US - Searching for the Cycle

In 'My Firmest Conviction' I argued that to date, the current expansion has been unusual for not developing any of the normal cyclical accelerators which usually give dynamic drive to a business cycle.  Rather, it has been what one might call a steady-state supply-led expansion. This lack of cyclical development is extremely unusual in recent US economic history, and it surely won't last for ever.

So it is important to keep a keen eye out for the emergence of pro-cyclical accelerators. These would include:
• an break-out of capital investment coming in response to rising demands on existing capacity;
• an acceleration in wage inflation in response to tightening labour markets;
• a spurt in consumption demand as inflationary expectations and a fall in precautionary motives allow a fall in the personal savings rate; and, of course,
• a solid inventory cycle.

The last two weeks have brought data which bears on all of these. For the investment cycle and for labour market cycle there are enough indications to keep expectations alive, but also in both cases there is no sign yet that these signs are generating predictable economic consequences. For the consumption cycle, the reported recovery of consumer demand is flatly contradicted by consumer behaviour, as personal savings ratios rise and consequently dampen consumer spending. Finally, there is no sign of life in the inventory cycle.

Investment Cycle Accelerator  October's capacity utilization rate came in at 78.9%, retreating from September's 79.3%, the highest it has been since pre-crisis mid-2008. It has been a long grind to get there, but utilization rates have essentially recovered to pre-crisis levels, and are still grinding higher. The implication is obvious: one should expect an acceleration in investment spending to kick in soon. Capital spending is growing, but there’s little sign that it is accelerating sharply: rather, the rise in orders of capital goods (nondef, ex-air) has been volatile, whilst fundamentally sticking to a 2010-2014 trendline which implies growth of around 5% pa in nominal terms.

This week, the NFIB’s Small Business Optimism survey for October, rose modestly to 96.1pts, which was one of the most optimistic post-crisis readings,  but was still 0.7SDs lower than the 2004-2008 average. More importantly, the subindex tracking the proportion of respondents planning to increase capex in the next 12m rose to 26%. Now, although this is one of the highest readings of recent years, it is still far lower than the proportions maintained pre-crisis. In fact, even with this reading,  capex intentions have recouped only about half the ground lost in the financial crisis.  Conclusion: the rise in capacity utilization is not yet enough, and probably not nearly enough, to engender an investment accelerator to the cycle.

Labour Market Confidence and Wage Inflation  When labour markets tighten, they tend to generate higher wages, primarily because with the pool of possible employees narrows, a company needing to fill an opening has to offer higher wages in order to lure away an employee from his/her existing job, or perhaps attract him/her back into the labour force. But the willingness to demand higher wages is also a function of an employee’s confidence in the labour market, and that will be revealed directly by the quit ratio (ie, the proportion of employees quitting their job in any given month). When quit ratios are low, it implies that workers are extremely unwilling to leave a job, presumably on the grounds that another job is difficult to find. When quit ratios are high, it implies greater employee confidence in the underlying strength of the labour market.  

Now, the current US expansion seems to be supply-led, and one of the signs of that is that the openings rate (number of new openings as a proportion of the labour force) has not only recovered to pre-crisis levels in the past four months, but at 3.4% in August rose to the highest level since early 2001. But contrary to expectations, this has not generated any significant wage pressure: in fact wage growth has been stuck at around 2% pa since 2010.  One explanation has simply been that employees have had very little confidence in the underlying strength of the labour market, and have consequently been unable/unwilling to demand higher wages. And that interpretation is borne out by the quit ratio, which fell from around 3.5% in 2007 to a low of around 1% in 2009, and has only very gradually and partially recovered. However, September’s JOLTS survey showed the quit ratio jump to 2% in September, which is finally within reach of pre-crisis levels.  Needless to say, it is probably a long way from here to a significant acceleration in wage pressures, but this week’s news perhaps brings that prospect nearer.

Consumer Confidence, Spending and Saving  Consumer confidence surveys, whilst not absolutely unanimous, suggest consumer perspectives on the economy have improved substantially: this week, for example, the Uni of Michigan November confidence survey reported the most optimistic assessment of current conditions and the outlook since July 2007, and in this it mirrored the Consumer confidence index’s conclusion for October, which was the strongest since October 2007. The natural corollary of this is that one would expect a fall in precautionary savings ratios which would accelerate retail sales. Has it happened?

It has not, because whatever respondents may be telling confidence surveyors, their wallets are telling a different story.  Retail sales rose 0.3% mom in October,  only reversing the 0.3% mom fall recorded in September and, as the chart shows, sales are struggling to maintain the growth rates maintained since 2010. The wider measure of personal spending tells the same story: the 0.1% mom fall in personal spending in September pushed the dollar total to furthest below the 20102-14 trend since the worst days of the 2013-2014 winter.  But at the same time, the personal savings ratio rose to 5.6%, which is the highest since 2012, and 40bps above the Sept 2013 level. In fact, if the rise in savings ratios seen throughout 2014 is maintained, it will take personal savings ratios back to 2010-2012 early-recovery levels. Far from revived confidence generating a boost in consumer spending based on falling precautionary savings and/or rising inflationary expectations, the reverse seems to be happening.   A rise in savings ratios, perhaps partly based on falling inflationary expectations (also reported in the Uni of Michigan’s November confidence survey), is compromising consumption demand.  

Inventories  There are no such complications about the inventory cycle: what data we have does not suggest any significant volatility: inventory ratios have been almost entirely flat since 2010 and remain so. This week saw wholesalers’ inventories up 0.3% mom in October, as did total business inventories.