Written by Jim Welsh
Macro Tides Monthly Report 01 May 2021
Long Term Downtrend in GDP
By definition a recession occurs when GDP declines in two consecutive quarters, which is one of the reasons why all recessions are not created equal. In 1970 and 1974 GDP contracted by a modest -0.32% and -0.54%, minor hick-ups compared to the 1982 decline of -1.80%. The 1990 recession was shallow as GDP only fell by -0.11%. In 2001 GDP actually rose by +1.00% but during the year there were two consecutive quarters in which GDP was lower so it was technically ruled a recession. In 2009 GDP shrank by -2.54%, which was the largest annual decline since the post World War II plunge of -11.6% in 1946.
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The Pandemic in 2020 caused GDP to fall -3.50%, but a record $3.1 trillion in fiscal stimulus during the year engineered a dynamic recovery by year end.
As this quick review illustrates, recessions vary in depth and longevity which can easily mask the strength of the expansion phase during each business cycle. This is why looking at GDP growth during the economic expansion phase of each business cycle is revealing.
After GDP plunged in 1946, the economy boomed as the U.S. transitioned from a war footing to consumer driven growth as G.I.’s started family’s, bought a home, cars and appliances. After the 1954 recession (-0.54%) the economy settled into a lower glide path, following the above trend boom in GDP growth after the war. After the 1958 recession which lowered GDP by -0.74%, GDP rebounded strongly. As one studies this chart it becomes clear that GDP growth during the expansion phase of each succeeding business cycle since 1958 has been trending lower.
After the quick recession in 1980 and the stiff 1982 recession, GDP growth firmed during the Reagan years. The downtrend in GDP growth accelerated after the 1980’s expansion ended in 1990. This is interesting.
Lower Interest Rates Have Lost Their Mojo
Monetary policy became increasingly accommodative after the federal funds rate peaked in 1981 at 20.0%, which seems surreal in today’s world. Since 2001, the real after inflation federal funds rate has been below zero percent for most of the past 20 years. Since March of last year the federal funds rate has been holding near 0.07% and in February the FOMC’s preferred inflation metric – the Personal Consumption Expenditures Index (PCE) – was 1.40%. The real adjusted federal funds rate was -1.33% in February and will drop further below zero percent as the PCE rises in coming months and the FOMC keeps the federal funds rate unchanged.
The 10-year Treasury yield dropped from over 15.0% in 1981 to less than 0.50% in March 2020.
At the end of February the 10-year Treasury was 1.46% so the real yield after subtracting PCE inflation was barely positive.
In coming months the PCE is expected to trend higher toward 2.0%, which will push the 10-year Treasury yield further below zero, unless the Treasury yields rise as the PCE moves higher.
With interest rates trending lower since 1981 and real rates approaching zero percent for much of the past decade, GDP growth would have been expected to accelerate. The fact that GDP growth failed to pick up suggests that monetary policy has progressively lost its leverage in spurring economic activity.
More Spending, Less Filling
Since 1970 the Federal government has only run a budget surplus in 4 years which is why Federal debt as a percent of GDP has been inexorably rising for the past 5 decades. It is interesting that federal debt as a percent of GDP reached a trough in 1981 and rose continuously until 1998. After running a modest surplus from 1998 through 2001, the federal government ran a deficit even as GDP grew from 2001 until 2008. In response to the Financial Crisis the budget deficit soared to 9.8% and 8.6% in 2009 and 2010.
However, during the longest business expansion in U.S. history from June 2009 until February 2020, the annual deficit averaged -4.35% without including 2010, and -3.95% in the first 3 years of President Trump’s tenure.
One would have expected GDP to be stronger after federal debt as a percent of GDP soared from 31% in 1981 to 125% in 2020. Instead, lower interest rates and more government spending didn’t stem the slowing trend in GDP growth, especially since 1990.
