LEIPline Newsletter - June 2015 The Jacksonville Economy in the First Quarter of 2015

Introduction

This is the thirty-fourth installment of the LEIPLINE.  Our primary focus here as in the past is the four variables for which we collect data and the implications of those data for the Jacksonville MSA overall.  We begin this installment, like the others, with a brief discussion of the national macro economy.  The first quarter of 2015 was quite disappointing, particularly after the fourth quarter came in below expectations following very strong second and third quarters.  The first and second estimates of real GDP growth suggest very weak conditions.  Inflation continues to persist at below historical averages despite improving U.S. growth, but there is some sign that inflation will accelerate later this year, reflected most substantially in improving housing markets and particularly due to increases in car and truck prices (both new and used).  The rest of the world is still contemplating or implementing expansionary monetary policy tools because of barely growing or falling real GDP, but the U.S. economy needs to continue to expand more rapidly both for our benefit and for the prospects for the rest of the world.

 

In this edition of the LEIPLINE, we report our eighth formal numerical forecasts of the data we collect, for the three months of the second quarter of 2015, plus August 2015.  


The National Macro Economy

The first quarter real GDP estimates unfortunately reinforced the fourth quarter weakness, and then some. While the first estimate was 0.2 percent growth, the revised data released on May 29th suggested that the movement was actually substantially negative at 0.7%. More specifically, growth in the first quarter was bolstered by personal consumption expenditures which rose 1.8% and by residential investment that grew by 5%, but fixed investment in structures fell 20.8% and exports of goods fell 14% (all on an annualized basis).  Imports reflect a negative influence on real GDP growth and in particular, imports of services were substantially higher at 7.6% growth. State and local government spending fell 1.8% during the quarter.

 

The May 29th release from the BEA indicated that “The GDP estimate released today is based on more complete source data than were available for the "advance" estimate issued last month.  In the advance estimate, real GDP increased 0.2 percent.  With the second estimate for the first quarter, imports increased more and private inventory investment increased less than previously estimated (…).   The decrease in real GDP in the first quarter primarily reflected negative contributions from exports, nonresidential fixed investment, and state and local government spending that were partly offset by positive contributions from personal consumption expenditures (PCE), private inventory investment, and residential fixed investment.  Imports, which are a subtraction in the calculation of GDP, increased.” http://bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

It has now been what has to be considered a consistent pattern that first quarter growth is generally weak by comparison to the rest of the year.  Although a couple of second quarters have been weaker than their corresponding first quarters, one must go back to 2006 to find a first quarter growth rate above 3.0% (that quarter at 4.9%) and after the update for 2015.1, there have now been three out of the last four first quarters that have been negative.  Each of the last two can legitimately partially be blamed on weather, but the reality within the numbers is that weak investment, particularly in durables and non-residential structures is most to blame.  It is an Austrian Economics perspective that recommends increased savings generating increased investment that drives long run growth.  Neither of these two drivers occurred in the first quarters of the recent past.  In addition, the relative weakness of particularly portions of the European Union is hurting U.S. exports while U.S. citizens are expending their dollars on cheap foreign goods in greater magnitudes.

 

First quarter inflation was negative overall due to a very large drop of 0.7 in January.  This change was driven by lower oil and gasoline prices which moderated some in February and March.  Whereas oil prices as of this writing are hovering below $58 per barrel, a year ago they were right at $100 per barrel and still moving upward for another three months.  Pundits can argue that oil is not as important to the U.S. economy as it once was, but the correlation between oil price inflation and aggregate inflation is still very strong.   There are, however, some signals of escalating inflation since January in the traditional areas where it tends to arise.  Gasoline prices are rising slightly at present, but more revealing are increases in prices for consumer durables like new and used cars and trucks and appliances.  Housing is the largest component of the CPI at between forty and fifty percent of the weighted average and these prices have risen particularly in March and April as interest rates have remained at very low levels.  Despite this evidence, overall the inflation rate for the last twelve months has actually fallen by 0.2%. This peculiarity is very strongly influenced by the huge decline in January 2015.

