US Perspectives: Will Commodity Inflation Stop This Economic Train?

The race between wages and inflation will be the most important factor in determining the direction of the economy this spring and summer.

Robert Johnson, CFA 15.02.2011
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Last week is the calm before the storm, as secondary and tertiary data points were released before a flood of economic statistics hits the newswires this week.


Initial jobless claims and the trade balance both came in better than expected. The trade balance results for December were good enough to make me believe that the second reading on fourth-quarter GDP growth may be revised higher by 0.5 percentage points compared with the initial 3.2% reading. Some inventory data due this week, along with retail sales adjustments, will provide some clarity on the prospects for even greater GDP revisions.


Weekly initial unemployment claims fell to their lowest level since the spring of 2008, taking some of the sting out of the week before last week's disappointing monthly employment report. Consumer credit expanded for the second month running, indicating improved consumer confidence. Small businesses were also more optimistic than they have been for some time according to a recent survey produced by the National Federation of Independent Businesses. Sluggish small-business results, due primarily to tight credit conditions, have been one of the items holding back the recovery thus far.


Commodity Price Increases Pinch Corporate Profits, Hiring Plans, and Potentially Consumer Spending

On the company front, disappointing news from PepsiCo illustrated the risk of rising commodity prices on corporate profits. Those pinched profits provide yet another excuse for some corporations to continue to defer hiring. Passing on those price increases isn't a particularly good thing for the economy, either. Higher prices constrain consumers' ability to spend, and that's the number-one way to end an economic recovery, especially when wages don't keep pace. The race between wages and inflation will be the most important factor in determining the direction of the economy this spring and summer. In the short term, the payroll tax cut, rising consumer confidence, and a rebounding manufacturing sector should keep the economy buzzing.


Pepsi Hurt by Rising Commodity Prices

Pepsi is the latest in a string of packaged goods companies reporting earnings misses due to rising input prices. In particular, rising corn prices are affecting a lot of the snack food category (think Doritos and Fritos). Plastic containers made from petroleum products, rising prices for aluminum cans, and transportation costs further exacerbated Pepsi's position. Pepsi reported a 5% drop in fourth-quarter profits last week.


Initial Unemployment Claims Continue Their Downward Trend

Despite contradictory data from previous monthly employment report, last week's initial claims report remained on a meaningful downward trajectory. The single-week claims number of 383,000 is the best figure of this recovery and the best number since June 2008. A typical non-recessionary figure would be for 300,000-350,000 claims to be filed. In terms of total employment, we are getting close to normal on the firing end of the scale, but hiring still seems subdued this far into the recovery.


New Job Openings Still Scarce, But Workers More Willing to Quit

This trend toward fewer layoffs but restrained hiring was also evident in last week's Labor Department report on job openings and layoffs. While the report showed that job openings have improved from a dismal 2.4 million positions at the end of the recession to 3.1 million openings as of December, it is still well off the pre-recession level of 4.4 million and just below the 3.2 million openings at the end of November. The one glimmer of renewed hope in the report is that the percentage of private sector workers quitting their jobs versus being fired has jumped to 49% from 42% over the last year, perhaps indicating renewed worker confidence in finding better jobs elsewhere.


Trade Data Better Than Expected

For the most part, trade has been an important part of this economic recovery. Therefore, I was pleased to see the trade deficit increased less than my forecast, the consensus forecast, and even the estimate used by the government in the advance report of fourth-quarter GDP.


The overall trade deficit (smaller is better) came in at $40.6 billion compared with $38.3 billion for each of the prior two months. Keep in mind that the deficit has ranged from $67 billion in August 2006 to a recession low of $25 billion. The deficit remained worse than $60 billion for almost the entire period from 2005 to 2008. The U.S. manufacturing sector is clearly taking advantage of a weaker dollar and huge efficiency gains to penetrate both emerging and developed economies.


