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CAMERON SCHOOL OF
BUSINESS
H. DAVID AND DIANE
SWAIN CENTER FOR
BUSINESS AND ECONOMIC
SERVICES
Economic
Barometer
Volume IX, Issue II
July 2016
The United States
Inside this issue:
Background
1
Sluggish economies
and low inflation
2
Heightened demand
for benchmark
securities
4
The road ahead
5
Monetary policy
implications
7
The Regional
Economy
7
Background. Global financial developments have been playing an unusually
prominent role this year in affecting our financial markets and the outlook for the
U.S. economy. Among these have been concerns about the health of the Chinese
financial system and economy and vulnerabilities in Europe. Most recently, the June
23 Brexit decision of the British electorate to leave the European Union (EU) has
raised concerns about the British economy and the viability of the EU.
These developments have heightened caution on the part of investors, causing a
re-pricing of risk and greater demand for sovereign debt. The chart below illustrates
investor perceptions of risk in the U.S. equity market—as measured by assessments
of prospective volatility of stock prices—which have driven investors toward safe,
sovereign debt. The volatility of the past year has been largely related to turbulence
in global markets—last fall, around year-end, and most recently with Brexit.
The Regional Outlook 13
Heightened demands for safe assets, along with sluggish economies and low inflation
have conspired to drag yields on sovereign debt to historic lows—in some cases to
below zero.
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and Diane Swain at
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Economic Barometer
This can be seen in the chart below showing ten-year benchmark sovereign yields for Switzerland (darker
blue line), Germany (red), United States (green), Great Britain (purple), and Japan (teal). Yields crossed
into negative territory in Switzerland last year and in Japan and Germany more recently. Those in Britain
and the United States have recently dropped below the 1-1/2 percent area—also an exceptional
development.
Sluggish economies and low inflation. U.S. growth has been tepid since the U.S. economy emerged
from the Great Recession in mid-2009. Aggregate demand over this period has grown grudgingly, despite
aggressive fiscal and monetary stimulus measures. At the same time, growth in potential output was
downshifting, owing to both anemic improvement in productivity and reduced net growth in the labor
force as baby boomers have been leaving the labor force for retirement. On balance, the result has been
a slow and painstaking absorption of slack in the economy. This situation also implies that the real
interest rate—the interest rate adjusted for inflation—will be lower than historical norms. (The nominal
interest rate is equal to the real interest rate plus the expected rate of inflation. Economic principles tell
us that the real interest rate will tend to equal the rate of growth of potential output—the rate of growth
of productivity plus the net rate of growth of the labor force.)
In addition, the low inflation experience of recent years appears to have lowered the expected rate of
inflation. This can be seen in the chart below that measures market-determined compensation for
inflation (mostly expected inflation, but also an inflation risk premium) based on yields on regular
(nominal) Treasury notes and those on Treasury Inflation-Protected Securities (TIPS). The chart
illustrates that inflation compensation has drifted lower over the past two years—roughly a percentage
point, from the 2-1/2 percent area to the 1-1/2 percent area.
Volume IX, Issue II
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Some survey-based measures of longer-term inflation expectations, presented below, also have shown
signs of dropping after a remarkably long period of stability. This is especially true of the Michigan
survey of household expectations. The decline in the Survey of Professional Forecasters (SPF) series
has been less pronounced to date.
An important contributor to this decline has been the actual inflation rate, shown in the next chart,
which has persistently run below the Fed’s 2 percent target. Other major industrial nations have had
similar experience.
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Economic Barometer
Heightened demand for benchmark securities. In addition to weak growth and low inflation,
investors have displayed a strong preference for Treasury benchmark securities. Indeed, they have been
willing to sacrifice yield to hold such debt. This can be seen in the chart below, which presents an
estimate of the term premium embedded in the ten-year Treasury note—the amount of yield required
by investors to hold such price-sensitive debt over and above the expected average of short-term
interest rates over the same time period. Ordinarily, investors require compensation of around two
basis points to compensate for the price risk, but recently the term premium has turned negative. In
other words, investors have become willing to forego some yield to be able to hold these safe and liquid
securities.
To some degree, this has been brought about by the massive amounts of Treasury securities that have
been acquired by the Fed as part of its large-scale asset purchase program (quantitative easing) over
recent years. The Fed’s holdings of Treasury securities soared from roughly $500 billion in 2008 to $2.8
trillion more recently. As a consequence, the Fed’s share of such debt rose from about 9 percent in
2008 to 21 percent more recently, shown in the chart below. In essence, the Fed’s acquisitions have
crowded some other investors out of the market, leaving the ones who are willing to give up the most
yield holding the debt.