 

The unemployment rates for the first quarter and April continued its downward trend that has taken it to 5.4% as of April.  The April rate was eight tenths lower than the 6.2% unemployment rate in April 2014.  The implications of the most recent data are that 8.5 million people remain unemployed, 2.5 million who have been unemployed for 27 weeks or longer or 29% of those who are unemployed.  The civilian labor force participation rate remained very low compared to the last forty years at 62.8%, reflecting departures from the labor force and particularly unfortunately, very slow assimilation of new entrants recently graduated from high school and college.  The largest component of the reported unemployment rates, U-6, is still 10.8% reflecting those marginally connected to the labor force plus those working part time that would prefer to work full time.  As we indicated for each of the last two quarters, the biggest drag on our economy’s growth right now is underemployment driven by baby boomers who cannot acquire suitable employment, young people who are having trouble breaking into the labor market due to the elimination of many entry level programs, and those boomers who cannot retire (who are thus, standing in the way of the young people) because interest rates are so low that the earnings on their retirement income are insufficient to allow them to depart.  Despite these concerns, the trend in unemployment is definitively in the right direction.  The announced rate of 5.4% has suggested to some that we are approaching the NAIRU (non-accelerating inflation rate of unemployment) which some argue is full employment while others do not.  We are of the mind that the NAIRU is still below where we are based on the empirical evidence that inflation is not yet accelerating, and that level is much lower than previous estimates (6% - 6.5% unemployment) due to the declining labor force participation rate distorting the supply of labor that would otherwise raise wage demands.  In effect, the large numbers of discouraged workers plus the structural shift in the age of our population towards older workers has diminished the upward pressure on wages.  The “Great Recession” also contributed extensively to these circumstances as the economy shifted from one of labor shortages due to declining populations coupled with increased demand for college graduates, to one where there is a surplus of college educated individuals and a lack of hiring motivations for corporations.

 

The last two quarters we told you that the average yield on three year treasury bonds (an intermediate term, virtually riskless asset) for the period identified as the “Great Moderation,” i.e. 1986-2005 was 5.69%.  This period was after the intervention of Paul Volker as Chairman of the Federal Reserve Board of Governors, but reflective of the time frame when inflation rates moderated and growth was relatively strong.  The October three year rate was 0.97% and it had not been above even 1% since April of 2011.  Fast forward to May 22, 2015 and the same rate was 0.98%.  Interest rates still remain very low for shorter term securities, but 30 year Treasury securities have seen their yields rise by 27 basis points so far this year, steepening the yield curve.  Many now believe that the FED will begin raising short term rates in September, reducing the steepness of the yield curve but also raising long term rates at the same time.  We presumed in the last LEIPLINE that since financial markets often precede FED policy shifts, the process of increasing interest rate may have begun in February, but unfortunately they still have not risen for short term assets.


What Does It All Mean?

We cannot evaluate the current macroeconomic conditions without reflecting back on an impactful article from 2012 from the Journal of Economic Perspectives (Reinhart, Carmen M., Vincent R. Reinhart, and Kenneth S. Rogoff. 2012. "Public Debt Overhangs: Advanced-Economy Episodes since 1800," 26(3): 69-86). The authors point out employing data for 22 countries over 110 years that those countries without large public debt over-hang relative to one year’s GDP tended to grow by 3.5% per year on average, but those with federal debt of 90%-120% grew by only 2.3% per year on average and those with debt of over 120% grew by only 1.2% per year.  The U.S. economy has federal debt currently between 105% and 106% of one year’s GDP.  If these authors’ study is predictive, it is not surprising that our growth is slower than desirable.  Consistent with massive debt but without wage pressures due to labor force indifference is low inflation and low interest rates.  However, we continue to believe that the culprit in this malaise is the Federal Reserve’s Monetary Policy that seems stuck in the 1942-51 time frames with its fundamental goal of maintaining low borrowing costs for government.  Higher interest rates will not crowd out private investment in the current climate because there is such a massive glut of loanable funds worldwide.  But what higher interest rates will do is increase the short and long run costs of federal government excesses which should motivate our political leaders to reduce their spending and permit the private sector to grow again. 

