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INTEREST RATE WATCH
Prepared by
R.J. O'Brien & Associates, Inc.
Fundamental
“To believe that wage pressures will not intensify as the group of people who are not working, but who would like to, rapidly diminishes, strains credibility. The law of supply and demand has not been repealed. If labor demand continues to outpace sustainable increases in supply, the question is surely when, not whether, labor costs will escalate more rapidly. The performance of the labor markets this year already suggests the U.S. economy has been on an unsustainable track.” Federal Reserve Chairman Alan Greenspan
Federal Reserve Vice-Chairwoman, Alice Rivlin, was quick to downplay Mr. Greenspan's warning to the stock and credit markets, but it's our opinion that his thinking is sound. A close inspection of the most recent labor reports suggests that he is correct in stating that the pool of workers available to meet strong demand appears to be shrinking dangerously.
Initial claims for state unemployment benefits (seasonally adjusted) fell by 5,000 to 304,000–that makes it the first time claims remained below 310,000 for four straight weeks since early 1989. The total number receiving benefits (four-week average, seasonally adjusted) fell to 2,226,250, the lowest level since October 1989. New claims are 8.3% below last year's level, and total claims are 9.73% below last year.
As our faithful readers know, we prefer to look at the real numbers, the actual data before the government's seasonal adjusters get their hands on them. In this case, the real picture is even scarier. Initial claims really totaled 259,028, more than 40,000 below the seasonally adjusted number and 11.31% below last year's actual number. Continuing claims really totaled 1,789,051–that's more than 430,000 fewer than the seasonally adjusted number and 16.74% below the actual level of last year. Finally, the real insured unemployment rate is 1.5%, not the seasonally adjusted 1.9%.
September's unemployment report gives the same picture of strong labor demand. Although the non-farm payroll number (seasonally adjusted) showed a disappointing increase of 215,000, the growth rate held firm at 2.07% over last year–and that's too much growth. Again, we think the seasonally adjusted numbers distorts the real picture. Non-farm payroll really increased by 903,000 jobs in September, a real growth rate of 2.23% over last year. According to the household survey, the picture was a little different: employment fell by 893,000. However, the available labor force declined by an even greater amount–1,085,000–a fact that underlies Mr. Greenspan's worry over the shrinking labor supply. Also, the household survey showed that the number of unemployed fell by 191,000 people, resting at a level 4.43% below last year.
Increasingly you hear more anecdotal stories about labor and other supply shortages. A few weeks ago, we related Boeing's problems: due to labor and parts shortages, they are unable to meet strong demand, and they are curtailing production. We also told of UPS. Despite a loss of 4% to 6% of their business, they are hiring more workers to make up for the loss of 15,000 (who they had threatened to fire) who never returned after the strike. This week we read about Union Pacific Corp. Their continuing service problems are beginning to have sweeping effects on industrial and consumer America. News reports state that more than 10,000 railroad cars a day are stuck in limbo on the Union Pacific route system that stretches from the Midwest to the West Coast. They are lacking the locomotives, the tracks, and especially, the crews to keep the network moving. That's triggering everything from production slowdowns at factories to a scramble to switch to other more expensive forms of transportation.
Inflation Watch
Following right after Chairman Greenspan's jarring comments about “unsustainable growth” and the danger of inflation, the larger than expected 0.5% increase in the Producer Price Index was unwelcome news, indeed, to all bond bulls. However, when looked at from a yearly perspective, the news was not all that bad: finished goods prices are unchanged from year ago levels. The difference is that unlike last year, the core rate shows more inflation (year- over-year percentage) than the total number. In the finished goods sector, prices were unchanged, but the core rate was up 0.4%; in the intermediate goods sector prices were down 0.6%, yet the core rate was up 0.3%; in the crude goods sector, prices were down 4.2%, but the core rate was up 1.7%. These numbers, by themselves are not troublesome, but traders should not expect that food and energy prices are going to remain quiescent too much longer. As we stated last week, grain prices have moved unseasonably higher during harvest, and that trend continued this week, as government projections of total grain supplies were scaled down. Have you noticed the stories about ecological damage in Malaysia and Indonesia, about fish being attacked by bacteria in North Carolina and the Pacific Northwest, and the recall of beef patties in the United States? We've said it before: over the long run, we can no longer be sure of an ever increasing supply of food. We can be sure, however, that an ever increasing population will add to the demand for that food. As far as energy is concerned, the recent price increases have occurred during a time of slack economies over most of the industrialized and developing nations, North and South America and Britain being the notable exceptions. What will occur when Asia and Europe finally get their economies back on stream?
The Wall street Journal today ran the headline: “Is There Enough Liquidity In Global Markets?” One analyst predicted that “economic activity will suck money out of financial assets into the real economy, or central bankers will drive up the cost of capital.” The Journal then cited the action by many European central banks to raise short-term interest rates. That doesn't seem to be a problem in the U.S. As we have mentioned before, M3 monetary growth is near a ten-year high, and that liquidity is an important factor in driving up the price of financial assets. The problem for the Fed is that huge increase in the money supply is also seeping into the real economy, helping drive consumer demand for goods and services. And as Mr. Greenspan reminded us this week, that demand level is uncomfortably high.
October 10, 1997R.J. O'Brien & Associates, Inc.
555 West Jackson Blvd., Ste. 700, Chicago, Illinois
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