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household net worth in relation to disposable personal income is approaching the very high level
With greater
investor caution and the consequent re-pricing of risk, risk spreads have remained somewhat
seen a decade ago. Moreover, lenders report that credit is readily available to consumers, and the
elevated, as shown below for BBB-rated corporate bonds. Risk spreads rose last fall and around year-end,
debt-servicing burden of households has swung from being an unprecedented strain on the eve of
accompanying global turmoil. And they remain abnormally high.
the Great Recession to being historically light more recently, as shown in the chart below. As a consequence, there is ample scope for a pickup in consumer spending.
The road ahead. The return to more normal conditions in financial markets will depend importantly on
the outlook for the economy and inflation. Various indicators point to a pickup in output growth in the
second quarter to a 2-1/2 percent pace—a little above the rate of growth of potential output of about 2
percent. Moreover, the labor market report for June suggests that the economy continues to have forward
momentum, but not enough to push growth in real GDP much above growth of potential output.
Household spending likely will be the primary driving force behind the expansion, propelled by job
growth, comfortable wealth positions (aided by ongoing home price increases and near-record equity
prices), and light debt-servicing restraints. The next chart shows that personal consumption expenditures
have revived in recent months, in better alignment with these factors. Housing activity is likely to also
contribute to growth in aggregate demand in the period ahead.
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Economic Barometer
Acting to restrain growth, at least in coming quarters, will be the strength of the dollar, shown below.
Earlier this year, the dollar had begun to drift lower, retracing some of its previous run-up and improving
the competitive position of U.S. exporters. However, this has been interrupted by the Brexit vote, as the
dollar has strengthened a good bit recently against both the British pound and the euro.
Prospects for inflation will depend importantly on the amount of slack in labor and other markets.
Although the unemployment rate, at 4.9 percent in June, is close to consensus estimates of the natural rate
associated with maximum employment, the still-large number of people working part-time for economic
reasons and discouraged workers (not counted as either employed or unemployed) implies that slack
remains in the labor market. Indeed, recent readings on growth in average hourly earnings, shown below
through June, are showing that strains have yet to emerge in the labor market (and thus minimal cost
pressures have developed that would boost inflation).
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Volume IX, Issue II
Monetary policy implications. In these circumstances, the Fed is likely to be very slow in normalizing
monetary policy. After taking the first step in the normalization of the federal funds rate last December,
speculation has been rampant about when the next step would be taken and also the pace of subsequent
hikes in the federal funds rate. At the time of the mid-June Federal Open Market Committee meeting, the
median forecast of Fed policy makers called for two 25 basis point increases by the end of this year and a
full percentage point increase over both 2017 and 2018. However, participants in the federal funds futures
market are much more skeptical. Quotes in that market imply only a 20 percent chance of a single 25
basis point increase this year and a 60 percent chance of a single 25 basis point increase by the end of
2018. The actual outcome probably will be somewhere in between.
The recent drop of benchmark interest rates into unprecedented territory around the globe reflects the
assessment by market participants that central banks are going to be extremely cautious going
forward—especially in the wake of Brexit. This drop in borrowing costs will help to rule out any
protracted slumps.
The Regional Economy
At the national level, consensus among forecasters is that the economy will grow slightly above potential
and continue to make slow progress against the remaining output gap from the last recession. However,
the outlook for southeastern North Carolina is far more uncertain. While there are bright spots and
reasons for optimism, other areas merit further examination and continued attention.
At the state level, North Carolina’s economy looks to be mirroring the national economy, to a large extent,
with NC State University’s Leading Economic Indicator index remaining strong even if ticking downward
slightly in June.
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Economic Barometer
In addition to North Carolina’s leading indicators pointing toward continued growth, the unemployment
rates for the southeastern portion of the state continue to fall. Economists argue about what might be
considered “full-employment” with the Federal Reserve’s FOMC suggesting it is somewhere on the order of
4.8%. Full employment can be thought of as the level of unemployment when the economy is running at its
potential. In other words, the level of sustainable unemployment. As shown in the chart below,
Wilmington, both the city and MSA, has dropped below this level of unemployment and Brunswick and
Pender Counties are moving quickly in the direction of full employment. However, focusing only on the
headline number glosses over remaining weakness in labor markets of part-time workers who wish to be full
time and potential workers who have given up looking for work and dropped out of the unemployment
statistics; more on this topic in a moment.
Further strengthening a growth outlook, home sales in the Wilmington area remain strong with a strong
upward trend in prices evident. Nationally, the housing market continues to move forward with home
prices, as measured by the Case-Shiller index, continuing their march back toward pre-crash levels.
Housing starts, at the national level, are continuing to move back toward a more “normal” level. The rise in
prices and increase in housing starts indicates the shadow inventory of homes is being worked off, slowly.