The Local Data

Since many of the data change for at least one month after we first report them, we have decided to wait until at least the middle of the following quarter to report each quarter’s implications.  Since the local CPI is the most significant variable that we analyze, we will start with it.

The 2015.1 Jacksonville CPI

The LEIP CPI began 2015 the way it has most of the last five years, annualized inflation rates significantly higher than what they eventually become later in the year.  The annual average inflation rate projected for 2015 from January through April was nearly 3%.  All four months this year have suggested positive inflation and three of the four months over 3% annualized.  As mentioned above, this includes January which was substantially negative at the national level.  The automobile industry has been a positive driver throughout 2015 with all but one of the first four months in 2015 also positive relative to housing.  Foods prices have been muted but apparel prices, like usual, have been the most volatile. 

 

Below is a chart that reveals the actual (annualized) inflation rates for the quarters of 2014 (plus January through April, 2015), with our forecasts through August 2015 reported in bolded red. The procedure employed to produce these forecasts is called vector auto regression or VAR.  It employs two periods of lags of past values of the variable being forecasted to estimate the future values. We attempted to employ what are called “black swans” related to oil prices and national retail sales in our modelling this quarter, but without much impact.  The forecasts for the second quarter of the year and August suggest inflation more than twice the average for the first quarter, or about 2%.  This is more statistically revealing support for our expectation of accelerating inflation later this year than the theoretical expectations from above.  

 

Year Month Actual Inflation
Monthly in Percent
Forecast Inflation
Monthly in Percent
2014 1 -3.33 2.61 
2014 2 3.81 2.31
2014 3 2.35 3.38
2014 4 3.86 3.03 
2014 5 1.42 2.49
2014 6 -3.54 3.41
2014 7 1.33 3.36
2014 8 -0.74 3.04
2014 9 -3.16 3.21
2014 10 1.66 2.66
2014 11 -2.56 5.39
2014 12 0.7 2.39
2015 1 3.23 1.23
2015 2 0.93 0.8
2015 3 2.69 0.84
2015 4 3.21 1.7
2015 5   1.86
2015 6   1.64
2015 7   2.19
2015 8   2.20 

Unemployment

 

The Jacksonville unemployment rate has bounced around the national average so far this year, but as of April it has fallen below the national rate again.   We are still optimistic that unemployment will fall below 5% by the middle of the year.   Like the national outcomes, part of the movement is positive associated with increased employment opportunities locally.   However, the discouraged worker issue and the numbers of individuals leaving the work force is evident locally too.   Through the first four months of the year the local workforce fell each month, while generally, the numbers of workers employed rose and those unemployed fell.

 

 

In the chart below, our forecasts for the seasonally adjusted unemployment rates are once again statistically superior to those for inflation, but are still biased towards a more optimistic view relative to the first quarter.  We forecasted more unemployment in April than arose but our estimates suggest substantial reductions in unemployment through August. If our estimates are correct, the local MSA unemployment rate is headed towards below 5% by July. With April better than forecasted, we perceive continued good news on the unemployment front.  