Less GDP from Each New Dollar of Debt
Total U.S. non-financial debt includes Household and non-financial debt in addition to federal debt. Since 1981 the ratio of Total non-financial debt has increased from 140% of GDP to 300%, with the government representing more than half of the total. In the 1960’s when debt as a percent to GDP was less than 140%, each $1 increase in debt increased GDP by roughly $0.80. In the 1990’s total debt as a percent of GDP was stable at 180%, but GDP only increased by about $0.60.
After the Financial Crisis consumer debt and corporate debt actually declined, even as Federal government debt kept climbing.
From June 2009 through February 2020, the U.S. enjoyed the longest business expansion in U.S. history, but GDP growth per $1.00 of new debt slipped to $0.50. GDP was $21.5 trillion at the end of 2020 and is projected to grow about 6% in 2021, which would amount to an increase of $1.30 trillion of GDP. The Federal budget deficit will exceed $3 trillion in 2021, household debt is likely to increase by $400 billion, and corporations could add $600 billion in debt. GDP would therefore increase by $0.33 for each new dollar of debt in 2021. In 2022 federal debt is unlikely to increase by $3 trillion, so the ratio of debt to debt growth will rise from $0.33 in 2021 in 2022.
More debt hasn’t delivered more GDP growth.
Congress passed a $1.9 trillion stimulus bill in March on top of the $2.1 trillion CARES Act in March 2020 and the $900 billion package in December of 2020. The boost from this spending lifted first quarter GDP by 6.4%, and GDP could exceed 10% in the second quarter, before GDP growth slows materially in coming quarters. In April President Biden proposed spending another $2 Trillion on infrastructure in his American Jobs Plan (AJP) bill. If some form of this spending initiative is passed by Congress the slowdown in 2022 may be less dramatic.
Goldman Sachs expects GDP to hit 10.5% in Q2 before plunging to 1.3% in Q4 of 2022.
Although the AJP is being marketed as an infrastructure program only about 36% of the spending is actually directed at improving bridges, roads, and public transit systems ($621 billion), with another $100 billion to provide broadband internet access to every American. Even if the bill manages to fly through Congress, it will take many months (years?), before each infrastructure project receives the environmental approval needed to proceed.
Based on the multi-decade downtrend in GDP growth, no matter how much money the Federal government spends in the American Jobs Plan the multi-decade decline in GDP growth for each new dollar of debt will not be reversed. The current tsunami in government spending won’t lift productivity either.
Good Intentions
After meeting with governors in December 2008 and attempting to boost support for a large spending bill, President elect Obama stated:
“‘All of them have projects that are shovel ready, that are going to require us to get the money out the door. I think we can get a lot of work done fast.”
Congress passed the ‘American Reinvestment and Recovery Act and President Obama signed it into law on February 17, 2009. Of the $787 billion of spending in the bill, only $98.3 billion was dedicated to transportation and infrastructure.
On March 3, 2009 President Obama praised Vice President Joe Biden, governors, and mayors for their quick response to the passage of the American Reinvestment and Recovery Act.:
“Because of Joe, and because of all the governors and mayors, county and city officials who are helping implement this plan, I can say that 14 days after I signed our Recovery Act into law, we are seeing shovels hit the ground.”
As President Obama was later forced to acknowledge in a New York Times interview in 2010:
“The problem is that spending it out takes a long time, because there’s really nothing – there’s no such thing as shovel-ready projects.”
According to an analysis by the New York Times in 2017, of the $98.3 billion dedicated to infrastructure, only $27.5 billion was actually spent on transportation and infrastructure projects.
Bridging Government Regulation Can Be Tough, Even for the Government
The National Environmental Policy Act (NEPA) was signed into law on January 1, 1970, and requires federal agencies to assess the environmental effects of their proposed actions prior to making decisions. The National Environmental Policy Act (NEPA) gives the Federal government oversight on permit applications, construction of highways, bridges, and other publicly owned facilities, and over federal land management. One reason there were no shovel ready projects was because of the regulations imposed by NEPA. The following is an excerpt from a March 8, 2018 article entitled ‘Removing the Roadblocks” in the Washington Times:
‘One of the key reasons President Obama’s vaunted nearly trillion dollar stimulus plan was a bust was thanks to NEPA; shovel ready jobs were nowhere to be found. A 2016 report from the National Association of Environmental Professionals found a bevy of cost overruns, project delays and bureaucratic reviews that were caused by NEPA’s regulatory regime. The report found that, on average, the permitting process – governed by laws such as NEPA – delayed most major public projects by more than five years, costing the nation $3.7 trillion. This includes the costs of prolonged inefficiencies and unnecessary pollution caused by delay. Tellingly, this $3.7 trillion overregulation price tag is more than double the $1.7 trillion needed to modernize America’s infrastructure through the end of the decade.’
