Ben Bernanke, former chair of the Federal Reserve, and Olivier Blanchard, former chief economist of the International Monetary Fund announced their two-year study on inflation. Bernanke is now at the Brookings Institution and Blanchard is at the Peterson Institute for International Economics. The two are among the world’s most cited academic economists. Blanchard was one of the few economists, along with Larry Summers who were the first to forecast inflation when the stimulus programs began.
Pandemic-related supply shocks explain why inflation shot up in 2021. An economy overheated by fiscal stimulus and low-interest rates explains why it has stayed high ever since. Their conclusion: For inflation to fade, the economy has to cool off, which means a weaker labor market.
“Monetary actions affect economic conditions only after a lag that is both long and variable,” said the great monetary theorist Milton Friedman. Fed Chairman Jerome Powell has quoted Friedman on this many times. The Fed has raised the interest rate to 5pc in the last 15 months, and inflation has dropped to 4pc, but not close enough to the 2pc goal.
Higher interest rates have not substantially slowed labor demand. May’s job openings were up by more than 400,000 to over 10 million again, with only 5.7 million people available to work. The calculus to drop inflation to 2pc by slowing the economy while raising the unemployment rate to close to 5pc doesn’t add up to me. However, Bernanke and Blanchard believe that slowing the economy may be possible without raising unemployment so much. They use the ratio of vacancies to unemployed to measure labor market tightness.
Amazingly, since late 2022, vacancies have dropped by about 20pc, with only a slight rise in unemployment. The road to accomplishing this soft landing will happen with a considerable amount of my favorite acronym, VUCA (Volatility, Uncertainty, Complexity, Ambiguity).
Breaking news, at least to me
New research from the Federal Reserve Bank of San Francisco reveals evidence that the labor market was never at the heart of the inflation problem anyway. Labor-cost growth has had a “small effect” on inflation, both overall and in the non-housing services category, where labor is a big proportion of company costs. The analysis found that recent increases in the employment cost index explained about 0.1-percentage point of the 3-percentage point increase in core personal consumption expenditures inflation. Who knew? I am still shaking my head as I try to digest this.
What else is causing inflation: rockets and feathers
When inflation started rocketing a few years ago, the reasons for raising prices were supply chain disruptions, logistics, the Russia-Ukraine war and higher gas and commodity prices. Large corporations, food chains, new and used cars, and durable goods manufacturers all raised their prices. We saw new and used car prices and housing prices rise fast.
Now commodity prices, especially oil prices, have fallen: Gas prices were over $5 and are now down 40pc. Logistics costs are back to pre-pandemic levels and there has been none of the dreaded wage-price spirals. With all of that, prices have been falling like feathers at grocery stores, restaurants, travel and on durable goods. Corporate profits are up and their stock prices are higher. Many companies have found that they can continue raising their prices without losing customers amid solid demand, at least for now. This could keep inflation too hot for some time and cause the Fed to tighten even more.
Inflation
Inflation measurements signal improvements.
– The Consumer Price Index (CPI) for May fell to 4pc from a year earlier and down 0.9pc from last month, which is the lowest in two years. The core CPI, excluding food and energy, eased to 0.4pc in May, in line with expectations, and still higher than the 2pc target.
– Super Core inflation, the Fed’s new preferred PCE sub-indicator, services only (no goods), excluding food, energy, and housing, increased 0.2pc in May after rising only 0.1pc in April. In the last 12 months, prices in the Super Core category are up 4.6pc, versus 4pc in the overall index, and 5.3pc in the “core” index.
– Producer Price Index for May fell sharply. Annual price increases seen by producers measured 1.1pc for the 12 months ended in May, falling from the 2.3pc bump recorded in April. Driven by a decline in energy prices and food prices, this inflation measure has now decelerated for 11 consecutive months. It’s now at its lowest annual reading since December 2020, when post-pandemic demand was starting to return and producer prices were beginning their upward inflationary march.
– Personal Consumption Expenditures [PCE], the Fed’s preferred tool for measuring inflation, rose 0.4pc in April, up from 0.1pc in March, raising the 12-month comparison to 4.4pc from 4.2pc in March. Core prices, which exclude food and energy, pushed the 12-month comparison up to 4.4pc from 4.2pc in March.
– Actual shelter/rent inflation remains very high. However, we know from the forecasts and the way inflation is calculated that it is dropping. We will start seeing shelter disinflation in the CPI and PCE in the months ahead.
Manufacturing
The ISM manufacturing index for May fell to 46.9 from 47.1 last month and is still in contraction. Fabricated metal products were one of four indices that reported growth in May, while 14 indices were down. The New Orders Index remained in contraction territory at 42.6, 3.1 points lower than in April. The Production Index rose to 51.1 points. The Prices Index fell a whopping nine points.