 

Year Month Actual Unemployment
Rate Monthly
in Percent
Forecast Unemployment
Rate Monthly
in Percent
2014 1 5.78 5.75
2014 2 6.16 5.94
2014 3 6.33 5.8
2014 4 5.8 5.7
2014 5 6.11 5.66
2014 6 5.75 5.62
2014 7 6.26 5.62
2014 8 6.54 5.4
2014 9 5.79 5.26
2014 10 5.79 5.73
2014 11 5.47 5.31
2014 12 5.38 5.21
2015 1 5.50 5.08
2015 2 5.56 5.4
2015 3 5.62 5.26
2015 4 5.30 5.73
2015 5   5.22
2015 6   5.04
2015 7   4.84
2015 8   4.64

Leading Economic Indicator

Despite a hiccup in February, the LEI has been up all year and six of the last eight months.  The local LEI is still not advancing as much as at the national level but is up almost two points since December. Building permits have been pretty stagnant in recent months except for in March, but they are considerable better than one year ago.  Help wanted advertisements is consistently above 2,500 per month as consumer confidence has mostly risen along with vendor deliveries and purchases of consumer goods.  Local stock prices are still way below the DOW in both categories, but initial claims for unemployment insurance are also down, despite still averaging between 3,000 and 3,500 per month.


The chart below reveals our forecasts for the leading indicator.  Our forecasts for the LEI for the second quarter and August are roundly positive, with each month an improvement on the previous.  We over estimated what the LEI would achieve in 2014, but we are honing our skills and we did much better in the first quarter of 2015 than ever before. This summer looks very good for the Jacksonville MSA and so too does the fall given the forecasting capabilities of the LEI.

 

 

Year Month Actual LEI Monthly
(2001.12=100)
Forecasted LEI Monthly
( 2001.12=100)
2014 1 114.6 113.58  
2014  2 116.57 114.95
2014  3 116.28 114.91
2014  4 116.27 114.81
2014  5 116.53 115.25
2014  6 115.76 115.29  
2014  7 115.68 115.37
2014  8 115.31 116.56
2014  9 116.34 116.83
2014  10 116.59 117.02
2014  11 117.29 116.66
2014  12 116.63 117.17
2015 1 118.2600287 117.36
2015  2 118.1496092 117.69
2015  3 118.3448542 118.20
2015  4 118.601452 118.59
2015  5   119.209
2015  6   119.4586
2015  7   119.8382
2015  8   120.1136

Stock Price Index

 

After three of the four months thus far this year generated performances below the DOW, we are forecasting better growth in the next four months.  Because our local companies are generally smaller than those in the DOW, it perhaps is not surprising that in a climate whereby bigger is viewed to be better, local stocks are being outperformed.

 

The final chart below presents the forecasts for the stock price index through the end of the second quarter of 2015, plus August. Let’s hope that we are right about the forecasts for local stocks for the benefits of those companies, their stockholders, and the local economy. 

 

Year Month Actual Stock Price Index Monthly
no change = 100
Forecasted Stock Price Index Monthly
no change = 100
2014 1 96.6 101.77
2014  2 102.3 102.8
2014  3 103.9 101.94
2014  4 98.7 100
2014  5 100.2 104.02
2014  6 101.7 102.11
2014  7 98.2 101.6
2014  8 91.1 101.17
2014  9 112.9 101.38
2014  10 101.8 101.78
2014  11 102.3 99.3
2014  12 101.3 102.9
2015 1 97.60 102.5
2015  2 101.97 100.2
2015  3 99.00 101.32
2015  4 98.90 100.94
2015  5   101.12
2015  6   100.86
2015  7   100.99
2015  8   101.00

The Bottom Line, Locally

The slightly rising oil and gasoline prices through the end of the first quarter of 2015 and into April have helped prices to rise in general.  Although we routinely prefer that inflation be low to moderate, given the stagnant growth phase that we are in, a little more inflation might be a coincident indicator that growth is also returning to normal.  It is time the FED and the fiscal side of government recognize that if they did anything to help recovery (which we doubt), that it is long past time to take a backseat to the private sector, and do so by reducing federal debt over-hang.  The FED in particular needs to return to the position that they should control inflation, and only that, so that the steps taken towards improving growth and/or government motivations fall away from their focus, so that the private sector can return to the normality we saw before the “Great Recession.”