Viewpoints

Was the recent rise in inflation caused by supply constraints or excess demand? The answer is vitally important for monetary policy. The Federal Reserve can’t do much about supply-chain issues, but it can influence the pace of demand. There is no question that supply chain issues are hampering firms’ ability to supply enough goods and services, which is driving up prices. But much of the supply issues in goods markets have occurred BECAUSE there is too much demand. The combination of expansionary monetary and fiscal policy during and after the lockdowns fueled demand beyond levels that firms could comfortably satisfy. So although there is ample evidence of supply constraints pushing up inflation, the actual root cause was too much demand – which is something the Fed can address.

A look at retail sales gives a clear picture of the excessive amount of spending that has occurred in 2021 and 2022 (Figure 1). Prior to the pandemic, consumer demand for goods was running at a pace that was close to its long-term trend. We can view this trend line as the steady state growth rate – the pace that spending can grow without generating supply-chain issues and ultimately inflation. In other words, the trend line in the chart represents the maximum amount of retail sales that will not generate demand-led inflation pressures.

The preliminary report on Q2 GDP does not confirm the US economy is in recession, but it does suggest that a corporate profit recession is underway.

Q2 Real GDP declined 0.9% annualized, following a 1.6% decline in Q1. Back=to-back quarterly declines in GDP are rare and usually occur when the economy is in recession. Yet, the drop in real GDP during the first half of 2022 is preliminary and not confirmed by the income side of the GDP accounts.

For example, Real Gross Domestic Income (GDI) expanded 1.8% in Q1, or 340 basis points faster than real GDP. That's a record gap. The long-run average is zero. In other words, Q1 had $677 billion more real GDI and $836 billion in nominal GDI than real and nominal GDP. That makes no sense. Q2 GDI data is unavailable, so it's unclear whether the income side confirms the second quarterly drop in real GDP.

Research has shown that the initial GDI reports are more accurate than GDP. Perhaps that is true because GDI has fewer data inputs. 80% of GDI comes from employee compensation and operating profits, whereas the GDP numbers include hundreds of series on sales, shipments, and inventories, many of which are revised a lot.

The Bureau of Economic Analysis plans to issue a report in September on the record gap between GDI and GDP.

The preliminary GDP report does not include an official figure on operating profits. But one can derive an estimate from the GDP data. Based on my calculation, Q2 operating profits will come in around $2,650 billion, off 6% from a year ago. That would be the second consecutive quarterly drop in operating profits, pushing the corporate earnings to their lowest level since Q1 2021.

Back-to-back declines in corporate profits are more common than back-to-back declines in GDP. In 2015, operating profits fell for four consecutive quarters, and the economy did not enter a recession.

Additional downward pressure on profits will probably come from further official rate hikes and slowing or declining economic growth. That might signal an economic recession down the road, but it would be wrong to conclude that the US is in recession today.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

The Federal Reserve Bank of Philadelphia's state coincident indexes in June continued to show some dispersion. Six states declined, while Massachusetts was up slightly more than 1 percent. At the 3-month horizon Montana and Arkansas saw drops, while 5 others (except for Hawaii, all in the middle part of the nation) had increases less than ½ of one percent, and 8 more had gains between ½ and one percent. Massachusetts, though, was up nearly 3 percent, and 5 other states clocked gains above 2 percent. Over the last 12 months, every state had gains of at least 3 percent, and 6 were up more than 10 percent, with West Virginia again number one, with a 13.5 percent increase.

Yet again, the independently estimated national figures of growth over the last 3 (.9 percent) and 12 (5.5 percent) months look substantively weaker than the state figures (in general, the weaker states were on the small side).

Michigan set a new monthly high in June, leaving Connecticut, Hawaii, and Louisiana as the only states that have not yet passed their pre-pandemic peaks in this series.