– Industrial production for April rose 0.5pc. The biggest contributor to the gain in April was the manufacturing sector where activity rose by 1pc, with auto output soaring 9.3pc and the rest of the manufacturing sector gaining 0.3pc. Capacity utilization at factories increased to a 15-year high of 79.2pc.
– ITR Economics US Total Industry Capacity Utilization Rate was flat from March to April. The general decline in the rate signals that the US industrial sector will remain on the back side of the business cycle into at least the fourth quarter of this year. The decline will be mild due to stable consumer and business finances, backlogs, and onshoring trends. It then calls for the 12-month moving average (MMA )to rise in 2025.
– Shipments of “core” non-defense capital goods ex-aircraft (an essential input for business investment in calculating GDP and a leading manufacturer indicator) rose by 0.5pc in April after being down in March, and, if unchanged in May and June, would be up at a 1.2pc annualized rate in the second quarter versus the Q1 average. We are still growing but at a smaller pace.
– Orders for core capital goods (excluding aircraft and transportation), which will lead to shipments in the future, were down 0.2pc after being up slightly in March. In the past year, orders for durable goods are up 4.2pc, while orders excluding transportation are down 0.2pc. After factoring in the inflationary rise in producer prices for capital goods, orders declined when adjusted for inflation.
– Automakers sold cars and light trucks at a 15 million annual rate in May, down 6.5pc from April but still up 19.6pc from a year ago. Moreover, sales of medium and heavy trucks hit a 558,000 annual rate in May, the fastest pace since 2019.
– New home sales were up 4.3pc despite 30-year mortgage rates at 7pc. Home prices have moderated and inventories, while still low, have grown. This is partly due to the low inventory of existing home sales because owners don’t want to give up low-interest rates.
– US Nonresidential Construction Contracts Index fell 28.74 pc from a record last month but is still up 10.72pc from one year ago. This includes commercial projects such as highways, hotels, and hospitals.
– The Shapiro Nonferrous Scrap Activity Index for May, which tracks our daily purchases from the same accounts across our 10 locations and a diverse industrial base, rose from April and is 6pc over our 12-month trailing average.
China and the world
China’s official PMI fell in May to 48.8 from 49.2. The private Caixin index rose to expansion for the first time in five months. Services also fell but are in expansion. Housing continues to be a big problem and it will be for some time. Youth unemployment for those under 25 is 20 pc. Car manufacturers produced 2.13 million units in April 2023, down a sizable 17.5 pc month over month while car sales were down 12pc year over year.
Publicly, the Chinese people follow what the government says they should do. Privately it is another story. The Zero-Covid policy has changed consumer confidence. Its impact will be felt for many years. Even when the government comes out with a new stimulus package, the Chinese economy will be slow for some time.
Europe saw two quarters of negative growth and is officially in a recession. Inflation is falling along with energy prices. The German economy, which is the manufacturing powerhouse of Europe had negative growth and is also in a recession.
The US is fortunate to have such a strong economy.
Metals
With the slowdown in China and Europe, metal prices remain soft. The Aluminum Association reported Q1 demand for aluminum in North America fell by 3.5pc, while the semi-fabricated – or “mill” – product demand was off 7.3pc year-over-year through the first quarter. Extruded products have been down over double digits in Q1. The index of Net New Orders of Aluminum Mill Products shows a decline of 8.2pc year-to-date. It is no surprise that prime aluminum prices and scrap fell again this month. Secondary prices were steady. Stainless steel, copper and steel prices were also weak and down close to 10pc from May.
Harbor’s 15th Annual Aluminum Summit was held last week. The content and the people make it the premier event to attend. Their forecast from last year was spot on. Their aluminum forecast for LME cash for 2023 and 2024 is:
Great manufacturing news
Construction spending as a percentage of GDP has more than doubled since the Inflation Reduction Act (basically an infrastructure act) and the CHIPS Act were passed a little over a year ago. The total dollars spent rose from $800bn annually 10 years ago to over $1.8trn currently. Annual spending should be close to $1.7trn over the next five years. This does not include the equipment that will be needed in these factories. These projects will also include many new jobs. The US will not get back to the 25pc manufacturing portion of the 1970s but this is still excellent news for us.
Circular futures for leaders in manufacturing
As we chart the future of manufacturing, Shapiro is in a unique position to lead the sector towards processes where environmental stewardship and economic value work together. Shapiro’s services for OEMs offer clear ESG reporting, circular supply chain management, and tailored master alloy programs. Circular services and solutions allow manufacturers to weather and thrive in the complexities of today’s market. Growth trends in manufacturing suggest this is the time to integrate future-forward strategies. Reach out to Shapiro’s sustainability experts to accelerate a sustainable future for your corner of the manufacturing industry.
“Nothing will ever be attempted if all possible objections must be first overcome.” Dr. Samuel Johnson
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– Bruce Shapiro
This report was prepared by Bruce Shapiro and reflects his current opinion of the economy. It is based on sources and data he believes to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice.