Low Inflation? No Problem: Employment Leads Demand

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The Chicago Fed National Activity Index (CFNAI) for June, one of the broadest measures of economic activity, has a surprise for all those who thought the economy was going to grow at a blistering pace. While there are definitely bright spots, consumption demand still remains weak, which means all the gains from the new jobs that have been added to the economy are yet to play out.

The CFNAI’s three-month moving average (CFNAI-MA3), which helps smooth out month-to-month volatility, decreased to +0.13 in June from +0.28 in May this year. A reading above zero indicates the economy is growing above its historical trend rate of growth, while a reading below zero indicates the economy is below growth. The index is a weighted average of 85 indicators of national economic activity. The CFNAI in the current range indicates that economic growth is positive but vulnerable. and that there is currently little inflationary pressure in the pipeline.

One of the bright spots is that the labor market has improved steadily. Employment-related indicators contributed +0.22 to the CFNAI in June, up from +0.14 in May. The unemployment rate fell to 6.1 percent in June from 6.3 percent in May. Nonfarm payroll rolls were up by 288,000 in June after increasing by 224,000 in May. But other indicators that measure the underlying strength of the labor market still remain weak.

For example, the labor force participation rate — the pool of workers who are employed or actively looking for jobs — has not changed much in the last few months from around 62.8 percent. The number of workers employed part time for economic reasons — those who were working part time but were looking to work full time — increased by 275,000 to 7.5 million in June, data from Bureau of Labor Statistics showed.

The contribution of production-related indicators like industrial production, manufacturing, and services remained neutral in June from a positive contribution of +0.14 in May. Industrial production rose 0.2 percent in June after rising 0.5 percent in May, while growing 4.3 percent year on year. Manufacturing rose 0.1 percent in June, but on a year-on-year basis, manufacturing output was up 6.7 percent. Industrial production in the second quarter has been up 5.5 percent at an annual rate. The contribution of the sales, orders, and inventories category to the CFNAI remained at +0.04 in June.

The weakest of the four categories has been the contribution from consumption and housing, which marginally edged up to -0.14 in June from -0.16 in May. Growth in the housing sector continues to wobble. Housing starts decreased to 893,000 annualized units in June from 985,000 in May, and housing permits decreased to 963,000 annualized units in June from 1,005,000 in the previous month, BLS data showed. According to Thomson Reuters/University of Michigan’s real-time estimates, consumer sentiment dropped to 81.3 in July, the lowest in four months, compared to 82.5 in June.

The CFNAI in June broadly indicates three things: production is picking up, labor markets are doing well, and consumption demand is still under repair. The hope is that as economy grows under a zero bound interest rate monetary policy and additional jobs generated in the economy, America’s consumption story will thrive in the coming months.

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