Recent inflation fears have helped lead to a sell off in bonds. From a total return perspective, the 30-year US treasury has declined by 13% and the 10-year US treasury has declined by 6% over the past 100-days. With the prospect of fiscal stimulus on the horizon while the official US unemployment rate is sitting at nine-year lows, it is understandable that investors are getting antsy about inflation. We believe, however, that there is still plenty of excess capacity in the economy and that could keep a lid on inflation.

As we mentioned, the official U-3 unemployment rate is just 4.6% which is the lowest levels since August 2007. However, the broader U-6 unemployment rate still stands at a 9.3%. In the previous two cycles, the U-6 unemployment rate fell below 8% and was as low as 6.9% in 2000. The spread between the U-6 and U-3 unemployment rates remains elevated relative to recent history as well.

US Economy


US Economy

The employment to population ratio is also below peaks in prior cycles. The employment to population ratio of 25-34 year olds is 77.4% well below previous highs of 80% in 2007 and 82.3% in 2000. The employment to population ratio among 35-44 year olds is 79.5% down from 81.5% in 2007 and 82.6% in 2000. Finally, the employment to population ratio of 45-54 year olds hold is 77.6% compared to 79.7% in 2007 and 81% in 2000.


The output gap is also well below previous cycles. The output gap capped out at 1.15% in 2006, 2.85% in 2000, 0.88% in 1989, 2.15% in 1979, 4.41% in 1973, and 5.72% in 1966. It currently remains negative at -1.47%.


Today’s release of capacity utilization showed a decrease industrial utilization. Capacity utilization is just 75%. This level is consistent with recessions in 1982 and 2001. Economic utilization (capacity utilization minus unemployment rate) is also at levels consistent with recessions in 1980 and 2001.



Finally, structural inflation, defined as the trailing 10-year average of the year-over-year change in CPI, is just 1.78%. This is the lowest level since 1968. Our CPI diffusion index is also at levels consistent with previous recessions.



Article by Eric Bush, CFA – Gavekal Capital Blog