A labyrinth is not a maze. It is unicursal (one line) and has only one path to the center and back out. The labyrinth has no dead ends or blind alleys like a maze. It is a circular path to a sole destination. The path often twists and turns back on itself many times before reaching its center. Once at the center, there is only one way back out. The same path in the opposite direction.
The labyrinth often symbolizes a journey to a predetermined destination such as a pilgrimage to a holy site. For example, the best known labyrinth is the beautifully preserved pavement labyrinth in Chartres Cathedral, France (pictured below). The cathedral was constructed during the second decade of the 13th century. The labyrinth is 12.9 meters (42.3 feet) in diameter and fills the width of the nave or center of the church. While much has been written about the purpose of this labyrinth, little contemporary documentation has survived. It is known that labyrinths in the French cathedrals were the scene of Easter dances carried out by clergy. It is also popularly assumed that the labyrinth is a symbol of the long tortuous path that Medieval pilgrims endured to visit Chartres and other sacred places.
This month's feature article will focus on another labyrinth - the Federal Reserve's long torturous path to inflationary conditions.
A white paper from the Congressional Research Service entitled Monetary Policy and the Federal Reserve: Current Policy and Conditions by Marc Laborite, a specialist in macroeconomic policy, dated February 7, 2017, summarizes the current state of the Federal Open Market Committee's (FOMC or Fed) monetary policy conditions:
"The Fed anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Thus, although rates are being raised, the Fed plans to maintain an unusually stimulative monetary policy for the time being. In terms of its mandate, the Fed believes that unemployment has reached the rate that it considers consistent with maximum employment (although other labor market indicators suggest some slack remains), but inflation has remained below the Fed’s 2% goal since 2013 by the Fed’s preferred measure. Debate is currently focused on how quickly the Fed should raise rates. Some contend the greater risk is that raising rates too slowly will cause inflation to become too high or cause financial instability, whereas others contend that raising rates too quickly will cause inflation to remain too low and choke off the expansion."
Recent inflationary data suggests that inflation is on the rise across the globe particularly in the world's two largest economies. According to Trading Economic's global macro models and analysts' expectations, the inflation rate in the United States is expected to be 2.50 percent by the end of the first quarter of 2017. In January 2017, consumer price inflation (CPI) on a year over year basis (YoY) reached their forecasted level of 2.50 percent. Core CPI YoY (excludes volatile energy and food prices) rose 2.3% in January.
Looking forward, Trading Economics estimates the inflation rate in the United States will remain at 2.50 percent for twelve months. In the long-term, the U. S. inflation rate is projected to trend around 2.50 percent to 2020. The chart below summarizes Trading Economic's inflation forecasts for the United States. Note the nice upward sloping pattern indicative of rising inflation.
Trading Economics forecasts the inflation rate in the world's second largest economy of China to be 2.60 percent by the end of the first quarter of 2017. China has also recently experienced a dramatic turn in inflationary metrics. China's January producer price index (PPI) posted a stronger-than-expected 6.9% YoY increase. A year ago in January 2016, Chinese PPI was a negative (5.3%) YoY. China's remarkable one-year inflationary turnaround was not isolated to producer prices. China's CPI has also increased 2.5 percent YoY up from a year ago CPI of 1.8 percent, well within earshot of Trading Economics forecast of 2.6 percent inflation by the end of the first quarter of 2017.
Looking forward, Trading Economics estimates the inflation rate in China to stand at 3.00 percent in 12 months time. In the long-term, the China inflation rate is projected to trend around 4.50 percent in 2020. Again the chart for China shows a nice upward sloping inflationary pattern.
As outlined in the white paper Monetary Policy and the Federal Reserve: Current Policy and Conditions, the difficulty for the FOMC is properly timing their monetary actions to act soon enough to prevent incipient inflationary pressures from taking hold while not tightening monetary policy too quickly and choking off economic growth. An additional policy wild card is the impact of Trump administration actions on economic activity. Most experts view Trump's policies as favorable and expect his administration's policy initiatives to enhance overall economic growth prospects in the United States. However, minutes from the Federal Reserve's January meeting released last week indicate that policymakers are highly uncertain about the impact of Trump's fiscal plan on the U.S. economy. The following are some quotes from the Fed's January minutes addressing fiscal policy and inflation:
"Participants again emphasized their considerable uncertainty about the prospects for changes in fiscal and other government policies as well as about the timing and magnitude of the net effects of such changes on economic activity."
"Regarding the outlook for inflation, some participants continued to be concerned that faster-than-expected economic growth or a substantial undershooting of the longer-run normal unemployment rate posed upside risks to inflation."
