Is There More Slack In The US Economy Than Is Generally Percieved?

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.

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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.

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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%.

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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.

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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.

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Article by Eric Bush, CFA – Gavekal Capital Blog