State labor market results in June were again somewhat mixed. 13 states had statistically significant increases in payrolls, but only 2 were striking in percentage terms (Montana's .9 percent and Tennessee's 1.0 percent). Texas's 82,500 gain was a smaller .6 percent. Two states (Alaska and West Virginia) had statistically significant declines. All states had at least point increases in payrolls over the last year, but the increases in Vermont, Ohio, Alabama, Louisiana, Wisconsin, and Kansas were less than 2 percent. On the other hand, California added more than 850,000 jobs (a 5.1 percent increase) and Texas nearly 780,000 (a 6.1 percent gain), while Nevada's increase was 6.6 percent.

Unemployment rates were little-changed. Missouri was the only state to see a .3 percentage point decline. Interstate variation in unemployment is now fairly narrow. Minnesota's 1.8 percent was the lowest in June, while no state was at or above 5 percent (DC, though, had a 5.5 percent rate).

Puerto Rico's improvement ebbed in June. Nonfarm payrolls fell, apparently reflecting a drop in government employment. The island's unemployment rate fell to 6.1 percent, but both the labor force and resident employment declined.

Before the academic arbiters debate whether the economy is in a recession, the Bureau of Economic Analysis (BEA) must first examine and hopefully find answers to the unprecedented and growing gap between income and output in the GDP accounts.

In Q1, Gross Nominal Income (GDI) exceeded Gross National Product (GDP) by a record $836 billion annualized. The gap widened by roughly $220 billion from the fourth quarter of 2021. That increase was sufficiently significant to produce two different outcomes--- GDI, adjusted for inflation, posted a small gain, while GDP, adjusted for inflation, recorded a decline.

In theory, the two series measure the same thing (the economy). But, in practice, there are substantial differences, but nothing on the scale of the past few years.

GDP measures the final output of goods and services, which involves many different series of sales, shipments (domestically and overseas), construction, inventories, and a wide range of private and public services. GDI measures the income associated with the output side, with employee compensation and operating profits accounting for 80% of the total and interest income and investment the remaining portion.

The income side of the accounts is not as timely as the product side. For example, BEA offers a preliminary estimate on the output side less than 30 days after a quarter ends. But, details on the income side are delayed 60 to 90 days due to companies reporting on operating profits.

Still, I have always felt that the income side is neater, as it has far fewer series and revisions than inputs in the output figures. And support for that view comes from a Fed staffer. He argued that GDI is probably a better indicator since his research found the initial estimates of GDI are much closer to the final numbers of both series.

The consensus expects Q2 GDP to show a slight decline when reported on July 28. Back-to-back declines will surely increase talk of recession, but it would be wrong to jump to that conclusion when the gap between income and output has quadrupled in the past two years, and GDI is still increasing in real terms.

BEA is investigating this issue. But it will take months before they issue any report.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

The strength of the US dollar and by extension the weakness of other major currencies in recent weeks has generated a great deal of comment. Heightened global risk aversion and an investor preference for the relative safety of US assets is one reason for the dollar's ascent. But relative growth and inflation fundamentals and their implications for interest rate differentials have also been key.

The outsized degree to which the dollar has climbed based on relative growth fundamentals alone, however, is noteworthy. As figure 1 below suggests, the US dollar has advanced by much more than the incoming US data-flow would suggest. This could be because US inflation has been more broadly-based compared with other major economies (where higher food and energy prices have been principal drivers). And this has caused the Fed - in the face of a weakening economy – to signal a more active inflation-fighting monetary policy campaign relative to, say, the BoJ or the ECB.

Figure 1: The US dollar is decoupling from relative growth fundamentals

This is a transcript of a brief webinar that we have posted on stagflation risks.

As a reminder we have been recommending that a neat way to keep tabs on those risks would be to look at the spread between global growth surprises and global inflation surprises. If that spread has been in negative territory for some time it would suggest that growth expectations have been ebbing or that inflation expectations have climbing and possibly both and with attendant increased risk of a stagflation combination

So where are we now? As the charts in figures 1 and 2 below suggest we have seen a higher risk of a global stagflation scenario emerge of late insofar as our indicator as plunged into deeper negative territory in the past few weeks. And that in turn can mostly be traced to a steady drumbeat of downbeat news on the global growth front.

Figure 1: An updated stagflation stress indicator