On The Economy, Oil Prices & Obama’s Temper Tantrum by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
December 2, 2014
IN THIS ISSUE:
1. Economy Rose More Than Expected in the 3Q
2. The Economy is Not Yet Out of the Woods
3. The Oil Price Decline is Like a Big Tax Cut
4. President Obama’s Post-Election Temper Tantrum
5. Webinar With Wellesley Investment Advisors on Thursday
Economy Rose More Than Expected in the 3Q, But…
Last Tuesday the Commerce Department raised its estimate of 3Q Gross Domestic Product to a 3.9% annual pace from the 3.5% rate reported last month, reflecting upward revisions to business investment and consumer spending and a smaller than previously reported decline in inventories. The pre-report consensus was for a slight cut to 3.3%, so the latest report was much better than expected.
The report came on the heels of the second quarter report in which GDP expanded at a 4.6% rate. Indeed, in four of the last five quarters GDP has increased by 3.5% or more (and by 4.5% or more in two of the last five quarters). The American economy hasn’t strung together five quarters like that since the late 1990s.
There are several positive trends occurring that have underpinned the above-trend growth over the last two quarters. The first, of course, is the sharp decline in the price of oil and other commodities. That has translated into much cheaper gasoline, with average prices down 24%, or 89 cents a gallon, since late April. Americans are also enjoying cheaper natural gas, fuel oil and electricity, which have common roots in the falling commodity prices.
These savings tend to flow directly into other forms of consumption, much as a tax cut would. Every dollar not spent to keep cars filled up is available to buy something else, which is helping prop-up spending and economic growth in the final months of 2014.
Next, over the last year, employment has grown at the fastest pace since 2006 and the pace of hiring seems to be trending upward. The nation has been adding jobs since 2010, but in 2014 the rate of that growth has taken a meaningful shift up. Employers added 2.64 million jobs to their payrolls in the year ended in October, compared with 2.2 million in the year ended in February.
The next positive trend won’t sound like a good thing, but it is: More people are quitting their jobs. One of the more predictable consequences of the terrible economy over the last several years was that people who had a job were holding onto it for dear life. But in a sign that the job market is improving, the number of people quitting their job voluntarily has soared this year, while the number being fired or laid off has gone down since late 2012.
In other words, Americans appear more confident that they can find a better job than they did even a few months ago, giving them more freedom to escape terrible hours, obnoxious bosses or low salaries for something better. (That could be a signal that workers will have stronger leverage in pay negotiations in the months ahead, but that’s a topic for another time.)
The Economy is Not Yet Out of the Woods
With the economy growing by more than 3% in four of the last five quarters, and with the hiring data shown above, it is so tempting to conclude that all is well in America at long last. But is it? It all depends on the timeframe you select. Let’s take another look.
Real GDP grew just 2.4% from the 3Q of 2013 to the 3Q of this year. That, of course, is due to the woeful 1Q in which the economy shrank at a 2.1% annual pace. Thus, at least some of the robustness of recent months is surely attributable to making up ground lost in the first three months of this year. The 2.4% year-on-year growth rate is entirely unexceptional, even by the standards of this recovery; indeed, it is very close to the GDP trend since 2010.
Meanwhile, growth in both wages and prices remains weak overall. Average weekly earnings have grown by only 2.8% over the last year, which is fairly normal for this recovery but well below the rates in past expansions. Meanwhile, the price index for personal consumption expenditures (the inflation measure preferred by the Fed) rose just 1.5% (annual rate) in the 3Q, down from a 1.6% increase in the 2Q.
This is all occurring, of course, in a world in which the Fed Funds rate has been near zero since late 2008 (while its balance sheet skyrocketed to $4.5 trillion). Things are clearly still not right in America when monetary policy has to remain so accommodating and for so long.
Despite the absence of inflationary pressure, the Fed is nonetheless preparing to “normalize” short-term interest rates. The first rate hikes are expected to begin around the middle of next year, and possibly sooner if economic growth continues above 3.5% in 2015. Yet the Fed continues to pledge that upcoming interest rate hikes will be dependent on the economic narrative at the time.
It could be that recent GDP data paint a misleadingly rosy picture of things. If, as suggested above, the surge in growth in the last two quarters was in part a rebound from the snowy start to the year, we should anticipate reversion to a slower growth rate more in keeping with the signals sent by prices and wages.
This suggests the Fed should be watching closely for any sign of a growth slippage. Of course, we won’t get our first glimpse of GDP growth in the 4Q until the end of January.
A second scenario might be an economy that has simply been lucky, thanks to the implosion of gasoline and energy prices this year. It might be the case that the economy is fundamentally unchanged from where it was a year or two ago, but has received a boost from the falling cost of oil and other commodities. If this is case, the Fed should again be on the lookout for indications that disinflationary tailwinds are abating, or that the economy is approaching capacity – either of which could nudge up inflation.
A third scenario is the so-called “secular stagnation” world, a term suggested by former Treasury secretary Larry Summers early this year. In that scenario, the Fed has finally succeeded in getting growth going, but it most likely has only managed this by creating unprecedented increases in asset prices. In this version, the Fed faces a difficult choice: to try to identify the most worrying sorts of excess and rein them in at the cost of growth, or to tolerate growing financial instability in hopes the fallout is relatively harmless.
A fourth might be a world in which underlying productivity potential is finally growing nicely, thanks in part to information technology advances, new digital business models and the tremendous boost from American energy production. These trends are allowing growth in output to run ahead of growth in employment. At the same time, technology is also keeping a lid on wage growth, thanks to possibilities for automation and