US: The Economy Slows, Inflation Grows

Dan North | November 2, 2021

The economy took a breather in the third quarter, as GDP slowed to a 2.0% q/q annualized rate, significantly weaker than already soft consensus estimates of 2.7%. It was the slowest quarter of the recovery, by a long way, but the details paint a different picture. Consumption grew by only 1.6%, but it was because auto sales fell by an extraordinary -54%.

Apparently, due to the chip shortage, there are no cars to buy. If auto sales had stayed at the same level as in Q2, GDP in Q3 would have grown 4.6% and consumption would have grown 5.2%. So consumers didn’t buy cars. But they did buy services at a q/q annualized rate of 7.9%, and that was after last quarter’s 11.5.

The GDP data is broken out in a separate report every month. In September, real disposable (meaning after inflation and taxes) personal income (DPI) fell a steep -1.6% m/m to a -2.0% y/y rate. The fall in income was largely due to the expiration of unemployment benefits at the beginning of September. However, that did not slow down consumers one bit. Real Personal Consumption expenditures (PCE) rose 0.26% m/m to a 6.2% y/y rate.
wages - sept2021
Perhaps more importantly, consumers still have $2.5T in excess savings from all of the rescue packages or 17% above what they would normally spend. So there is plenty of cash to spend this holiday season (if there’s anything on the shelves since the supply chain is still badly clogged), but the spending gravy train won’t last forever. In September, consumers’ savings rate fell to 7.5%, a bit below the long-term average, and it will likely continue to fall.
nfibsurvey - sept2021
The same report has two inflation measures, the Personal Consumption Expenditures (PCE) deflator and the PCE core deflator (which strips out volatile food and energy prices). The PCE core deflator is the Fed’s favorite gauge of inflation and the Fed tries to keep it around 2% over the long term.  It is currently 3.6%, which is the highest in a remarkable 30 years.
job openings-sept2021
But consumers don’t live in a “core” world without food or energy, they live in a world where they have to eat and stay warm. That’s what the PCE deflator measures and it is currently at 4.4%, also the highest in 30 years. Note how steeply both curves are rising, demonstrating a rapid acceleration in inflation, not just a leisurely 2%.
job openings-sept2021
Another measure of inflation came out last week called the Employment Cost Index (ECI). It measures wages & salaries, benefits, and the combination of the two. On a y/y basis, the overall index is growing at 3.7%, the fastest in 10 years. The increase is driven mostly by salaries which are growing 4.2% y/y, the fastest in 17 years. Benefits are also rising but more slowly at 2.5% y/y.
continuing jobless claims - sept2021
The Institute of Supply Management’s manufacturing index for October showed… you guessed it… supply chain issues, long delivery times, scarcity of materials and labor, and rising prices. And at the same time, new orders, backorders, and the overall index remain very strong, despite having slipped in the past few months. There is still plenty of work in the pipeline but it’s getting more expensive at both ends.
continuing jobless claims - sept2021

Once again the comments from the ISM participants are compelling:

  • “Global supply chain issues continue. Getting anything from China is near impossible — extreme delays. Microchip and circuit breaker shortages continue and are expected to continue into 2022.” [Computer & Electronic Products]
  • “Business is getting stronger, but the supply chain is getting worse every day.” [Chemical Products]
  • “Strong sales continue; however, we have diverted chips (semiconductors) to our higher-margin vehicles and stopped or limited the lower-margin vehicle production schedules.” [Transportation Equipment]
  • “Import costs and delays hurting business, requiring more safety stock for uncertainty. Rolling blackouts in China starting to hurt shipments even more.” [Food, Beverage & Tobacco Products]
  • “Domestic original equipment manufacturer (OEM) capital-expenditure spending is trending up for our business. We are seeing an increase of capital equipment with life spans of more than 10 years in the fourth quarter.” [Fabricated Metal Products]
  • “Demand continues to be strong, but we continue to be held back by supply chain issues — logistics delays, as well as capacity and labor issues at suppliers.” [Electrical Equipment, Appliances & Components]
  • “Business remains strong, with brisk incoming orders. We have become much more supply driven versus demand driven, due to shortages of labor, materials and freight. Costs continue to increase on all fronts, and we are considering our third price increase of the year for our customers.” [Furniture & Related Products]
  • “Customer demand remains high. COVID-19 related supply chain issues still hamper our ability to meet demand. Labor is still difficult for our suppliers to obtain, and labor costs are rising.” [Machinery]
  • “Demand for our products remains strong, but we continue to struggle to secure enough raw material to keep our manufacturing lines running.” [Miscellaneous Manufacturing]
  • “My prediction is that 2022 will be very similar to 2021 — similar demand, constrained supply, restricted logistics and rampant inflation.” [Plastics & Rubber Products]

Speaking of inflation, again, housing prices are growing at nuclear-powered rates. The Case-Shiller national home price index is rising at a record high rate of 19.9% y/y as compared to the 30 year average (ex-Covid) of 3.8%. 

Again, like in the PCE deflator charts, note how quickly housing prices have ramped up; last year at this time the rate was only 5.8%. The second chart compares the growth rate of housing prices to wages, starting in 2019. Over that time, housing prices have risen by an astonishing 28.5%, almost three times as much as wages have. Clearly, this is an unsustainable situation.

continuing jobless claims - sept2021
continuing jobless claims - sept2021
Here is another measure of how scarce labor is. It’s the number of people quitting their job every month, and of course, it’s at a record high. Probably only a small portion of these people are quitting permanently. More likely they know they can get another job right away, probably with better pay and better working conditions. It’s called “The Great Resignation.”
continuing jobless claims - sept2021

So the economy slowed in Q3, and inflation has clearly picked due to a still snarled supply change, and a critical lack of labor. We do expect to see a pickup in growth in Q4 however, and we still anticipate 2022 to be another good year, but inflation is clearly the biggest risk on the horizon. 

Keep an eye on what the Fed says on November 3, and what the Employment report says on November 5.

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