‘Take the Bayonne Bridge – which connects Bayonne, New Jersey with Staten Island, New York. Because it required an increase in span elevation to allow for the clearance of larger ships under the bridge, the permitting for this project was a five-year process, including a 10,000-page environmental assessment required by NEPA with another 10,000 pages of required permitting and other materials required by state and local authorities. The expansion of the Port of Savannah has been stalled for almost 30 years. The environmental review of the project took 14 years alone. Per the Heritage Foundation, the average time to complete an environmental impact statement increased from 2.2 years in the 1970s to 8.1 years in 2011.”
Economic Enervation
The Total number of pages in the Federal Register increased significantly over time from a few hundred in the 1902 to 87,012 in 2020. On the surface it would be easy to view the increase as a big negative for economic growth as costs rose for businesses and consumers. In the 1970’s environmental regulation led to cleaner air and water and safer working conditions, was beneficial for all Americans, and led to lower costs for health care. President Obama learned that Mae West was wrong when she quipped that ‘Too much of a good thing is wonderful.’ The balance between smart regulation and regulation that ignores the unintended consequences of too much regulation is difficult to achieve but important.
In 1835 Alexis de Tocqueville warned that the real threat to American democracy wasn’t forceful tyranny, but a new kind of challenge:
“Society will develop a new kind of servitude which covers the surface of society with a network of complicated rules, through which the most original minds and the most energetic characters cannot penetrate. It does not tyrannize but it compresses, enervates, extinguishes, and stupefies a people, till the nation is reduced to nothing better than a flock of timid and industrious animals, of which the government is the shepherd.”
Enervates means to weaken or destroy the strength and vitality of something. The cumulative impact of a network of complicated rules over time certainly has the potential to weigh on economic growth and sap its vitality.
Over time the massive increase in government regulation at the federal, state, and local government levels has weighed on economic growth modestly, even as most of the regulation did some good. If the past is prologue, the expected boost to GDP and job growth from the American Jobs Plan is not likely to meet the Biden Administration forecasts in 2023 and beyond.
GDP Growth Determinants
Lower interest rates and more federal government debt since 1981 failed to generate stronger GDP growth since the 1950’s, and especially since 1990.
This is counterintuitive as lower rates and more government spending should have generated more demand and higher GDP growth. Why didn’t they? The larger forces of productivity and labor market growth have overwhelmed monetary and fiscal policy, and are set to continue to weigh on growth at least for the next decade.
The main contributor in the decline in GDP growth since 1950 has been the decline in the working age population. After peaking in the 1970’s as Baby Boomers entered the labor force en masse (last previous chart), labor market growth has fallen from 2.5% annually to just 0.5% in 2020. Since 1990 labor force growth has slowed from 1.2% to 0.5% or by -58%. On April 26, 2021 the Census Bureau reported that the U.S. population grew 7.4% in the decade from 2010, a decline of -23.7% from the 9.7% growth rate from 2000 – 2010.
The rate of growth in population is now the lowest since the 7.3% increase in the 1930’s. The Great Depression consumed most of the 1930’s so it is easy to see why parents decided to have fewer children, and they didn’t have the availability of birth control. In contrast, the period from 2010 into 2020 experienced the longest economic expansion in U.S. history.
With population growth so low in the past decade the U.S. economy is sentenced to have weak labor market growth for at least the next 15 to 20 years. The Congressional Budget Office recognizes this fact which is why they have projected the labor market to growth by just 0.3% in the next 20 years. This is one reason why the CBO has projected GDP to grow less than 2.0% for the next 30 years and average a meager 1.63% annual pace.