Initial releases of the most recent, local, data suggest this trend in median home sales prices is continuing
beyond that shown in the graph on page 9.
Volume IX, Issue II
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Turning to the sources of income for the region, this year is poised to be another very good year for
tourism in the coastal area. Gas prices have risen from their lows earlier in the year but still remain
relatively low. The decrease in gas prices reduces the cost of a trip to the coast and, more importantly,
puts extra dollars in consumers’ pockets.
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Economic Barometer
Low oil prices have a mixed effect nationally as they hurt oil producing areas and reduce investment in the
energy sector as marginal producers hunker down and hope for the return of higher prices to support their
production. However, from the perspective of coastal areas in the Carolinas, not yet oil producing areas, low
oil prices tend to translate into lower gasoline prices and increased tourism business. The improvements in
employment prospects and disposable income are reflected in rising taxable sales figures and increased
tourism as shown by the room- occupancy tax collections below.
Volume IX, Issue II
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While there has definitely been an improvement in economic conditions in the recent past, there is also
considerable uncertainty about the regional economy’s ability to maintain its momentum going forward.
The unemployment rate is nearing what is referred to as “full employment” but recent gains may have
come from the wrong sources. (Future revisions to the data and time will help us sort out the driving
factors behind the decline.) Over the last year the unemployment rates, as show above, have fallen
considerably suggesting the labor market has improved considerably. However, digging a little deeper
shows that much of this improvement owes to a small decline in the size of the labor force and not an
increase in jobs. Local labor force numbers are not detailed enough to tease out the magnitudes of
various drivers of the change and while some of the change is undoubtedly due to shifting
demographics and the greying of the workforce, the decline may also suggest a mobile workforce
relocating to other areas in search of better employment prospects. This is seen in the graph by looking
at employment’s recent tick downward (which should increase the unemployment rate, ceteris paribus)
and the decline in the size of the labor force which corresponds to the decrease in the unemployment
rate.
Despite the data being too general to parse out the possible effects mentioned above, there is evidence
to suggest there is more at play than simply an aging workforce. Business’ perception of the economy
in the Carolinas, as measured by the Richmond Fed’s regional survey, also suggests conditions are less
than ideal and while usually optimistic, their outlook has begun to sour recently.
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Economic Barometer
This dampened, but not depressed, outlook matches the still subdued pace of incorporations in New
Hanover County.
Volume IX, Issue II
Page 13
The slowing of growth in the area is especially evident when looking at the business and professional
services sector. These are business primarily engaged in providing services to other businesses, rather
than consumers, and serve as a bellwether for business expectations and sentiment. Employment in the
sector has declined suggesting a cautious outlook by local firms. This cautious outlook should come as
no surprise with the great deal of uncertainty in the current environment: slowing growth abroad and a
European market in turmoil with Brexit, a contentious presidential election with potentially enormous
policy implications on the horizon, and continued media coverage of the HB2 debate and economic
protests. While the magnitude of many of these events often turns out to be smaller than anticipated, it
is the current expectations that drive near term, and some long term, decisions.
The Outlook: While there are many risks to the outlook, mostly to the downside, growth is likely to
continue at a subdued pace in the short to medium term. As uncertainty around international and
political events wanes, investment and consumer expenditures should slowly pickup and increase the
pace of growth. However, the pace and effect of the Fed’s removal of accommodation is yet to be
determined. To the extent that the Fed follows its current guidance of a slow removal of
accommodation, the effect locally should be relatively small as the removal will lag the necessary
improvements in economic conditions. Nevertheless, there remains significant uncertainty around the
regional outlook in the short term.
H. DAVID AND DIANE SWAIN
CENTER FOR BUSINESS AND
ECONOMIC SERVICES
601 S. College Rd.
Wilmington, NC 28403
Phone: 910-962-2237
Fax: 910-962-3579
E-mail:
uncwprofessionaldevelop
[email protected]
www.uncw.edu/swaincenter
The H. David and Diane Swain Center for Business and
Dr. Rob Burrus
Dean, Cameron School
of Business
Economic Services at UNC Wilmington provides professional
Dr. Laura Lunsford
Director, Swain Center
organizations and professionals. Center staff also collect and
Dr. Adam Jones
Senior Economist
development and continuing education opportunities for
analyze local, state, and national economic data that impact our
region and its growth. For more information about The H. David
Dr. Thomas Simpson
Executive in Residence
and Diane Swain Center for Business and Economic Services,
Jennifer Schacher
Administrative Assistant
Jennifer Schacher at [email protected].
visit our web site, www.uncw.edu/swaincenter or contact