Produce Price Index
The Producer Price Index (PPI) increased 0.1% in May and is now up 1.8% over the past year, which is down from last month’s 2.2% annual increase. A 3.0% decline in energy prices is keeping the PPI in check. The core rate, which excludes food and energy, is up 2.3% year-over-year and up a faster 3.5% annualized rate over the past three months. This is well ahead of the Fed’s 2% target, and it suggests there will be no rate cuts anytime soon.
Consumer Price Index
Consumer prices rose 0.1% in May and 1.8% over the past year. The core rate increased 0.1% for the month and 2.0% on a year-over-year basis. This is right at the Fed’s target, which is why it makes absolutely no sense for the Fed to cut rates if it is focused on its mandate of stable prices and full employment.
Real (inflation-adjusted) average hourly earnings for production and non-supervisory employees rose 0.3% in May, while hours worked per week declined 0.3%. This resulted in real average weekly earnings rising 1.1% year-over-year, which is unchanged from last month. Real average weekly earnings growth has been stagnant around 1% over the past few months. I have been expecting a more rapid increase in real wages this year, but it has yet to materialize.
We had a small bounce in output. Industrial production rose 0.4% in May, fueled by a 2.1% surge in utilities, but the manufacturing component only managed a gain of 0.2% and mining rose 0.1%. Still, this is better than a decline as we are staving off an outright decline on an annualized basis.
Inventories held by manufacturers, retailers, and wholesalers rose 0.5% in April, while sales declined 0.2%, resulting in an increase in the inventory-to-sales ratio to 1.39. Inventories continue to grow at a faster pace than sales, which means that the rate of growth behind us will strengthen, but it will slow growth moving forward until sales fall in line.
Last month, alarm bells rang with a sharp deceleration in retail sales for April, but today’s report was an upside surprise with sales for May rising 0.5%. Additionally, last month’s decline of 0.2% was revised up to an increase of 0.3%. The consumer continues to spend, which means that the economy continues to expand. Even when we exclude autos and gasoline sales, the number still rose 0.5%. Sales at department stores, restaurants, and online all remain steady.
The Budget Deficit
No one is talking about the burgeoning budget deficit! What makes this situation so unusual and concerning is that the deficit typically narrows as economic expansion continues, but it has been growing over the past three years to what is now close to $1 trillion. This has resulted in a false sense of economic strength, as the rate of growth would not be what it has been in recent years without the unprecedented level of borrowing at this stage of the economic cycle. It will also dramatically limit our ability to employ fiscal stimulus during the next economic downturn.
The deficit for May was $207.8 billion, which puts the trailing 12-month deficit at $985 billion. The fiscal year-to-date total of $738 billion is 39% larger than it was last year. Tax revenues are up 2.3% from last year, but it isn’t coming from corporate America. Individual income tax revenue was $104 billion last month, while corporate tax revenue was $0.4 billion. That’s right, less than $1 billion. Individual income tax revenue is up 1.5% from last year, while corporate tax revenue is down 8.6%.
Meanwhile, spending continues to grow with outlays for the first eight months of this year, up 9.3% from the same period last year. Again, this is not sustainable. The deficit is one of the strongest headwinds to the rate of economic growth that NO ONE is talking about.
The rate of economic growth is clearly slowing from what was a tax-cut-induced spike to 3% last year, but it is hard to argue that the economy is on the verge of recession. My forecast at the beginning of this year was for growth of 1-2% in 2019. At the same time, I’ve been expecting to see a modest rise in the rate of inflation, which has yet to transpire except for financial assets.
The Fed will soon be ending its balance sheet reduction program, at which point, it will no longer be tightening monetary policy. The consensus of investors believe that an interest rate cut is a foregone conclusion at either the June or July meeting, but I seriously doubt that will happen. We have a stock market at all-time highs, full employment and a rate of inflation at 2%. The Fed has met its mandate. There is absolutely no reason for the Fed to cut interest rates.
The Portfolio Architect is a Marketplace service designed to optimize portfolio returns through a disciplined portfolio construction and management process that focuses on risk management. If you would like to see how I have put my investment strategy to work in model portfolios for stocks, bonds, and commodities, then please consider a 2-week free trial of The Portfolio Architect.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.