 1.9 percent growth in hourly compensation. The inflation-adjusted real hourly compensation has dropped to 0.2 percent in the second quarter of 2018, down from 0.5 percent a year ago, making new hires more attractive to employers. At last, the average annual hourly earnings is reflecting the labor market conditions with a 2.8 percent growth for manufacturing and non-supervisory workers by the end of the second quarter. The number of long-term unemployed and part-time workers measured in the U-6 unemployment rate dropped to 7.4 percent, the lowest since 2001, further reducing slack in the labor market. The labor force participation has stabilized at around 62.8 percent. The average workweek for all private employees nudged up since January of 2017 and has stabilized at 34.6 hours in the second quarter. Baby boomers are finally retiring at a large number due to the rebounding of home prices and the equity market, reducing the employment-population ratio. Average hourly earnings has increased from $21.18 to $27.18, a 28 percent rise from December 2007 to August of 2018. However, the inflation-adjusted wage has increased only by 5 percent since 2012. The long-delayed investment in capital equipment is finally paying off with improved labor productivity that should translate to a long-delayed increase in compensation.
CONSUMERS:
Consumers Upbeat And Spending More of Their Paychecks
A combination of higher employment, increased wealth due to rising home and equity values, and lower personal income tax have contributed to robust consumer spending. The change in consumer spending continues to exceed the rate of change in disposable income, signaling rising consumer confidence. In August of 2018, the Conference Board Consumer Confidence index rose to 133.4, almost 7 points above the forecasted 126.7. The annualized growth in consumer spending rose by 4.0 percent in the second quarter, compared with a dismal 0.5 percent in the first quarter of 2018. The revised IRS data shows a higher than the previously calculated saving rate by proprietors and small business owners of 6.7 percent, up from 4.2 percent since 2013. However, the wage-earners' saving rate has not changed. The consensus expects 3.46 percent growth in personal consumption expenditure by the third quarter of 2019, slightly below the rate of growth of disposable income at 3.57 percent. The ratio of consumptions spending to disposable income is 97 percent, up from 95 percent from the last issue. This trend suggests that U.S. households are spending most of their paycheck and rely on home and equity value appreciation as their primary source of savings. This household behavior will significantly contribute to economic volatility, particularly during an economic downturn. For the time being, the growth in consumer spending stems from a mix of higher employment, personal income tax cut, and asset wealth effect. The consensus expects unemployment to decline further to 3.72 percent by the third quarter of 2019. The GDP grew at 4.2 percent in the second quarter of 2018, almost double the 2.2 percent in the previous quarter. However, the consensus put the GDP growth at 1.83 percent through the third quarter of 2019, surprisingly below the 1.95 percent growth reported in the last issue and recent robust GDP growth figures. The forecast for change in the consumer price index has nudged up to 1.94 percent by the third quarter of 2019, close to the 2 percent rate target set by the Fed. Change in the chained price index remains unchanged from the last quarter's report at 1.71 percent. Despite the partial revival of manufacturing, it is the service industry workers who have experienced a higher wage growth, while government employees have benefited the least from the tight labor market. The persistent gap between male and female employment has narrowed for the time being due to growth in the manufacturing sector.
