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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. Hourly compensation rose 3.4 percent in February while the Consumer Price Index increased modestly by 1.5 percent, resulting in 1.9 percent real wage growth. A mix of the government shutdown and negative wealth effect of equity market losses were the culprits in dampening consumer spending, according to Dhawan of Georgia State University. Psychological distress due to employment insecurity and depletion of asset values exasperated an already weakened worker-employer relationship in the era of global supply chains and the platform economy.
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 is expected to remain on a positive growth trajectory to achieve the longest recovery cycle in history, surpassing the 120-month expansion of 19912001. The slow but steady economic growth has produced a lasting imprint in the psyche of both employers and workers that, in part, explains tamed wage and price inflation. The unemployment rate stands at 3.8 percent in February, a rate last seen in 1966. The broader measure of unemployment (U6) that includes discouraged and part-time workers stands at 7.3 percent in February, a sharp drop from 8.1 in January. The lowest U6 unemployment rate was in October 2000 at 6.8 percent. Broken down by ethnicity, the unemployment rate of Hispanics, African-Americans, and whites stand at 4.3, 7.0, and 3.3 percent respectively, with the largest gain among Hispanics and a slight retreat for African-Americans. The labor force participation rate has reversed the downward trend in April 2015 and stands at 63.2 percent but far short of the 67.3 percent rate in February 2000. A sustained higher labor force participation will have both material and psychological dividends in the long-run. Employment growth of 20,000 in February was far short of the anticipated 180,000 the worst since September 2017. However, the survey of firms does not indicate a drop in need for workers. One piece of good news is that real wages are finally rising. Hourly compensation rose 3.4 percent in February while the Consumer Price Index increased modestly by 1.5 percent, resulting in 1.9 percent real wage growth. A tight labor market and rising hourly earnings are contributing to a higher labor turnover and absenteeism, a sign of worker confidence. The average weekly hours worked has declined since February 2016 after an upward trend since June 2009. Overall, the average weekly hours worked is below that of the pre-great recession. Manufacturing hourly earnings have been on the rise since February 2012 and are at the pregreat recession level.
CONSUMERS
Wage gains are finally exceeding the rate of inflation since the recovery began in 2009. Real wages rose by 1.3, 1.7, and 1.9 percent between December 2018 and February 2019 in contrast with a 0.7 percent rise in December 2017. The good news is that the rise in real wages is accompanied by the rise in productivity of 1.7 and 1.9 percent in the third and fourth quarters of 2018, and moderate inflation, keeping the change in unit labor cost-the difference between the change in hourly compensation and productivity growth-at 2 percent in February. A modest rise in unit labor cost is critical to the non-inflationary tight labor market and demand for workers. The Conference Board Consumer Confidence Index stands at 131.4 in February, up by ten points from January. Further, the index's short-term outlook on income, business and labor conditions has jumped considerably from 89.4 in January to 103.4 in February. The consensus put the growth in personal consumption expenditure at 3.34 percent between the second quarter of 2019 and the first quarter of 2020, up slightly from the 3.23 percent we reported in the last issue. Meanwhile, the consensus expects growth of personal disposable income at 3.19 percent in the same period, down from the 3.38 percent we reported in the last issue. Disappointing news came from the Federal Reserve, announcing the highest drop in household net worth to $104.3 trillion in the last quarter of 2018, a 3.4 percent decrease from the third quarter. The decline in net worth is due to a sliding equity market, mitigated slightly by rising home prices. The good news is that household net worth is up by 73 percent since 2009. The Perryman Group is expecting an economic slowdown as the euphoria of tax cuts has worn off but does not believe the anticipated, record-breaking expansion will be derailed. Wealthier Americans are taking advantage of falling mortgage rates with average loans reaching a record high of $326,000, well above the median home value of $247, 500 in January. In several geographic areas, home sales have come to a halt as new buyer's affordability has vanished. Mounting student and credit card debt is contributing to the sluggishness in first-time home ownership.
