Economic Commentary Daniel Laufenberg, Ph.D.
Numerous economic data series are released between the publication dates of the Laufenberg Economic Quarterly (LEQ). Therefore, this page is designed to provide commentary on the more recent data and their implications for the economic outlook.
The dollar, oil and the Fed (January 16, 2015)
Although the current Laufenberg Quarterly (LQ) forecast is only a month old, it looks as if recent developments require some near‐term adjustments to the outlook for certain items, including the foreign exchange value of the dollar, the price of crude oil, inflation and interest rates. The net result of recent developments is likely to be positive for real output growth as measured by real gross domestic product (GDP) but net neutral for corporate profits. Since employment is a lagging indicator predicated on real output growth, it should be no surprise that the labor market continues to improve, albeit with a slightly different mix than anticipated earlier. In particular, jobs in the oil‐producing sector will be replaced by jobs in the oil consuming sectors of the U.S. economy. And by the way, nearly every sector in the U.S. economy uses or consumes a petroleum‐based product and may help explain the recent out‐of‐consensus pop in consumer sentiment in the wake of lower in oil prices.
First, in the LQ forecast, the trade‐weighted dollar in the first quarter of 2015 was expected to slip back to an average of 80.2, down from an average of 81.9 in the fourth quarter. As it turns out, the fourth‐quarter average was 82.6, a bit higher than the LQ expected a month ago (see Chart 1). But more importantly, the dollar index currently is at 86.5, which is not only considerably higher than the fourth‐quarter average but also up from the 85.1 reading at the end of last year.
Interestingly, despite the recent jump in the dollar, the downward secular trend since the mid‐1980s, as shown in Chart 1, still seems in place. In other words, the dollar has rallied but it has done so off a level close to its historic low. The impact of a stronger dollar on the U.S. economy under these circumstances most likely is mixed. On the one hand, a higher valued dollar means that imports are cheaper, which in turn will put downward pressure on domestic inflation and provide consumers with added purchasing power. On the other hand, a higher valued dollar means that our exports are more expensive, which in turn could put downward pressure on the manufacturing of products sold in foreign markets. An interesting aside is that imports used as intermediate inputs in the production process of domestic firms are now less expensive than they were. This may encourage them to use more imports when possible, but it most certainly will allow such firms to improve profits at the margin, as well as possibly lower prices a bit. However, if final product demand is strong, the more likely outcome would be more profits rather than lower prices.
Second, crude oil prices have fallen more than the LQ forecast was expecting and is likely to stay low longer. Recall that the LQ expected the average price of a barrel of West Texas Intermediate oil to be a tad higher than the fourth quarter average of $76.5. Not only was the fourth quarter average $73.2 rather than $76.5, but the average so far this quarter, albeit early, is a mere $49.0 a barrel (see Chart 2). This makes it very difficult, if not impossible, for the first‐quarter average to get anywhere close to the December forecast. It now seems more likely that the firstquarter average will be closer to $50 than to $75 a barrel.
The implications of a lower price of crude oil are discussed in considerable detail in the recent Perspective posted to the Laufenberg Quarterly website. The bottom line is that since there are more users of petroleum‐based products in the U.S. than crude oil produced in the U.S., lower prices likely will be a net positive for the U.S. economy and for corporate profits other than oil companies. The adverse effect of lower oil prices on OPEC economies is far less important to the U.S. economy than the positive effect from the lower price of oil. Of course, there could be some national security issues associated with lower oil prices that could make investors nervous but if they do occur they are likely to be temporary.
Indeed, the plunge in oil prices in 2008 (see Chart 2) was considered one of the key factors behind to the economic recovery that started in mid‐2009. There is every reason to expect a similar outcome again this time around. Of course, there are a few headwinds in place currently that may obstruct the stimulus a bit but they are very unlikely to derail it. They include some regional economic slowdowns in oil‐patch states, the misunderstood concern about deflation and the future path of monetary policy. Given time, these headwinds should be proven to be gentle breezes. My guess is that this realization will occur sooner rather than later.
The final items are inflation and interest rates. Given the recent strength of the foreign exchange value of the dollar, it should be no surprise that commodity prices, which are denominated in U.S. dollars, have declined, led by crude oil. Moreover, given the widespread use of petroleum‐based products, as well as imports more generally, in the U.S. economy, it should be no surprise that the overall inflation has slowed markedly.