The other primary determinant of long term GDP growth is productivity but it too has trended lower after the post World War II period between 1950 and 1973 when it grew at an annual rate of 2.4%. (Chart bottom of page 8.) After productivity dipped in the 1970’s as inflation soared (0.7%), there was a nice rebound in productivity from 1981 into 1990 as interest rate declined and business investment improved (1.6%). This was followed by further improvement due to the introduction of the internet (2.0%), before another decline to 1.2% took hold.
A clearer view of how productivity changes over time is to use a 5-year moving average, which does a better job a catching the cyclical swings. During the 1980’s the 5-year average of productivity fluctuated between 1.2% and 2.0%. The advent of the internet and large increase in technology capital spending ignited a mini boom and the 5-year average of productivity jumped to 2.5% in 2004. Since that peak productivity has trended lower with the 5-year average falling to 1.2% in 2019 before the Pandemic.
The increase in productivity from 1995 and 2004 is correlated with an increase in business investment for equipment and Intellectual Property (IP) relative to its trend from 1979 through 2006. After the financial crisis business investment has trended sharply lower as has the 5 year average in productivity.
Business Investment, Where Are Thou?
One way to evaluate the priorities of any company is to look at how the company spends its cash flow. In 1990 S&P 500 companies have lowered the ratio of capital expenditure spending on plant and equipment (Capex – ) from 80% of their cash flow to 40% (dark blue).
During that same period companies have kept the amount of cash flow to pay out dividends relatively constant (powder blue).
In the mid 1990’s stock buybacks represented a small percentage of cash flow. That changed materially in 2004 as companies significantly ramped up their buybacks from a quarterly average of $150 billion in 2003 to more than $650 billion in 2007. It may be just a coincidence but the sharp increase in stock buybacks that began in 2004 coincided with the peak in the 5-year average of productivity growth in 2004. After curtailing buybacks in response to the financial crisis and deep recession, companies steadily increased buybacks from the quarterly trough in 2009 of $150 billion to another quarterly high near $650 billion in 2016.
President Trump’s Tax Cuts and Jobs Act of 2017 lowered the corporate tax rate from as high as 35% to a flat rate of 21% and offered a lower tax rate on profits earned overseas that were brought back to the U.S. The selling point for the tax cut was to make U.S. firms more competitive internationally and to encourage an increase in business investment. The Trump Administration said that repatriated profits couldn’t be used for stock buybacks.
As I discussed in the December 2016 Macro Tides, I was skeptical that repatriated profits wouldn’t be used for buybacks based on how the Homeland Investment Act of 2004 failed to increase business investment.
“In 2004 the “Homeland Investment Act” was passed which allowed multinational firms to bring overseas profits back home and pay a tax rate of 5.25%, rather than the normal 35% corporate tax rate. It was ‘sold’ as a way to spur investment in new plants, research and development, and new jobs. A 2010 study by academics at Harvard University, the University of Chicago, and the Massachusetts Institute of Technology estimated that for every $1.00 that was repatriated, stock buy backs increased by $0.79. I have no doubt that Trump’s proposed repatriation program will be trumpeted as a way to increase business investment, research and development, and job creation. While these goals are worthwhile, the result from the Homeland Investment Act suggests we shouldn’t believe the marketing of Trump’s program. Money is fungible and corporations are likely to circumvent whatever restrictions that are put into place, just as they did after bringing $300 billion in overseas profits home in 2005.”
Stock buybacks dropped to $475 billion in 2017 before the Tax Cuts and Jobs Act of 2017 was passed and then soared to $875 billion in 2018. There was no real increase in business investment as a percent of cash flow.
It would have been far better had the Tax Cuts and Jobs Act of 2017 stipulated that companies would only qualify for the tax cut if they first gave their hourly employees a 3% pay increase as well as salaried workers earning under a specific threshold i.e. $90,000. Some firms paid employees one-time bonus checks which garnered attention but didn’t increase wages, which would have led to more spending than a one-time check. Shifting the increased cash flow corporations received from lower taxes directly to employees would have strengthened the economy far more than buying back stock which doesn’t.
