Wages

This year it’s been popular to say the Fed will hike interest rates until it “breaks something.” Has that not already happened? Pull up charts of the Japanese yen, the British pound, and the euro, among others. And stateside, the Fed has broken one of economists’ favorite toys: the Phillips Curve.

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As Yogi Berra might have quipped, it’s not just the leading indicators that are lagging… the lagging ones are, too.

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We take a look at different data sets reflecting labor costs. The main finding is that using Unit Labor Cost as the measurement for the true cost suggests that the labor market is very tight in terms of affordability for businesses.

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Corporate profits were outstanding last year, but even the benefit of a 40% cut in the top income-tax rate wasn’t enough to lift the net profit margin back to the all-time high of 10.6% established in early 2012. Still, the latest 10.0% figure is more than a percentage point above the 2007 cycle high and about two points better than any other cycle high.

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The sell-off in risky assets in early October promptly led to expectations of a more dovish Fed.

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CPI inflation accelerated again in March. As we see it, the important development is that inflation has broadened out.

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CPI and PPI monthly inflation kicked up a bit with February readings and could  do so again when March results are released.

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Inflation trends are a mixed bag at present.

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Twelve month rates of change for both CPI and PPI have been trending down over the past fifteen months, and seem to be less of an immediate threat. But, the Core CPI seems to be in an uptrend.

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Inflation prospects are especially unclear. While many inflation gauges seem to be slowing, the threat of an inflation flare-up remains.

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Looking ahead, CPI twelve month rate of inflation is likely to be in the +2% area for the first half of 2007.

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Inflation expectations seem to be on the rise.

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CPI on a twelve month basis still expected to decelerate over the next three months. The final 3 months of the year, however could be another story, with CPI twelve month inflation accelerating.        

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Major reason for lower inflation forecasts is expectation of slowing economy (recession?) in 2006.

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Consumer spending may have finally peaked in this cycle, but a consumer collapse is far from imminent. Consumers can be expected to remain supportive of economic growth.

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After a brief dip, project twelve month CPI to accelerate to about +3.8% by year end.

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We continue to be more optimistic about the dollar than most, and believe the post election U.S. dollar weakness was overdone.

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Further U.S. dollar weakness could certainly be an inflation negative (higher import prices), but we are more optimistic about the dollar than most.

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For now the economic expansion remains healthy, but could fade some in the second half of the year.

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We estimate +3.3% real GDP growth in 2005, after weakening in the second half of the year.

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