Economic Monitor – Weekly Commentary
by Scott J. Brown, Ph.D.

And if you try sometimes…

May 22, 2017

Following the election, stock market participants gained optimism on the view that the new administration would push through a reduction in regulations, sharply boost infrastructure spending, and achieve broad tax reform. Developments last week suggested that the Trump agenda was at risk. However, even with one-party control in Washington, it was always going to be an upward battle to get things done. Moreover, even if the full legislative agenda were to be achieved, economic growth would surely be restrained by the demographics.

Prior to his dismissal, FBI Director Comey was investigating ties between the Trump campaign and Russia. The day after his firing, Trump met with Russian officials in the oval office, where he has been accused of sharing “highly classified” information (that’s not necessarily illegal, but it doesn’t look good). While the administration put forth a number of reasons for Comey’s firing, the president admitted a couple of days later (on TV) that Comey was let go due to “the Russia thing.” President Trump has refuted the claim of Russian ties with his campaign and called the investigation “a witch hunt,” which, coincidentally, is the same phrase Richard Nixon used at the start of the Watergate investigation (you can’t make this stuff up). Critics of the president charge that Comey’s firing was obstruction of justice, which Trump appeared to admit to on live TV.

Is it too soon to talk about impeachment? That’s a rhetorical question, as people have already been discussing the possibility. The proper question is whether impeachment is likely. Recall that the House of Representatives needs only a simple majority to impeach. That means he would be put on trial in the Senate, where a two-third majority would be needed to remove him from office. At present, this doesn’t seem likely. Impeachment is essentially political, drawn along party lines. Andrew Johnson and Bill Clinton were both impeached. Neither was removed from office by the Senate (Johnson came close with a margin of a signal vote, 35-19, and Clinton was acquitted on two charges, 45-55 and 50-50). Nixon would have almost certainly been impeached, but resigned before that could happen.

While impeachment doesn’t appear to be likely anytime soon, the investigation will consume much of the oxygen on Capitol Hill over the next several months. Robert Mueller, who was confirmed as FBI Director by a Senate vote of 98-0 and served 12 years, has only just been appointed as special counsel. He will have to hire a team, find a secure location to conduct the investigation, and so on. Hearings will come later, if at all.

Stock market participants were only briefly sidelined by last week’s developments, still believing that the Trump agenda is intact. However, things are never easy in Washington.

As noted previously on these pages, infrastructure spending costs money and House members are unlikely to want to add to the budget deficit (except where tax cuts are concerned). Broad tax reform is virtually impossible, as nobody wants to get rid of their tax deductions. If you can’t pay for tax cuts by eliminated deductions, how about a border tax? That is dead on arrival, as it would prove extremely disruptive to supply chains. Lower tax rates are still possible (and likely), but on a much smaller scale than was hoped for previously. A tax holiday on foreign earnings is also possible, but studies show that when this was done during the Bush administration, the vast majority went to dividends or stock buybacks, and not to capital investment.

Still, even if the full Trump agenda were to be enacted, the economy is facing increased constraints in the labor market. Labor force growth is currently less than a third of what it was a few decades ago. So, unless we increase immigration or are able to sustain an unprecedented increase in productivity growth, the underlying trend growth in GDP will be limited. Granted, there may be greater slack in the job market than there appears. If that’s the case, GDP growth could pick up over a few quarters, but limits will eventually be reached, leaving growth near its long-term trend (1.5-2.0%, depending on the underlying pace of productivity growth).

For the Fed, the tighter job market is the main factor in moving toward a more neutral policy. The inflation outlook, the other key factor, remains moderate, with mixed pressures.

Investors who expect that the full Trump agenda will be enacted, lifting the pace of growth, will be disappointed. Yet, while slower than in previous decades, GDP growth is still expected to remain positive. Without any sense of irony, Trump campaign events (before and after the election) ended with the Rolling Stone’s “You Can’t Always Get What You Want.” And, indeed, if you try sometimes, you get what you need.

Employment, inflation, and the Fed

May 8, 2017

Growth in nonfarm payrolls rebounded in April, following a soft increase in March, consistent with a longer-term downward trend. The unemployment rate fell to 4.4%, the lowest level in over a decade. The results in recent months remain consistent with a labor market that is getting tighter. Average hourly earnings rose 0.3%, up just 2.5% from a year ago – a relatively soft pace considering the job market picture. This is consistent with the Fed gradually increasing short-term interest rates. However, might the Fed want to let things ride a lot longer?

Nonfarm payrolls rose by 211,000 in the initial estimate for April, following a 79,000 gain in March (revised from +98,000). Needless to say, there is a fair amount of statistical noise from month to month (the monthly change in payrolls is reported accurate to ± 120,000) and seasonal adjustment is often challenging (we added 1.026 million jobs prior to seasonal adjustment in April, a little less than we saw a year earlier). Looking at payroll gains over a period of months smooths out a lot of the noise. Private-sector payrolls averaged a 164,000 gain in the last three months, compared to a 170,000 average for all of last year (vs. +213,000 in 2015 and +239,000 in 2014). The underlying trend in job growth has been slowing.