The propensity of companies to buy back their stock was enabled by the Federal Reserve’s policy of keeping real interest rates below 0% after the financial crisis and their QE programs.
According to JP Morgan Chase in 2016 and 2017 the proportion of buybacks that were funded by corporations taking on more debt rose to 30%, and held at 30% in 2018, according to the International Monetary Fund’s (IMF) Global Financial Stability Report.
The IMF also found that the 465 companies that were in the S&P 500 from 2009 through 2018 spent $4.3 trillion on buybacks amounting to 52% of net income.
Dividends represented 39% of income and totaled $3.3 trillion.
In 2018 companies in the S&P 500 spent 68% of net income on buybacks and 41% on dividends. The difference between the 109% of income spent on buybacks and dividends was funded with debt.
Obsession with Maximizing Shareholder Value
The emphasis on maximizing shareholder wealth that took hold in the 1980’s has reached an extreme, based on the most recent data available from 2016. Given the increase in stock prices and home prices since 2016 the percentages shown in the table would show even more concentration of income and wealth in the top 10% and everyone else.
Since 1989 the share of income going to the Top 10% of earners increased by 19% (42% to 50%), while dropping for everyone else through 2016. The ratio of income received by the Top 10% to the bottom 90% is 1 to 1. In 2016 the Top 10% held 77% of all the wealth in the U.S., 3.3 times the amount of wealth owned by the bottom 90%. (77% / 23%)
In 2020 the CEO’s at the 350 largest companies in the U.S. were paid a median of $13.7 million, according to an analysis by the Wall Street Journal. Less than 10% of the compensation was salary, which is consistent with analysis by the Economic Policy Institute (EPI) of CEO earnings in 2017 that found 74% of CEO compensation came from stock options. The balance of their earnings came from Non Equity incentives.
In the last decade CEO’s have allocated a significant portion of their firm’s cash flow to buy their company’s stock and increase the value of their personal stock options. In some years firms borrowed 30% of the money used to buy stock because the Federal Reserve’s monetary policy made it possible. The decision to buy stock rather than increase business investment has resulted in less productivity and slower GDP growth. There is something wrong with this picture.
Business Roundtable’s Changing Mission
This description is from the Business Roundtable’s website:
“Business Roundtable exclusively represents chief executive officers (CEOs) of America’s leading companies (181 firms). These CEO members lead companies with 20 million employees and more than $9 trillion in annual revenues.”
The Business Roundtable’s Mission statement has changed over years. In 1981 it was:
“Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy. The long term viability of the corporation depends upon its responsibility to the society of which it is a part. And the well being of society depends upon profitable and responsible business enterprises.”
Milton Friedman believed that businesses had only one focus:
“There is one and only one social responsibility of business, which is to engage in activities designed to increase its profits.”
In 1997 the Business Roundtable changed its Mission Statement so it aligned more closely to Milton Friedman’s view:
“The paramount duty of management and of boards of directors is to the corporation’s stockholders. The interests of other stakeholders are relevant as a derivative of the duty to stockholders.”
In other words the other stakeholders – customers, employees, suppliers, and communities – were secondary to the mission of enriching stockholders. This philosophy found its expression in corporations justifying the use of cash flow to buy back stock or pay dividends, even if it meant borrowing money.
In August 2019 the Business Roundtable changed its Mission Statement again and the new statement is closer to the 1981 version at least in spirit:
- “Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.
- Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
- Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.
- Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
- Generating long-term value for shareholders, who provide the capital which allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.
Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.”
It was a nice touch that the revised Mission Statement put shareholders last. It would be better if the Business Roundtable had provided specifics on how corporations can elevate the other stakeholders to an equal status with shareholders. Without action the new Mission Statement is just words.
If a company fails to deliver value to its customers it won’t flourish and may not be around for long.
If a company fails to pay it bills, its suppliers won’t ship more products.