The following chart from Advisor Perspectives summarizes the components of the consumer price index (CPI) to provide perspective on assessing inflation. Please note that the largest category is housing representing 42% of CPI followed by transportation and food and beverage components which both represent about 15% of CPI. These three components together represent approximately 72% of CPI.
Given the lengthy period of accommodative monetary policy since the Great Recession of 2008/9, it is not surprising that we are finally beginning to see an uptick of inflationary trends impact these three key components of CPI. Most noteworthy is the rebound in commodity prices from the late 2014 to early 2016 correction which are essential inputs to the transportation and housing construction components. West Texas Intermediate oil prices are up 63% year over year. Industrial metal prices also saw large increases in 2016. Copper prices advanced 27% in 2016 and are up 10% so far in 2017. Over the last twelve months, copper is up 28%, nickel is up 27%, silver is up 19%, and gold is up 2%. Meanwhile indices of home prices show a continued inflationary trend as home prices rose 6.2% year over year in December 2016, as institutional/landlord ownership of single family homes increased to 37% in 2016, the highest percentage in over a decade. These factors show how dynamic and resilient the U.S. economy has been as capital and supply have rapidly adjusted to aggregate demand and prices.
One of the more visible aspects of Trump's policies on economic growth and inflation is immigration. Some experts suggest that less immigration would inhibit U.S. economic growth given poor underlying demographic trends. U.S. fertility rates are falling, leading to a natural population growth rate of 0.4%, the lowest level since the founding of our nation. Fertility is perhaps more of a longer term than immediate issue as relates to near term inflation monitoring. Experts suggest that immigration - legal or unauthorized - is necessary to meet the economic growth requirements in the labor force and that absent robust immigration trends, particularly lower paying, less skilled employment, we would see a pick-up in inflationary pressures as wages are increased to attract needed productive labor capacity.
The following chart from Pew Research Center suggests that based upon the most recently available census data for the period from 2009 to 2014, that unauthorized immigration declined over this period and therefore was not a significant factor in the growth in the U.S. labor force during this time period.
In 2014, the nation’s civilian labor force of 160.4 million people consisted of about 132.8 million U.S.-born workers (83% of the total and up 1.6% from 2009), 19.5 million lawful immigrant workers (12% of total and up 7.8% from 2009 ) and 8.0 million unauthorized immigrant workers (5% of total and down 100K). The numbers of U.S.-born members of the workforce and lawful immigrant members of the workforce both increased from 2009 to 2014, while the number of unauthorized immigrant workers did not. As depicted in the chart below, the estimated number of unauthorized immigrants in the labor force plateaued in 2005 and has essentially flatlined since.
So while legal immigration has been a significant positive contributor to labor force growth over the relevant period, unauthorized immigration has not been a significant factor. Arguably, a continuation of policies that promote legal immigration would have a continued positive effect on labor force growth and government tax revenues while policy actions to discourage unauthorized immigration would have negligible or minimal impact on the overall U.S. labor force and economy. The table below sets forth the U.S. industries and occupations that employ the highest share of unauthorized immigrant workers.
Although unauthorized immigrants work throughout the U.S. economy, they are particularly concentrated in some sectors, according to the Pew Research Center analysis. Compared with their 5% share of the civilian workforce, they were overrepresented in the agriculture (17%) and construction (13%) sectors, as well as in the leisure and hospitality industry (9%). They were underrepresented in some sectors such as the educational and health services sector and the financial and information industries.
By occupation, unauthorized immigrants held a higher share of U.S. farming jobs (26%) in 2014 than would be expected given their share of the workforce. They also held a disproportionate share of construction jobs (15%). By contrast, unauthorized immigrants held a lower share of maintenance, management, professional, sales and office support jobs than their share of the workforce overall.
Although the foregoing data suggests Trump immigration policies would likely have minimal overall impact on the U.S. labor force and economy, aggressive policy actions could result in labor force disruptions and spark inflationary pressures in specific sub-sectors such as agricultural/food and beverage and construction/housing sector where unauthorized immigration labor is a key production input.
Based upon the more hawkish tone of its policy statements, it would appear that the FOMC is much closer to the center of the inflation labyrinth than they would otherwise publicly admit for fear of being seen as behind the curve. Even before the impacts of Trump fiscal policies, current CPI readings are running above the FOMC's 2% inflation target. In addition, two key components of CPI - housing (42% of CPI) and transportation (15% of CPI) - are already on an uptrend. Moreover, there is considerable data supporting the view that aggressive immigration policy actions could be highly disruptive to the labor cost inputs in the important agricultural and construction sectors of the U.S. economy. As President Trump would say it could be "yuge."