According to the latest report from the Bureau of Labor Statistics, the overall consumer price index (CPI) in December 2014 was up a mere 0.7 percent from a year earlier (see Chart 3). This was the lowest such inflation reading since October 2009 when the overall CPI declined 0.2 percent from October 2008. On the other hand, the December 2014 core CPI, which excludes food and energy from the overall index, was up 1.6 percent versus a year ago, which was only slightly lower than the 1.7 percent reading a month earlier but matched the twelve‐month advances earlier in the year. You probably heard all of this given the press coverage of the CPI report.
However, the LQ forecast is calculated on a quarterly basis, not monthly. In the December LQ forecast, the overall CPI was expected to be up 1.9 percent on a fourth‐quarter to fourth=quarter basis in 2014, versus a 1.2 percent advance over the four quarters of 2013. As it turns out, the overall CPI by this measure was up 1.2 percent again last year.
This gets us to the LQ inflation forecast for 2015, which based on more recent statistics seems too high. This is true for both overall and core inflation measures. Nevertheless, with crude oil prices below $50 a barrel, the unemployment rate down to 5.6 percent, and capacity utilization in manufacturing flirting with 80 percent, I contend that the likelihood of inflation rising in the year ahead is much greater than it was at the end of 2013 when crude oil was $100 a barrel, unemployment was 7.0 percent and capacity utilization was 75 percent.
With inflation falling, it is no wonder that interest rates have followed. An interesting aspect of this development is that not all interest rates have followed to the same degree, until recently. As shown in Chart 4, over the last year the 10‐year Treasury yield has fallen, the 5‐year yield has been roughly flat, while the 3‐year Treasury yield has risen. Such a conversion of rates is not unusual for an economic expansion in its sixth year.
That being said, rates seem to have dropped in unison in recent days, probably reflecting expectations of a massive bond buying program from the European Central Bank, the Swiss National Bank scrapping a three‐year cap on the franc, concern about a few U.S. economic statistics reports that failed to live up to expectations, and growing speculation that the Fed will postpone a hike in the federal funds rate this year because of the strength of the dollar and the concern of deflation. I expect the ECB to disappoint, the Swiss central bank finally faced reality, the U.S. data will recover (if it has not already) and the Fed will stay on track to raise the funds rate.
We will know the ECB decision soon, but the other issues may take longer to be resolved. Part of the problem is that monetary policy is the only macroeconomic tool available in many countries, especially Europe. Unfortunately, monetary policy cannot do it alone or be everything to everyone, which may explain why investors generally seem less confident in central bankers now than they were.
On balance, if the LQ forecast was revised today, the inflation outlook for all of 2015 would be lower but probably not as much as might be expected in light of the recent plunge in petroleum prices. In large part, I doubt that crude oil prices will remain as low as they are for long. While the average price of crude oil in the first quarter of 2015 would be estimated at a level closer to $50 a barrel than $75, but still would be expected to average closer to $90 a barrel in the fourth quarter. Obviously, this is debatable and would represent a risk to the forecast. However, even if oil prices do not rebound as much as I expect, they will rebound enough to give the Fed some cover to hike its federal funds rate target. Finally, the forecast for real GDP growth in 2015 most likely would not be changed much, but I would be even more confident that the first half performance will exceed the second half. Corporate profits for all of 2015, as measured by the operating earnings of the S&P 500 companies, would be expected to remain in line with the December forecast of a 10 percent gain.
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The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.
The dollar, oil and the Fed (Current Article) -- January 16, 2015
Press Conference in honor of U.S. Opens -- June 20, 2014
Implications of an even weaker First Quarter (current article) -- March 29, 2014
Invasion! -- March 3, 2014
Furloughed! -- October 25, 2013
Doomsday forecasts: Honest people can disagree -- April 26, 2013
Making sense of the February jobs report -- March 10, 2013
Growth gyrations continue (current article) -- January 28, 2013
Optimism, not irrational exuberance -- October 15, 2012
Disappointing but far from disastrous -- July 31, 2012
Assessing the recent weak economic data -- June 8, 2012
Consensus too pessimistic about everything -- April 16, 2012
Risks to the forecast -- March 7, 2012
A good finish to 2011 but still not good enough -- January 27, 2012
More evidence of a strong finish -- December 22, 2011
Finishing Strong -- October 14, 2011
Living in interesting times -- September 8, 2011
A not so pleasant surprise! -- September 2, 2011
Surprise! -- August 16, 2011
Debt ceiling politics -- July 25, 2011
Q2 growth: Another disappointment likely -- July 14, 2011
A slower start to 2011 than anticipated earlier -- April 14, 2011
Is the dollar's status as the reserve currency at risk? -- March 21, 2011
More trouble in the Middle East -- February 26, 2011
Searching for the next debt crisis -- January 13, 2011
What's going on? -- October 15, 2010
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