The commitment to customers and suppliers is somewhat empty. If a company truly wants to create success for its employees, communities, and the country, it should pay its employees more. Since 1993 profit margins for the average company in the S&P 500 has grown from 4% to more than 10%. Stock buybacks have surely played a role in lifting margins, as in 2018 and 2005, when buybacks soared after the 2017 and 2004 tax cut.
The election in 2020 resulted in a political shift that the Business Roundtable would be wise to recognize and get out in front of the coming backlash directed toward corporations. The effort to increase corporate tax rates may be just the beginning of pressuring corporations to change on a number of fronts. It would be smart for the Business Roundtable to advocate for corporations to pay their employees more out of profit margins that have doubled since 1993, than merely altering its Mission Statement. If corporations don’t voluntarily change the amount and how their executives are paid, it may be done for them in the next 4 years in ways that will prove less palatable.
Core Inflation Set to Surge
Federal Reserve Chair Powell says headline inflation will be transitory, as he repeated on April 28:
“Inflation has risen, largely reflecting transitory factors. We know that the base effects will disappear in a few months. We think of them as not calling for a change in monetary policy, since they’re temporary and expected to resolve themselves.”
Chair Powell is right. Some of the coming surge in inflation will fade as base effects contribute less to headline inflation after June. Investors want to believe the FOMC’s inflation assessment will be correct so monetary policy can remain full throttle easy. There are two hurdles that may challenge investor’s inflation complacency.
The increase in headline CPI inflation will exceed 3.0% and could approach 3.5% in the next few months and generate attention grabbing headlines. Investor’s confidence in the FOMC’s sanguine outlook may be shaken, especially if oil and gas prices continue to climb as the U.S. and global economy gets back to business. From 2013 through 2018 Goods inflation was negative, offsetting the rise in service inflation. With raw material prices soaring Goods inflation is the highest since 2012 and is likely to rise further.
During the Pandemic consumer spending on appliances, furniture, new and used cars soared as people moved out of cities and into larger living quarters. Spending on these big ticket items continued in the first quarter as consumer spending on goods rose by a whopping 8.1%. The surge in demand has given many companies the power to increase their prices and not fear a loss of market share. When Goods inflation was negative companies had no pricing power which meant no pricing power.
The percent of companies mentioning inflation has exploded relative to the period when Goods inflation was negative and far more than in 2010 – 2011. Since 2004 an increase in company’s mentioning inflation has been a leading indicator of a future increase in the Consumer Price Index (CPI). The number of mentions has historically led the CPI by a quarter with a 52% correlation. The big increase in mentions suggests the coming rise in the CPI is likely to be stronger and more lasting than at any time since 2004. The wave of prices increases has already begun.
Kimberly-Clark, the maker of Huggies diapers and Scott paper products, said it will start raising prices on much of its North America consumer products to help defray higher raw-material costs. Cheerios maker General Mills, Skippy peanut-butter maker Hormel Foods Corp. and petsnacks maker J.M. Smucker Co. have indicated similar plans.
Two big U.S. manufacturers of heating and cooling equipment have announced price increases. Lennox International Inc. said this week it would raise prices by about 6% to 9% on heating and cooling equipment starting June 1 for commercial and residential orders. Trane Technologies PLC recently increased prices by up to 7.5% on some products in its commercial HVAC business. In early March, Trane boosted prices on some residential equipment by up to 6%.
A bigger threat to the FOMC’s mantra that the pick-up in inflation will be transitory may come from a steady but persistent increase in core inflation. While Goods inflation was negative between 2012 and early 2020, Core Service inflation fluctuated between 2.5% and 3.0%.
When the Pandemic hit, Goods inflation rose but service inflation plunged as lockdowns impacted travel, attendance at sporting events and movie theatres, eating in a restaurants and any activity that brought people into close proximity. For the first time since the Pandemic began Service inflation rose in March and will continue to rise in coming months.