FIRMS
U.S. wholesale prices measured by the producer price index rose by 0.1 percent in February, after a 0.1 slip in January. Despite trade barriers and rising wages, the cost-ofproduction before reaching the consumer remains in check. The consensus expects GDP growth of1.49 percent by the first quarter of 2020, down from the 1.71 percent we reported in the last issue. The unemployment rate is expected to drop to 3.72 percent by the first quarter of 2020. The manufacturing purchasing managers index (PMI) has been declining since mid-2018 and stands at 54.2 in February. The index below 50 signifies contraction. Total light-vehicle sales are expected to contract by half a percent to 16.8 million units by the first quarter of 2020, down significantly from 18.1 million in September of 2017. The average price of cars has risen to $35, 000 in February, causing several manufacturers to experiment with car sharing platforms to help owners to lease their vehicle, making the sticker price more attractive. This is designed to generate revenue and help manage the staggering seven million auto loan delinquencies. The after-tax corporate profit margin adjusted for inventory valuation and capital consumption has been declining in growth since the middle of 2012 due to rising costs and competitive pricing. Retail sales has reversed course from a surprisingly bad performance in December 2018. A mix of the government shutdown and negative wealth effect of equity market losses were the culprits in dampening consumer spending, according to Dhawan of Georgia State University. Firms satisfying household discretionary consumption with lower price sensitivity have gained the most. The increase in discretionary spending is reflected in the reversal of the rate of growth of the chained price index. For the first time in several quarters, the chain price index has dropped below the consumer price index as households are returning to more expensive items. The consensus expects the chain and consumer price indexes to be at 1.63 and 1.75 percent respectively by the first quarter of 2020. Consensus expects non-residential fixed capital formation to grow by 2.84 percent by the first quarter of 2020, down from the 3.08 percent we reported in the last issue. Growth in labor productivity continues to be anemic at 1.8 percent in the fourth quarter of 2018, well below the 3.4 percent in 2010, averaging 1.3 percent for 2018. Growth in output comes from more hours worked and less from improvement in productivity. Tight labor market and rising wages unmatched by the rise in productivity is expected to put downward pressure on profit margins and market valuations of firms. Industrial capacity utilization is expected to decline slightly by the first quarter of 2020 to 78.16 percent, a full two percentage points below 2007.
INTEREST, CREDIT, AND THE FED
The Fed has put key interest hikes on pause, causing equity markets to soar despite a drop in growth of profit margins. Partly due to tamed price inflation, there is no clear signal as to future hikes despite long-anticipated wage inflation. Dhawan of the Georgia State University expects no new hikes until September. The consensus expects the Federal Fund Rate-the overnight borrowing rate among major financial institutions- to rise from 2.42 to 2.71 percent between the second quarter of 2019 and the first quarter of 2020. The triple-A corporate bond rate is expected to rise slightly over the next year to 4.31 percent. Tax repatriation has produced a $300 billion cash inflow, mostly used for stock buybacks. The M2 money supply- cash, checking, saving deposits, money market securities, and mutual funds-is expected to grow to 3.32 percent by the first quarter of 2020, up from the 2.79 percent we reported in the last issue. The growth of the money supply is expected to be double the rate of growth in GDP. We do not expect inflationary pressure from growth in M2. Households will not experience a shortage of liquidity to purchase what the economy can deliver. Despite declining mortgage rates, the consensus expects the private housing starts to grow to 2.42 percent or 1.3 million units, down from the 3.4 percent growth we reported in the last issue. In hindsight, all fears associated with the quantitative easing to produce runaway inflation and the hot economy did not materialize.
CONCLUSION
We are living in remarkable times that requires revision of economic theories and assumptions. Contrary to expectations, historically low unemployment has not produced runaway wage inflation, and price inflation is nowhere in sight. A decade ago, the Fed was able to finetune the economy confidently with incremental monetary policies. These days, the Fed is unsure how to react when ex-post data becomes available. A combination of globalization and supply chains have altered the importance of national economic slack as the determinant of wage and price inflation. Consumers are increasingly not limited to local markets as their purchase can be sourced globally and delivered to their doors, increasingly on the same day. Producers can break down production into multiple parts and geographic locations and are not pressured by capacity or labor market limitations. Pointing to the experience of Japan, there is a contentious debate around modern monetary theory (MMT) that suggests that countries that print their own money can run large deficits without risking the kind of hyperinflation seen in the 80s. If it gains traction, the MMT can pave the way for bi-partisan spending on infrastructure. The post-recession lackluster growth in productivity has puzzled economists for some time. We offer an explanation based on worker psychology that orthodox economists fail to take into account. The Great Recession of 2007 produced massive overnight wealth destruction and rapid loss of employment by millions. Combined with a slow recovery, the emotional wellbeing of workers has been adversely impacted. Psychological distress due to employment insecurity and depletion of asset values exasperated an already weakened worker-employer relationship in the era of global supply chains and the platform economy. The fact that a large number of workers have not fully recovered from the loss of their assets provides the missing explanation for sluggish labor productivity. Output per hour worked can be significantly different depending on the emotional wellbeing of the worker. Showing up to work while worried that your home might be foreclosed on, or worried about how long it'll take to recoup lost family savings, can quash the motivation for innovation and creativity that are critical to productivity growth.
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Copyright Journal of Business Forecasting Spring 2019