Weekly claims for unemployment benefits continue to trend at a very low level. Job destruction is limited. Anecdotal reports suggest that firms are increasingly having a harder time finding qualified workers, a consequence of tighter job conditions.

The unemployment rate fell further in April, now well below what Fed officials believe to be the natural rate. The broad U-6 measure fell even more sharply, reflecting a drop in involuntary part-time employment (those working part-time, but wanting full-time employment). Involuntary part-time employment rose sharply during the recession, but has actually declined since the Affordable Care Act went into effect.

While the job market has grown tighter, there is still a wide difference in the demand for skilled and unskilled labor. Wages for skilled workers should be picking up. There are couple of reasons that wage growth may be slower than in past periods of tight job conditions. One is that union membership is a lot lower than a few decades ago, suggesting less bargaining power for workers. The other is that there has been a consolidation of major firms, consistent with greater bargaining power for those employing workers. For the relatively unskilled workers, there is little bargaining power, and apparently, still a lot of slack remaining. Efforts could be made to educate those workers, but it’s typically unclear what kind of work to train people for. Training would best be handled by the firms, and can be encouraged through tax incentives (although reducing such deductions is expected to be a key issue in tax reform efforts).

How does this relate to the inflation outlook and monetary policy? The Fed’s thinking is that a tighter job market will lead to higher wage inflation, which will be passed through to higher consumer prices. That was the story of the inflation booms of the 1970s and early 1980s. However, firms may not be able to raise prices of the goods and services they produce. Higher wages should then lead to a more efficient use of labor, boosting productivity growth. As workers move up to better jobs, that leaves space for new entrants to come in and acquire work skills. This seemed to be the story of the late 1990s. The Federal Reserve, under Chair Greenspan, was willing to test the theory of the natural rate. Yet, the conclusion, for most Fed officials, is that policy needs to keep economic growth on a more even keel and prevent wage inflation from taking hold.

At this point, the analogy remains largely the same – the Fed is not hitting the brakes, but is taking its foot (gradually) off of the accelerator pedal. There are other arguments for normalizing policy, but the Fed should be willing to let this run.


May 1, 2017

Real GDP rose at a 0.7% annual rate in the advance estimate for 1Q17, below the median forecast (+1.1%). Relatively speaking, that’s not a huge forecasting error. The headline growth figure will be revised and revised and revised over the next few months. The story behind the numbers was largely as anticipated, and that shouldn’t change much from here. However, the GDP data raise some important questions about the prospects for growth in the remainder of the year.

No surprise, consumer spending growth slowed sharply in the initial estimate for the first quarter – a 0.3% annual rate (vs. +3.5% in 4Q16). A slower pace of motor vehicle sales subtracted nearly a half of a percent from overall GDP. Personal income rose moderately in 1Q17, but inflation was higher, limiting consumer purchasing power. Mild temperatures reduced home heating expenditures, which are part of consumer spending. The near-term trend in gasoline prices has been relatively flat recently, which means that real income growth should pick up. More normal temperatures should lead to an unwinding of the dip in household energy consumption. The University of Michigan’s April consumer sentiment survey results noted that, over the last two months, evaluations of current personal finances posted the strongest improvement in 15 years.

Business fixed investment surged in the first quarter (a 9.4% annual rate, vs. +0.9% in 4Q16). Consumer optimism doesn’t always translate into higher consumer spending growth. However, business investment decisions are, by necessity, forward-looking. Business structures accounted for nearly half of the first quarter surge in nonresidential fixed investment. That could have been helped by mild weather. Spending on information-processing equipment picked up. Spending on industrial equipment was moderate. Inventory growth slowed sharply, subtracting 0.9 percentage point from GDP growth.

Can the strength in business investment continue beyond the first quarter? Businesses do not exist simply to sell to other businesses. The consumer is the end-point. Businesses will need to see a sustained increase in the demand for the goods and services they produce to keep expanding. A big part of the 1Q17 pickup in business investment has to do with the situation in Washington. Surveys show that households generally feel better about their personal financial situation regardless of their political affiliations. However, there is a sharp divide in expectations about the further. Naturally, one-party control has led to a sharp increase in optimism for Republicans and a decrease in optimism for Democrats. Most business owners are Republicans – hence, the increase in business confidence.

One might be led to conclude that an economist’s outlook, like that of any individual, is based on his or her political viewpoint, and in some cases that may be true. However, the broader conclusion is driven by arithmetic. The demographic story has become more accepted. The underlying trend in labor force growth is a lot slower than in previous decades and will slow even more in the years ahead. While GDP growth over the last several years has been viewed as subpar, it’s been beyond a sustainable pace. We know that because the job market has gotten tighter over the last several years.

Does that mean we can’t get to much stronger GDP growth? Not at all, but clearly, the main issues should be whether to increase (not decrease) immigration and what efforts can be made to boost productivity growth. The last time we had strong productivity growth was in the late 1990s, when new technologies (cell phones, networking equipment, the internet) came into play (assisted partly by a misallocation of capital).

Over the next couple of months, the economic data will be key. We’ll find out whether consumer spending growth will rebound and whether business investment will stay strong.

The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

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