Net petroleum imports were a relatively big detractor to the import figure this month. Excluding petroleum, the trade deficit has been improving for several months. Capital goods and agricultural exports have been the keys to the improvement.


Non-Oil Trade Deficit Continues to Shrink:
Trade Deficit Less Petroleum Products ($bil)

July 2010


Aug 2010


Sept 2010


Oct 2010


Nov 2010


Dec 2010


Source: Census Bureau, Morningstar Calculations


However, as good as the numbers were, the trade numbers in the fourth quarter probably fit in the too-good-to-be-true category. I would caution that the fourth quarter is typically a favorable time for the trade figures as capital goods tend to have a big year-end spike (and the U.S. is a powerful exporter) and most of the importing for the holidays is largely completed before we enter the fourth quarter.


A disruption in an oil pipeline during the fourth quarter served to depress some oil imports as well. It is also unusual to see imports fall when consumer spending is increasing so rapidly. Therefore, I suspect it will be a while before trade can be as huge a contributor to GDP growth as it was in the fourth quarter of 2010. It may even be a struggle to keep trade from subtracting from GDP growth for all of 2011.


This Week Is Manufacturing's Chance to Shine

January industrial production figures are scheduled to be released on Wednesday as both a broad swath of industrial analysts and our own industrials team expect decent results. These positive results are coming in the face of December's numbers that were inflated by weather-related utility issues. Consensus is for 0.4% sequential improvement. The director of our industrials team summed up the report's potential as follows:  

Our industrial production leading indicator is reaccelerating. It's no surprise given the impressive performances of the ISM indexes as well as other indicators, but it appears industrial production is set to increase its year-over-year growth rate in the very near future. Our composite leading indicator bottomed in September and has been trending higher since. Actual industrial production likely realized its slowest annual growth rate of the current cycle in November of last year and has also started to bounce. Because our indicator leads IP by a few months, we look for the latter to break solidly into the 6% annual growth range possibly starting with next week's release of January results. On the flip side, the annual comparisons get much tougher in the spring months, and December industrial production was aided by outsized activity in the volatile utilities space, a dynamic that may possibly dampen sequential performance. Even so, all the indicators are pointing to solid mid- to high-single-digit growth in this influential index over the next several months. We wouldn't be surprised to see the reacceleration begin next week.

 Also this week we get to see some of the regional purchasing managers' reports, which should give us an early read on whether the strong manufacturing performance in January can be sustained into spring. Both the Empire State and the Philly Fed manufacturing reports will be released this week.


Based on Early Returns, Retail Sales Should Look Good for January

Initially there was a lot of fear that retail sales would fall off a cliff in January after a relatively strong holiday season. However, individual retail store reports and the monthly report from the International Council of Shopping Centers all showed more strength than expected. The ICSC report showed 4.2% growth for January versus expectations for a more miserly 2.7%. On Tuesday we'll see the much more comprehensive government retail sales report. Consensus is for a sequential improvement of 0.5%, which seems reasonable given the same-store sales data announced earlier. As always, I'll be checking the report to see whether the lackluster restaurant sector shows any signs of life. Restaurant spending is a key indicator of consumer confidence and also sheds some light on employment trends.


Will Price Increases Erode Hourly Earnings Gains?

This week both the Consumer Price Index and the Producer Price Index are expected to back off modestly from the very strong spike in prices that was evident in the December reports. On the consumer side, prices are expected to show a 0.3% (3.6% annualized) sequential increase that follows an awful 0.5% (6% annualized) increase in December. Energy prices were a little tamer, but increased food prices should have finally worked their way into the January report. The forecast 0.3% increase in the CPI strikes me as potentially being a little light, but we shall see.


One of the few bright spots in January's employment report was healthy growth in the nominal hourly wage. It would be a shame to see all those gains eaten up by higher inflation. Real wage growth is scheduled for release on Thursday just after the CPI data are published. 

This is an edited version. The article originated from Robert Johnson’s column at

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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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