In the December Macro Tides I discussed the outlook for Core CPI inflation and the role Owners’ Equivalent Rent plays:
“One has to look at the composition of the CPI to better understand why the CPI and Core CPI are likely to remain tame in coming months. Housing represents 42.1% of the CPI and the decline in apartment rents in major cities has weighed on the CPI. The downward pull from OER in the CPI will keep the Core CPI from rising and may cause it to fall in coming months. In order to calculate the costs associated with Housing (Shelter), the Labor Department uses owners’ equivalent rent (OER) of primary residences. Most households in the United States own the home in which they live so OER represents the rent that homeowners implicitly pay to themselves. The downward pull from OER in the CPI will keep the Core CPI from rising and may cause it to fall in coming months.”
The Core CPI was 1.6% in October and 1.6% in March of 2021, so it hasn’t gone up in the last six months. That’s about to change.
According to Realtor.com median asking rent rose 1.1% in March from March of 2020, the first uptick since a modest increase last June. San Francisco experienced one of the largest declines in rent during the Pandemic as renters moved out in droves, but rents were up 3.4% in March from February, according to Apartment List. The increase in rents will begin to lift Owners’ Equivalent Rent (OER) back to the level that prevailed prior to the Pandemic.
The OER rose by more than 3% annually from June 2015 until it fell to 2.8% in June 2020. In March 2021 OER was 2.0%, but will rise as the rising rents bleed into the monthly calculation. OER comprises 24.1% of the CPI and Rents add another 7.9%, so the change in trend for rents will boost Core CPI in coming months.
FOMC’s Credibility Will Tested
The FOMC is about to be tested. Headline CPI inflation could jump more than expected (i.e. 3.5% or more) before easing as base effects recede, only to be offset by a steady and persistent increase in Core CPI inflation. By pledging the FOMC will not lower their monthly QE purchases or increase the federal funds rate no matter how high inflation flies or GDP soars, the FOMC has drawn a line in the sand at the worst possible time. In the next few months many factors are going to combine to make it look like a serious bout of inflation is beginning.
If monthly job growth averages 1.0 million or so in coming months and inflation jumps as much as expected, the FOMC may be forced to consider tapering its monthly QE purchases at the July 28 meeting, and if not at the July 28 meeting then certainly at the September 22 meeting. Prior to these meetings a number of FOMC governors will provide hints as to which meeting the discussion will occur. The minutes of a meeting are released 3 weeks later so confirmation of the debate within the FOMC will then become known.
Investors want to believe that Chair Powell and the members of the FOMC will prove correct that the coming wave of inflation will be transitory. A basic understanding of how base effects will shape the data in the next three months makes it easier to embrace this outlook. However, the current surge in prices is stronger than at any time in more than a decade. Companies have the need and opportunity to raise prices into the post Pandemic demand funded by government stimulus and they will.
Service inflation is set to return to its pre Pandemic level of more than 3.0% as consumers use an enormous pool of savings to fund everything they haven’t been able to do for more than a year. As service inflation climbs and goods inflation doesn’t drop below 0%, as was the case prior to the Pandemic, headline and core inflation rates are likely to reach uncomfortable levels for a FOMC that will continue to insist this bout of inflation is transitory.
This scenario could increase concerns that the FOMC may be forced to move more aggressively through balance sheet tapering and earlier rate hikes in 2022 as it tries to play catch up. Financial markets are facing headwinds in the second half of 2021, even before the prospect of higher corporate and personal taxes are factored into the picture.
Related Links
US Budget Deficit by Year Compared to GDP, Debt Increase, and Events
Federal Debt: Total Public Debt (GFDEBTN)
U.S. corporate debt soars to record $10.5 trillion
Obama jokes about ‘shovel-ready projects’
Press Release – President Obama’s Not-So-Shovel-Ready Jobs
The Obama Legacy: America’s Crumbling Infrastructure
The Stimulus Plan: How to Spend $787 Billion
What is the National Environmental Policy Act?
Why Stock Buybacks Are Dangerous for the Economy
Global Financial Stability Report: Lower for Longer, October 2019
CEO pay at S&P 1500 companies: 2020
One Year Later: Purpose of a Corporation
THE PURPOSE DEBATE Back to the ’80s: Business Roundtable’s “Purpose” Statement Redux
Ratio between CEO and average worker pay in 2018, by country
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