FIRMS:
Corporate Profit At An All-Time High; Capital Deepening Improving Labor Productivity
After-tax corporate profit adjusted for inventory and capital consumption valuation was at an all-time high at the end of the second quarter 2018 at more than 2 trillion dollars, double the amount seen in the second quarter of 2009. Robust growth in income, employment, tax cuts, reduction in regulation, and stable unit labor cost are expected to keep the upward trend in corporate profits. The consensus expects healthy growth in nonresidential fixed investment by the end of third quarter 2019 at 3.87 percent, slightly above the previous quarter forecast of 3.65 percent. The new capital equipment, once installed and absorbed by the workers, will further improve the labor productivity, with dividends in terms of lower unit labor cost and profitability. Dismal 0.9 growth in labor productivity in the 2013-17 period made firms reluctant to grant wage increases in the past. Robert Gordon of Northwestern University expects the labor productivity to grow for the next two years, allowing firms to pay higher wages and be profitable at the same time. The industrial capacity utilization rate is expected to remain on a growth trajectory from 77.39 in the last quarter of 2018 to 77.59 by the end of the third quarter of 2019. More intensified capacity utilization should improve the cost-of-production and profitability of the manufacturing sector. Trade policies that reduce competition are expected to contribute to the ongoing trend in market concentration and market power by firms to set price. The good news is that, according to Sungki Hong of the St. Louis Fed, markups are countercyclical as firms invest in customer capital in an economic upturn for future profitability. A combination of moderate cost-of-production and markup should put a check on the inflationary pressure. The consensus expects private housing starts to grow by 1.35 million units by the end of the third quarter of 2019, a sharp drop from the 4.14 percent growth rate we reported in the last issue to 2.69 percent. The decline in new construction is expected to feed the inflation in home prices and a potential bubble in the housing market with a host of consequences for wealth valuation, consumer confidence and spending, employment and GDP growth. The light vehicle total sales is expected to decline by 0.66 percent by the end of the third quarter of 2019 to 16.87 million units. A combination of a drop in new housing starts and auto sales will make sustained growth in GDP more challenging. The triple-A corporate bond rate is expected to nudge slightly up from 4.33 in the last quarter of 2018 to 4.72 by the end of the third quarter of 2019, keeping the cost of borrowing manageable. However, firms are awash with profit, and cash for investment will not be a concern.
INTEREST, CREDIT, AND THE FED:
The Fed Expected To Remain Accommodative
At the Fed's meeting in August, there was a unanimous decision to leave the key interest rate unchanged at 1.75 - 2 percent. However, the Fed has strongly hinted that it is prepared to raise the rate for the third time in 2018 in September and most likely one more hike before the end of this year. The consensus puts the Federal Fund Rate at 2.88 percent by the third quarter of 2019, consistent with the expectation that the Fed will normalize the rate around 2.75 percent that some analysts believe is the neutral rate, i.e., neither inflationary nor deflationary. The inflation rate is at 1.9 percent, close to the 2 percent target goal set by the Fed. If the growth in labor productivity continues, fatter paychecks will not add to the unit labor cost and real wage inflation. This outcome will reduce the pressure for the Fed to hike the interest rate. There is a significant divide between the consensus and the Fed's estimates of long-run GDP growth, and the rosy outlook expressed by the administration. This difference is based on the unsustainability of the current deficit spring.
CONCLUSIONS:
The Downward Pressure On Labor Participation, Aging population, and Need for More Innovation As A Source of Growth
Baby boomers who have postponed retirement after the great recession are now retiring due to increased home and equity evaluation and the fact that some had remained in the labor market to support their unemployed family members. This phenomenon is keeping the overall labor participation stable at 62 percent despite a large influx of previously discouraged workers entering the labor market. Although some capital deepening is taking place, in the long-run, higher output growth is needed to support the aging population, and that has to come from innovation instead of more capital and labor input alone. Robert Gordon of Northwestern University and Joel Parkken of the HIS Markit's Macroeconomic Advisors are concerned about stagnant total factor productivity or innovations in the U. S. economy. The increase in full-time employment is improving labor-attachment to their jobs and contributing to higher productivity. In addition, workers realize that their employers are experiencing difficulty in finding additional help for them and are working harder to keep up production, further contributing to more output per hour worked. The supply-side policies in investment in technology, human capital, and infrastructure is the responsibility of the legislative and executive branches of government and cannot be managed through monetary policy choices. Investment in infrastructure, human capital, and more equitable income and wealth distribution to rejuvenate the middle-class is necessary for long-run growth. The structure of the labor force has shifted in favor of women, particularly for households where the husband's education is below that of their spouse. If this pattern is continued, it will impact labor participation, family formation, the number of children per household and population growth in the long-run. This has implications for long-term growth in output and the ability of the economy to support the aging population.
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Copyright Journal of Business Forecasting Fall 2018